Catch-up Contributions

[Guest Terry W]

Good Afternoon:

I have a general question that has been posed by a potential new client. The client is over age 50, has a New Comparability Plan, wants to make a deferral contribution of $5,500 and recharacterize it as a "catch-up" contribution for the 2009 calendar year without making any other derrerals, and then wants to receive the maximum employer contribution of $49,000. In essence, what he is looking at is for the adp test to show zero deferrals made on his behalf and a 415 test to show $49,000 as all employer contributions. I'd like to know what anyone's thoughts are on this.

Thank you.

Terry W.

[austin3515]

Create a plan imposed limit to limit deferrals of owners to 0% of pay.

If there was no 401(k) before, use PY testing, and then they can contribute 5% of pay PLUS $5,500. Then, on the first day of the next plan year, add the plan imposed limit of 0% on the owners.

[BG5150]

On a side note, would a $49,000 allocation blow up your Avg Bene Test on the cross-test?

[Bird]

It works. To be precise, it's determined to be a catch-up AFTER the $49,000 'er contribution is allocated (unless you go with a plan imposed limit, as suggested, but I don't think it's necessary).

[BG5150]

What I meant was: is giving the owner a 49,000 allocation going to affect the allocation to the other ee's? (I poorly worded my question) How much would the allocation increase to others with 49k instead of 32.5k?

Is this person an owner? If so, why not put in the max deferral and then maximize the p/s contribution?

[Kevin C]

I don't think a plan imposed limit of $0 works. A catch-up eligible participant is someone who is eligible to make deferrals without regard to the catch-up. He would not be eligible for non-catch-up deferrals with a $0 limit.

1.414(v)-1(g)(3) Catch-up eligible participant. --An employee is a catch-up eligible participant for a taxable year if --

(i) The employee is eligible to make elective deferrals under an applicable employer plan (without regard to section 414(v) or this section); and

(ii) The employee's 50th or higher birthday would occur before the end of the employee's taxable year.

I agree with Bird. The owner can defer $5,500 and use the $49,000 PS allocation to make the deferrals catch-up.

Then, later this year, I would be talking to them about adding a 3% safe harbor for 2010. Then he could max out deferrals and reduce the employer contribution needed for him to max out for the year.

[Tom Poje]

The ERISA Outline Book (at least the 2006 edition) suggests it is possible to have a 0% limit.

by the way, there are other instances in which an individual can not make deferrals but is still treated as an eligible employee.

by definition, an eligible employee (1.401(k)-6) is someone who is directly or indirectly eligible to make a deferred election....an employee does not fail to be treated as an eligible employee merely because the employee may receive no annual additions because of 415. (or due to suspension because of hardships)

[Kevin C]

Tom, "the EOB suggests it is possible" wouldn't bring me much comfort if I was preparing for an IRS audit on the plan.

The regs say "The employee is eligible to make elective deferrals under an applicable employer plan (without regard to section 414(v) or this section)". It doesn't say "eligible employee under ..." If they wanted it to say that, they could have easily done so. But, in this case, I'm not sure it makes a difference. If an employee is limited under all circumstances to a maximum of 0% deferrals, how is that being eligible to make a CODA election? What cash are they able to elect to defer? Remember, the regs say without regard to catch-ups.

Your reference to hardship brings up an interesting question. Is an age 50+ employee able to make catch-up contributions during the suspension period following a hardship distribution? I'm thinking that all deferrals, including catch-up are suspended. What do you think?

[Bird]

A plan imposed limit of 0% makes me uncomfortable too, FWIW.

BG5150, you're right that maximizing deferrals is safer in terms of assuring test passing w/min er contributions for the employees. But it might not matter.

[Tom Poje]

so in regards to the plan, I guess to be on the 'safe' side, they could put a cap of 1 cent on deferral? Then it would be ok to treat 4999.99 as catch-up?

actually, under EPCRS if an individual exceeds the 415, the first return is deferrals (assuming no related match)

thus you could give an individual who deferred 5,000, a 46,000 profit sharing contribution. he now has exceeded the 415 limit, and the 5000 in deferral could be treated as catch up.

as to hardships, that is not one of the 'limits' eligible for catch-ups, and I certainly don't think it is in the intent of the regulations why deferrals should cease when one has taken a hardship to allow deferrals to continue in any way shape or form.

