Current developments in employee benefits.

• Author: Walker, Deborah
• Position: Part 2

Part II of this two part article analyzes a variety of qualified plan issues, including revised nondiscrimination rules, SIMPLE plans, model corrective and amendment procedures, contemplated benefit changes, correction of improper plan investments and distributions, excess Sec. 415 amounts, distributions of illiquid assets, the "same desk" rule, vesting of survivor benefits and receipt of mutual fund fees.

This two-part article provides an overview of recent developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part I, published in November, focused on current developments in welfare benefits and compensation (excluding changes made by the Taxpayer Relief Act of 1997 (TRA '97)). Part II, below, focuses on current developments affecting qualified retirement plans (excluding changes made by the TRA '97).

Revised Nondiscrimination Rules

Testing

Attempting to simplify plan administration, the IRS released Notice 97-2(21) to provide guidance on (1) the new Sec. 401(k) and (m) rules(22) permitting nondiscrimination testing based on nonhighly compensated employees' (non-HCEs) actual deferral percentages (ADP) and (2) returning excess deferrals to highly compensated employees (HCEs).

Prior to the Small Business Job Protection Act of 1996, plans had to use current-year data to determine the ADP and actual contribution percentages (ACP) for both HCEs and non-HCEs. After 1996, plans can use prior-year data in determining the ADP and ACP of non-HCEs, while using current-year data for HCEs.

Notice 97-2 provides that the ADP for non-HCEs for the preceding plan year is the ADP for the preceding plan year for the group of employees who were non-HCEs in the preceding plan year, using the definition of HCE in effect for the preceding plan years. Thus, for purposes of Sec. 401(k)(3)(A)(ii), the individuals taken into account in determining the prior-year's ADP for non-HCEs are those individuals who were non-HCEs during the preceding year, without regard to their status in the current year. For example, an individual who was a non-HCE for the preceding plan year is included in this calculation even if he is no longer employed by the employer or has become an HCE in the current plan year.

Future guidance will address the extent to which Sec. 401(m) matching contributions and qualified nonelective contributions can be used in determining the non-HCEs' ADP or ACP for nondiscrimination testing.

Plan sponsors can use current-year data in determining the ADP or ACP for non-HCEs for the 1997 plan year and use prior-year data in the 1998 and future plan years without IRS approval. For the 1997 plan year, no plan amendment or formal election is required. Guidance will be issued on how employers who use current-year data for 1998 and later years may switch to using prior-year data in subsequent plan years.

Excess Contributions

The process for distributing excess contributions and excess aggregate contributions requires the amounts returned to be based on the total dollar amount in excess. This method will not necessarily result in the ADP, if recalculated after the distributions, meeting the Sec. 401(k)(3) requirements.

Example: HCE1 has elective contributions of $8,500 and $85,000 in compensation, for an actual deferral ratio (ADR) of 10%; HCE2 has elective contributions of $9,500 and compensation of $158,333, for an ADR of 6%. As a result, the ADP for HCE1 and HCE2 under the plan is 8%. The ADP for the non-HCEs is 3%. Under the Sec. 401(k)(3)(A)(ii) ADP test, the ADP of HCE1 and HCE2 under the plan may not exceed 5% (i.e., two percentage points more than the ADP of the non-HCEs under the plan).

Under Sec. 401 (k)(8)(B), Regs. Sec. 1.401(k)-1 (f)(2) and Notice 97-2, the total excess contributions for the HCEs is determined as follows:

Step 1: The elective contributions of HCE1 (the HCE with the highest ADR) are reduced by $3,400, which reduces HCE1's ADR to 6% ($5,100/$85,000), which is HCE2's ADR. Because the HCEs' ADP still exceeds 5%, the Sec. 401(k)(3)(A)(ii) ADP test is not met; further reductions in elective contributions are necessary. The elective contributions of HCE1 and HCE2 are each reduced by 1% of compensation ($850 and $1,583, respectively). Because the ADP of the HCEs now equals 5%, the Sec. 401(k)(3)(A)(ii) ADP test is met; no further reductions in elective contributions are necessary.

Step 2: The dollar amount of excess contributions for the HCEs that must be distributed is $5,833, the total reductions in elective contributions under Step 1 ($3,400 + $850 + $1,583). Under Sec. 401(k)(8)(C), the $5,833 in total excess contributions for the 1997 plan year would then be distributed as follows.

