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ADP test refund going to automatic non-deductible contribution bucket?


ldr

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Good afternoon!  A client just asked for something I have not heard about before (not that this is unusual)!

They don't like failing the ADP test and making refunds to the owner of the business.  They won't adopt a Safe Harbor contribution formula.  Instead, they want to know if an ADP test refund can automatically become a non-deductible contribution and remain in the plan instead of being refunded to the owner.

I have never heard of such an arrangement but that doesn't mean it doesn't exist.  Does anyone have some insight on this?  Thanks in advance.

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I'm not sure I understand?

Are you talking about recharatcerizing failed ADP amounts as voluntary after contributions? I think that is in an option if the plan allows for it and it may require a participant election. However, I believe that just changes one problem for another as you would then need to test those amounts in ACP...

I believe you would still need to issue a 1099-r so the taxation is picked up.

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Lou, I am not sure I understand either!  I was assuming that what you described is what they are looking to do.  We don't have any plans with voluntary after tax contributions so I am not very conversant on that subject.  Like you, I thought that even if the ADP refund could be "recharacterized" as a voluntary after tax contribution it wouldn't buy them anything due to the ACP test.  I had not thought as far as the 1099-R yet but that makes sense.  

Like everything else, there is always a "new" or "cutting edge" or "aggressive" way to approach a problem and I wanted to run this up the flagpole and see what everyone else is doing.  This is why 90% or more of our 401(k) plans are Safe Harbor plans, but there are just a few employers will not agree to a Safe Harbor.

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Oh yeah and as M Weddell points out your plan already has to allow for the after tax contributions, you can just do it only for failed ADP test, though as a practical matter in a small plan those might wind up being the only ones actually made. But like I said then you probably have the same problems on the ACP side.

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Hi Lou and MWeddell,

I was wondering over the weekend:  This plan at the moment only has deferrals and a discretionary match.  Suppose the plan offered voluntary after tax contributions and the only person who actually used the feature was the owner of the company.  His "spillover" refund that was due to him on the deferral side gets re-characterized as a voluntary contribution.  Now, does his new "voluntary contribution" get mixed in with the normal discretionary match and all get tested together?  If that's the case, everything might be okay.  This plan typically fails the ADP test but not the ACP test.  However, if the voluntary contributions are tested all by themselves, apart from the discretionary match, then of course this won't work.

The Edward Jones broker who brought this question to me says that Edward Jones' own 401(k) plan has this feature and that's why he just assumed that it is a common practice.  

What are you thoughts on this?

Thanks again!

 

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Well, the plan would have to allow after tax contributions to everyone.  (Though, any NHCE  using that feature would only be a benefit).  Does the plan also allow for Roth?  If so, that could get very confusing.  Payroll could be a nightmare if anyone wanted to do, say half pre-tax, half Roth and an additional $150 after tax per paycheck.

Did you actually do a projected ACP test to make sure it would be ok?  (The after-tax gets tested with the match in the ACP test).

Besides, the money will still be taxable to the HCE if that's what they are trying to avoid. Plus any earnings on it when they take it out will be taxable (unlike the Roth).

Does the Edward Jones guy really know about the after tax thing?  Most plans I've seen replaced voluntary after-tax with Roth a while ago.  Maybe the EJ plan has it so people can go over the 402(g) limit?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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1 hour ago, BG5150 said:

Does the Edward Jones guy really know about the after tax thing?  Most plans I've seen replaced voluntary after-tax with Roth a while ago.  Maybe the EJ plan has it so people can go over the 402(g) limit?

You're on to something here.  There is little doubt that the broker has conflated this with something else.  (Surprise!)  I don't see how you could retroactively change an election in the next year unless somehow it had all of this nonsense built into it in the first place.

ldr - JUST SAY NO.  If you want to drag it out for some reason, start by asking the broker for materials on how it works in their plan.

Ed Snyder

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ldr, I agree with your latest post.