I think one of the arguments for a cap of 0 comes from the preamble.

the preamble to the regs says

"Thus, for example, a plan could provide for an employer-provided limit that applies to HCEs, even though no employer-provided limit applies to NHCEs. However, as under the proposed regulations, these final regulations retain the rule that an applicable employer plan is not permitted to provide lower employer-provided limits for catch-up eligible participants. Furthermore, a plan fails to provide an effective opportunity to make catch-up contributions if it has an applicable limit (e.g., an employer-provided limit) and does not permit all catch-up eligible participants to make elective deferrals in excess of that limit. "

so under the universal avilability rule you have to provide a catch up eligible person the chance to defer above that plan provided limit.

[Kevin C]

I was thinking the safe side would be to suggest the owner elect to defer $5,500 for the year and not use a plan imposed limit. Then, let the PS allocation and the 415 limit trigger the catch-up.

[austin3515]

Taken from EOB:

Caution: example withdrawn from regulations. It should be noted that, when the catch-up regulations were in proposed form, there was an example exactly on point, where a plan set the plan-imposed deferral limit at 0%, but also included a catch-up provision. This example was absent from the final regulations issued under IRC §414(v). Treasury officials have not discussed the reasoning for removal of this example, or whether it represents a decision by the Treasury that a 0% deferral limit is improper, or that they simply didn't want to promote such a plan design by way of a regulatory example. Clearly, a plan could set $1 as the deferral limit and there would be no question it is acceptable, so setting a $0 limit shouldn't make a difference. Some would argue that with a $0 limit, the plan really doesn't have a 401(k) arrangement. But that argument fails to recognize that, even with a $0 limit, those employees who are catch-up eligible could make elective deferrals, so the 401(k) arrangement is still available, just not to all eligible employees.

Personally, I'm comfortable with anything Sal is comfortable with. In addition, I am also comfortable withy any Tom Poje is comfortable with

[Lou S.]

I was thinking the safe side would be to suggest the owner elect to defer $5,500 for the year and not use a plan imposed limit. Then, let the PS allocation and the 415 limit trigger the catch-up.

This is the answer the IRS gave at both the ASPPA (10/08) annual conference and LABC (1/09). The wording from my handout is -

Once the employer contribution is made, the salary deferrals in excess of the 415 limit are reclassified to be catch-up contributions.

[Tom Poje]

While I appreciate Austin's comments, I know there are times when I am not 100% correct - nor Sal.

Here was the difference between the proposed regs and final regs (or at least the best I could find)

and oddly enough, pertaining to the top heavy rules! Thus, by implication, a plan that was top-heavy, could impose a limit on the key employees, and because of the catch-up rules, the key employees could at least get something without blowing the plan out of the water!

Proposed regs

iv) Application for top-heavy. Catch-up contributions with respect to the current plan year are not taken into account for purposes of section 416. Thus, if the only contributions made for a plan year for key employees are catch-up contributions, the applicable percentage under section 416©(2) is 0%, and no top-heavy minimum contribution under section 416 is required for the year. However, catch-up contributions for prior years are taken into account for purposes of section 416. Thus, catch-up contributions for prior years are included in the account balances that are used in determining whether the plan is top-heavy under section 416(g).

Final Regs

(3) Contributions not taken into account for other nondiscrimination purposes--(i) Application for top-heavy. Catch-up contributions with respect to the current plan year are not taken into account for purposes of section 416. However, catch-up contributions for prior years are taken into account for purposes of section 416. Thus, catch-up contributions for prior years are included in the account balances that are used in determining whether the plan is top-heavy under section 416(g).

as to why some examples 'disappear', I was told by someone it was more a matter of space - but I have no idea if that is true or not. There is nothing in the preamble that I found that says "In the proposed regs we indicated you could have a cap of 0%, but after consideration and comments that is not possible.."

[austin3515]

But the reality is,

a) this is an EXCELLENT plan design in certain situations

b) There is an excellent case that it is legit.

Also, Corbel's document (as an example) does not say "limit must be greater than 0%." which I think the IRS should have insisted on if this was going to be a problem...

[Kevin C]

Tom and Austin,

Your arguments presume that an age 50 participant subject to a 0% deferral limit is a catch-up eligible participant. Even Sal, in the quote trying to counter the argument that a 0% limit doesn't work, admits that the participant is not eligible to defer, except for catch-up. That means he would not satisfy the wording of the definition of "catch-up eligible".

Some would argue that with a $0 limit, the plan really doesn't have a 401(k) arrangement. But that argument fails to recognize that, even with a $0 limit, those employees who are catch-up eligible could make elective deferrals, so the 401(k) arrangement is still available, just not to all eligible employees.

