Log in

Minimum Plan Participation - With or Without You

DWC 03/11/21

Cash Balance Corner_Post Intro CTA

Sponsoring a retirement plan can provide significant benefits to a company (and its participants). But with great benefits comes great responsibility…responsibility to follow all of the various regulatory requirements. Since these plans provide hundreds of billions of dollars in tax deductions each year, Congress and the various agencies want to be sure everyone is playing by the rules.

In our last installment, we geeked out a little bit about the oh so fascinating world of nondiscrimination testing, so we thought we would allow some additional time for the excitement to settle down before this next post. Who are we kidding…the month-long wait between posts just might have been because we decided to publish new Cash Balance Corners once a month instead of twice. A person can only take so much excitement!

Last time, we explored the nondiscrimination rules as they apply to the number of people covered and the benefits they receive. Those tests compare highly compensated employees (HCEs) to non-HCEs. This time, we are looking the minimum participation requirements, which look simply at head count. Those rules require:

  • a specific number or percentage
  • of otherwise eligible employees (OEE)
  • to receive a meaningful benefit.

Those three bolded terms are important, so let’s break them down.

Otherwise Eligible Employees

In general, OEEs include those employees who have met the plan’s age and service requirements, which for most plans are attainment of age 21 and completion of one year of service. Once we have identified the OEE group, we can move to the specific number or percentage.

Specific Number or Percentage

In most cases, the minimum participation test requires 40% of the OEEs to receive a minimum benefit, but there are bookends of sorts. If there are only two OEEs, then both must receive the meaningful benefit. If there are at least 125 OEEs, then at least 50 of them must receive a meaningful benefit. We should also note that even though the average family may have 2.4 children, the minimum participation test does not allow fractional people, so that 40% calculation must always be rounded up to the next whole person.

Meaningful Benefit

This is a much deeper rabbit hole than you might expect. We will spare you the gory details and just summarize here. Typically, an allocation of 3% to 5% of plan compensation will produce enough meaningful benefits to enough OEEs to meet the 40% requirement. The calculation projects current allocations to retirement age, so if the employee group is younger than average, the percentage will be closer to 3% level and vice versa. Depending on demographics, it may also be possible to meet the requirement by providing a flat dollar amount to the non-owner employees, which is what many of our clients do.

Review time is now over. The remainder of this installment contains examples of how the minimum participation test impacts the overall design and funding of a cash balance plan. Excluding certain groups of employees that do not help the test can not only can lower the funding costs, but also lower administrative costs. By excluding certain classes of employees, a plan may be able to avoid PBGC coverage, which further reduces cost and administrative burden. However, as we discussed in a previous post, being exempt from PBGC coverage can limit the available tax deductions, which can affect the overall funding strategies of both the 401(k) and cash balance plans.


The plan sponsors in the examples below are assumed to not meet the PBGC plan coverage exemption due to being a small professional service employer.

Example One

2 OEEs (1 owner HCE and 1 NHCE)

As soon as our friend Robert Smith hired Simon and Simon became an OEE, both had to receive meaningful benefits. The meaningful benefit provided in the cash balance plan does not have to be nondiscriminatory on its own, because it is tested in combination with the 401(k) plan.

Example Two

3 OEEs (1 owner HCE, 1 non-owner HCE and 1 NHCE)

Robert hires Laurence, another songwriter, and pays him $175,000 year, which makes Laurence an HCE. Only two out of the three OEEs must receive a meaningful benefit (40% x 3 = 1.2, rounded up to 2), Robert can decide whether to provide the meaningful benefit to either Simon or Laurence in addition to himself. He can cover both but only has to cover one of them.

Since the nondiscrimination rules are there to protect NHCEs, the typical arrangement would be to provide the benefit to NHCE Simon rather than HCE Laurence. With that said, the plan becomes subject to PBGC coverage either way, because it now covers someone who owns less than 10% of the company.

Example Three

3 OEEs (2 owner HCEs and 1 NHCE)

Robert sells 10% of the business to Laurence! If the cash balance plan was being established after this event, Robert could elect to cover Laurence instead of Simon. That would allow the plan to remain exempt from PBGC coverage as it would only cover those who own at least 10% of the company. However, that would also mean that deductible contributions to the paired 401(k) plan would be capped at 6% of pay. So it would likely work to the company’s advantage to cover Simon either in addition to or in lieu of Laurence to trigger PBGC coverage and the higher deduction limit.

Example Four

13 OEEs (3 owner HCEs, 2 non-owner HCEs and 8 NHCEs)

Robert Smith, Inc. is really taking off. By providing meaningful benefits to all 3 owners and 3 of the NHCEs, the plan passes the minimum participation requirement (40% x 13 = 5.2, rounded up to 6). In order to accomplish this, the plan could be written in one of two ways:

  • The NHCEs could be broken into classifications, and the plan document could exclude the non-benefitting group. The challenge here is that any demographic shifts could change the calculations and trigger the need for corrective amendments.
  • The other is to cover all NHCEs but set the benefit formula at a level that provides that meaningful benefit to those 3 targeted NHCEs. This minimizes the likelihood of corrective amendments and also lessens the potential for uncomfortable conversations around the water cooler…if we ever get to have those again!)
Example Five

480 OEEs (60 owner HCEs, 20 non-owner HCEs and 400 NHCEs)

Between a worldwide tour and launching a record label, Robert Smith, Inc. is going gangbusters. Thanks to the 50-participant cap on the minimum participation test, Robert can structure his cash balance plan to cover only the owners. Sure, nondiscrimination testing still matters, but the company can provide all of the non-owners their benefits in the 401(k) profit sharing plan.

What if the Plan is not passing minimum participation?

The plan must be terminated if a plan does not pass the minimum participation test. Not really – just making sure you are still paying attention. The actual answer is much easier - the plan must be amended to expand benefits enough to is to pass. Although such an amendment can be adopted during the plan year, we don’t run the test and confirm the failure until after year-end

Fortunately, this is one of the very few instances in which the IRS allows companies to adopt plan amendments retroactively into a previous year. There is a time limit though. Companies must adopt this type of corrective amendment no later than 9 ½ months after the end of the plan year (October 15th for calendar year plans).

In our next installment, we will delve into how benefit amounts affect the nondiscrimination testing.

Until then, have a great start to Spring and happy daylight saving time (unless you are in Arizona or Hawaii)!

If a defined benefit plan makes sense for your company, DWC can work with you to design a plan that accomplishes your objectives while maintaining maximum flexibility.

Contact us today to get started.

Download DWC's "Everything You Want to Know About Cash Balance Plans" Webinar on Demand Here

Topics: Highly Compensated Employees, DWC, Cash Balance, Cash Balance Corner


See all

The views expressed in this blog are those of the authors and do not necessarily represent the views of any other person or organization. All content is provided for informational purposes only and is not intended to be tax or legal advice.