Kevin C

What are the active participant counts in Plans A & B? If at least 50% of the eligible employees in the post merger Plan B were eligible employees in Plan A in the prior year, Plan B would be considered a successor plan. Successor plans can not have a short intial plan year and be safe harbor. Of course, as mentioned, a year end merger is probably the best way to handle this anyway. 1.401(k)-3(e)(2) Initial plan year. --A newly established plan (other than a successor plan within the meaning of §1.401(k)-2©(2)(iii)) will not be treated as violating the requirements of this paragraph (e) merely because the plan year is less than 12 months, provided that the plan year is at least 3 months long (or, in the case of a newly established employer that establishes the plan as soon as administratively feasible after the employer comes into existence, a shorter period). Similarly, a cash or deferred arrangement will not fail to satisfy the requirement of this paragraph (e) if it is added to an existing profit sharing, stock bonus, or pre-ERISA money purchase pension plan for the first time during that year provided that -- (i) The plan is not a successor plan; and (ii) The cash or deferred arrangement is made effective no later than 3 months prior to the end of the plan year. 1.401(k)-2©(2)(iii) Successor plans. --A plan is a successor plan if 50% or more of the eligible employees for the first plan year were eligible employees under a qualified cash or deferred arrangement maintained by the employer in the prior year. If a plan that is a successor plan uses the prior year testing method for its first plan year, the ADP for the group of NHCEs for the applicable year must be determined under paragraph ©(4) of this section.

Sorry, but that is not right. You seem to be confusing 401(a)(4) general testing with average benefits testing. Passing the 410(b) ratio percentage test does not give you a free pass on 401(a)(4). If your DC allocation uses a safe harbor allocation method, then you do not have to do a 401(a)(4) general test. If it is not a safe harbor allocation method, 401(a)(4) general testing is required.

Why would you want to do this even if it is allowed under the current regs? It's easy for a participant to get around it. All they have to do is change their election during the year. I defer as Roth for the first six months and then change to regular for the remainder of the year. Then my deferrals for the year are split 50/50 between Roth and regular. The only difference between this and allowing a split election is that payroll will have to process more deferral election change forms. We are allowing split elections for all of our clients that chose to allow Roth deferrals. I can't imagine going to the trouble to add a Roth feature, then severely restricting the participants' ability to take advantage of it.

At the bottom of page 3 of Pub 560, it says: "What this publication does not cover. Although the purpose of this publication is to provide general information about retirement plans you can set up for your employees, it does not contain all the rules and exceptions that apply to these plans. You may also need professional help and guidance." That doesn't sound like IRS guidance to me. This thread has been amusing, but I'm out of here, too.

From the IRS website: http://www.irs.gov/taxpros/actuaries/artic...=123390,00.html How can I find out whether a practitioner is an enrolled actuary in good standing with the Joint Board? To find out whether a practitioner is an enrolled actuary, you may contact us at: Joint Board for the Enrollment of Actuaries Internal Revenue Service SE:OPR 1111 Constitution Avenue, NW Washington, DC 20224 Phone: (202) 622-8229 Fax: (202) 622-8300

Here is the IRS letter to Kyle Brown: IRS Information Letter, December 9, 1999. IRS: Highly compensated employee (HCE): Compensation limitation. -- The IRS has issued an information letter explaining that the increase in the compensation limit from $80,000 in 1999 to $85,000 in 2000 effectively applies to plan years beginning in 2001. DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE WASHINGTON, D.C. 20224 Mr. Kyle N. Brown Watson Wyatt & Company Research and Information Center 6707 Democracy Boulevard, Suite 800 Bethesda, MD 20817-1129 In re: General Information Request Dear Mr. Brown: This letter is in response to your letter dated October 28, 1999, concerning the application of the increase in the compensation limit from $80,000 to $85,000, in determining highly compensated employee (HCE) status based on compensation. Specifically, you inquired whether the increased compensation limitation of $85,000, effective January 1, 2000, applies for purposes of determining who is an HCE for plan years beginning in 2000. Section 414(q)(1)(B)(i) of the Internal Revenue Code (Code), as amended by the Small Business Job Protection Act of 1996, Pub. L. 104-188 (SBJPA), provides in relevant part that an HCE includes any employee who, for the preceding year, had compensation from the employer in excess of $80,000. This limitation is adjusted at the same time and in the same manner as under §415(d) of the Code, except that the base period is the calendar quarter ending September 30, 1996. Notice 97-45, 1997-2 C.B. 296, provides guidance relating to the definition of an HCE under §414(q) of the Code, as amended by the SBJPA. The notice describes the determination year and the look-back year. The determination year is the applicable year of the plan or other entity for which a determination is being made, and the look-back year is the preceding 12-month period. The HCE regulations under §1.414(q)-1T specifically address how to apply the change in compensation limits in determining HCE status. These regulations were first effective prior to the SBJPA changes, so some of the provisions relate to pre-SBJPA law. In addition to providing guidance on how to apply the dollar limit for a determination year (no longer relevant after the SBJPA changes in determining HCE status based on compensation), the regulations state how to apply the limit with respect to a look-back year, which is how an HCE based on compensation is generally determined after the SBJPA changes. Section 1.414(q)-1T, Q & A 3©(2) provides that the dollar amount for purposes of determining the highly compensated active employees for a particular look-back year is based on the calendar year in which such look-back year begins, not the calendar year in which such look-back year ends or in which the determination year with respect to such look-back year begins. Thus, except as noted below, for plan years beginning in 2000, the look-back years begin in the 1999 calendar year, and the compensation limitation for determining HCE status is therefore $80,000. The compensation limitation for determining HCE status is $85,000 for plan years beginning in 2001, based on look-back years beginning in 2000. It should be noted that if a special calendar year data election described in Notice 97-45 is made, the calendar year beginning with or within the look-back year is treated as the look-back year for purposes of determining whether an employee is an HCE based on the employee's compensation for a look-back year. This election does not change the look-back year for calendar year plans. However, making this election does change the applicable compensation limitation used in determining HCE status for plans with non-calendar plan years beginning in 2000, because the look-back year for these plans is the 2000 calendar year. Thus, if the calendar year data election is made for a plan with a non-calendar plan year beginning in 2000, the compensation limitation for determining HCE status is $85,000. We hope this general information is of assistance to you. Please note that this letter is not a ruling and cannot be relied upon as such. If we can be of further assistance in this matter, please contact John Heil at 202-622-7383. Sincerely yours, Martin L. Pippins (ID# 50-05722) Manager, Actuarial Group 2