If the definition of "catch-up eligible" means what it says, then they are not catch-up eligible. You have to be catch-up eligible before you can contribute catch-up contributions.

1.414(v)-1(g)(3) Catch-up eligible participant. --An employee is a catch-up eligible participant for a taxable year if --

(i) The employee is eligible to make elective deferrals under an applicable employer plan (without regard to section 414(v) or this section); and

(ii) The employee's 50th or higher birthday would occur before the end of the employee's taxable year.

It all boils down to interpretation of the regulations. I don't feel comfortable in using a plan design that requires an interpretation of a regulation that appears to me to be contrary to the plain wording of the regulation. Others have other interpretations of the regulations. Our chosen field is full of areas where not everyone agrees. This is one of those areas.

[austin3515]

OK Fine, so I'll amend the document to limit 401(k) for the owners to $.01.

Are you happy with this plan design now?

If so, we're literally debating over a penny.

[Tom Poje]

Austin - you know, you really should have put in your 'two cents' worth instead of just a penny!

[Kevin C]

We've been debating the rules, not a penny.

Am I happy with the design? Actually, no. You have an age 50+ owner that doesn't want to put any employer contributions in the plan and does not want to contribute more than $5,500 of his own money. He needs an IRA, not a 401(k). Why incur the expenses of setting up and administering a 401(k) plan if you have no intention of using it?

[masteff]

Just to throw this out there for anyone perusing the regs further... I always took a suble but important distinction on this one between a service-imposed limit, a plan-imposed limit, and an employer-imposed limit. Each seems to have a slightly different role in how the rules play out.

[J Simmons]

Just to throw this out there for anyone perusing the regs further... I always took a suble but important distinction on this one between a service-imposed limit, a plan-imposed limit, and an employer-imposed limit. Each seems to have a slightly different role in how the rules play out.

Masteff,

To be an employer-imposed limit does it have to be specified in the plan documents and thus become a plan-imposed limit?

[masteff]

Masteff,

To be an employer-imposed limit does it have to be specified in the plan documents and thus become a plan-imposed limit?

I knew as I typed that that I should have expanded... I took an employer-imposed limit to be one that's permitted under a plan but not explicitly specified in it. Best example being an ADP limit on HCEs which might change from year to year and the % is not explicitly specified in the plan text but has full power to limit deferrals.

Personally, I'd rather "sponsor" imposed limit, but since the regs used the word "employer" (as quoted several posts above), I won't buck the system over it. Of course the word "employer" might have implications relevant to multi-employer plans.... *groan*.

[masteff]

Guess I should correct myself somewhat ... the regs distinguish the ADP limit as a separate distinct item. But I still definitely find some subtle differences, especially statutory vs plan/employer limits. A couple places that start cross-referencing point to statutory items but fail to point to items that permit the plan/employer limits. Guess it depends on how literally you try to read certain lines.

[austin3515]

Am I happy with the design? Actually, no. You have an age 50+ owner that doesn't want to put any employer contributions in the plan and does not want to contribute more than $5,500 of his own money. He needs an IRA, not a 401(k). Why incur the expenses of setting up and administering a 401(k) plan if you have no intention of using it?

Shame! Many small employers (I dare note say most ) have these plans as a tool for recruitment and a desire to help employees save for retirement! Personnaly, I would never take a job with an employer that wouldn't do this for their employees.

[Tom Poje]

JSimmons:

yes, an employer imposed limit must be desribed in the plan. the preamble to the catch-up rules says:

As noted in the preamble to the proposed regulations, the condition that an employer-provided limit be contained in the terms of the plan is intended to correspond with the requirements of §1.401-1 that a qualified plan be a definite written program and provide for a definite predetermined formula for allocating contributions made to the plan. Accordingly, if a limit is otherwise permissible under a section 401(k) plan, the limit will also satisfy the requirement in section 414(v)(5) that the limit be contained in the terms of the plan.

(and the catch-up regs say "An employer-provided limit is ANY limit on the elective deferrals an employee is permitted to be made..")

..........

interestingly enough, at least to me, or at least I hadn't thought about it, and have never seen it done, but a plan could say an individual is not eligible to defer if they have a loan. This is found under the definition of conditions on eligibility in the 401k regs

...an employee who would be eligible to make elective contributions but for a suspension due to a distribution, loan...

