Problems and Issues with Nondiscrimination Rules - Case Studies

March 18, 2003

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Agenda

• Controlled Group Issues

• Plan Aggregation Issues

• Determination of HCEs

• Determination of Most Valuable Accrual Rates

Controlled Group Issues

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Groups to Include

• Who knows the group?• Are there leased

employees?• Are there affiliated

service group relations?• Are there acquisitions?

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Issue 1: Who knows the controlled

group?

Essential to involve legal counsel• HR contacts may not know

– whether or not they have a parent or sub

– percentage of ownership if they do

– that foreign parent owns other U.S. companies

– whether business relationships constitute an affiliated service group or leasing arrangement

• Requires interpretations of corporate law• WE DO NOT PRACTICE LAW

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Issue 1:Who knows the controlled

group?

A

B

C D

E F G

H

K J

I

USAUSA

USA USA

USAUSA

USA

USA

France

France

Canada

Acquires 80%

100%80%

40% 40%50%50%-acquired prior year

85%0%-Leasing grp

0%-Mgt Svcs only

0%-Svcs only

Exercise: Identify controlled groups in years 0, 1, and 2, assuming acquisitions admitted to controlled group at end of transition period

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Issue 1: Who knows the controlled

group?

Situation: Company with foreign ownership• Family, Inc. family company owner retiring• Sells to New Dad, Inc., a large European company so

children don’t take over• Family, Inc. checks and finds other US companies

owned by New Dad to include in testing• Later Family, Inc. finds that New Dad’s Canadian

subsidiary also owns additional US entities to include in testing, but wonders about finding others

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Issue 1: Who knows the controlled

group?

Situation: Holding company• All Alone Company is acquired by a holding

company (Hold My Hand But Pretend I’m Not Here, Inc.)

• All Alone is happy it still gets to maintain its own plans, payroll, do its own filings

• But, now All Alone must figure out who else Hold My Hand owns and how to collect data from who in order to do its testing

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Issue 2: Are there leased employees?

Leasing arrangements• Considered leased employee if

– provide services pursuant to an agreement

– services performed substantially full time for at least a year

– services provided under direction of recipient employer

– not covered by a safe harbor retirement plan

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Issue 2: Are there leased employees?

Situation: Typical leasing arrangements• In NDT planning meeting, Who Me, Lease? Co.

states they have only 3 leased employees– jokes passing a small group in the hall that we had just

passed all their leased employees

• After reviewing a leased employee checklist, Who Me Lease calls back with 200 leased employees– since the controlled group had only 2000 NHCEs before,

the 75% ratio test changes to 68% and now requires an average benefit percentage test

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Issue 2: Are there leased employees?

Situation: Company employees work at JV• Division J is owned by Bigger Fish Company• Bigger Fish Company spins off Division J to form a

joint venture• Division J employees become employees of the JV• Bigger Fish Company also has a few employees who

remain Big Fish, but work at the JV– these employees are tested as employees by Bigger Fish,

but also must be included as leased employees by the JV

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Issue 2: Are there leased employees?

Situation: Company acquires employees• We Do Everything, Inc. acquires the office staff, their

portion of the retirement plan, and the whole building of the We Don’t Do Floors Co.

• The professional staff of We Don’t continues to work in the building & control the work of the office staff

• We Do tests the office staff as employees• We Don’t includes the office staff as leased

– aggregates office plan as if its own

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Issue 3: Are there affiliated service groups?

Affiliated Service Groups• No ownership involved, based in part on regular

provision of services or management services by a service organization

• Don’t forget affiliated service groups of affiliated service groups

• IRS will rule via Form 5300 filing whether an affiliated service group relationship exists

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Issue 3: Are there affiliated service groups?

Situation: Company acquires employees - 2• We Do Windows, Inc. acquires the office staff, their

portion of the retirement plan, and the whole building of the We Don’t Do Windows Co.

• The professional staff of We Don’t continues to work in the building & control the work of the office staff

• An affiliated service group relationship exists• We Do and We Don’t are tested as one controlled

group

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Issue 3: Are there affiliated service groups?

Situation: Attorneys disagree• We Do Everything, Inc. now acquires We Do

Windows, Inc. • The affiliated service group relationship is causing its

plan to fail under the new controlled group• The attorney for We Do Windows thinks it should

pass since they feel the relationship with We Don’t Do Floors should also be an affiliated service group

• The attorney for We Do Everything disagrees

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Issue 4: What about acquisitions?