I was hoping one of the experts would respond, since I'd like to follow the discussion, too. Does your document allow bonuses paid within 2.5 months after the plan year end to be deferred in the prior year? If not, you can point them to the plan document and 1.401(k)-2(a)(4)(i)(B)(2).

Look at the examples in 2520.104-46. A bond is not required to aviod an audit unless non-qualifying assets are in excess of 5% of plan assets. If non-qualifying assets are >5% the bond coverage must be at least as much as the value of the non-qualifying assets. I found the second example the most interesting. A bond of less than 10% of assets will still exempt a small plan from the audit requirement as long as the coverage is at least equal to the non-qualifying assets. Examples. Plan A, which reports on a calendar year basis, has total assets of $600,000 as of the end of the 1999 plan year. Plan A's assets, as of the end of year, include: investments in various bank, insurance company and mutual fund products of $520,000; investments in qualifying employer securities of $40,000; participant loans, meeting the requirements of ERISA section 408(b)(1), totaling $20,000; and a $20,000 investment in a real estate limited partnership. Because the only asset of the plan that does not constitute a "qualifying plan asset" is the $20,000 real estate investment and that investment represents less than 5% of the plan's total assets, no bond would be required under the proposal as a condition for the waiver for the 2000 plan year. By contrast, Plan B also has total assets of $600,000 as of the end of the 1999 plan year, of which $558,000 constitutes "qualifying plan assets" and $42,000 constitutes non-qualifying plan assets. Because 7% --more than 5% --of Plan B's assets do not constitute "qualifying plan assets," Plan B, as a condition to electing the waiver for the 2000 plan year, must ensure that it has a fidelity bond in an amount equal to at least $42,000 covering persons handling non-qualifying plan assets. Inasmuch as compliance with section 412 requires the amount of bonds to be not less than 10% of the amount of all the plan's funds or other property handled, the bond acquired for section 412 purposes may be adequate to cover the non-qualifying plan assets without an increase (i.e., if the amount of the bond determined to be needed for the relevant persons for section 412 purposes is at least $42,000). As demonstrated by the foregoing example, where a plan has more than 5% of its assets in non-qualifying plan assets, the bond required by the proposal is for the total amount of the non-qualifying plan assets, not just the amount in excess of 5%. [Added March 9, 1978, by 43 FR 10130. Amended October 19, 2000 by 65 FR 62957.] As to the SAR's, they were obviously not done timely, but can be done now. I don't see anything in the reg that says the SAR's have to be timely, only that they be provided with the proper disclosures.

MJB, There is nothing flippant about my attitude. I don't see a clear distinction between the two situations you describe. Both are improperly excluded because the terms of the Plan were not followed. As far as no harm to the participant, what about matching contributions and potential investment earnings? The participant in my example who lost 6% of pay in match each year certainly seems to me to have been harmed. In the case of an employee who made an election that was ignored, you say the employee is solely responsible. What about the Plan Administrator? Are you saying the Plan Adminstrator has no duty to monitor the employer to make sure all proper deferral elections are implemented according to the terms of the Plan? I'm not saying the the employee has no responsibility here. It is a difficult issue any time this happens and each situation is different. That's part of what I was trying to point out with my example. The closest IRS guidance I've seen weighs heavily in the employee's favor, but that doesn't mean there aren't other reasonable alternatives. I just don't see your approach as being reasonable.

Does the Plan have nonqualifying assets? The bonding requirement only applies if the nonqualifying assets are more than 5% of the assets.