[Kevin C]

Shame! Many small employers (I dare note say most ) have these plans as a tool for recruitment and a desire to help employees save for retirement! Personnaly, I would never take a job with an employer that wouldn't do this for their employees.

Our admin fees are not cheap. When the administration fees are a large percentage of the total annual contributions to the plan, is the plan really worth it? There are other options available and a 401(k) is not always the best choice.

I talked to the manager of a small company a while back. They could not afford any employer contributions. He polled the 5 employees and the estimated total annual deferrals would have been between less than $5,000. Most of that was the $3,500 the manager intended to defer. Are you saying I should have put them into a 401(k) plan?

[austin3515]

I would never suggest you should put anyone in a 401(k) plan that doesn't want one. I'm suggesting that the benefit of the owner is not always the sole determining factor (nor should it be).

[ERISA1]

Hi All,

It's been a while since anyone has posted to this topic. So, I'm writing to pose a two-pronged question:

1. Has any one heard of any developments regarding plan provisions that limit deferrals to Catch-up?

2. The following approach would avoid the question of whether a participant is 401(k) eligible. Do you know of anything specifically precluding the following:

Draft a plan provision that says participants who are age 50 or better are not eligible to make 401(k) deferrals in excess of the ADP limit for the year; however, if they hit that limit, they are eligible to make catch-up contributions. This approach will let 50 year-olds make full catch-up contributions without forcing younger participants to take corrections. And to the extent you cannot determine the exact ADP limit until the end of the, you can always return the excess.

I'm sure many will say this approach is too good to be true, and therefore, cannot be used. I'll respect you if that is your religion. However, what I'm wondering is whether you know of a specific quote or citation that would preclude this.

thx

[Belgarath]

I tend to side with Kevin on this one. Yes, I happen to be of a conservative mindset on such issues, but I think folks sometimes tend to forget the following:

"(3) Anti-abuse provisions. This section and §§1.401(k)–2 through 1.401(k)–6 are designed to provide simple, practical rules that accommodate legitimate plan changes. At the same time, the rules are intended to be applied by employers in a manner that does not make use of changes in plan testing procedures or other plan provisions to inflate inappropriately the ADP for NHCEs (which is used as a benchmark for testing the ADP for HCEs) or to otherwise manipulate the nondiscrimination testing requirements of this paragraph (b). Further, this paragraph (b) is part of the overall requirement that benefits or contributions not discriminate in favor of HCEs. Therefore, a plan will not be treated as satisfying the requirements of this paragraph (b) if there are repeated changes to plan testing procedures or plan provisions that have the effect of distorting the ADP so as to increase significantly the permitted ADP for HCEs, or otherwise manipulate the nondiscrimination rules of this paragraph, if a principal purpose of the changes was to achieve such a result."

[ERISA1]

Your points are well taken. However, consider the following: IRS allows plans to be drafted in a manner that permits the Plan Administrator to limit deferrals by HCEs, in whatever manner it deems fit so as to avoid an ADP/ACP problem. Isn't the IRS, therefore, authorizing exactly the kind manipulation that you are concerned about?

[Guest Sheila Calleja]

Create a plan imposed limit to limit deferrals of owners to 0% of pay.

If there was no 401(k) before, use PY testing, and then they can contribute 5% of pay PLUS $5,500. Then, on the first day of the next plan year, add the plan imposed limit of 0% on the owners.

I am totally new here, but I have a basic question. Does the HCE limitation preclude/include the catch up? Me and many other people at my company will be limited to 5% of our comp next year (or possibly less). So do I get my 5% PLUS my $5,500??

[austin3515]

Yes, you should get the 5% limit plus the catch-up. The 5% limit is a plan imposed limit and you're permitted to exceed plan imposed limits by the catch-up amounts. I would think if you asked your employer they would say this is OK. I'm pretty sure if catch-ups are allowed, that tney would be required to allow you to do what I'm suggesting, but I suppose that would only be relevant if they refuse you.

[Guest Sheila Calleja]

Yes, you should get the 5% limit plus the catch-up. The 5% limit is a plan imposed limit and you're permitted to exceed plan imposed limits by the catch-up amounts. I would think if you asked your employer they would say this is OK. I'm pretty sure if catch-ups are allowed, that tney would be required to allow you to do what I'm suggesting, but I suppose that would only be relevant if they refuse you.

They are refusing us, which is why I am looking into it. I dont' agree. I did get something from someone at D & T who said the following:

"David says that is the case (that you can make the catch up on top of the limit), but it can be difficult to set the contribution parameters correctly at the outset depending on when you do the non-discrimination testing, etc."

