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Off Calendar Year Catch-Up Contributions


buckaroo
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I have a couple of issues related to catch-up contributions Below are a couple of examples and the associated questions:

Example 1: Due to the failure of the 04/05 ADP testing, Participant D (age 50+ on 12/31/05) must reduce his 04/05 deferrals by $1,900. To avoid a refund, the plan recharacterized $1,900 of his 05 contributions as CUC. The question is how does this recharacterization affect the 05/06 testing and refund requirements.

Participant D made the following deferrals:

1st Q 05 --- $3,400

2-4th Q 05 ---$14,600

1st Q 06 ---$ 3,500

The following applies to this example:

• Out of the $3,400 for 1st Q 05, $1,900 is CUC , the remaining $1,500 (3,400-1,900) is regular deferral

• For the last 3 quarters of 05, $2,100 (4,000 – 1,900) is CUC and $12,500 (14,600-2,100) is regular deferral

• For the 05/06 ADP testing, the amount of deferral is $16,000 (12,500+3,500)

• If the 05/06 ADP fails and D is due a refund, up to $3,500 of that refund could be avoided by recharacterizing as 06 CUC.

• No refund is required for D unless the 05/06 failure requires a refund larger than $3,500

1) Is this correct? (I think this is.)

2) Can a plan recharacterize catch-up contributions which have not been contributed yet? Take the example above except the only change is in the fourth and fifth bullet. It would be that that the plan requires a refund of $5,000 for the failure of the test for PYE 03/31/2006. Can the plan recharacterize the whole $5000 from the 2006 plan catch-up level? (Based on the idea that the participant would make additional 401(k) contributions during 2006.) I believe that this is not allowed because the only contributions made for the 1st quarter of the 2006 calendar year were $3,500 and you cannot reclassify more than was made in the portion of the calendar year that was contained in the plan year.

Now I am taking the example above and changing a few items. Below I have stated the revised example:

Example 2: Due to the failure of the 04/05 ADP testing, Participant D (age 50+ on 12/31/05) must reduce his 04/05 deferrals by $1,900. To avoid a refund, the plan recharacterized $1,900 of his 05 contributions as CUC. The question is how does this recharacterization affect the 05/06 testing and refund requirements.

Participant D made the following deferrals:

1st Q 05 --- $3,400

2-4th Q 05 ---$12,600

1st Q 06 ---$ 3,500

The following applies to this example:

• Out of the $3,400 for 1st Q 05, $1,900 is CUC , the remaining $1,500 (3,400-1,900) is regular deferral

• For the last 3 quarters of 05, $100 (4,000 – 2,000) is CUC and $12,500 (12,600-100) is regular deferral

• For the 05/06 ADP testing, the amount of deferral is $16,000 (12,500+3,500)

• The 05/06 ADP fails and D is due a refund of $4,000.

• Based on my assumptions above, $3,500 is recharacterized as 2006 CUC because that is all that was contributed in 2006 calendar.

• Based on my assumptions above, since we still have CUC available from 2005 ($2,000), I can recharacterize the remaining $1,500 as CUC for 2005 so the participant does not have to receive a refund.

3) Is this correct? Can I use the remaining 2005 CUC as a recharacterization of a refund for the 3/31/2006 PYE ADP/ACP test once I have exhausted the 2006?

Any citations would be greatly appreciated. Also, multiple opinions would also be appreciated.

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I think the regulations are silent on this issue. Very nice example, by the way. You might want to correct the mathematical errors, though, via editing. But the basic premise is well stated: can a 2006 catchup determination exceed the amount of deferrals made in the 2006 calendar year?

I think the answer is yes. I see nothing in the regulations that indicates otherwise. I see glimpses of language that supports it. Basically, the hallmark of the catch up determination is that it is made at the end of the plan year. For a calendar year plan, the catchup contributions are coincident with the calendar year limits. For a non-calendar year plan, the catchup contribution limits are determined with reference to the calendar year limits of the calendar year that the last day of the plan year falls within. While not completely clear, the language in 1.414(v)-1©(3) seems to be close to authorizing this:

"For purposes of determining the maximum amount of permitted catch-up contributions for a catch-up eligible participant, the determiantion of whether an elective deferral is a catch-up contribution is made as of the last day of the plan year.....".

