Is there a rate group issue with establishing Employee Groups by compensation level?

One could argue that such a grouping violates the definitely determinable benefit requirement, that by using compensation, which is within the employer's control to some extent, there is room for excessive employer discretion. Just a personal opinion-I don't know if the IRS has raised this type of objection.

It may be done; I have not seen it.

I've done it, and received a clean Det. Letter.

Since the IRS is approving documents with each person in their own rate group, I don't see the problem. You could define the groups by how low they can limbo and it shouldn't matter.

Good point.

I'm in agreement with everyone on this one, but would like to add that if it is determined that defining rate groups by compensation is not a reasonable business classification, then one would have to pass coverage using the Ratio Percentage Test (vs. Average Benefits).

Sorry, Nate, but I must disagree. It is not the allocations but the plan eligibility criteria that has a reasonable classification issue. If, for example, the plan only allowed people who earned over $20K to participate, then I would agree with you. But if the question is allocations, not eligibility, and everybody gets something, then I don't think that reasonable classification is an issue.

Sorry I meant to say “the classification ratio percentage test (vs. average benefit ratio).”

In order to pass average benefits you must pass both the average benefit ratio test and the nondiscrimination classification test. One could not use the classification test if unless the benefit formula used a “reasonable classification established by the employer.” So instead, one would have to use the classification ratio percentage test. If you pass the classification ratio percentage test, then you do not need to run the average benefit ratio.










(Sorry- started to edit wrong post by mistake-now I can can't clear my trail)-AH

If you are talking about coverage testing of the plan for 410(b) purposes then that is true, but that test is concerned with who is eligible for the plan, i.e. the age and service requirements. We are presuming those are reasonable.

If you are talking about the NCT sub-part of the 401(a)(4) test then if you look closely you will find that you get a "free pass" past that requirement. I don't know the cite off hand but it is there if you look for it and IRS officials have both noted it and confirmed this interpretation at conferences.




p.s., the cite is here, from I think 1.401(a)(4)-2©(3). The bold is my emphasis:

A rate group satisfies the nondiscriminatory classification test of §1.410(b)–4 (including the reasonable classification requirement of §1.410(b)–4(b)) if and only if the ratio percentage of the rate group is greater than or equal to the lesser of—</p> <p> (A) The midpoint between the safe and the unsafe harbor percentages applicable to the plan; and </p> <p> (B) The ratio percentage of the plan.

This post has been edited by AndyH: Jul 13 2006, 03:30 PM

Thanks to all of you for your input.

There was concern about the reasonable classification of the Employee Groups since there would be a few rate groups who by definition would always be made up of NHCEs and a few rate groups who by definition would always be made up of HCEs.