Transition rule application• Not much guidance• Generally agreed the transition rule can’t be relied on to

avoid testing indefinitely if frequent M&A– some attorneys suggest testing the company and its acquisition

as separate controlled groups until the end of the transition period

– some suggest testing the company only without its acquisition until the end of the transition period

– some ignore the transition rule

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Issue 4: What about acquisitions?

Situation: Separate testing during transition• All Together Now, Inc. acquires Not Quite Together

Yet, Inc. and instructs Not Quite Together to continue testing as usual until transition ends

• Not Quite Together tests its multiple employer plan– plan provides cuts to HCEs

• After transition, All Together Now attorney gets involved in testing and determines there is a single employer, not multiple employers

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Groups to Exclude

• Are there multiple employer plans?

• Are there joint ventures?

• What about the tax-exempt exclusion?

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Issue 1: Any multiple employer plans?

Multiple employer plans • Each employer adopting a multiple employer plan

must test separately from other adopting employers• However, failing results for one adopting employer

affect the qualified status of all in the plan

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Issue 1: Any multiple employer plans?

Situation: Plan has adopting employers • Wild Blue Company sponsors a profit sharing plan

and Limp a Lot, Inc. and Come Fly With Me, Inc. also choose to adopt the plan.

• Come Fly uses the “top 20%” election for HCEs. • Limp a Lot dissolves, but Come Fly hires many of the

Limp a Lot employees.• Come Fly includes its new employees for testing, but

ignores them for HCE determination.

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Issue 1: Any multiple employer plans?

Situation: Continues benefits after sale • Wild Blue Company sells its Flap Your Wings division,

but allows the employees to continue in its plans for one year.

• The new Flap Your Wings Company becomes another adopting employer for the year.– The Wild Blue Company will test including Flap Your Wings

employees/benefits up to sale

– Flap Your Wings will do its own testing of the plan from the sale date until benefits cease

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Issue 2: What happens with JVs?

Joint Ventures • When there is not an 80% ownership relationship for

a joint venture, each group becomes a separate controlled group

• As stated previously, there may be some employees included in testing for both, as a leased employee in one entity

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Issue 2: What happens with JVs?

Situation: Continues benefits after JV• You Complete Me, Inc. and Ditto, Inc. each spin off

divisions to form a joint venture. • The employees from each company remain in their

respective plans and the JV becomes an adopting employer of both plans.

• Neither plan passes testing with respect to the JV

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Issue 3: What about tax-exempt exclusions?

Tax-exempt exclusion• Only allowed for 401(k) plan testing• Requires no tax-exempt employees benefiting in

401(k)• Requires 95% coverage of non tax-exempt

employees in the 401(k) plan• If requirements met, 401(k) plan testing for 410(b)

can exclude tax-exempts from the controlled group

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Issue 3: What about tax-exempt exclusions?

Situation: For Profits have own 401(k) plans• You Keep It Company is “not for profit” and acquires

We’ll Take It, Corp., a “for profit” company• Smaller We’ll Take It has four divisions, each with its

own 401(k) plan• Even aggregated, 401(k) plans fail 410(b)

– no other employees left to offer 401(k) to improve results

• No division’s 401(k) plan covers 95% of We’ll Take It employees to exclude tax-exempts

When to Aggregate Plans

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Issue 1: Can’t Pass NCT?

Situation: Two plans with different BRFs • Company has two plans with identical formulas• One plan is discriminatory alone, so desires to

aggregate with second plan• BRFs are different, but the second plan’s BRFs are

more generous, so can be aggregated with first plan’s BRFs to pass

• Frequent requests to improve first plan benefits and BRFs are monitored to ensure testing compliance

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Issue 1: Can’t Pass NCT?

Situation: Plans amended to be identical • We Are All Individuals, Inc. has a discriminatory plan• The plan aggregates with a second plan• First plan requires cuts to HCEs to ensure passing and

can eliminate 401(a)(4) cuts if aggregated plan is safe harbor

• First plan won’t give up accruals for terminations, and company insists on last-day for second plan

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Issue 2: Aggregating to Avoid ABT?

Situation:

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Issue 2: Aggregating DB and DC?