This certainly seems to say that in your case, you determine the permitted catch-up contributions as of 3/31/2006 and if that amount is $4,000, then by golly, it is $4,000 whether the contributions that made the $4,000 required were made in calendar 2006 or 2005.

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Mike,

Thanks for your response. I am in the minority at my firm thinking that you could not reclassify what has not yet been deferred. You seem to support the position of my colleagues. ;)

Let me see if I can present two additional issues to you that may sway your opinion

1) What if the employee does not defer anything in the second calendar year? Wont he then have contributions being recharacterized for 2006 when he has not physically made contributions to 2006?

2) Next is his W-2 will show 0 for the 2006 year. If the client gets audited and actually checks his W-2 for the deferral amounts, the ADP/ACP test, and the re-charaterized amounts, then, again, he'll have contributions being recharacterized for 2006 when he has not physically made contributions to 2006?

Does this sway you at all or am I just off-base here?

As always, thakns for your help.

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Neither. I see your position and I understand it. I just feel that the general interpretation of the regulation supports the alternate view a tad bit better. Your view is based purely on logic. <g> That won't get you anywhere!

I see no problem with the extrapolation. In for a penny, in for a pound. Or something like that. Whether it is $3,500 contributed in 2006 and a catch-up determination of $4,000 or $0 contributed in 2006 and a catch-up determination of $4,000 matters not to me. They are functionally identical. If I would have had a problem with the extrapolation I would have had a problem with the initial facts.

Note that my interpretation is a bit less favorable to the participant than yours, if you are effectively borrowing from 2005 (rather than insisting a refund must be made). You would then be using a portion of the unused 2005 catchups and leave the 2006 catchups at $3,500. Looking at the next 9 months you would let your hypothetical participant enjoy additional catchups for 2006. In my interpretation, the participant loses that $500 for the balance of the 2006 year.

Of course, if your interpretation requires a refund, you are taking the most disadvantageous position possible for the participant, but you at least still get the $500 for use in the next 9 months.

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Boy, I would think the conservative position should be Buckaroo's position. The reg section Mike sited relates to "timing."

It would seem to me that if the intent was to classify catch-ups only on a plan year basis, then couldn't we have simplified the 402g catch-up determination on a plan year end basis - w/o regard to the most recent calendar year end? The regs wouldn't have used the term "taxable years" to determine the catch-up limits.

It's my vote that you need deferrals during a taxable year so that they may be classified as catch-ups.

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enough already! read example 5 of the regs! There are 5 points to this.

plan year is 11/1/05 - 10/31/06

(i). ee deferred 3200 from 11/1/05 - 12/31/05 and 16,000 from 1/1/06 - 10/31/06

so he has 19,200 for the PLAN YEAR

(ii) oh no, he exceeded the 402(g) limit in 2006 of 15,000. thus 1000 is automatically counted as catch up.

so for testing purposes only 18,200 is used in the ADP test

(iii) oh no ADP test. he can only have 14,800 for the PLAN YEAR

(iv) thus 18,200 - 14,800 = 3400 in catch up

(v) THIS IS THE CRITICAL ONE. REPEAT. THIS IS THE CRITICAL ONE.

ee can defer an additional 600 in calendar year 2006 because he has only used up 4400 in catch up.

NOW READ THE LAST SENTENCE

the 600 in catch will NOT (I repeat) will NOT be taken into account for the plan year ending 10/31/07.

the emphasis might be mine, but the example is the regs. end discussion!

conclusion: he deferred 600 in 2006 (not 2007) yet it is still treated as catch up in 2007.

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Tom, you're the moderator and can certainly end the conversation.

But I don't think the question is whether the $600 will be considered catch-up for the next plan year. I think the question is, if this person stopped contributions by 12/31/06 contributing the full $20k (which he must to get the $600 catch-ups) and he is subject to an adp refund come 10/31/07 of say $1,000, would the $1,000 also be considered catch-up for plan year ending 10/31/07?