But I'm not sure what 'setting the contribution parameters means'.

Thanks so much.

[austin3515]

The issue is that one half of the limit is a percentage and the other half is a flat dollar amount. The easiest thing is to have two deduction buckets, one set up for the 5% of pay, and the other set up to hit $5,500 (perhaps $106 per week for 52 weeks).

[Tom Poje]

Austin, in theory that might work, but if the person stops deferring during the year, then what?

and don't say it would never happen.

[austin3515]

If they stop deferring mid-year then they wouldn't exceed the limits. What I laid out would set them on course to comply for the year as a whole, so if they stop short they will have done less than 5% on one deduction code and less than 5,500 on the other deduction code.

[Kevin C]

The regs say prorating the catch-up limit by pay period is allowed.

The only way they can refuse to allow her to contribute catch-up is if the plan doesn't allow catch-ups. That is assuming the union and 410(b)(6)© transition period exceptions don't apply to her. Otherwise, the plan fails the universal availability requirement for catch-ups.

1.414(v)-1(e)Universal availability requirement

(1)General rule

(i)Effective opportunity.—

An applicable employer plan that offers catch-up contributions and that is otherwise subject to section 401(a)(4) (including a plan that is subject to section 401(a)(4) pursuant to section 403(b)(12)) will not satisfy the requirements of section 401(a)(4) unless all catch-up eligible participants who participate under any applicable employer plan maintained by the employer are provided with an effective opportunity to make the same dollar amount of catch-up contributions. A plan fails to provide an effective opportunity to make catch-up contributions if it has an applicable limit (e.g., an employer-provided limit) that applies to a catch-up eligible participant and does not permit the participant to make elective deferrals in excess of that limit. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) solely because an employer-provided limit does not apply to all employees or different limits apply to different groups of employees under paragraph (b)(2)(i) of this section. However, a plan may not provide lower employer-provided limits for catch-up eligible participants.

(ii)Certain practices permitted

(A)Proration of limit.—

A applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because the plan allows participants to defer an amount equal to a specified percentage of compensation for each payroll period and for each payroll period permits each catch-up eligible participant to defer a pro-rata share of the applicable dollar catch-up limit in addition to that amount.

(B)Cash availability.—

An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because it restricts the elective deferrals of any employee (including a catch-up eligible participant) to amounts available after other withholding from the employee's pay (e.g., after deduction of all applicable income and employment taxes). For this purpose, an employer limit of 75% of compensation or higher will be treated as limiting employees to amounts available after other withholdings.

(2)Certain employees disregarded.—

An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because employees described in section 410(b)(3) (e.g., collectively bargained employees) are not provided the opportunity to make catch-up contributions.

(3)Exception for certain plans.—

An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) merely because another applicable employer plan that is a section 457 eligible governmental plan does not provide for catch-up contributions to the extent set forth in section 414(v)(6)© and paragraph (a)(3) of this section.

(4)Exception for section 410(b)(6)©(ii) period.—

If an applicable employer plan satisfies the universal availability requirement of this paragraph (e) before an acquisition or disposition described in §1.410(b)-2(f) and would fail to satisfy the universal availability requirement of this paragraph (e) merely because of such event, then the applicable employer plan shall continue to be treated as satisfying this paragraph (e) through the end of the period determined under section 410(b)(6)©(ii).

[masteff]

The only way they can refuse to allow her to contribute catch-up is if the plan doesn't allow catch-ups.

Kevin hit the nail on the head... the key question is: does the plan allow catch-up contributions for anyone, if so then they need to talk to their ERISA attorney immediately. Inconvenience is not an excuse for non-compliance.

[Molly the cat]

I bet the response from D & T that is indicated by Sheila may be answering from a testing stand point. Because you may limit the deferrals to 5% plus catch up, but that doesn't mean that it will still pass ADP at year end. I know that doesn't mean that they can't do catch up, but due to the complication of ADP testing with multiple HCEs, you may still have a failure. And because they are limiting deferrals, I am sure they are trying to avoid ADP refunds. But I agree, if document allows catch up, HCEs need to be allowed to do catch up if eligible and the chips fall where they may when testing is completed.

[Guest EricWings]

Many employers will limit their HCE's to a percentage for an entire year or part of the year in order to pass the ADP, but will not add that limit into their plan document. Can these HCE's catch-up above this plan limit?