Step 3: The plan distributes $1,000 in elective contributions to HCE2 (the HCE with the highest dollar amount of elective contributions) to reduce HCE2's elective contributions to $8,500, the dollar amount of HCE1's elective contributions.

Step 4: Because the total amount distributed ($1,000) is less than the total excess contributions ($5,833), step 3 must be repeated. As the dollar amounts of remaining elective contributions for both HCE1 and HCE2 are equal, the remaining $4,833 of excess contributions must be distributed equally to HCE1 and HCE2, $2,416.50 each.

HCE1 must receive a total distribution of $2,416.50 of excess contributions; HCE2 must receive a total distribution of $3,416.50 of excess contributions. This is true even though HCE1's ADR exceeded HCE2's ADR. The plan is now treated as satisfying the Sec. 401(k)(3) nondiscrimination test, even though the ADP would fail that section if recalculated after distributions.(23)

SIMPLE Plans

Rev. Proc. 97-9(24) supplies a model amendment allowing employers to adopt Savings Incentive Match Plan for Employees (SIMPLE) Sec. 401(k) plans if they currency have Sec. 401(k) plans that have received determination letters that take into account the requirements of the Tax Reform Act of 1986 (TRA '86). Eligible adopters include sponsors of individually designed plans, master and prototype plans, regional prototype plans or volume submitter specimen plans.

Because the procedure essentially applies only to plan sponsors that currently have a Sec. 401(k) plan with a determination letter, the procedure will be of use to institutions offering model plans, but of limited or no use to individual employers who have not in the past sponsored Sec. 401(k) plans. Also, because SIMPLE Sec. 401(k) plans must be on a calendar year, if the employer currency sponsors a fiscal-year plan, it must be converted to a calendar year if it is amended to become a SIMPLE Sec. 401(k) plan.

Model Corrective Amendments

Rev. Proc. 96-55(25) contains a model amendment for certain sponsors of profit-sharing and stock bonus plans that sponsors could have used until June 30, 1997 to comply with Rev. Rul. 94-76,(26) relating to a transfer of assets from a qualified money purchase pension plan to an otherwise qualified profit-sharing or stock bonus plan.

Rev. Rul. 94-76 states that a transfer of assets and liabilities of a qualified money purchase pension plan (Plan A) to a qualified profit-sharing or stock bonus plan (Plan B) does not divest Plan A's assets and liabilities of their attributes as pension assets and liabilities. Thus, to satisfy Sec. 401(a), the assets and liabilities transferred from Plan A to Plan B must remain subject to the restrictions on distributions from a qualified money purchase pension plan. Because a money purchase pension plan cannot provide for in-service distributions, the application of an in-service distribution provision in Plan B to the accrued benefits transferred from Plan A would result in the merged plan failing to satisfy Sec. 401(a).

To remain qualified, Plan B would need to be amended to provide that on and after the transfer, the accrued benefits attributable to the Plan A assets and liabilities (the account balances and post-transfer earnings) would be distributable only on or after events permissible under qualified pension plans. This amendment would generally need to be adopted by the date of the transfer. The right to take an in-service distribution is a Sec. 411(d)(6) protected benefit; thus, if Plan B is amended to eliminate that right with respect to accrued benefits, the amendment would violate the Sec. 411(d)(6) anti-cutback rules.

The IRS's model amendment provides language for amending a profit-sharing or stock bonus plan under the relief provision in Rev. Proc. 94-76. Eligible plan sponsors may amend their plans by adopting the IRS's model amendment verbatim. Neither an application to the IRS nor a user fee is required; the IRS will not issue new opinion, notification, advisory or determination letters for plans amended solely to add the model language.

The model is available only to master and prototype, regional prototype, volume submitter specimen and individually designed plans (including volume submitter plans) (1) eligible for Rev. Rul. 94-76 relief from failure to qualify under Sec. 401(a) and (2) that, as of the date of the adoption of the model amendment, have reliance on a favorable opinion, notification, or determination letter that takes into account the requirements of the TRA '86, under Rev. Proc. 89-9,(27) 89-13,(28) 90-20,(29) 91-41,(30) 91-66,(31) 93-39(32) or 96-6.(33) Affected plans required to make the amendment had until June 30, 1997 to do so.

Retroactive Amendment...