I think this is rarely an issue because such a person is unlikely to be subject to a refund. We also don't normally see 401k plan years ending early in the year.

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The only way Tom can end the discussion is to lock the thread. I don't think he is close to actually doing that (besides, I could unlock it :lol: )

Tom, I don't see where the example you cite gives any guidance on this issue.

Rlb, I don't see where the regulations specifically agree with your assertion that providing FOR the refund is the conservative course of action. If there shouldn't be a refund, then making one is a violation of the catch-up rules.

At this point, it seems to me that EITHER interpretation is reasonable and as long as a plan sponsor didn't flip-flop on the interpretation in consecutive years should be immune from attack. **NOTE BY MBP - I no longer hold this opinion. See the balance of this thread**

That is, unless somebody comes up with something that tips the scales one way or the other more definitively than what we've collectively come up with so far.

I did note the following from the 2003 Grey Book:

Company X sponsors a 401(k) plan with a July 1 – June 30 plan year. The plan limits contributions to 5% of each month’s pay. The plan begins offering employees the opportunity to make catch-up contributions on July 1, 2002. The plan allows catch-up eligible employees to make contributions in excess of the plan limits by specifying a dollar amount of additional contributions each month.

An employee with an annual rate of pay of $192,000 begins participating in plan on July 1, 2002. He elects to defer 5% of pay of each month’s pay, plus an additional $100 per month. From July 1 to December 31, 2002, the employee defers $4,800 plus an additional $600. The $600 in excess of the plan limit is treated as a catch up contribution for the calendar year in which the plan year ends, or 2003.

The employee quits on December 31, 2002 and goes to work for an unrelated company, Company Y that sponsors a calendar year 401(k) plan. The employee elects to defer a total of $14,000 during 2003 (including a $2,000 catch-up contribution).

Has the employee violated 402(g) for 2003?

RESPONSE

No. Although the employer treated the $600 deposited between July 1 and December 31, 2002 as a 2003 catch-up contribution, the employee treats it as a 2002 deferral. The individual’s limit is determined separately from the limit determined by the plan(s). Unrelated employers are not required to aggregate deferrals under the catch-up rules.

==============================================================

Doesn't that lean in my direction?

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my response was to only answer the question that was posed as follows from above:

1) What if the employee does not defer anything in the second calendar year? Wont he then have contributions being recharacterized for 2006 when he has not physically made contributions to 2006?

2) Next is his W-2 will show 0 for the 2006 year. If the client gets audited and actually checks his W-2 for the deferral amounts, the ADP/ACP test, and the re-charaterized amounts, then, again, he'll have contributions being recharacterized for 2006 when he has not physically made contributions to 2006?

the example from the regs is simply one year different from the question posed above. ee deferred 600 from 11/1/06 - 12/31/06. no mention is made of what took place in 2007. yet the 600 is still treated as catch up for the plan year ending 10/31/07. thus, even if the ee defers nothing in 2007 (the second calendar year), and thus his w-2 will show 0 deferrals, he still had something treated as 'catch-up' for the plan year ending in 2007 - that is - amounts that can not be used in the ADP test. (Of course, this 600 is not applied to the calendar year 2007)

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Even though I agree with your conclusion, I don't see your logic in the last post. The example in the regs indicates that the balance of the 2006 catch-up allowance ($600) will be excluded from the ADP test done as of 10/31/07. What we were talking about was whether (using this example as a base) $600 could be used to eliminate a refund even if the $600 wasn't treated as a catchup in 2006. Slightly different fact pattern.

Nonetheless, in re-reading 1.414(v)-1©(3), I'm convinced that the only reasonable interpretation is to treat the amounts deferred in 2005 (as originally posited by the OP) as catchups in 2006 even though there are zero actual deferrals in 2006. I asked the question of an ERISA attorney (who shall remain nameless unless he/she gives me permission to identify him/her by name) and s/he was quick to say that this is the correct result.

