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

Groups to Include
Who knows the group? Are there leased employees? Are there affiliated service group relations? Are there acquisitions?

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
Acquires 80% USA

0%-Svcs only
USA

USA

B
80% USA

France

0%-Mgt Svcs only

100%

H
50%

Canada

C
40%
-acquired prior year

D
40%

USA

USA

50%

85%

0%-Leasing grp

France Exercise: Identify controlled groups in years 0, 1, and 2, assuming acquisitions admitted to controlled group at end of transition period 6

USA

USA

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 dont take over Family, Inc. checks and finds other US companies owned by New Dad to include in testing Later Family, Inc. finds that New Dads 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 Im 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

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 Dont Do Floors Co. The professional staff of We Dont continues to work in the building & control the work of the office staff We Do tests the office staff as employees We Dont 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 Dont 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 Dont Do Windows Co. The professional staff of We Dont continues to work in the building & control the work of the office staff An affiliated service group relationship exists We Do and We Dont 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 Dont 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 cant 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 taxexempt 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 Well Take It, Corp., a for profit company Smaller Well 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 divisions 401(k) plan covers 95% of Well Take It employees to exclude tax-exempts
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When to Aggregate Plans

Issue 1: Cant 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 plans BRFs are more generous, so can be aggregated with first plans BRFs to pass Frequent requests to improve first plan benefits and BRFs are monitored to ensure testing compliance
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Issue 1: Cant 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 wont 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 cant 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 cant 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 couldnt pass NCT, so wont 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 cant 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

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Determining HCEs

Issue 1: Acquiring HCEs?

Situation: New member of controlled group
BuyCo acquires NewCo assets on November 1, 2002 NewCo employees immediately join BuyCos 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
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Determining Most Valuable Accrual Rates

Issue 1: Dont 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 employees 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

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Odds and Ends

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
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