What’s Important for Plan Sponsors in IRS Hybrid Plan Notice 2011-85

IRS Notice 2011-85 announces the relief and postponed effective date for several items related to hybrid pension plans IRS logo(e.g., cash balance and PEP plans). The notice is pretty technical (of course), but the IRS also published a nice summary of what’s affected by the relief.

Here’s what it means for plan sponsors:

  • The scope of the announcement is relatively narrow and only applies to certain hybrid plan rules and regulations. These rules were spelled out in a combination of proposed and final regulations issued in October 2010.
  • Important take-away from the notice: By extending the proposed 2010 hybrid plan regulation effective date, the IRS is hinting that they are still reviewing the definition of “market rate of return” for interest crediting rates. They’ve clearly received lots of comments from plan sponsors and practitioners about what a “fair” market rate of return should be. At this point, it looks like we won’t be getting final regulations about this issue until sometime in 2012.
  • Here’s an abbreviated summary of the notice’s relief items:
    • Extension of the effective date of the proposed 2010 hybrid plan regulations (which include the definition of market rate of return for interest crediting purposes) to a date no sooner than January 1, 2013 (they were expected to be finalized and effective January 1, 2012). The notice also extends the effective date of the final 2010 hybrid plan regulations from January 1, 2012 to the same date that the 2010 proposed regulations are effective.
    • Extension of the deadline for adopting amendments under § 411(a)(13) (other than § 411(a)(13)(A)) and § 411(b)(5)). This includes the 3-year vesting requirement for statutory hybrid plans. Plan sponsors now have until the last day of the year preceding the year that the 2010 proposed hybrid plans become effective to adopt the necessary amendments.
    • Additional 411(d)(6) relief for reducing accrued benefits as long as the amendment to reduce/eliminate benefits is done solely to comply with 411(b)(5) [i.e., age discrimination and interest credit rules for hybrid plans]. These amendments also need to be adopted before the last day of the year prior to when the proposed 2010 hybrid plans become effective.
    • Additional 204(h) notice timing relief in specific situations related to amendments that changed the interest crediting rate for a statutory hybrid plan.

Strategic 401(k) Design: Preventing ADP Failures

If your 401(k) plan is failing the Actual Deferral Percentage (ADP) test, then it’s time to consider some plan design changes. You need to figure out a way to encourage non-highly compensated employees (NHCEs) to save more retirement money in their 401(k) accounts while keeping benefit costs under control. This post will guide plan sponsors through some strategic (yet straightforward) benefit changes that can improve your plan’s chances of passing the ADP test next year.

1. Add a 401(k) match. If your plan doesn’t already have a 401(k) match, adding one will encourage employees to at least defer a minimal amount into their 401(k) accounts. More NHCE deferrals = better ADP test results.

2. Enhance the current 401(k) match. If your plan already has a match but it isn’t getting NHCEs to defer, then there are a couple of options:

Increase the match: Maybe that 1% match just isn’t worth it for some folks. A 3% match is about average, and any increase can be factored-in when considering an employee’s total compensation package.

“Extend” the match: The goal here is to increase the amount of compensation eligible for a match while not increasing employer costs. For example, if you currently match 50% of the first 6% deferred then consider amending the plan to match 40% on the first 7½% deferred. Both formulas have a potential match of 3% of compensation, but the latter encourages employees to save at a higher rate in order to earn the full match.

3. Add an automatic enrollment feature. An Eligible Automatic Contribution Arrangement (EACA) is a feature where new participants are automatically enrolled in the 401(k) plan at a uniform deferral rate, unless they elect to opt out. If your 401(k) plan is suffering the ADP failure blues because few new hires are deferring, then this is a great way to increase your ADP rate and encourage employees to save for retirement. There’s also the Qualified Automatic Contribution Arrangement (QACA) option, which is a safe harbor plan combined with an automatic enrollment feature.

4. Add a “safe harbor” plan design. If you adopt one of these IRS-prescribed benefit formulas, then you get a “free pass” on ADP testing. Safe harbor benefits are 100% vested immediately and you must provide notice of the safe harbor status to participants at least 30 days prior to the start of the plan year. The minimum safe harbor benefit formulas are:

– At least a 3% automatic (i.e., non-matching) employer contribution to each participant’s 401(k) account; or

– An employer match of at least 100% on the first 3% deferral plus a match of at least 50% on the next 2% deferral (i.e., a potential match of 4% of pay).