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All: I want to thank you all for your continued efforts to help me understand this issue. I apologize if I ruffled some feathers, but I was just trying to understand the topic and the disconnect in my thought process.

Tom,

I appreciate your response and you really know how to end a conversation:) I am sorry if you felt my comments questions were not intelligent. I am just trying to make sure that I understand.

Mike,

I want to apologize for sending you the private message. I did not realize that it was genrally not accepted as I sent them to you and Tom for the first time. I believe that your time is very valuable and I would not want to take you away from the more pressing issues that you have. I will refrain from doing so again.

Finally, I have a related scenario. It does not question the method, but more how something is not a violation.

Ptp is a member of Company A with a plan of 2/1/2005 -- 1/31/2006. He contributes 14,000 from 2/1/2005 -- 12/31/2005. He does not contribute anything in 1/1/2006 -- 1/31/2006. The client runs the ADP for 2/1/2005 -- 1/31/2006 and it fails and he needs a refund of 5,000. Since he is catch-up eligible, it is recharacterized. He then quits his job on 2/1/2006 and joins Company B with a calendar year plan with immediate entry. He then contributes 20,500 to the new plan for 2/1/2006 -- 12/31/2006. The new employer would take a catch-up of 5,000 from his 20,500. He would receive two W-2s: one from the Company A showing 0 deferred and one from Company B showing 20,500 deferred. It appears from this example he would have 10,000 of catch-up. Company B would not know about the recharacterization in Company A's plan and the ptp would not know because ptps are not informed that their recharacterization. (At least we never have informed a ptp directly and I do not think a client would.) How does this get caught? How is he prevented from exceeding the catch-up limit?

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Again, I am confused. If the 2/1/2005 -- 1/31/2006 Plan Year fails the test and the $5,000 refund is recharacterized as catch-up, then he has met his $5,000 catch-up limit for 2006. Then he contributes 20,500 to the new employers plan from 2/1/2006 -- 12/31/2006. He now needs to have $5,000 recaharacterized as catch-up because Employer B has allowed him to defer $20,500 and does not know about the previous employer's test failure.

In this case, he has had $5,000 recahracterized by Employer A's plan that failed the ADP/ACP for PYE 1/31/2006. (This is a 2006 catch-up.)

He then has an additional $5,000 recharacterized by Employer B's plan dues to him exceeding 402(g) for PYE 12/31/2006. (This is also a 2006 catch-up.)

Now he has recharacterized $10,000 as catch-up. How does this not violate the catch-up limit? Please explain.

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  • 1 month later...

Mike - similar but not related.....we're trying to maximize the owner in a small off calendar plan year. Owner over age 50 contributed $16943 in 401(k) deferrals for the 2006/2007 plan year.

To maximize his profit share amount, am I correct in thinking: 415 limit is $45000 - I can't work off of the total with catchup ($50,000) because he didn't contribute the whole catchup amount, is that right?

Can I add the amount over $15,500 and then would have an overall total of $46,443 leaving me $29,500 for ps?

I know this should be basic, but I can't get my arms around it today!

Thanks in advance.

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If deferrals are as follows:

1st Q 05 --- $3,400

2-4th Q 05 ---$14,600

1st Q 06 ---$ 3,500

And the ADP test failed in the 3/31/05 plan year, then we have another problem that no one has yet mentioned:

The individual deferred $18,000 in 2005, which exceeds 402g by $4,000. But they had already exceeded the ADP limit by $1,900 in 2005. Therefore, the employees has 402(g) excess of $1,900.

What say everyone else? I'm concerned that no one else mentioned this--am I missing something? I've been reducing my client's max 401(k) limits by the amount reclassified as catch-ups in this scenario. For for example, I would've told this client the max they can defer in 2005 is $16,100 ($18,000 - 1,900). To NOT do this completely negates the point of the ADP test. In other words, if every year they get to defer the full max, then really the only applicable limit is 402g.

Looks like Buckaroo and I are on the same page...

