Jump to content

Allocations in Excess of 415 Limit


Gruegen
 Share

Recommended Posts

A participant (under age 50) makes 401(k) contributions and receives matching contributions each payroll period during the 2011 plan year. The total 401(k) and matching contributions equals $33,000. In March, 2012, the company declares a profit sharing contribution for the 2011 plan year. Under the terms of the plan document, the participant would be entitled to a $20,000 profit sharing allocation for the 2011 plan year. Such profit sharing allocation would cause his 415© annual additions limit to be exceeded by $4,000.

Can the employer knowlingly allocate the $20,000 profit sharing contribution in March, 2012 (attributable to the 2011 plan year), and then use the correction methodology under the Final 415 Regulations (EPCRS) to issue a refund of $4,000 of 401(k) contributions? Or, must the 2011 profit sharing contribution be limited to $16,000 prior to it being funded to the participant's account?

Link to comment
Share on other sites

Yes, without language in the profit sharing formula stating the contributions will be curtailed at the 415 limit, then they can. Typically, qualified plans must make it impossible to exceed 415. However, when you "failed to limit the amounts an employee may defer", then you may proceed with allocating pursuant to the plan's formula and then correct the 415 excess under the terms of the plan (presumbly by distributing deferrals (and forfeiting attributable match) first. Some plan documents state you'd forfeit Profit Sharing first.

I would say the key here is the read your plan closely and understand that the employer isn't exercising any discretion with respect to who receives what. Once the contribution is determined, then you must follow the terms of the plan.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

Link to comment
Share on other sites

Since actually paid in 2012, why don't they rescind their allocation resolution and do a new resolution making part of the contribution an advance for 2012?

(caveat - there is one school of thought that says once a resolution is made, it creates an enforceable obligation to make that contribution for the prior year. However, since it will be an excess that can't be allocated, then I wouldn't think this is much of a risk, unless the plan allocation method gives some of that excess to other NHC participants. Even then, this may be deemed an acceptable "risk" - if it seen to be a risk at all.)

Link to comment
Share on other sites

How do you correct the excess under the terms of the plan when the plan is required to provide that there will be no excess?

VCP submission under EPCRS.

And get the document drafted differently. As the conversation here is making clear there are ways to make this work better then a VCP but it needs to be in the document.

Link to comment
Share on other sites

Let me venture a response to my question. If the plan has a detailed priority for reduction of allocations to avoid an excess contributions, the VCP people might allow a correction that respected those reductions because if the plan terms had been followed, the participant would have been in that position. One issue with that thought is that if elective contributions have a priority for being reduced, as a practical matter that will not work unless the plan knows some time in advance what all the other contributions will be for the year. Elective contributions are already deposited by year-end and cannot be reduced after the deposit. The best practical candidate for reduction is the discretionary employer contribution that is determined after the end of the year. But that is not the most desirable reduction for the participant.

Link to comment
Share on other sites

but see examples 22 and 23 of Appendix B.

no mention is made that "since deferrals were deposited before the nonelective they can't come out first"

Appendix B refers back to Appendix A.08

last sentence reads

For limitationm years beginning on or after 1/1/2009, the failure to limit annual additions allocated to participants in a dc plan as required in section 415 is corrected in accordance with section 6.06(2) and (3)

[which would be the retun of deferrals first]

so unless the plan is specific and says the 'nonelective' will be capped...

this was possible under the old regs 1.415-1(d)(2)

Link to comment
Share on other sites

ESOP Guy: Please explain. I do not see how plan terms could have any effect on dealing with an excess. Having an excess means that plan terms to avoid the excess have been disregared.

See Erisa's reply...

If I understand what he is saying he is saying what I see all the time. I have seen plans that say something to the effect: If annual additions exceed the 415 limit you reduce the annual additions and then it gives the order of reduction.

I have seen plenty of ESOP companies with 401(k) plans in which both plans say if annual additions exceed the 415 limit you make the correction from the 401(k) plan, and that plan says you take 401(k) deferrals out as the first source. (To keep it simple assume no match so one doesn't have to worry about forf match on returned def.)