If you have a cross-tested profit-sharing plan or cash balance plan, then the 3% non-elective option is often the best choice since those benefits count towards the non-discrimination tests whereas the matching formula does not.

Each of the options above has variations and can be combined with the others. Combined with a thorough campaign to educate participants about the changes, they’ll improve your chances of passing the ADP tests next year and avoid having to refund HCE deferrals as taxable income.

Explanation of 436 and Hybrid Plan Amendment Extensions

As we speculated a few weeks ago, the IRS has extended the deadline for plan sponsors to amend their plan documents to comply with certain law changes under PPA and WRERA. Notice 2010-77 essentially just adds a year to the previously extended deadlines from Notice 2009-97. These extensions may be a moot point for many plan sponsors since the relief has come so late in the year and many have already made good-faith amendments.

So, what retirement plan amendment deadlines have been extended and what do they mean? They are:

1. Amendments to comply with the IRC 436 benefit restriction rules. These are the benefit restrictions that are activated when a pension plan’s funded status (AFTAP) falls below certain thresholds. The deadline for adopting 436 amendments has been extended from the end of the 2010 plan year to the end of the 2011 plan year.

2. Amendments for cash balance and other applicable defined benefit plans (e.g., PEP plans) to comply with IRC 411(a)(13), other than 411(a)(13(A) and 411(b)(5). These are the amendments necessary for a hybrid plan to be considered a Statutory Hybrid Plan (SHP) under PPA. An SHP defines a benefit as an accumulated balance (or accumulated percentage of pay). Read more…

Possible 436 Amendment Extension

Nothing’s official yet, but there are rumors circulating in the benefits community that the IRS may extend the deadline for amending defined benefit pension plan documents for the IRC 436 benefit restriction rules.

So, what’s the practical implication for pension plan sponsors? Perhaps not much. Many plan documents were already amended late in 2009 since deadline relief came so late last year. Presumably even more plan sponsors have drafted 436 amendments since then, so there may not be many who need the relief if the IRS ever delivers it. A more realistic scenario: The IRS will finally issue additional guidance in 2011 (or later) and plan sponsors will have to amend their current 436 amendments to recognize any clarifications. We’ll just have to wait and see.

To Freeze or Not to Freeze (A Pension Plan)

Freezing a defined benefit (DB) pension plan has become common practice over the past decade. Plan sponsors give many reasons for freezing the DB plan, but one of the most common is that the funding requirements are too expensive and volatile. In a recent article, two actuaries from Milliman dissected a sample pension freeze and argue that this tactic is not always cheaper for the plan sponsor, and often provides a worse benefit for participants.

This post does a quick analysis of the article, but I’d encourage you to read the entire document (5 pages) for all of the details. The basic set-up of the case study is this:

  • A DB plan with fairly rich benefits is underfunded and subject to large IRS minimum required contributions. So, the plan sponsor decides to freeze benefit accruals in the DB plan in order to limit their exposure to future liability accruals.
  • In order to soften the effects of participants of the DB freeze, the 401(k) defined contribution (DC) plan benefit is increased from a 50% match on 6%-of-pay (i.e., maximum 3% company match) to a maximum 401(k) match of 4%-of-pay along with an additional non-matching contribution of 4%-of-pay (i.e., increase from maximum 3%-of-pay to maximum 8%-of-pay DC benefit).
  • Maintain current DB plan asset allocation

Read more…

Fixing a §401(a)(4) test failure

Our philosophy for coverage and nondiscrimination testing has always been “everything passes, some plans just take a little longer to prove it”.

That was put to the test recently for one of our law firm clients:  an unusually young new partner was causing their  §401(a)(4) nondiscrimination test to fail.  We emptied the whole toolbox on it, but nothing worked.  Thought we were out of luck.  Adding an extra contribution for all NHCE’s was going to be very expensive.

Ah, but wait!  The IRS came to the rescue with the §1.401(a)(4)-11(g) corrective amendment rules.  Within 9½ months after year end, we can amend the plan to give an extra allocation to a carefully selected group.  Problem solved, at very low cost.

Note that the amendment must have “substance”, i.e. provide real benefits for real people.  One that doesn’t is described in Suzanne Wynn’s blog here.  Nice try, creep…

There’s more detail in the regulations.  Go to paragraph (g) for corrective amendments.