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Pro-Rata Allocation and Gateway Test


emmetttrudy

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401k plan ha a new comp design. But the testing doesnt really work out well. So instead they want to do a pro-rata allocation. There are 5 keys and 2 NHCEs. One of the NHCEs terminated part of the way through the year and has not met the allocation requirements (1,000 hour and last day).

Assume all 5 keys and the 1 NHCE who is still active receive 15% of compensation as a PS contiribution. The terminated NHCE receives 3% SH nonelective. Must he also receive a 2% PS contribution to get him to the Gateway? Or because they are foregoing using the new comp testing, do they not need to worry about the Gateway test and the 1 terminated NHCE can jsut receive the 3% SH?

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The problem you're having is that 100% of the HCEs receive 15% and only 50% of the NHCEs receive that rate. Therefore, that formula fails to pass 410(b) by used of the coverage ratio test on the allocation. You can attempt to cross-test the plan, but must satisfy the gateway into cross-testing before you use the cross-tested rates. Even then, the HCEs would need a signficant age advantage over the NHCEs in order to pass (but that's done with your mathematical analysis). But, to answer your question, you'd likely need the gateway since you'd likely need to cross-test the plan.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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What about the ABT for coverage. If the NHCE getting 15% is very young, it may be possible that the ABPT is >70%. And the safe harbor percentage at that point is 50%... and no cross-testing "yet", so no gateway "yet".

If you're not cross-testing, then why would it matter that the NHCE receiving 15% is very young? You'd need the gateway :D

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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at the 2009 ASPPA Conference they said (Q and A 44) the IRS response was:

"No. There is no gateway requirement for a general tested plan under Treas. Reg.

§1.410(b)-5(d)(5), unless cross-testing is used to determine the rate group testing.

The gateway rules are in §1.401(a)(4)-8(b)(1)(I)."

remember, there is one and only one avg ben pct test. you first run coverage and if your plan fails ratio %, you could pass using the avg ben test (which includes the avg ben % test)

you are not testing nondiscrimination at this point so there is no gateway.

Mike:

Saturday Feb 2 is ground hog day. That means 6 more weeks until Michigan gets the # 1 seed on selection Sunday in basketball.

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if the term'd NHCE is receiving a SH contribution doesn't that count as benefiting for 401a? so 2 of 2 NHCEs are benefiting and coverage passes? at least thats they way our testing software is doing it (Relius)?

Each formula must pass non-discrimination. If you merely provide a benefit to an NHCE and run a straight benefit or not benefiting, then you may design a plan to give each NHCE a contribution of $1 while giving each HCE 15%. When you impose a standard to say each formula (or rate) provided must be provided to a non-discriminatory group of employees, then that would require more testing. The software isn't going to tell you which test needs to be ran.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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For a real simple example suppose I have a plan with 10 NHCEs.

Plan's formula is a straight 5% across the board.

4 of the NHCEs term, > 500 hours and receive nothing.

so for ratio % I have 60%.

I run the average benefits % test on an accrual basis and it passes 75%.

Since the plan as a whole passes avg ben pct test, and the ratio % test is 60% the IRS says no gateway is needed.

But people get worried because the avg ben pct test was run using accrual rates.

Now, in this simple example everyone received the same %, so gateway wouldn't come into play.

so lets modify it. formula is now 10%, but the 4 people in question received 3% top heavy because they were active but failed hours requirement.

using the allocation method (not accrual) you still have 60% in the rate group, which will satisfy the midpoint and the plan as a whole passes avg ben % test, so you have a plan with different allocation rates (e.g what people refer to as cross tested rates because they are different)

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yes, if you test dc nonelective contributions using allocation rates (even though the avg ben pct was tested using accrual rates), you have not 'cross-tested', and therefore there is no gateway, even though, conceivably you may have more than one allocation rate.

I think, what happens in many cases such plans would pass the broadly available gateway anyway, but maybe that is an overstatement.

Of course, technically, at least in a prototype plan you have to define the specific gateway, you can't pick and choose, otherwise the IRS says the formula is not definitely determinable.

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yes, if you test dc nonelective contributions using allocation rates (even though the avg ben pct was tested using accrual rates), you have not 'cross-tested', and therefore there is no gateway, even though, conceivably you may have more than one allocation rate.

I think, what happens in many cases such plans would pass the broadly available gateway anyway, but maybe that is an overstatement.

Of course, technically, at least in a prototype plan you have to define the specific gateway, you can't pick and choose, otherwise the IRS says the formula is not definitely determinable.

I'm familiar with the broadly available, primarily DB exceptions. It is new to me that if you 'define your rate groups on an allocation basis', but test on a cross-tested basis, you're exempt from the gateway requirement. I just wanted to be clear on what you're saying so I can research. Conceivably, you can design a plan with various rates without requiring a gateway. However, it wouldn't work if non of the NHCEs at least benefit (on an allocation basis) at a rate at or above the highest HCE. Would you agree?

CPC, QPA, QKA, TGPC, ERPA

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if the term'd NHCE is receiving a SH contribution doesn't that count as benefiting for 401a? so 2 of 2 NHCEs are benefiting and coverage passes? at least thats they way our testing software is doing it (Relius)?

Yes, it does. Coverage (410(b)) is not the issue. Non-discrimination (401(a)(4)) is the issue.

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(e.g what people refer to as cross tested rates because they are different)

You can rate group test on an allocation basis. I refer to cross-testing as the conversion of an allocation to a straight life annuity at Normal Retirement Age. So, I'm not concerned with the fact there are different allocation rates (i.e. you can have 10 different allocation groups where only one HCE and one NHCE is in each group, and pass on a restructured basis; when each group receives its own percentage).

