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Accrued Benefit Requirements Fundamentals I of Retirement Plan Issues Chapter Six Requirements of IRC §411(b) • Concept of “accrued benefit” tied in with vesting requirements • Annual allocations for DC plans, versus accrued benefits for DB plans • Possibility of discrimination with a DB’s plan AB formula 2 Definition of an Accrued Benefit • In a DB plan, the accrued benefit (AB) is a formula defined under the plan, in the form of an annual life annuity or joint and survivor annuity, payable as of the normal retirement age (NRA) • In a DC plan, the accrued benefit is the balance of the participant’s account • Accrual rate versus accrued benefit • Valuation required annually 3 Accrual Computation Period • A year of participation = 12-consecutive period, measured beginning with the date the employee becomes a participant • Generally the 12-month period is the plan year (PY) • Generally all years of participation are counted for benefit accrual purposes • A plan may require more than 1,000 hours of service for a year of participant, but a pro rata amount must be extended if the participant has at least 1,000 hours 4 Accrued Benefits under a DC Plan • AB under a DC Plan = cumulative account balance • If the DC plan permits employee and employer contributions, separate accounts need not be made, but must be determined for vesting purposes • Allocation may be conditioned on a required number of hours during the PY and/or employment as of the end of the PY • Accruals under DC plans are generally a percentage of the participant’s compensation and unrelated to the participant’s age 5 Anti-cutback in Accrued Benefits • An issue arises if the employer wishes to amend the DC’s allocation formula after the end of the plan year, retroactively for the prior plan year • Another issues arises if the employer wishes to amend the DC’s allocation formula retroactively for terminated participants; this issue arises in the case where the plan’s valuation date is retroactively altered 6 Accrued Benefits under DB Plans • Like the NRB which is a benefit determined at retirement as an annuity, commencing as of the NRA, the AB must be defined as a cumulative benefit (based on current years of participation) as an annuity, commencing as of the NRA • If the AB is determined under the plan as of an age other than NRA, the actuarial equivalent of such benefit must be determined as of the plan’s NRA 7 Anti-Backloading Tests of IRC §411(b) • The Code does not require uniform accrual rates under the DB’s AB formula; however the Code does not want excessive backloading in the accrual rates as such result would defeat the vesting rules. • Hence the accrual rate under the plan’s AB formula must satisfy one (and only one) of the three tests set forth in IRC §411(b) – The 3% method – The 133⅓ rule – The fractional rule 8 Top Heavy Minimum Accruals • If a qualified DC plan is top heavy, IRC §416(i) requires a minimum allocation equal to the lesser of 3% × compensation or the maximum allocation accrued by any key employee • If a qualified DB plan is top heavy, IRC §416(i) requires a minimum benefit for each year in which the plan is top heavy equal to the lesser of 2% × his/her vesting year, or 20%, applied to FAE 9 Anti-Cutback in Accrued Benefits • The rules of ERISA §204(g) and IRC §411(d)(6) protect an existing participant’s AB from being retroactively reduced through a plan amendment. • What is a plan amendment? • What is a reduction in the AB? • What is included in the AB that is being protected? • Are subsidies also protected? Optional forms? 1