Nondiscrimination Requirements: Part Two

1. Nondiscrimination Requirements: Part Two Fundamentals I of Retirement Plan Issues Chapter Eight, Part Two/Week 11

2. General Test for DC Plans • Step 1: For each participant, compute the ratio of [his/her allocation ÷ total comp] = allocation rate • Step 2: Group all the allocation rates for NHCEs and all the allocation rates for HCEs • General Test: if the highest allocation rate for any HCE exceeds the lowest allocation rate for any NHCE, the regulations “restructure” the plan into various rate groups • Step 3: Count the number of different allocation rates of the HCEs – this determines the number of rate groups • Step 4: Start with HCE with the smallest allocation rate and his/her rate group will include all HCEs and all NHCEs with an allocation rate equal or greater • Step 5: Perform the Coverage Tests of IRC §410(b) on that rate group, using the Test Group’s NHCE and HCEs numbers as the denominators • Step 6: Repeat Steps 4 and 5 for each of the other rate groups • Conclusion: Every rate group must satisfy one of the coverage tests of IRC §410(b); if not, the plan does not satisfy IRC §401(a)(4)

3. General Test for DC Plans • Applying the IRC §410(b) coverage tests to the various rate groups: • Percentage test requires that the rate group cover at least 70% of all NHCEs in the Test Group • RP test requires that the [% of NHCEs in the rate group ÷ NHCEs in Test Group] is at least 70% of [% of HCEs in the rate group ÷ HCEs in the Test Group] • ABT will require some alteration as applied to the rate group analysis

4. ABT applied to the Rate Group Analysis • Review of the ABT under IRC §410(b): • The eligibility criteria used satisfies a “reasonable business criteria” • Modified RP test with a safe and unsafe harbor and facts & circumstances in between • Average benefits test comparison between NHCEs and HCEs under all qualified plans maintained by the ER • Since the rate group analysis is a creature of the IRS regulations, the first two criteria of the ABP must be adjusted

5. ABP applied to the Rate Group Analysis • In our example: • Rate group #1: RP = 25% • Rate group #2: RP = 33.3% • Rate group #3: RP = 33⅓% • ABP as modified: • Reasonable classification requirement is deemed met • Modified RP: for NHCE concentration ratio of 15 ÷ 20 = 75%, we’d normally have a safe harbor and unsafe harbor of 39.5% to 29.50%. When applied to rate groups, we’ll use the midpoint of 34.5% as our rate group’s new safe harbor • In our example, none of the RP of the rate groups is at or above 34.5% -- hence all three rate groups fail the ABP

6. General Test for DB Plans • The general test is different for DB Plans than DC Plans if the DB plan provides certain subsidies. In that case, the subsidized benefit is more valuable than the AB and should be tested. • Step 1: For each participant, compute [his/her accrual under the AB formula ÷ total comp] = normal accrual rate. If there is a subsidized early retirement benefit, subsidized optional forms, other retirement type subsidies, early retirement window benefits or social security supplements that the participant is currently eligible for, compute [his/her most value accrual under the subsidy ÷ total comp] = most valuable accrual rate. • Step 2: Group all the normal and most valuable accrual rates for the NHCEs and all the normal and most valuable accrual rates for the HCEs • General Test: The ER-provided benefits under a DB plan are nondiscriminatory in amount if each rate group under the plan satisfies IRC §410(b). A rate group exists for each HCE and consists of the HCEs and NHCEs who have a normal accrual rate + most valuable accrual rate greater than or equal to that HCE’s normal accrual rate + most valuable accrual rate. • Step 3: Count the number of different accrual rates and most valuable accrual rates for the HCEs – a rate group consists of different accrual rates + most valuable accrual rates.

7. Example of General Test for DB Plans • DB Plan: Test Group = 20 – 15 NHCEs and 5 HCEs; NHCE concentration ratio = 15/20 = 75% • 4 HCEs: all have normal accrual rates of 1% and most valuable accrual rates of 1.1%, 1.4%, 1.4% and 1.6% • 8 NHCEs: all have normal accrual rates of 1% and most valuable accrual rates of 1%, 1.2%, 1.4%, 1.4%, 1.5%, 1.6%, 1.6% and 1.6% • 3 rate groups: 1% + 1.1%; 1% + 1.4%; 1% + 1.6% • Rate group #1: 3 HCEs with at least 1% + 1.1% and 7 NHCEs with at least 1% + 1.1% -- RP = [7÷15]/[4/5] = 46⅔%/80% = 58% • Rate group #2: 3 HCEs with at least 1% + 1.4% and 6 NHCEs with at least 1% + 1.4% -- RP = [6÷15]/[3÷5]=40%/60%= 66⅔% • Rate group #3: 1 HCE with at least 1% + 1.6% and 3 NHCEs with at least 1% + 1.6% -- RP = [3÷15]/[1÷5]=20%/20%= 100% • Under the RP test of IRC §410(b), rate group #3 satisfies the 70% test, but rate groups #1 and 2 do not • Under the ABP test of IRC §410(b), reasonable business criteria is waived and the modified RP test is the midpoint of 39.50% - 29.50% which is 34.5%. Since the RP of rate groups #1 and 2 are at or above 34.5%, they meet this part of the test. Actuary must verify that the average benefit % for all NHCEs is at least 70% of the average benefit % for all HCEs, taking into account all qualified plans.

8. Test 2 under IRC §401(a) • A benefit, right or feature (BRF) offered under a qualified plan must be tested under a two-fold test of “current availability” and “effective availability” • BRF extend beyond “protected benefits” that cannot be reduced through plan amendment; Treas. Reg. §1.401(a)(4)-4(e)(3) lists what is considered a BRF • “Current availability” – BRF available to a nondiscriminatory group • “Effective availability” – BRF is actually utilized by a nondiscriminatory group

9. Test 3 under IRC §401(a)(4) • In the event there are other benefits available in “special circumstances,” those benefits must also be nondiscriminatory – a facts and circumstances test • Regulations consider whether a plan amendment or the timing of an amendment could be considered a benefit available in “special circumstances”