At this year’s Enrolled Actuaries meeting, we presented a session on “DC Plan Issues When Combined with DB Plans.” This session focused on what we considered to be issues that should be thought about when designing and operating DB/DC combos. Following are a few of our suggestions.
For non-discrimination and coverage testing, you can only aggregate tax-qualified plans. You cannot aggregate qualified plans with SIMPLEs, SEPs or 403(b) plans. However, if an employer sponsors such plans, then the contributions to them must be recognized under §§404 and 415.
Plan years for all plans being aggregated must be the same. That is, the beginning of the plan year and the end of the plan year for each is must be the same. In a recent Gray Book the IRS indicated that plan termination does not result in a change in the plan year.
DC Plan Design
We find that using 401(k) plans with safe harbor provisions helps maximize principals’ benefits while allowing staff to increase their retirement savings. With the elective contributions, allocations to highly compensated employees (HCEs) are reduced, thereby potentially reducing the gateway requirements.
Eligibility for Participation
Generally, it’s a good idea to use the same eligibility requirements for all plans. If there is a difference, the DB plan should not allow entry in a year before an employee is covered under the DC plan.
Eligibility for Allocations or Benefit Accruals
Eligibility for allocations or benefit accruals should always be the same whenever possible. Be wary of a DC allocation requirement that requires employment at year end. If a participant terminates after accruing a DB benefit, that participant is likely under the requirement to be provided with a gateway allocation. The DC plan must then be amended under Treasury regulation §1.401(a)(4)-11(g) to provide the gateway allocation. If that participant is not vested then the amendment must provide an increase in the vested percentage.
Normal Retirement Age (NRA)
It’s a good idea to use the same uniform NRA for each plan. If the plans being tested have different uniform NRAs, then testing age is oldest age in any plan. If any of the NRAs is not a uniform NRA, then testing age is age 65.
Top Heavy Provisions
Top heavy minimum benefits may be provided under the DB plan, a minimum allocation under the DC plan, a comparability analysis using IRS Revenue Ruling 81-202 or a floor offset approach. We find that the minimum allocation approach works the best most of the time.
If the DB plan is covered by the PBGC, then each plan complies with §404 individually.
If the DB plan is not covered by the PBGC, you should consider leaving a margin such that the DC allocation fits within 6% of the compensation of employees’ benefiting under the DC plan. For larger payrolls, the 25% rule (plus 6% of pay for the employees benefiting under the DC plan) may prove to be a better approach. Be careful of a contribution to the DC plan that exceeds 6% of compensation. The results may drastically reduce the total deduction.
Average Benefit Percentage Testing
Likely the non-discrimination testing will rely on the Average Benefit Percentage (ABP) test. If a plan is not aggregated for non-discrimination purposes, it likely will be aggregated for the ABP test. That plan’s NRA may change testing age when computing the test.
With a 401(k) feature, complications may arise when a lower paid HCE defers a large percentage of compensation. At that point, you might try testing using an average of past years’ EBARs. If this does not work, try restructuring so that all rate groups exceed 70%.
Top Paid Election
Some situations with a significant number of non-owner HCEs may prove to produce better results by using the top paid election and reducing the number of HCEs.
Non-Discrimination in Benefits, Rights and Features
The computations that show plans are not discriminatory are not the only criteria you should consider. For instance, if a plan allows for in-service distributions and that plan provides substantial benefits to HCEs, if another plan that covers NHCEs does not allow the same feature (if allowed), then there may be a discrimination issue.
Vesting schedules of plans being aggregated are subject to non-discrimination standards based on all relevant facts and circumstances. This requirement does not provide guidance that can be relied upon.
A safe harbor is provided, statutory minimum vesting schedules are deemed to be equivalent. So a cash balance plan with a 3-year cliff vesting schedule may be paired with a 401(k) plan that has a 6-year graduated vesting schedule. We strongly recommend that vesting service be the same for all plans. If vesting service is not the same, then non-discrimination will be based on relevant facts and circumstances.
Be prepared to use all tools available, such as plan year compensation, average compensation, annual testing, accrued to date testing, restructuring or permissive disaggregation.
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