In short I have seen plenty of plans that are drafted such that the employee money is sent back first and only after that employer money is taken from an account in case of 415 failer:

Simple example:

In the ESOP because of the large loan payments A gets $40,000 in annual additions and that person also defered $16,500 for 2011. The combination of plan provisions are written such that the 401(k) plan would give back 401(k) deferrals to get this person under $49k. We tend to call that writing the plans so it maximizes everyone gets the most "free money". I have seen PS plans that are 4k plans also have the same provisions within the plan-- 4k back first.

I have never heard an objection to that method. I will admit it has been years since I have had this kind of conversation also.

Link to comment
Share on other sites

The problem is not with the correction and I did not say the correction under VCP could not involve priority to deferrals. The problem is with the plan terms. Detailed plan terms concerning priority of reductions have to provide for the reductions to be effected before amounts are deposited to the plan. The old regulations allowed adjustments after deposit. That does not work any more. It is very difficult to reduce elective deferrals before deposit accurately unless all the other contributions are known (except the match that goes with the deferrals unless the match is discretionary). Discretionary contributions are usually not determined until after the end of the year. All deferral amounts are determined and deposited by then. Plan terms are supposed to work to prevent violation. The same terms do not necessarily work very well to inform correction of a violation.

Link to comment
Share on other sites

To me the new rules just seem silly in most applications. The old rules that allowed for a 415 excesss without VCP were much better in my humble opinion. The new rules just seem to punish a plan that has a good year, makes a large PS (or ESOP) contribution and pushes someone past the 415 limit simply because tehy deferred the max 402(g) limit. I mean there are built in mechinisms for refunds for 402(g), ADP & ACP, why not 415? Though I will say with the increased 415 limit to 100% of pay under EGTRRA, we see these 415 excesses far less frequently than when the old 25% pay limit would kick in.

I guess the IRS had some logic for eliminating the built in correct in the EGTRRA cycle but damned if I know what it was. So unless the IRS changes it back you either limit allocations by plan doc to avoid the excess in the first place, which seems to punish savers, or do the refund under VCP.

Link to comment
Share on other sites

One reason for the change is tha the old regulations were being applied inappropriately. They did not provide for the employer to dump all contributions in the plan and then sort it out later, but that is the way too many people understood them (or applied them, no matter what the understanding). An employer can do that once under VCP, but then has to clean up its act.

Link to comment
Share on other sites

QDRO-- as a rule you tend to know this stuff really well, but in this case I can't find anything that talks about you can't fix def because they are already in the plan.

Can you point me in the right direction?

I have looked at Sal's book, read rev proc 2008-560, I even found this IRS webpage that was last reviewed/updated a few days ago and none of them seem to be saying what you are saying. I am not saying you are wrong, I am saying you are normally right but I would like to read more and can't find that "more".

http://www.irs.gov/retirement/article/0,,id=204360,00.html

Link to comment
Share on other sites

The plan document for this client does not include any verbiage requiring the profit sharing contribution to be limited by IRC 415©. As such, if the plan sponsor allocates the full $20,000 profit sharing, could the $4,000 excess annual addition be corrected under the Self-Correction Program, rather than VCP?

Link to comment
Share on other sites

The section 415 regulations require the plan to have terms that prevent a 415 excess. If the the plan has a 415 excess (money in the plan), it has violated plan terms. The old 415 regulations that allow a plan to correct the excess in certain cases by certain means (distribution, suspense accounts) are no longer available. That leaves VCP as the only way to correct. The IRS reviewers are going overboard in their checklist approach to plan tems. Some of them will not allow any correction language in the plan unless it specifically references EPCRS by number. They even reject correction "in accordance with applicable IRS procedures." That is merely the determination letter position, but it reflects the IRS thinking. The reviewers are so simplistic that they reject plan terms that provide for adjustment to contribution or allocation amounts before the actual delivery of trhe contribution. They back off when it is shown the "correction" is outside the plan before the funds are delivered.

