Posts

Compliance Rules Guidelines Regulations Laws
Print Friendly Version Print Friendly Version

The “High 25” and Benefit Restrictions

The “High 25” and Benefit Restrictions

“My client, a senior partner with an engineering firm, called and was upset because the administrator of his firm’s cash balance plan told him he can’t take a lump distribution, even though the plan document specifically permits lump sums. How can this be? I thought the plan sponsor had to follow the plan document.”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • Unfortunately for your client, in certain circumstances, defined benefit (including cash balance) plans, cannot make lump sum distributions to highly compensated employees (HCEs), despite the option being available under the terms of the plan.  This restriction, sometimes known as the “High 25” or claw back rule, affects the top 25 highest paid HCEs. The rule is intended to ensure large lump sum distributions made to the top HCEs don’t jeopardize the funding status of the plan and its ability to make benefit payments to other participants.
  • Treas. Reg. 1.401(a)(4)-5(b)(3)(ii) states that a plan cannot make certain benefit payments (including a lump sum payment) to an HCE (a restricted employee) who is in the top 25 of employees in terms of compensation unless one of the following is satisfied:

 

  1. After taking into account the payment to the restricted employee of all benefits payable to or on behalf of that restricted employee under the plan, the value of plan assets must equal or exceed 110 percent of the value of current liabilities;
  2. The value of the benefits payable to or on behalf of the restricted employee must be less than one percent of the value of current liabilities before distribution; or
  3. The value of the benefits payable to the restricted employee must not exceed $5,000 [the amount described in section 411(a)(11)(A) of the Internal Revenue Code (IRC) related to restrictions on certain mandatory distributions].

 

  • Revenue Ruling 92-76 prescribes three workarounds, permitting a lump sum if the client does not wish to take an annuity payment.  A  lump sum is permitted if

 

  1. The distribution is placed in an escrow account;
  2. A surety bond is obtained for the distributed amount; or
  3. A letter of credit is secured that allows the plan to recoup all or a portion of the distribution in the event of future funding shortfall.

These rules are complex and expert counsel is necessary to ensure compliance.

Conclusion

When discussing benefit restriction rules for defined benefit plans with your clients, do not forget the well-entrenched benefit restrictions that may apply for the High 25 HCEs in the plan.

 

 

© Copyright 2017 Retirement Learning Center, all rights reserved
money
Print Friendly Version Print Friendly Version

What is the Definition of Compensation for HCEs

What is the definition of compensation for determining HCEs?

“What definition of compensation is used to determine who is considered an HCE for nondiscrimination testing in a 401(k) plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

A plan must use an Internal Revenue Code Section (IRC §) 415 definition of compensation when determining which employees are HCEs under IRC §414(q).

  • More specifically, according to  Temporary Treasury Regulation 1.414(q)-1T, Q&A 13, the term “compensation” for HCE determination means compensation within the meaning of IRC §415(c)(3) without regard to §§125, 402(a)(8), and 402(h)(1)(B) and, in the case of employer contributions made pursuant to a salary reduction agreement, without regard to § 403(b). Thus, compensation for this purpose includes elective or salary reduction contributions to a cafeteria plan, cash or deferred arrangement or tax-sheltered annuity.

 

  • Only compensation an employee received during the “applicable period” is considered in determining HCE status.  HCE status based on compensation (not on ownership) is determined using compensation earned during the preceding year or 12-month period, referred to as the “look-back year.” If the year for which HCE status is being determined is not a calendar year, the sponsor may make a calendar year election so that HCE status is determined based on compensation earned during the calendar year beginning with or within the look-back year.

 

  • A compensation threshold applies for determining HCE status. This amount is subject to indexing.  When the amount is indexed, the new dollar amount applies to the year in which the compensation is earned, not the year in which HCE status is determined.  For example, when determining HCE status for 2017 based on compensation, plans must use the indexed amount for 2016, which was $120,000.  When determining HCE status for 2018 based on compensation, plans must use the indexed amount for 2017, which is $120,000.

Conclusion

Plans must follow a specific definition of compensation as defined in the IRC and supporting Treasury regulations when determining whether an employee is or is not an HCE.

 

© Copyright 2017 Retirement Learning Center, all rights reserved