But, you are saying that nonwithstanding any exceptions for broadly available rates, the fact (alone) that the rate group being tested is being defined by an allocation rate as opposed to an accrual rate, then you are exempted from the gateway (regardless of the fact that cross-testing is needed in order to pass the non-discrimination test).

I keep reiterating this because I don't want to associate one specific thing with something else (e.g. state it works this way, but have it work for an entirely different reason).

CPC, QPA, QKA, TGPC, ERPA

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agreed, just to make sure the terms are being used in the same way.

if I test on an allocation basis I take contr / comp so I am not converting to a straight life annuity.

it could very well be I fail the ratio % testing on an allocation basis (e.g. 60% instead of being greater than 70%) (but 60% is greater than any midpoint) and

however, it could also be true the avg ben pct test passes at 70% on an accrual basis 9e.g. converting to a straight life annuity). but the avg ben pct test does not trigger the gateway.

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agreed, just to make sure the terms are being used in the same way.

if I test on an allocation basis I take contr / comp so I am not converting to a straight life annuity.

it could very well be I fail the ratio % testing on an allocation basis (e.g. 60% instead of being greater than 70%) (but 60% is greater than any midpoint) and

however, it could also be true the avg ben pct test passes at 70% on an accrual basis 9e.g. converting to a straight life annuity). but the avg ben pct test does not trigger the gateway.

Okay, Poje. We have two out of three. Let's go for 3 out of 3.

1) We agree that allocations testing is not converting to straight life annuity (hence no cross-testing).

2) We agree that the rate group (defined by the allocation rate) passes the midpoint.

3) The average benefits test may be done on an allocations basis or utilizing cross-tested rates. I've never said anything to imply avg. ben means gateway. What I am saying is the usage of the cross-tested rates as opposed to the allocation rates is what imposes the gateway requirement.

Mike is saying that ship as sailed, because you're beyond the definition of the rate group (which was already done on an allocation basis) and that any cross-testing does not need the gateway because the rate groups have already been defined.

I have alway held that "any cross-testing" in the absent of established exceptions for broadly available or primarly DB, etc... would require the gateway. I understand Mike's argument and going to research that point. Is that also your understanding?

CPC, QPA, QKA, TGPC, ERPA

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Tom is real good at citations. :-)

But the fact is that this issue has long been put to bed.

Not thrilled with your tenses ("rate groups already been defined"). I don't think you start with the rate groups. You could just as easily start with the ABPT, note that it passes and then do a rate group analysis dependent upon the mid-point. All tests must pass and the order of performing them shouldn't cause concern.

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if the term'd NHCE is receiving a SH contribution doesn't that count as benefiting for 401a? so 2 of 2 NHCEs are benefiting and coverage passes? at least thats they way our testing software is doing it (Relius)?

Yes, it does. Coverage (410(b)) is not the issue. Non-discrimination (401(a)(4)) is the issue.

OK. But I was responding to ERISATookKits response that this scenario would NOT pass coverage. And I'm still confused by his comments about cross testing. If I am allocating a profit sharing contribution pro-rata, what's the issue with 401(a)(4)? There are seven employees. Five of them key. Two of them NHCE. All five key employees and one NHCE receive 15% profit sharing contribution. The terminated NHCE, who did not meet either the last day requirement or 1,000 hour requirement, receives the 3% SH and $0 profit sharing because he did not meet the eligibility criteria. Pro-rata allocation of profit sharing. No cross testing. Passes 410(b), passes 401(a)(4).

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It is not my intent to thrill or trigger any emotional state of any member on this board. What I am attempting to do is understand a position (without the introduction of other issues not pertaining to what we are addressing). I think I have articulated my questions in an attempt to understand how you get to cross testing without the gateway.

CPC, QPA, QKA, TGPC, ERPA

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if the term'd NHCE is receiving a SH contribution doesn't that count as benefiting for 401a? so 2 of 2 NHCEs are benefiting and coverage passes? at least thats they way our testing software is doing it (Relius)?

Yes, it does. Coverage (410(b)) is not the issue. Non-discrimination (401(a)(4)) is the issue.

OK. But I was responding to ERISATookKits response that this scenario would NOT pass coverage. And I'm still confused by his comments about cross testing. If I am allocating a profit sharing contribution pro-rata, what's the issue with 401(a)(4)? There are seven employees. Five of them key. Two of them NHCE. All five key employees and one NHCE receive 15% profit sharing contribution. The terminated NHCE, who did not meet either the last day requirement or 1,000 hour requirement, receives the 3% SH and $0 profit sharing because he did not meet the eligibility criteria. Pro-rata allocation of profit sharing. No cross testing. Passes 410(b), passes 401(a)(4).

did not meet the "allocation" criteria...not eligibility criteria, that was a typo.

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It is not my intent to thrill or trigger any emotional state of any member on this board. What I am attempting to do is understand a position (without the introduction of other issues not pertaining to what we are addressing). I think I have articulated my questions in an attempt to understand how you get to cross testing without the gateway.

i understand that but who is trying to get to cross testing without the gateway? that's what i'm confused about. the original question was if you do a pro rata allocation (no cross testing), does the terminated NHCE need the Gateway contribution, and I believe the answer to that is no. i'm not sure how the performing cross testing and not having to worry about gateway conversation started, but it wasnt realyl related to the original post.

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The answer was no. However, your formula provided a coverage ratio percentage of 100% since everyone in the plan received a nonelective contribution. However, that alone does not satisfy nondiscrimination. This is why we started on crosstesting, because there is clearly a need for additional testing. You cannot have a formula providing 3% to NHCEs and 3.5% to HCEs and think that is okay merely because everyone has received a contribution. Additional testing would be necessary.

CPC, QPA, QKA, TGPC, ERPA

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