However, the facts do sound a wee bit dodgy.  The plan has to not just officially allow traditional employee after-tax contributions but they have to be effectively available to NHCEs during the plan year being tested.  Is that feature mentioned in an SPD?  Mentioned in the enrollment materials (either hard copy or on the web)?  One can't just discover an after-tax contribution feature now.

I am less skeptical than BG5150 is about having both Roth and traditional after-tax contributions and about payroll handling it well.  However, I typically work with large and jumbo employers, so my practical experience may not be as relevant to your situation.

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Thanks to everyone for their ideas.  @MWeddell:  This client isn't trying to correct something that happened in 2019, after the fact.  They are asking on behalf of 2020, before the test fails again.  If we put in voluntary after tax contributions right now and offered it to everyone and changed the SPD and handed out the SMMs, it would seem to me that they could use this tactic for 2020, if the test fails again.  Nobody is going to sign up for voluntary after tax contributions but it can be announced and offered correctly.  The reason I say that is that this is a manufacturing unit and nobody is going to understand the first word of any announcement about it.  The CFO and her broker are looking for a way to keep from irritating the owner of the company with failed tests and required refunds again for 2020, that's all.

All that being said, I did like Bird's answer better......"ldr - JUST SAY NO."

 

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Did you run a hypothetical ACP test with the re-characterized amounts yet?  It'll be very embarrassing telling the owner he doesn't have to take an ADP refund, but after all is said an done, an ACP refund is needed.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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14 hours ago, ldr said:

If we put in voluntary after tax contributions right now and offered it to everyone and changed the SPD and handed out the SMMs, it would seem to me that they could use this tactic for 2020, if the test fails again.

It doesn't work.  https://www.law.cornell.edu/cfr/text/26/1.401(k)-2 -- look for the phrase "first day of the plan year" at the end of Treas. Reg. Section 1.401(k)-2(b)(3)(iii)(B).

When it comes to technical questions, there just isn't any substitute for looking carefully at the relevant regulations.

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36 minutes ago, MWeddell said:

When it comes to technical questions, there just isn't any substitute for looking carefully at the relevant regulations.

That's what I have you guys for!  ?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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Thanks, all of you.  I had not gone into this deeply enough to look at any regs yet.  Thanks for posting the reference, MWeddell.  @Bill Presson:  I wonder if that is what the broker at Edward Jones actually has?  Maybe if they fail their ADP test, excess contributions actually go into a deferred compensation plan and he just thinks they are after tax contributions.  No telling.

@BG5150: No, I haven't run any hypothetical tests.  I wouldn't be embarrassed at all because if we did this, I was going to make it very clear that there is no guarantee this will work, due to the shifting of the funds to the ACP test.  Remember, I did not offer this to them as a "cure" for their problems.  I told them to become a Safe Harbor plan.  Their broker is the one who came up with this cockamamie scheme and I am just trying to investigate it and see if it has any merit.  My inclination is to simply say NO.  However, I once worked for a CPA firm where the partners spent a lunch time (and bought lunch for 50 employees) for the sole purpose of telling us that saying NO is the easy way out.  They said our job was to see whether perhaps, legally, there was a way to say YES to whatever the client wanted to do.  Ever after, I have at least tried to see if YES could be the answer.

I appreciate the feedback from all of you.

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Here is an ASPPA powerpoint on ADP/ACP testing and has some information on recharacterizing contributions.    If the ACP test is passing, could you shift the ACP contribution to the ADP as long as the required rules are followed (the powerpoint provides an example)?  This could be another option without changing the plan document.

https://www.asppa.org/sites/asppa.org/files/PDFs/Education/Webcasts/WEB180523%20Riordan.pdf

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From the slide:

Matching contributions may be included in the ADP test to the extent they are:
–100 percent vested
–Subject to the same distribution restrictions as 401(k) deferrals
–Designated as QMAC
–Not tested in the ACP test
–Not disproportionate (over five percent or two times rep rate)

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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