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Employer uses "lottery" to select HCEs who must stop making


Guest SJPrince
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Guest SJPrince

My husband works for a large company who has a 401(k) plan for the unionized employees. I assume the company has more than 1 of these plans, but anyway, what the company has JUST done (and yes they are on a calendar year) is to send some employees letters saying that they were over $80,000 for W-2 wages last year (hence HCE) and were chosen at random (by lottery) to now lose their ability to defer anymore income this year (and thus receive a match).

These employees are naturally upset. The company doesn't want to run amok of the ADP or ACP tests so I understand why they have done this. (These employees reached the $80K limit by working mandatory and voluntary OT in 1999.)

Is this random selection of HCE's to give up deferring common practice? This is news to me as we don't represent any companies who have so many employees that they wouldnt just make ALL HCE's stop for the year.

What are other ways or more common ways of addressing this kind of problem?

TIA

SPrince

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regardless of the lottery, does the plan say these people can not defer? If not, then I would have a problem with the plan not following the terms of the document, especially if the participants never filled out a form saying they chose to defer 0 for the remainder of the current year. If the company has simply stopped withholding from a selected random group without any other procedures, then I think you have problems. In fact, my understanding would be that the company would have to rstore the 'lost' deferrals and match.

If the selected employees filled out an election form saying they chose to stop deferring the rest of the year I don't thyink you can do anything about it.

(Nothing like trying to rock the boat - it sounds like your husband is stuck between a rock and a hard place)

On the other hand, if you really feel treated unfairly, you can probably contact the DOL and question the practice. Hopefully, the company wouldn't know who was rocking the boat as a result, especially since you indicated a number of people were randomly chosen.

but that is only my opinion based on the info you provided.

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...and I suggest that you start by carefully reviewing the plan's SPD. If that does not help, then request some detailed information about the plan's actual language on this point, and any administrative procedures that may have been adopted.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Guest SJPrince

Thanks... I have requested a copy of the plan doc and SPD. Only could tell you what I know so far. Oh I see here that they are just going to 'receive information confirming the reduction of their contribution.'

My husband fortunately didn't 'win'(?) this lottery, but his friends are quite aggravated.

The company says they can start up deferrals again in the new year.

My husband wanted to know what other things the company could have done instead of this. I told him depends on the plan but could be QNECs or QMACs. I will reiterate that they can call DoL too.

Thanks again.

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Some plans include an automatic limitation on HCE's, ususally to limit the percent of deferral. Not sure how common this is, or whether it is difficult to administer/communicate?

BTW, does this plan cover only union EEs?

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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If I understand your scenario, deferrals are being reduced/stopped for select HIGHLY COMPENSATED EMPLOYEES only. Since when has the government cared if this group of employees is treated unfairly?

Food for thought.

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Guest SJPrince

No, not all hce's... only the ones who got picked in this lottery are ineligible to further defer this year.

the IRS may not care how this test was met in this case but the employees sure do.

and i dont have a copy of the plan as of yet either so cant answer about if only union employees or not.

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1. Check the plan document to make certain that the administrator has the right to freeze accurals.

2. Is this a union only plan? If not, make certain that the union and non-union employees are being tested separately.

3. If any of the lottery winners earned between $80,000 and $85,000 last year, tell them to threaten to sue. The cutoff for HCE status under the law is $85,000. (If you don't beleive me, read the statute. The IRS doesn't understand the concept that Congress can override a regulation with a new law, and it is relying on an obsolete regulation.) The IRS has never issued anything that anyone is entitled to rely upon that the cut-off is not $85,000. (The letter that everyone seems to be relying upon states that the recipient is not entitled to rely upn it.) Maybe the Company can arrange for a friendly lawsuit and get the $80,000 v. $85,000 issue resolved on summary judgement.

If you do sue, please keep me informed.

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hold on. the hce limit applies to ees making 85,000 in 2000 and therefore determines who is an HCE in 2001.

an ee who made 80,000.01 plus in 1999 is still an hce in 2000. The question indicated that deferrals were cut off for the remainder of this year. (It is entirely possible for the company to make a top-paid group election and therefore this ee might not be an hce. that is doubtful ince it was indicated it was a large company)

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While others have correctly pointed out that it may be hard to get the IRS or DOL interested, there is an IRS requirement that a profit sharing plan that includes a 401(k) arrangement must have a definite allocation formula. In other words, the plan document must state how contributions are allocated. While this requirement is generally viewed as not violated if the plan document gives the plan administrator administrative discretion to limit all HCEs' contributions to minimize the chance of an ADP/ACP test failure, randomly choosing which HCEs to limit sounds to me like a violation of the definite allocation formula requirement. You probably want to examine the plan document before proceeding too far with this argument.

