General Testing - One Employer with 2 Plans

[Rob P]

I know this has been discussed a few times, but I am hoping to just get a simply clarification.

The situation is that we have a law firm that sponsors two plans. One plan includes only partners and staff. The second plan includes only associates. The partner/staff plan allows for both 401(k) deferrals and ER ps contributions (new comp allocation). The associate plan only allows 401(k) deferrals.

The plans each satisfy the 410(b) ratio test on their own. Since aggregation is not required the associates have not been getting the top-heavy minimum.

It is my understanding that we must include both plans in the average benefits test, and if passed we get to use the mid-point for rate group testing.

Questions: When the general test is performed must both plans be included in determining whether each rate group passes? More specifically, do associates get included in the denominator for each rate group? I understand the numerator only includes those participants actually receiving a ps contribution.

I just want to make sure that I am not including the associates improperly in any tests that would deem this aggregation in some way and therefore require the associates to get a TH minimum. In this case, the inclusion of associates would greatly benefit the GT.

Any input is appreciated.

[John Feldt ERPA CPC QPA]

You are correct that the average benefits test includes both plans. The concentration percentage is determined and your midpoint is set (both plans' data combined).

When you test the rate groups for the plan that allows PS, you only consider the employees in that plan that you are testing. Thus, your NHCE denominator (for the numerator portion of the rate group test) will include all the NHCEs in that plan. Likewise, the HCE denominator (for the denominator portion of the rate group test) will include all the HCEs in that plan.

With that, you now have a feel for how component plan testing might work.

[Mike Preston]

Huh?

[John Feldt ERPA CPC QPA]

Good afternoon Mike. I suppose I misspoke?

[Rob P]

Hi John,

Thank you for responding. Apparently this was much more of an issue than I originally thought. I guess that’s why very few people felt comfortable responding. In the interim, I contacted a prominent ERISA attorney (a regular ASPPA speaker) and he was kind enough to go over the issues with me. This is what I found out:

1) If each plan satisfies the 410(b) ratio percentage test separately, then each plan needs to have a separate ADP test. Also, the Partner/Staff plan would be General tested (GT) and only count the employer contributions of the Partner/Staff plan in the numerators but include the Associate plan in the denominators. The kicker is that each rate group would need to pass at 70%, not the mid-point.

2) If we wanted to use the mid-point in the GT we would need to pass an Average Benefits test (ABT). Since the ABT is an aggregated test, that would also require us to pass one aggregated ADP test. However, if we pass the ABT, in the GT each rate group would only need to pass by the mid-point. As above, in the GT we would only count the employer contributions of the Partner/Staff plan in the numerators but include the Associate plan in the denominator.

I guess the bottom line is that regardless of how it's tested, the denominators in each rate group would include all plans of the employer.

His conclusion was that it did not matter if we aggregate for ABT (and a single ADP test). Since there is no key employee in the Associate plan, there would be no top heavy contribution requirement to that plan.

If I have misspoken I hope someone will correct me. Thanks again.

[John Feldt ERPA CPC QPA]

My response was without regard to any ADP testing. I will re-read your original post again and then go over your most recent post with that in mind.

[Mike Preston]

I'm just not connecting your dots with an actual example. Can you say what you said using a simple example, say 3 participants in PS Plan (1 HCE 2 NHCE). 4 excluded non-excludable NHCE's (kind of reminds me of the actuarial funding method "individual aggregate"). I get a concentration percentage of 85%, a midpoint of 26.25% and a safe-harbor %-age of 31.25%. So, ABPT must pass. If it does, then the coverage %-age of 33.33% works (presuming it is a reasonable classification), because 33% exceeds 31.25%, otherwise it fails. Now turning to the rate group testing presume that only one of the 2 NHCE's is in the HCE's rate group. Is the rate group testing (1/2)/(1/1) = 50%, which passes? Or is it (1/7)/(1/1) = 14%, which fails? I've always thought it fails, but as I read your description it seems to imply that the correct %-age is 50%, which passes. Am I misinterpreting what you wrote?

[Mike Preston]

The reason I didn't respond to the initial post is that I didn't have the time to properly explain the misunderstandings and hoped somebody else would point them out. Once the misunderstandings are ironed out the issue being addressed is properly classified as "hyper-technical" and worthy of a complete airing whenever it arises.

Let's skip the misunderstandings and go straight to the issue:

Does inclusion of the associates' plan in the ABPT of 1.410(b)-5 trigger 416(g)(2)(A)(i)(II)?

The short answer is no. The not-so-short answer is that this is such a hyper-technical issue that you can bank on needing to educate an IRS auditor who decides the answer should be yes. And that task is so potentially arduous (sometimes ending in "well, I guess you are just going to need to file for Tech Advice") that cautious (some would say overly conservative) advisors sometimes go through great lengths to "prove" the answer is "no." For example, some have been known to run the ABPT without the associates' plan, note that it "passes" and then declare "See, the ABPT passes without the associates' plan so there is no way to interpret the circumstances as invoking 416(g)(2)(A)(i)(II)". To those who do this sort of thing it bothers them not that the ABPT can't be run excluding the associates' plan because such a test isn't an ABPT. I don't know what it is, but it certainly isn't an ABPT because the ABPT *MUST* be run with all plans of the employer.

In any event, I think there is a Gray Book answer that addresses this issue, I just don't have time to look for it.

[John Feldt ERPA CPC QPA]

Mike,

I agree that getting an agent to agree regarding the lack of top heavy in the second plan can be difficult.

Back to your example, I agree and say it is (1/7)/(1/1) = 14%, which fails, as you stated.