Austin Powers, CPA, QPA, ERPA

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Mike - similar but not related.....we're trying to maximize the owner in a small off calendar plan year. Owner over age 50 contributed $16943 in 401(k) deferrals for the 2006/2007 plan year.

To maximize his profit share amount, am I correct in thinking: 415 limit is $45000 - I can't work off of the total with catchup ($50,000) because he didn't contribute the whole catchup amount, is that right?

Can I add the amount over $15,500 and then would have an overall total of $46,443 leaving me $29,500 for ps?

I know this should be basic, but I can't get my arms around it today!

Thanks in advance.

This issue is not an easy one to get ones arms around. My reading of the regs is that it matters not where the annual addition comes from, you can recharacterize elective deferrals as catchups if needed. The IRS seemed to have a little hiccup over the issue at the ASPPA annual conference in 2006. You might want to listen to the tape of the final session. They are concerned that a plan sponsor could contribute $1 (above the $29,500 in your example) and "turn" a regular deferral $ into a catch-up. Even Sal's outlines and worksheets on the issue are ambiguous on whether this is allowable. So, we are back to our own reading of the regs. I see nothing that prohibits it and I give my clients a choice when the issue comes up (believe it or not, it actually has!).

So, I believe you should be able to work off of $50,000. But it is worth noting that there is at least somebody at the IRS who has, consistent with your initial comment, pretty short arms.

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Austin, <loudspeaker invoked> Step away from the plan. <loudspeaker turned off>.

Now that you are away from the plan, just look at what this individual deferred in 2005. $18k, right? Isn't that the limit for that year? From a personal perspective, he has contributed no more than the max allowed for the calendar year.

Now, back to the plan. That, too, doesn't have a violation in any year, so all is well.

I really don't see the issue.

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Well, I think I'm amending all my plan's with ADP troubles to fiscal year-ends as soon as possible.

Calendar Year Plans:

Participant contributes $20,000.

ADP Test fails, needing refunds of $1,800.

Because participant is already maxed out, cash refunds are required.

Off-Calendar Year Plan, 9/30/07 year end:

Participant contributes 10,000 in September 2007.

ADP test fails for 9/30/07, requiring refunds of $1,800, all of which are recharacterized as catch-ups.

Based on what you're telling me, participant can now defer another $10,500, bringing his total deferrals to $20,500 for all of 2007, thereby using an additional $5,000 of catch-ups. So, participant was allowed to exceed ADP limit by $1,800 and 402g limit by $5,000.

So now for the 9/30/08 Plan Year, participant has only the 10,500 deferred in the 4th quarter of 07, and the test fails again in 9/30/08, requiring "refunds" of $1,800. Most people agreed above that you could avoid the $1,800 refund by reclassifying as catch-ups. And now, once again, I can do a contribution in the 4th quarter of 08 equal to 20,500 to max.

So I've completely circumvented the ADP test for two calendar years.

Austin Powers, CPA, QPA, ERPA

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Although I think the regulations are WRONG (as evidened by the fact that a failure in a fiscal year plan results in the HCE being able to max out his 402(g), while an HCE in a calendar year plan will NEVER have that opportunity), I concede that the regulations do in fact state as much. Although it is somewhat buried, in Example 5 of the 414v regs, the HCE who failed the test was able to contribute the full 402(g) limit, despite the fact that some of his contributions were reclassified as catch-ups.

Austin Powers, CPA, QPA, ERPA

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I think there is a slight misconception. In your calendar year plan, the max allowed by ADP is 402(g)-1800, which if catchups allowed in that year are 5k, means the person can contribute all that the ADP allows, plus 5000 more. The same thing happens "to" the HCE that decides to put in money in a non-calendar year plan to the tune of 1800 more than the max allowable. Because of the effect of "rollover" you are stating that the individual never suffers. But carry it to the extreme, where the amount rolled, when added to the amount deferred again goes over the allowable limit.

Do you get a spillover effect of "one 402(g)" limit? Sure you do. I am hopeful that this would not be enough of a reason to have a non-calendar year k plan, though, because frankly, they are a bit of a struggle to deal with.

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