For the DOL, you'd have to take a slightly different tack, arguing that the plan wasn't administered in accordance with its written plan document, since the above argument raises an IRS issue.

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Guest SJPrince

Yes, what the company did was take all ppl who made over $80K last year and put then into a lottery. Anyone chosen in this lottery lost their ability to continue making deferrals the rest of this year. Hence there continue to be many that are HCEs who remain able to defer.

I take it from the comments I am receiving that this isn't a common practice?

I have yet to see the plan doc... the HR dept. is giving my husband and even the union president a hard time about giving it up. I told my husband he is to tell them that they are required to provide it to anyone who asks, but no luck just yet. (HR is 'checking into it'.)

I still don't know if the plan only covers union employees yet.

Thanks for all the participation in here.

Samantha

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As is common among us benezoiks, all here have jumped in on the technical niceties of Mr. Prince's firm's hare-brained 'solution' to testing issues, and not spent any time pondering the colossal stupidity of the thing from an employee's perspective.

Let's see, as a plan participant I'm marched into a 'lottery' in which, if I "win", my deferrals are summarily yanked...hmmm, yeah, I can really get behind the mgmt that came up with that one.... I'd love to hear the watercooler chitchat on this thing.

Based on SJ's description of the situation, her husband got little or no advance word that this is how testing issues would be dealt with--which if you're management is understandable; how would you like to get up in front of any group of employees who might be impacted & explain this one?

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Guest SJPrince

Laughing here!!

Well let me tell you... these ppl who won/lost the lottery are not even management or anything... they are professionals but 'rank and file' so to speak and only are above that level due to the overtime that they were encouraged to do.

I too think it is a hare-brained solution to keeping the ADP and ACP tests under control! But wanted to find out from everyone that this wasn't some new cutting edge invention that I missed out on hearing about!!!

Thanks Greg.

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I don't think that the hare-brained solution even works. If the persons who lost the lottery aren't eligible to make deferrals, my recollection is that they can't be taken into account in apply the ADP test. Thus, keeping them from deferrals results in them being completely ignored for the nondiscrimination test, which isn't the result that the employer was trying to achieve. Accordingly, I don't think that this lame-brained idea achieves any good, and certainly alienates the employees.

If my analysis is right, whoever recommended this approach to the employer better may sure his or her malpractice insurance premiums are up to date.

Kirk Maldonado

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Guest SJPrince

They were making deferrals all year until now... they calendar year is the plan year. The notification letter was sent out 9/27/00 and is only applicable to any more deferring in the year 2000.

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Tom-

I'm quite serious. What is your authority for the position that someone who made $80,000.01 in 1999 is an HCE in 2000 (ignoring the top 20% election)?

The number for 2000 is $85,000. If you plug $85,000 into the statute, you reach the conclusion that anyone with comp. over $85,000 in 1999 is an HCE in 2000. I have yet to see anything that constitutes authority to the contrary.

As far as I can tell, every major law firm, accounting firm, and actuarial firm took the position that $85,000 was the correct number for 2000 until Jimmy Holland mumbled something to the contrary at an ASPA program. The IRS then issued a letter (not a reg. or revenue ruling) that because of some regulation that pre-dated the current law, the correct number for 2000 is $80,000. The letter states at the end that the recipient is not entitled to rely on it.

If you start with the basic premise that a new law from Congress overrides a preexisting regulation (a concept that the IRS apparently has a hard time grasping), anyone who had comp in the range of $80,000-$85,000.00 in 1999 is not an HCE in 2000.

Apparently most ( nearly all?) of the profession is taking the path of least resistance and using $80,000 for determining HCE status. Nevertheless, IMHO anyone who had comp of $85,000 or less in 1999, who is being treated as an HCE, and who has his contributions cut-back because of his HCE status has a legitimate complaint.

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Let's assume the company properly defined who is an HCE, the plan is properly amended (or contains language that allows discretion in restricting deferrals by HCEs), and the SPD/SMMs are issued properly and timely.

Let's think about this from the company point of view.