I was not talking about the coverage test, though, which is where the reasonable business classification would apply. I was going for the 401(a)(4) test, not the coverage test.

With that in mind, a different example is what I am getting at:

Suppose you have 10 employees overall and 2 plans as well.

Plan A covers only HCE#1 and 5 NHCEs, includes PS.

Plan B covers only the others: HCE#2 (associate) and 3 NHCEs associates, but no PS.

Coverage passes ratio percent for both plans for all purposes:

A = (5/8)/(1/2) = 125%

B = (3/8)/(1/2) = 75%

Plan B provides no PS. Plan A does.

Isn't plan A's PS portion tested as follows:

Concentration percent = 80% (8/10), midpoint = 30%

If A has 2 of its 5 NHCEs whose benefit rates are at or above HCE#1, then plan A's 401a4 test is (2/5)/(1/1) = 40%, not (2/8)/(1/2). And, if the average benefits test (all employees, both plans) is over 70%, then Plan A is okay, right? That's what I was hoping to get at. If there's something amiss, however, please give a sound whack on the wrist and I will run laps if needed (no push-ups please).

[Rob P]

Sorry if I was not clear. Mike, there is there is no doubt in my mind that you know this stuff better than I do, and I am happy that you took the time to help out. In your example, you are correct and the rate group would fail. How it was explained to me was as follows:

Example 1 (no ABT, reach rate group must pass by 70%):

Partner/Staff Plan: 3 HCEs and 7 NHCEs

Associate Plan: 2 HCEs and 3 NHCEs

410(b) ratio test would be [(7/10)/(3/5)]=117% and [(3/10)/(2/5)]=75%, as such each pass coverage.

No requirement to do an ABT. So if I assume each HCE is in there own rate group in the GT an example of one rate group with the highest EBAR would be [(2/10)/(1/5)]=100% , in this rate group I would need at least 2 NHCEs with an EBAR equal to or greater than the HCE to pass at 70%.

Example 2 (use ABT, so I may use mid-point instead of 70%):

Partner/Staff Plan: 3 HCEs and 7 NHCEs

Associate Plan: 2 HCEs and 3 NHCEs

My ratio tests are greater than the SH%, and assume I pass the ABT. The concentration is 10/15 = 66%. SH%=45.5% and NSH%=35.50%. Therefore, the mid-point is 40.5%.

Using an example of the rate group for the HCE with the highest EBAR, I would need to have only 1 NHCE equal to or greater than the HCE to pass this rate group [(1/10)/(1/5)]=50%.

Comments:

On a side note, my original question was if I needed to aggregate the Associate Plan into the denominator; which was confirmed that you do. The ADP test comment was something that this attorney said to me so I thought I would just reiterate; if you aggregate for coverage (ABT) you need to aggregate for ADP. Also, thank you for confirming your understanding of the TH minimum requirements.

Thanks for your comments.

[Mike Preston]

"I was not talking about the coverage test, though, which is where the reasonable business classification would apply. I was going for the 401(a)(4) test, not the coverage test."

I was talking about the coverage test when I talked about a 33% coverage ratio. After that I switched to the 401(a)(4) test, more commonly known as the rate group test. That is the one that comes in at 14%, which you agreed with, so ......

"(2/8)/(1/2)" is what I think the 401(a)(4) test requires.

As you noted, most of the time passing it the way you described satisfies the rules, so those that do it that way end up on their feet.

No whacks or laps or push ups.

[Mike Preston]

Rob, your example is spot on. Couple of comments re: misunderstandings.

1) Almost everybody confuses the ABT with the ABPT. It is almost always clear, in context, which they mean so I have long ago given up explaining the difference every time the confusion arises. Sigh.

It is confused, in part, by the way the IRS uses the terms.

The ABPT is a numeric test that results in PASS or FAIL and revolves around 70%. We all know how to do the calcs.

The ABT is a test that incorporates 2 parts: the reasonable classification test and the ABPT. You have to pass BOTH to pass the ABT. Stated another way, passing the ABPT is a necessary but not sufficient component of satisfying the ABT.

To make things thoroughly confusing the IRS says that, when testing rate groups, you are deemed to satisfy the reasonable classification test so in this case, passing the ABPT is both a necessary and sufficient requirement.

Frequently an ABT isn't even required (note in your example your coverage ratio for both plans exceeds 70%) so the only time you would need to satisfy the ABT is for rate group analysis. In that case, people refer to either one and they would be right either way (see above comments re: necessary and sufficient).

'Nuff said.

2) "if you aggregate for coverage (ABT) you need to aggregate for ADP."

Just to clarify: the use of the parenthetical "(ABT)" is misleading. Yes, I agree if you aggregate for coverage you need to aggregate for ADP. But it is irrelevant whether you test your aggregated group at the 70% threshold or at the lower threshold one can use if the "plan" satisfies the ABT. And, as pointed out before, the ABT includes the ABPT and the ABPT is always performed by aggregating all plans of the employer and this aggregation for ABPT purposes does not in any way cause anything to be aggregated involuntarily.

[Rob P]

Thanks for clarifying. Hopefully this thread will be helpful to others. Sometimes when I try to over simplify I may not be as clear as I should. I generally get accused of being too detailed and wording.

Truly appreciate the help and comments from you and John.

[Tom Poje]

to clarify a comment made a few posts ago


"1) If each plan satisfies the 410(b) ratio percentage test separately, then each plan needs to have a separate ADP test"

I don't think I would word this quite this way - but rather

If each plans chooses to test 401(k) coverage separately, then each plan needs to have a separate ADP test.

(in other words, even if each plan satisfied 410(b) coverage separately there is no requirement to do so, they could be tested together, in which case the ADP test would be combined as well)