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What is the purpose of 1.401(a)(4)-5?
The timing of a plan amendment or series of amendments cannot discriminate in favor of HCEs or former HCEs.
How is discrimination determined under 1.401(a)(4)-5?
It is determined at the time the plan amendment first becomes effective and based on facts and circumstances.
What are some of the factors in determining whether an amendment or series of amendments are discriminatory?
· Relative number of current and former HCEs and NHCEs affected by the plan amendment
· Relative length of service of current and former HCEs and NHCEs
· Length of time the plan or plan provision being amended has been in effect
· Turnover of employees prior to the plan amendment
· Relative accrued benefits of current and former HCEs and NHCEs before and after the plan amendment and any additional benefits provided by other plans
What is the safe harbor for grants of benefits for past periods?
An amendment that credits service in the past (or increases benefits attributable to) – is deemed nondiscriminatory if
· the period does not exceed the five years immediately preceding the year in which the amendment first becomes effective,
· the credit/increase is uniform for all employees
· the current formula is used in applying the past service
· the service credited is service with the employer or previous employer that may be taken into account under 1.401(a)(4)-11(d)(3).
Examples in 1.401(a)(4)-5
Example 1. Plan A is a defined benefit plan that covered both HCEs and NHCEs for most of its existence. The employer decides to wind up its business. In the process of ceasing operations, but at a time when the plan covers only HCEs, Plan A is amended to increase benefits and thereafter is terminated. The timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.
Example 2. Plan B is a defined benefit plan that provides a social security supplement that is not a QSUPP. After substantially all of the HCEs of the employer have benefited from the supplement, but before a substantial number of NHCEs have become eligible for the supplement, Plan B is amended to reduce significantly the amount of the supplement. The timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.
Example 3. Plan C is a defined benefit plan that contains an ancillary life insurance benefit available to all employees. The plan is amended to eliminate this benefit at a time when life insurance payments have been made only to beneficiaries of HCEs. Because all employees received the benefit of life insurance coverage before Plan C was amended, the timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.
Example 4. Plan D provides for a benefit of one percent of average annual compensation per year of service. Ten years after Plan D is adopted, it is amended to provide a benefit of two percent of average annual compensation per year of service, including years of service prior to the amendment. The amendment is effective only for employees currently employed at the time of the amendment. The ratio of HCEs to former HCEs is significantly higher than the ratio of NHCEs to former NHCEs. In the absence of any additional factors, the timing of this plan amendment has the effect of discriminating significantly in favor of HCEs.
Example 5. The facts are the same as in Example 4, except that, in addition, the years of prior service are equivalent between HCEs and NHCEs who are current employees, and the group of current employees with prior service would satisfy the nondiscriminatory classification test of §1.410(b)-4 in the current and all prior plan years for which past service credit is granted. The timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.
Example 6. Employer V maintains Plan E, an accumulation plan. In 1994, Employer V amends Plan E to provide that the compensation used to determine an employee's benefit for all preceding plan years shall not be less than the employee's average annual compensation as of the close of the 1994 plan year. The years of service and percentage increases in compensation for HCEs are reasonably comparable to those of NHCEs. In addition, the ratio of HCEs to former HCEs is reasonably comparable to the ratio of NHCEs to former NHCEs. The timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.
Example 7. Employer W currently has six nonexcludable employees, two of whom, H1 and H2, are HCEs, and the remaining four of whom, N1 through N4, are NHCEs. The ratio of HCEs to former HCEs is significantly higher than the ratio of NHCEs to former NHCEs. Employer W establishes Plan F, a defined benefit plan providing a benefit of one percent of average annual compensation per year of service, including years of service prior to the establishment of the plan. H1 and H2 each have 15 years of prior service, N1 has nine years of past service, N2 has five years, N3 has three years, and N4 has one year. The timing of this plan establishment has the effect of discriminating significantly in favor of HCEs.
Example 8. Assume the same facts as in Example 7, except that N1 through N4 were hired in the current year, and Employer W never employed any NHCEs prior to the current year. Thus, no NHCEs would have received additional benefits had Plan F been in existence during the preceding 15 years. The timing of this plan establishment does not have the effect of discriminating significantly in favor of HCEs or former HCEs.
Example 9. The facts are the same as in Example 7, except that Plan F limits the grant of past service credit to five years, and the grant of past service otherwise satisfies the safe harbor in paragraph (a)(3) of this section. The timing of this plan establishment is deemed not to have the effect of discriminating significantly in favor of HCEs or former HCEs.
