Many employers have modified their traditional defined benefit (DB) plans by moving to a “soft frozen” plan (or “closed” plan), where the existing participants continue to accrue benefits, but plan participation is closed to new employees. One common design is to maintain the DB plan for a closed group of employees and to establish or enhance a defined contribution (DC) plan for newer (and future) employees. In Part 2 of our earlier series on nondiscrimination testing, we explored the issues faced by a typical plan sponsor electing this route.
As an example of how circumstances change, many years ago Employer F permitted a “grandfathered” group of longer-service employees to continue accruals under its DB plan, and established a profit-sharing plan for all of the remaining employees. New employees joined the profit-sharing plan when eligible. At the time of the program change, the plans met the three main nondiscrimination tests, which are:
• Participation (only applicable to the DB plan)
A number of years have passed since the change, and the DB plan population has now declined and become more heavily weighted toward highly compensated employees (HCEs). The DB plan is no longer passing the 70% ratio percentage test, and is currently meeting the coverage requirement via the more complex average benefits test. Employer F is concerned that the average benefits test is in danger of failing in the near future, and is now looking for alternative ways to ensure that the DB plan continues to meet the coverage requirements.
In many circumstances, the nondiscrimination rules will currently allow plan sponsors to consider two or more plans to be a single combined (or “aggregated”) plan for purposes of meeting the coverage and benefit requirements (but not the participation requirements). If this is done for a DB plan and a DC plan, the combined plan is known as a “DB/DC” plan.