Link to comment
Share on other sites

Thought it might be useful to have the RP 2008-50 language from 6 (.06)(2) handy.

Tom - I've got a question re your response. I'm not clear from this whole discourse what the plan language here really says. I'm guessing that it has an allocation formula that provides that once a person has received annual additions up to their 415 maximum, that the remaining contribution is allocated to other participants? If so, and if there is still left over money, then it must be corrected as per RP 2008-50 - so in this situation, once the allocation is complete, the remaining money is allocated, causing 415 violations, then the deferrals are refunded first to those participants who deferred? Is that what you are saying, or am I misunderstanding? Thanks.

QDRO - I'm uncertain about something in your last response. Yes, the plans require that a 415 excess be corrected in accordance with RP 2008-50. But doesn't that allow for SCP? Why do you say it is VCP only? P.S. - correction of a 415 excess is specifically used as an example in SCP under Section 8.

(2) Correction of Excess Allocations. In general, an Excess Allocation, as defined in section 5.01(3)(a) of this revenue procedure, is corrected in accordance with the Reduction of Account Balance Correction Method set forth in this paragraph. Under this method, the account balance of an employee who received an Excess Allocation is reduced by the Excess Allocation (adjusted for earnings). If the Excess Allocation would have been allocated to other employees in the year of the failure had the failure not occurred, then that amount (adjusted for earnings) is reallocated to those employees in accordance with the plan’s allocation formula. If the improperly allocated amount would not have been allocated to other employees absent the failure, that amount (adjusted for earnings) is placed in a separate account that is not allocated on behalf of any participant or beneficiary (an unallocated account) established for the purpose of holding Excess Allocations, adjusted for earnings, to be used to reduce employer contributions (other than elective deferrals) in the current year or succeeding year(s). While such amounts remain in the unallocated account, the employer is not permitted to make contributions to the plan other than elective deferrals. Excess Allocations that are attributable to elective deferrals or after-tax employee contributions, (along with earnings attributable thereto) must be distributed to the participant. For qualification purposes, an Excess Allocation that is corrected pursuant to this paragraph is disregarded for purposes of § 402(g), § 415, the actual deferral percentage test of § 401(k)(3), and the actual contribution percentage test of § 401(m)(2). If an Excess Allocation resulting from a violation of § 415 consists of annual additions attributable to both employer contributions and elective deferrals or after-tax employee contributions, then the correction of the Excess Allocation is completed by first distributing the unmatched employee’s after-tax contributions (adjusted for earnings) and then the unmatched employee’s elective deferrals (adjusted for earnings). If any excess remains, and is attributable to either elective deferrals or after-tax employee contributions that are matched, the excess is apportioned first to after-tax employee contributions with the associated matching employer contributions and then to elective deferrals with the associated matching employer contributions. Any matching contribution or nonelective employer contribution (adjusted for earnings) which constitutes an Excess Allocation is then forfeited and placed in an unallocated account established for the purpose of holding Excess Allocations to be used to reduce employer contributions in the current year and succeeding year(s). Such unallocated account is adjusted for earnings. While such amounts remain in the unallocated account, the employer is not permitted to make contributions (other than elective deferrals) to the plan.

Link to comment
Share on other sites

that's the problem, I have no idea what the document language is.

again, the old regs said you could write the document to say "the nonelective will be capped to prevent a 415 limit, w/o causing discrimination issues"

on the other hand, if the document simply states no one will receive above the 415 limit, I think its a different issue.

The EPCRS example 22 is

7500 nonelective

10000 deferral

500 after tax

total contrib 18000

because of comp, 415 c limit is 15,000.

so excess is 3000.

the example does not say The nonelective was improper, it violated the terms of the document, you need to reallocate the excess to other NHCEs, rather the example says 500 after tax plus 2500 deferral (all adjusted for earnings) are distributed.

I vaguely (but only vaguely) recall at one of the ASPPA Conferences the IRS saying if you alloacte a 5% profit sharing to employees and limit someone to the 415 limit without language indicating that is how the alloaction will be performed when someone hits the limit then you violate the terms of the document in regards to the formula.