Example 10. The facts are the same as in Example 9, except that, five years after the establishment of Plan F, Employer W amends the plan to provide a benefit equal to two percent of average annual compensation per year of service, taking into account all years of service since the establishment of the plan. The ratio of HCEs to former HCEs who terminated employment during the five-year period since the establishment of the plan is significantly higher than the ratio of NHCEs to former NHCEs who terminated employment during the five-year period since the establishment of the plan. Although the amendment described in this example might separately satisfy the safe harbor in paragraph (a)(3) of this section, the safe harbor is not available with respect to the amendment because, under these facts, the amendment is part of a pattern of amendments that has the effect of discriminating significantly in favor of HCEs.
Example 11. Employer Y maintains Plan G, a defined benefit plan, covering all its employees. In 1995, Employer Y acquires Division S from Employer Z. Some of the employees of Division S had been covered under a defined benefit plan maintained by Employer Z. Soon after the acquisition, Employer Y amends Plan G to cover all employees of Division S and to credit those who were in Division S's defined benefit plan with years of service for years of employment with Employer Z. Because the timing of the plan amendment was determined by the timing of the transaction, the timing of this plan amendment does not have the effect of discriminating significantly in favor of HCEs or former HCEs. See also §1.401(a)(4)-11(d)(3) for other rules regarding the crediting of pre-participation service.
Example 12. Plan H is an insurance contract plan within the meaning of section 412(i). For all plan years before 1999, Plan H purchases insurance contracts from Insurance Company J. In 1999, Plan H shifts future purchases of insurance contracts to Insurance Company K. The shift in insurance companies is a plan amendment subject to this paragraph (a).
Who is a Restricted Employee for 1.401(a)(4)-5 purposes?
A restricted employee is any HCE or former HCE. The employer can limit the number of restricted employees to 25 (or a larger number) nonexcludable employees and former employees with the largest compensation in the current or any prior plan year.
What is the limited distribution amount if the participant’s benefits are restricted?
They are limited to the amount of his accrued benefit when paid as a straight life annuity, plus the amount payable under any social security supplement offered by the plan.
Do restricted payments apply at plan termination?
Yes. 1.401(a)(4)-5(b)(2) states:
Restriction of benefits upon plan termination.—
A plan must provide that, in the event of plan termination, the benefit of any HCE (and any former HCE) is limited to a benefit that is nondiscriminatory under section 401(a)(4).
When do restricted payments not apply?
Restricted payments do not apply if any of the following conditions are satisfied:
- After taking into account payments to or on behalf of the restricted employee, the ratio of the plan’s assets to the value of its current liabilities equals or exceeds 110%. Current liabilities must be calculated based on interest assumptions specified by law.
Current liabilities rise as participants accrue additional benefits, usually upon completion of 1,000 hours of service during a plan year. Plan sponsors may want to make benefit payments prior to the time participants accrue these additional benefits.
- The value of the benefit payable to or on behalf of the restricted employee is less than 1% of the value of the plan’s current liabilities prior to the distribution.
- The value of benefits payable to or on behalf of the restricted employee does not exceed $5,000.
What are the acceptable security arrangements (outlined by Revenue Ruling 92-76) in which a plan will not violate the restrictions?
-Establishing an escrow account
-Posting a bond
-Obtaining a bank letter of credit
Do the restrictions continue to apply to the beneficiary of a deceased restricted employee?
IRS officials have informally stated Yes, if the deceased employee was a restricted employee in the current or any prior plan year.
Are alternate payee’s in a QDRO restricted?
IRS officials have stated that an alternate payee entitled to a benefit under a QDRO is subject to the same restrictions. The highly paid participant and alternate payee are treated as one employee for purposes of determining if there is a restriction on payments payable to either party.
Restricted payment example
A DB plan provides for a normal retirement benefit equal to 2% of final average compensation times years of service. This benefit is paid to unmarried participants in the form of a straight life annuity, while married participants receive the equivalent of this benefit paid on a 50% joint and survivor basis. Employees who retire before they are eligible to receive Social Security benefits may receive a supplemental benefit from the Plan until they become eligible for Social Security benefits.
John is a “restricted employee” in the Plan. He is 65 years old, married, and the annual amount of benefit payable to him as straight life annuity is $50,000. The Plan applies a joint and survivor adjustment factor of .95 to determine John’s retirement benefit payable at age 65 under the Plan’s form of annuity for married participants. In addition, the Plan provides a social security supplement of $2,000 per year until he reaches his social security retirement age (i.e. age 67).
Without the supplement, John’s annual joint and survivor benefit is $47,500 ($50,000 x .95 J&S adjustment). However, his non-restricted benefit amount is $52,000, because the amount of benefit payable to him as straight life annuity is $50,000 and the value of the Social Security supplement is $2,000.