Combined plans must satisfy minimum aggregate allocation gateway for nondiscrimination testing on basis of equivalent benefits

A combination of plans must satisfy the minimum aggregate allocation gateway of IRS Reg. §1.401(a)(4)-9(b)(2)(v)(D) to be eligible for testing for nondiscrimination on the basis of equivalent benefits, according to an IRS Chief Counsel memorandum. The guidance was issued regarding a floor-offset arrangement where benefits under a defined benefit plan were offset by benefits under a defined contribution (DC) plan only for nonhighly compensated employees (NHCEs), so that for NHCEs who participated in both plans, benefits were eliminated under the defined benefit plan.
An employer maintains a cash balance plan and a profit-sharing plan. All employees are eligible to participate in the profit-sharing plan. The cash balance plan covered two groups of participants. The first group of participants consists of the owner-employees of the employer, all of whom are highly compensated employees. These participants receive the lesser of (1) the maximum pay credit so that the resulting annual benefit will not exceed the limitations of Code Sec. 415(b), and (2) the maximum pay credit that enables the plan to comply with Code Sec. 401(a)(4). The second group of participants (all of whom are NHCEs) consists of the lowest-paid group of employees who are not owner-employees and who perform at least one hour of service during the plan year. This lowest-paid group is limited to the number of employees necessary so that the plan covers the lesser of 40% of the total number of employees for the plan year or 50 employees. This second group of participants receives an annual pay credit of 1% of compensation.
The accrued benefit of an owner-employee under the cash balance plan is the single life annuity payable at age 65 that is the actuarial equivalent of the current balance of the cash balance account. For a participant who is not an owner-employee, the accrued benefit under the cash balance plan is the single life annuity payable at age 65 that is the actuarial equivalent of the current balance of the cash balance account, offset by the single life annuity payable at age 65 that is the actuarial equivalent of the participant’s vested account balance attributable to employer contributions under the profit-sharing plan. Because the benefits for this second group of participants attributable to employer contributions under the profit-sharing plan is larger than the benefits payable under the cash balance plan absent the offset, the offset for this second group of employees reduces the benefit under the cash balance plan to zero.

Nondiscrimination in contributions or benefits

The special rule of IRS Reg. §1.401(a)(4)-3(f)(9) (under which an employee’s accrued benefit under a plan includes that portion of the benefit that is offset by benefits under another plan) applied only to the extent that the benefit was attributable to pre-participation service or past service. Therefore, the offset was taken into account in determining whether the combination of plans was primarily defined benefit in character within the meaning of IRS Reg. §1.401(a)(4)-9(b)(2)(v)(B) or consisted of broadly available separate plans within the meaning of IRS Reg. §1.401(a)(4)-9(b)(2)(v)(C). Because, after the offset, the NHCEs received no benefit under the defined benefit (DB) plan, the combination of plans was not primarily defined benefit in character. Similarly, the combination did not consist of broadly available separate plans because the defined benefit plan did not satisfy the applicable conditions set forth in IRS Reg. §1.401(a)(4)-9(b)(2)(v)(C). Thus, the DB/DC plan must satisfy the minimum aggregate allocation gateway of IRS Reg. §1.401(a)(4)-9(b)(2)(v)(D) to be eligible for testing for nondiscrimination on the basis of equivalent benefits.

Minimum participation

Moreover, the NHCEs were not taken into account for purposes of satisfying the requirements of Code Sec. 401(a)(26). The special rule of IRS Reg. §1.401(a)(26)-5(a)(2)(iii) (under which an offset of benefits under a defined benefit plan by benefits under another plan is disregarded) could not be used for an offset that applied only to a subset of participants in the defined benefit plan. Because the offset should be taken into account and reduced the benefits of NHCEs under the defined benefit plan to zero, the NHCEs did not benefit under the defined benefit plan within the meaning of Code Sec. 401(a)(26)(A) and IRS Reg. §1.401(a)(26)-2(a), and did not have meaningful benefits under the plan’s prior benefit structure as specified in IRS Reg. §1.401(a)(26)-3(c).

Source: Chief Counsel Advice Memorandum 201810008
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