They could do nothing, and after the end of the year, retroactively cut back the HCEs using the IRS's procedures specified in their regulations (or was it a revenue ruling).

Or, they could prohibit HCEs earning above a specified pay level (say $170,000) from future deferrals. This might be workable especially if the company has a nonqualified 401(k) make-up plan in place.

Or, they could limit future deferrals for all HCEs to a certain percent of pay. Maybe, limiting them to 3% of pay prospectively.

The lottery approach dramatically hurts some HCEs and doesn't affect other HCEs. I'd say the approach is unusual, but probably is allowed if done carefully. However, to avoid hurt feelings, they should have made the lottery known to employees before doing it. Essentially, they could say that rather than giving a little pain to a large group of employees, they'd rather give more than a little pain but to a small group of employees. (OK communications consultants out there, you can say this better than I.) Even in a large organization, the total number of HCEs should be manageable, and they should have been contacted beforehand.

It's unfortunate that this approach caused hard feelings. My personal bias would be to inflict a small amount of pain on a large number of HCEs, but thats just my thought.

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Originally posted by richard

I'd say the approach is unusual, but probably is allowed if done carefully....Essentially, they could say that rather than giving a little pain to a large group of employees, they'd rather give more than a little pain but to a small group of employees.

richard, you're among friends here, & you're essentially anonymous. G'head, call this 'solution' what it is--stupid.

& I'm with Kirk on the technical flaws with the thing.

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IRC401 -

I believe we will agree to disagree. (Hopefully not 'I'm right, your wrong attitude'. especially with the complexity of the regs)

The determination of limits (e.g. 85,000) are not made until after Oct.15. This is two weeks before the ASPA conference. I know when the 85,000 figure was released, our question was 'to what year does it apply' well, lets find out at the ASPA conference. I thought Mr. Holland was fairly clear in 'his' interpretation that it applies to 2001.

the following is one interpretation - can be found under the Q & A board) - I would disagree with example 3 since the calendar year election was eliminated.

Question 22: The compensation limit for determining an HCE is increasing to $85,000 in 2000. Does this mean that when we do the testing of the 2000 plan year, someone who made in excess of $85,000 in 1999 will be an HCE, or does the $85,000 limit start with the 2001 plan year testing (looking back to 2000)?

Answer: For purposes of the HCE definition under Code Section 414(q), the 2000 adjusted compensation limit is indeed $85,000. See IRS News Release 1999-80 (Oct. 19, 1999).

For plans determining HCE status based on the "lookback year," the $85,000 limit will first apply when testing the plan year beginning in 2001 (looking back to compensation earned in the plan year beginning in 2000). See Treas. Reg. § 1.414(q)-1T, Q&A 3©(2). For fiscal year plans that have made a calendar year data election (see IRS Notice 97-45), the $85,000 limit will first apply when testing the plan year beginning in 2000 (looking back to compensation earned in calendar year 2000).

Example 1: A plan year ends on December 31 and the plan uses the lookback year. For the plan year beginning January 1, 2001, the plan will use 2000 compensation to determine if an employee earned compensation in excess of $85,000 and is therefore an HCE for the 2001 plan year.

Example 2: A plan year ends on June 30 and the plan uses the lookback year. For the plan year beginning July 1, 2000, the plan will review compensation for the lookback year of July 1, 1999 through June 30, 2000. Because the lookback year began in 1999, the plan will use the 1999 limit (compensation in excess of $80,000) for purposes of determining HCEs for the plan year beginning July 1, 2000.

Example 3: A plan year ends on June 30 and the plan has made the calendar year data election. For the plan year beginning July 1, 2000, the normal lookback year is the plan year beginning July 1, 1999. However, with the calendar year data election, the lookback year becomes calendar year 2000. So the plan will review compensation for the calendar year 2000 to determine if an employee earned compensation in excess of $85,000 and is therefore an HCE for the plan year beginning July 1, 2000.

Copyright 2000 Stuart Harris, Kurt Linsenmayer, Cheryl Musselman-Brown, Cynthia Van Bogaert and EBIA

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Guest SJPrince

Ok here goes...

I hear from my husband there was a conf. call today during which the corp. atty said that this plan only covers union employees. Any non-union ees are kept separate.

When I look at the document, the only option I see to fix the ADP excess deferrals is to distribute. "The Excess Contributions with respect to HCEs shall be determined by reducing Pre-Tax Contributions made on behalf of such HCEs in order of the greatest dollar amount of Pre-Tax Contributions."