Link to comment
Share on other sites

I was incorrect to state that VCP is all that is available. I should have identified EPCRS in all instances. An important point under EPCRS is that you cannot use it year after year for section 415 problems. The plan is required to fix systemic problems as a condition of correcting under EPCRS.

Link to comment
Share on other sites

I'd agree with that. In fact, that is the basis of EPCRS, that procedures are in place to prevent the things from happening over and over.

And in you self correct, there is no 100% guarantee your method will be accepted.

I think other factors come into play.

for instance I would imagine it is less likely a problem if all employees receive the same % of contribution, or if the total contribution was something like a nice round 200,000.

on the other hand if it is a cross tested plan, and its an HCE that is involved it might not look as good.

still, at the end of the day, the person ends up at 49,000 for the year. if he receives 5000 additional profit sharing then he receives a distribution of 5000 and pays taxes on it.

If you limit the profit so there is no excess, he is still at 49,000, and the company puts in 5000 less, so the company pays the taxes (I guess)

I should have pointed out in example 22 there is a secong person with excess. And instead of distributiong deferrals, the nonelective (because the person was 0% vested) was forfeited.

so same situation for 2 people, one was handled one way and the other was handled another way - both methods in EPCRS.

oh well, someday soon hopefully they will release a new EPCRS (they have promised with language about correcting missed safe harbor notices, etc.) and we will see if the 415 limit example is still there.

Link to comment
Share on other sites

Thank you both. And FWIW, here's the language from RP 2008-50, section 8 under SCP for insignificant errors.

04 Examples. The following examples illustrate the application of this section 8. It is assumed, in each example, that the eligibility requirements of section 4 relating to SCP (for example, the requirements of section 4.04 relating to established practices and procedures) have been satisfied and that no Operational Failures occurred other than the Operational Failures identified below.

Example 1: In 1991, Employer X established Plan A, a profit-sharing plan that satisfies the requirements of § 401(a) in form. In 2005, the benefits of 50 of the 250 participants in Plan A were limited by § 415©. However, when the Service examined Plan A in 2008, it discovered that, during the 2005 limitation year, the annual additions allocated to the accounts of 3 of these employees exceeded the maximum limitations under § 415©. Employer X contributed $3,500,000 to the plan for the plan year. The amount of the excesses totaled $4,550. Under these facts, because the number of participants affected by the failure relative to the total number of participants who could have been affected by the failure, and the monetary amount of the failure relative to the total employer contribution to the plan for the 2005 plan year, are insignificant, the § 415© failure in Plan A that occurred in 2005 would be eligible for correction under this section 8.

Example 2: The facts are the same as in Example 1, except that the failure to satisfy § 415 occurred during each of the 2005 and 2007 limitation years. In addition, the three participants affected by the § 415 failure were not identical each year. The fact that the § 415 failures occurred during more than one limitation year did not cause the failures to be significant; accordingly, the failures are still eligible for correction under this section 8.

Example 3: The facts are the same as in Example 1, except that the annual additions of 18 of the 50 employees whose benefits were limited by § 415© nevertheless exceeded the maximum limitations under § 415© during the 2005 limitation year, and the amount of the excesses ranged from $1,000 to $9,000, and totaled $150,000. Under these facts, taking into account the number of participants affected by the failure relative to the total number of participants who could have been affected by the failure for the 2005 limitation year (and the monetary amount of the failure relative to the total employer contribution), the failure is significant. Accordingly, the § 415© failure in Plan A that occurred in 2005 is ineligible for correction under this section 8 as an insignificant failure.

Link to comment
Share on other sites

I really don't want to beat the dead horse here, but this stopped being a theory question and now is a practical question. I just had a client who simply put too much money into the plan. If we allocate it all some of the HCEs would be over the 415 limit.

If I understand some of you we can't refund with earnings 401(k) money, but have to stop allocating PS money.

Why do you guys think that? Can you quote something or give me a specific cite?