Situation: DB/DC plan can’t pass gateways• PS plan for Over There division employees and defined

benefit plan for Over Here division• Over There PS provides 6% to rank and file, 3% to

executives (rank and file includes some HCEs)• Over Here is a discriminatory group providing defined

benefit plan with 1% of pay formula• Highest HCE allocation is a DB participant with 38%• Average NHCE rate for DB is 2.5%

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Issue 2: Aggregating DB and DC?

Situation: DB/DC plan can’t pass gateways• DB/DC plan fails Minimum Allocation Gateway

– 1/3 of 38% > 2.5%

– 2.5% < 7.5%

• DB/DC plan fails Primarily DB Gateway– DB group couldn’t pass NCT, so won’t have 50% NHCEs

• DB/DC plan fails Broadly Available Separate Plans– if DB group could pass the NCT, there would be no reason

to aggregate

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Issue 2: Aggregating DB and DC?

Situation: DB/DC plan can’t pass gateways• Consider implications under proposed cash balance

regulations if DB plan converted to a cash balance plan with 6%/3% allocations as in PS, but– provided DB/CB choice to all in DB plan

– provided “greater of” formula to all in DB plan

– provided CB with frozen DB minimum to all in DB plan

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Issue 3: Aggregating vs. Merger?

Situation: Merger of target plan and MPP• Safe harbor target plan participation was frozen several

years ago• All employees hired since then participate in a safe

harbor money purchase plan• To save money, trusts were combined, plans merged• Target and MPP tested by restructuring• …until cross-testing regulations

– now is supposed to pass Gateways without restructure

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Issue 4: Different plan years in ABT?

Situation: One employee, two plan years• Not really an aggregation issue• Employee benefits in a calendar year 401(k) plan and

in a 4/1 plan year MPP plan• Employee is HCE for 2003 testing of the 401(k) plan• No testing done for the MPP since no HCEs benefit

– would have been NHCE for plan year ending 3/31/2003

• Average benefit test required for 401(k) plan

Determining HCEs

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Issue 1: Acquiring HCEs?

Situation: New member of controlled group • BuyCo acquires NewCo assets on November 1, 2002• NewCo employees immediately join BuyCo’s DB

plan• As part of transaction, certain senior NewCo execs

will lose their jobs in early 2003• Can the BuyCo DB plan provide the execs with

annual normal retirement pensions equal $16,000?

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Issue 2: Collecting the right pay?

Situation: Average benefits test with different plan years

• Plan A is being tested for its 12/31/2002 plan year• Plan B (10/31 pye) is also in the testing group• HCEs for the ABT are either Plan A (12/31/2002) or

Plan B (10/31/2002) HCEs• Does Plan A keep track of fiscal 10/31 employee

compensation? Or Plan B 12/31?

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Issue 3: When are snapshots not enough?

Situation: Required to cross-test a defined contribution plan

• Minimum allocation gateway requires each NHCE to receive an allocation at least 1/3 of the largest HCE allocation

• The highest allocation rate is likely to belong to an HCE with partial year of pay

• Snapshot testing identifies HCEs on the snapshot date, so could miss HCEs who leave mid-year

Determining Most Valuable Accrual Rates

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Issue 1: Don’t forget to close windows

Situation: Plan offers an early retirement window

• Window benefits are reflected in most valuable accrual rates in first year it is open

• In MVAR iteration, include window benefits at first age, but exclude them at ages after window closes

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Issue 2: What is average annual comp?

Situation: Short-service employees • The regulations state that the averaging period must

consist of three or more years, but need not be longer than the employee’s period of employment

• They have less than a full averaging period of compensation

• Can the rest of the averaging period be filled with zero compensation?

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Issue 3: Improving the rate grouping

Situation: Not all rate groups pass 410(b)• Most often, rate group ranges are determined

mechanically, starting at 0%• Frequently, better results are had by adjusting the

starting point• The HCE rates within a range cannot be significantly

higher than the nHCE rates

Odds and Ends

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Issue 1: Union membership

Situation: Union and non-union members covered by same plan

• Employer believes entire plan is collectively bargained

• Identity of union members not always clear• Actuary has entire census, but no union indicator nor

plan year compensation

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Issue 2: Non-resident aliens

Situation: US and British employees covered by same plan

• Brits are totally excludable if they have no US source income

• Can provide separate discriminatory benefit structure for the Brits

• Must comply with applicable UK tax and benefits rules, if applicable