Corresponding language falls under the Matching section as well.

(I see no language that says that deferrals can forcibly be stopped when a problem arises.)

My gut reaction here is that the lottery flies in the face of the method set forth in the plan document. That the plan requires the Company to actually take the deferrals at year end and start giving back to HCEs who are the top deferrers. OR.... do you think that the Company's premise is that doing the lottery prevents them from getting to this step altogether so the lottery should be permissible?

I would argue that the Company doing the lottery could be penalizing the wrong people and those people are losing out not only on the deferral but on the company match. That if the Company would permit all the deferrals to continue it would then in turn have to look at who deferred the most and start correcting ADP that way.

Additional thoughts?

Thanks all!

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Two Comments:

1. Tom- The reg cited in your response pre-dates the current statute. Therefore, I don't see how it could be applicable unless you take the position that a new law doesn't override an old reg. I'm not disagreeing with your interpretation of Holland's position. I'm taking the position that he is wrong and that the employees have a basis for a suit (and that somebody in the Chief Counsel's Office of the IRS should know better). I'm also taking the position that the IRS has never issued anything that constitutes "authority" that supports the ($80,000) position in the response above. You are, of course, free to disagree.

2. With regard to the plan document: There isn't an ACP problem until the plan year is over. Therefore, it is premature to look at the correction provisions. You need to look at the contribution provisions to see if the plan administrator is giving authority to stop HCE contributions in mid-year in order to head off a problem. The language should be in both the plan document and the SPD.

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Guest SJPrince

Correct, in my haste I failed to state that the contribution sections do not say anything that would permit this. The only cessation of contributions that COULD apply here is the section that says an ee can advise the Trustee he/she wants to cease making contributions for a period of time.

Recall, the Company is giving them all forms to sign saying they will change their deferral %age.

So I guess my point was, I don't think they should be permitted to force anyone to do this and that there will be an ADP problem. etc etc.

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Greg,

The word "stupid" does come to mind. And in consulting in a situation such as this, I'd probably be able to convince management that this isn't the best way to go (I hope).

However, there have been many times that management has disagreed with me, and then it's my role to make it work as best as I can. That includes making sure that the legal niceties are all lined up, and advising them on some of these employee relations / communications issues. And then I duck!

Yeah, "stupid" does come to mind.

(Seriously, though, I'd be interested in what advantages this approach would have for management.)

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Originally posted by richard

(Seriously, though, I'd be interested in what advantages this approach would have for management.)

Now here's a challenge!

OK, I'll go first:

Advantages of a contribution cutback lottery for plan sponsor management--

1) enhanced employee appreciation of mgmt team's sense of humor

2) potential to broaden company's product line ("mfgr of brass-plated widgets, & industry-leading qualified plan compliance gaming innovator")

3) most novel excuse for late filing of 1999 5500s ("well, the auditors spent so much time convulsed in laughter over our plan's testing provisions they took twice as long as expected to complete their work")

Who's up?

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based on the info provided, it sounds like, at least to me, the compnay has done nothing 'wrong' as far as plan processing goes.

ee signed (maybe begrudgingly) that he chooses not defer the rest of the year.

if that is indeed the case, there is not much that can be done. if ee had not signed the form, but deferrals were stopped anyway, then there would be a problem.

(even if the company said, you 'won?' the lottery, tough, no more deferrals)

And I will go back to what I originally said (I think, without looking it up)

ee is stuck between a rock and a hard place. If you have a job you like, and are well paid, just what do you?

does the whole thing pass the 'smell' test? no, something smells.

suppose the following is the scenario:

its mid year, we need to cut back the HCEs.

I have some hces who have already deferred 10,500 so I cant cut them back. so all other hces get tossed into the lottery.

now, one of the hces who lost the lottery was only going to defer 7,000. he is now cut back to 6,000 because he stopped deferring. end of year arrives, plan passes. if he had been allowed to defer, plan would have failed, and would have returned 1000. but he would not have received the refund, it is the hce who deferred 10,500. thus, this lower paid hce is out a deferral plus a match.

again, though, if he signed a paper saying I choose not to defer the rest of the year, I don't think there is much that can be done.

if the company was really on the ball, it would make things up to the employee with a bonus = match amount lost. that might be a better way to pursue things. "look, I stopped deferring so you could pass the test, I lost this much in match, can I get reimbursed somehow?"

oh well so much for my ramblings...

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