Vesting Computation Changes

Plan sponsors occasionally wish to change aspects of their plan vesting provisions. But that can be more easily said than done. A recent ASPPA webcast offers a look at the technical requirements to making changes to a plan’s vesting provisions and how to avoid common pitfalls in doing so.

As a general rule, a plan’s schedule must satisfy vesting schedule minimums in all respects, said presenter Kelsey N.H. Mayo, Lead Partner, Employee Benefits Group at Poyner Spruill LLP. But there are some variations, she pointed out:

• Traditional defined benefit plans generally must satisfy requirements of one of two minimum schedules: (1) 5-year cliff vesting or (2) 7-year graded vesting.
• Hybrid defined benefit plans must satisfy requirements of a 3-year cliff vesting schedule. Mayo added that “the big rule here” is that it has to apply to the entire benefit for any participant who earns an hour of service after 2007.
• Defined contribution plans, for plan years beginning 2007 and after, generally must satisfy requirements of one of two minimum schedules: (1) 3-year cliff vesting; or (2) 6-year graded vesting.
• Top heavy plans (DB or DC) must meet either (1) a 3-year cliff or (2) a 6-year graded vesting schedule.
• Statutory hybrid DB plans generally follow a 3-year schedule.

Direct Changes

The most common direct changes to plan vesting provisions, Mayo said, are discretionary changes due to design choice and changes to the plan itself; for instance, due to a merger or spinoff.

All direct changes to vesting schedules must comply with Code Section 411, Mayo cautioned. When changing a vesting schedule, she said, keep the following Code sections, as well as the regulations that implement them, in mind:

• Section 411(a)(10)(A) — Nonforfeitable percentage cannot decrease
• Section 411(d)(6) — Cannot reduce an accrued benefit
• Section 411(a)(10)(B) — What if at least 3 YOS at change?
• Section 401(a)(4) — Vesting schedule is an “other right or feature”

Section 411(a)(10)(A). The general rule in Section 411(a)(10)(A), Mayo noted, says:

[T]he nonforfeitable percentage of the accrued benefit derived from employer contributions (determined as of the later of the date such amendment is adopted, or the date such amendment becomes effective) of any employee who is a participant in the plan, must be protected/cannot decrease.”

“This is actually somewhat ambiguous,” she said, remarking that it was unclear whether the text in parentheses refers to the nonforfeitable percentage or the accrued benefit. “The interesting thing,” she said, “is that the IRS says we have to protect all of the percentages.” However, she observed that the legislative history of Section 411 when Congress drafted and passed it “seems to contradict the IRS position.” Nonetheless, she added, “The IRS isn’t bound by legislative history.”

For instance:

ERISA conference report concerning direct changes to vesting schedules under Section 411(a)(10)(A): The value of the vested portion of the accrued benefit at the time of the amendment may not be reduced.

IRS concerning direct changes to vesting schedules under Section 411(a)(10)(A): The vested percentage at the time of the amendment may not be reduced, even with respect to benefits accruing after the amendment. An aside: Mayo said of the IRS position, “Following this approach probably carries less risk — think audits!”

Section 411(d)(6). The general rule is that a participant’s accrued benefit may not be decreased by an amendment to the plan. Plan sponsors must ensure that no amendment to the plan — including one changing a vesting schedule — has the effect of impermissibly reducing an accrued benefit.

Section 411(a)(10)(B). The general rule is that each participant having at least 3 years of service must be permitted to elect to remain on the vesting schedule in effect before the amendment.

Section 401(a)(4). The general rule, and common pitfall, Mayo said, is that one needs to keep in mind that a vesting schedule is an “other right or feature.” This means it is subject to nondiscrimination requirements, she said, and testing may be necessary.

Indirect Changes

It also is common for there to be indirect changes that affect vesting, Mayo said; for instance, a change in methods of counting service.

How years of service are measured is a critical component of counting years of service; this is accomplished through either the actual hours method or the elapsed time — or equivalency — method. Under the former, the plan measures years of service by counting hours of service during a vesting computation period; under the latter, the plan measures years of service by counting periods of service since hire. Mayo warned that changing from one method counting service to another may indirectly change a participant’s vesting computation percentage. However, she noted that “there is no specific equivalency required” by Treasury regulations when implementing a change from elapsed time to actual hours.

And other decisions also can have an impact on vesting, Mayo noted, such as:

• disability;
• involuntary termination;
• plant closing; and
• change in control.

“Be careful with special vesting conditions,” Mayo cautioned.

Webcast Available

More information about the webcast “Vesting Computation Changes,” is available here.