Making a Bad Situation Worse: An -11g Corrective Amendment Allocating to a Non-Vested Terminated Employee

When a plan fails the minimum coverage requirements of Code section 410(b), or the nondiscriminatory amount requirement of Treasury Regulation 1.401(a)(4)-1(b)(2), or the nondiscriminatory plan amendment requirement of Treas. Reg. 1.401(a)(4)-1(b)(4), the IRS permits the plan sponsor to adopt a corrective retroactive amendment to correct any of these failures.

Often, the corrective amendment design which provides a solution with the least amount of cost to the plan sponsor is increasing accruals or allocations to non-highly compensated employees (NHCEs) who have terminated. If the NHCE is terminated and is also non-vested, such a correction is ineffective because it snags one of the IRS trip-wires in Treas. Reg. 1.401(a)(4)-11(g) by failing to satisfy the IRS requirement that -11(g) amendments have “substance”.

For an -11(g) amendment to have “substance”, Treas. Reg. 1.401(a)(4)-11(g)(4) states that:

a corrective amendment is not taken into account in determining whether a plan satisfies section 401(a)(4) or 410(b) to the extent the amendment affects nonvested employees whose employment with the employer terminated on or before the close of the preceding year, and who therefore would not have received any economic benefit from the amendment if it had been made in the prior year.

Treas. Reg. 1.401(a)(4)-11(g)(6) provides Example (6), which states:

Example (6). Employer Y maintains Plan C, which does not satisfy section 401(a)(4) in a plan year. Under the terms of paragraph (g)(2) of this section, Employer Y amends Plan C to increase the benefits of certain employees retroactively. In designing the amendment, Employer Y identifies those employees who have terminated without vested benefits during the period after the end of the prior plan year and before the adoption date of the amendment, and the amendment provides increases in benefits primarily to those employees. It would be inconsistent with the purpose of preventing discrimination in favor of HCEs for Plan C to treat the amendment as retroactively effective under this paragraph (g). See section 1.401(a)(4)-1(c)(2).

As a practical matter, not permitting a plan sponsor to correct a 410(b) failure or a 401(a)(4) failure by increasing accruals or allocations to terminated non-vested NHCEs make sense because the increased accruals or allocations will circle the plan without the NHCE receiving the benefit of the increased accruals or allocations. Assume that in order to correct a 410(b) failure, the plan sponsor adopts an -11(g) corrective amendment granting an allocation to a terminated NHCE. If that NHCE is not vested, the contribution will then be forfeited, creating a circling effect through the plan for the allocation. The NHCE never receives any benefit from the allocation because it is deposited into his account, and then subtracted out of his account when it is forfeited. Therefore, the correction has no substance.

[tags]Pension Protection Act, ppa, blogs, 401(a)(4), 410(b), 11(g), corrective amendment, ERISA[/tags]