I keep going back to the document, the IRS site I linked to earlier. This is the example from rev proc 2008-50 here:

Example 22:

Employer G maintains a § 401(k) plan. The plan provides for nonelective employer contributions, elective deferrals, and after-tax employee contributions. The plan provides that the nonelective contributions vest under a 5-year cliff vesting schedule. The plan provides that when an employee terminates employment, the employee's nonvested account balance is forfeited five years after adistribution of the employee's vested account balance and that forfeitures are used to reduce employer contributions. For the 1998 limitation year, the annual additions made on behalf of two nonhighly compensated employees in the plan, Employees T and U, exceeded the limit in § 415©. For the 1998 limitation year, Employee T had § 415 compensation of $60,000, and, accordingly, a § 415©(1)(B) limit of $15,000. Employee T made elective deferrals and after-tax employee contributions. For the 1998 limitation year, Employee U had § 415 compensation of $40,000, and, accordingly, a § 415©(1)(B) limit of $10,000. Employee U made elective deferrals. Also, on January 1, 1999, Employee U, who had three years of service with Employer G, terminated his employment and received his entire vested account balance (which consisted of his elective deferrals). The annual additions for Employees T and U consisted of:

T U

Nonelective

Contributions $ 7,500 $ 4,500

Elective 10,000 5,800

Deferrals

After-tax

Contributions 500 0

_______ _______

Total Contributions $18,000 $ 10,300

§ 415© Limit $15,000 $ 10,000

§ 415© Excess $ 3,000 $ 300

Correction:

Employer G uses the Appendix A correction method to correct the § 415© excess with respect to Employee T (i.e., $3,000). Thus, a distribution of plan assets (and corresponding reduction of the account balance) consisting of $500 (adjusted for earnings) of after-tax employee contributions and $2,500 (adjusted for earnings) of elective deferrals is made to Employee T. Employer G uses the forfeiture correction method to correct the § 415© excess with respect to Employee U. Thus, the § 415© excess is deemed to consist solely of the nonelective contributions. Accordingly, Employee U's nonvested account balance is reduced by $300 (adjusted for earnings) which is placed in an unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to reduce employer contributions in succeeding year(s). After correction, it is determined that the ADP and ACP tests for 1998 were satisfied.

I just don't see where you guys are getting your idea from. Not saying you are wrong, I am worried you are right and I am wrong.

But what are you reading that I am not reading?

Link to comment
Share on other sites

again, you might be stuck by the terms of the document

the old Corbel language (this was back when the limit was only 30,000 or 25% of comp, but it was simply the first thing I opened on the computer)

If the Employer contribution that would otherwise be contributed or allocated to the Participant's accounts would

cause the "annual additions" for the "limitation year" to exceed the maximum "annual additions," the amount contributed or allocated will be reduced so that the "annual additions" for the "limitation year" will equal the maximum "annual additions," and any amount in excess of the maximum "annual additions," which would have been allocated to such Participant may be allocated to other Participants.

with language like that I would say NO you can't do what you want to do - its pretty specific how to handle.

but absence language like that it makes no sense to me the IRS would even provide a couple of examples in which excess deferrals are returned.

or put another way, you have an clear example in EPCRS. self correcting does not guarantee the IRS will accept it if the plan was audited, but if you followed the guidelines, its my understanding they are less likely to frown upon it.

Link to comment
Share on other sites

Perhaps there is a misunderstanding about what is considered wrong. I don't think anyone has argued about correcting a 415 excess under EPCRS. In at least one post I mistakenly used "VCP" when I should have used "EPCRS."

It is wrong to think that EPCRS under 2008-50 is available to cover corrections year after year. The IRS posted its power point slides and its program on EPCRS correction in which it confirms that the correction is a one-time opportunity and the problem has to be fixed to prevent subsequent excesses.

Outside of EPCRS you cannot correct an excess by distribution or otherwise. Do you dispute that? With respect to reductions of contribution amounts before actual contribution (the method required by the regulations), it is impractical to try to reduce elective deferrals unless you know very early in the year that there will be a section 415 excess and who will be affected.

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
 Share

×
×
  • Create New...