From Appendix A of Rev Proc 2003-44: .05 Exclusion of an eligible employee from all contributions or accruals under the plan for one or more plan years. The permitted correction method is to make a contribution to the plan on behalf of the employees excluded from a defined contribution plan or to provide benefit accruals for the employees excluded from a defined benefit plan. If the employee should have been eligible to make an elective contribution under a cash or deferred arrangement, the employer must make a QNC (as defined in §1.401(k)-1(g)(13)(ii)) to the plan on behalf of the employee that is equal to the actual deferral percentage for the employee's group (either highly compensated or nonhighly compensated). If the employee should have been eligible to make employee contributions or for matching contributions (on either elective contributions or employee contributions), the employer must make a QNC to the plan on behalf of the employee that is equal to the actual contribution percentage for the employee's group (either highly compensated or nonhighly compensated). Contributing the actual deferral or contribution percentage for such employees eliminates the need to rerun the ADP or ACP test to account for the previously excluded employees. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees (as permitted in §1.410(b)-6(b)(3)) in order to reduce the amount of QNCs. Likewise, restructuring the plan into component plans under §1.401(k)-1(h)(3)(iii) is not permitted in order to reduce the amount of QNCs. This may be a slightly different situation than the one being discussed, but I don't see it as much of a stretch to say the applicable elective contribution rate for someone who properly filled out a deferral election form that was not implemented would be their chosen deferral rate instead of the ADP for their group. Now to throw out our pending example. A client just discovered that a payroll system change in late 2001 stopped deferrals for one participant. He was deferring 6% of pay and they match 100% of deferrals up to 6%. When the client called about this, the administrator noted that this guy had not looked at his paychecks or plan statements in all this time and jokingly asked what is he, blind? Yes, he is blind. They are discussing the issue with their attorney. Based on the client's comments, I'll be surprised if they do anything other than contributing the missed deferrals, match and lost income.

The Opinion letter addresses a single Plan with 5 Participating Employers. The reference to "profit sharing programs maintained pursuant to the Plan document" is a little strange, but it does repeat that this is a single plan. The phrase also seems to be referring to the allocation method for the PS contributions which is determined separately for each "Participating Employer." The original question asked if separate plans among controlled group members are aggregated to determined if an audit is needed. That is a completely different situation than the one discussed in the Opinion Letter. The DOL regulation specifies when a Plan is subject to the audit requirement, so I agree with Locust that each Plan stands on its own.

Post 1988, hardship distributions of deferral accounts are limited to the dollar amount contributed. Prior to that point, hardship distributions could also be taken from investment earnings on the deferrals. Does anyone know if this change was due to a statutory change or a regulations change? I found a reference to the restriction in 401(k) regs from that time period, but couldn't find anything in the code about it.

In this case, it doesn't really matter what the PS allocation formula is as long as the Plan limits the employer allocation to an individual participant to comply with section 415. Even a salary proportional allocation will work. When the husband reaches a PS contribution of $29,000, the remainder of the PS contribution gets allocated to the remaining participant, the wife, until she hits 415. If the Plan's 415 language says deferrals are refunded if the employer allocation would cause a 415 violation, you need two allocation classes or a carefully designed PS allocation method.

How about Section 414(q)? 414(q)(1) IN GENERAL. --The term "highly compensated employee" means any employee who -- 414(q)(1)(A) was a 5-percent owner at any time during the year or the preceding year, or 414(q)(1)(B) for the preceding year -- 414(q)(1)(B)(i) had compensation from the employer in excess of $80,000, and 414(q)(1)(B)(ii) if the employer elects the application of this clause for such preceding year, was in the top-paid group of employees for such preceding year. The Secretary shall adjust the $80,000 amount under subparagraph (B) at the same time and in the same manner as under section 415(d), except that the base period shall be the calendar quarter ending September 30, 1996.

How does the document define the match formula? I don't see your two statements as being the same match formula.

You might want to revisit what you are doing with the entire "restored" surrender charge. IRS Letter Ruling 200317048 addresses a situation where a company wants to reimburse surrender charges. The IRS says it would not qualify as a restorative payment, so it would be an employer contribution. Reg 1.415©-1(b)(2)©: © Restorative payments. --A restorative payment that is allocated to a participant's account does not give rise to an annual addition for any limitation year. For this purpose, restorative payments are payments made to restore losses to a plan resulting from actions by a fiduciary for which there is reasonable risk of liability for breach of a fiduciary duty under Title I of ERISA, where plan participants who are similarly situated are treated similarly with respect to the payments. Generally, payments to a defined contribution plan are restorative payments only if the payments are made in order to restore some or all of the plan's losses due to an action (or a failure to act) that creates a reasonable risk of liability for such a breach of fiduciary duty (other than a breach of fiduciary duty arising from failure to remit contributions to the plan). This includes payments to a plan made pursuant to a Department of Labor order, the Department of Labor's Voluntary Fiduciary Correction Program, or a court-approved settlement, to restore losses to a qualified defined contribution plan on account of the breach of fiduciary duty (other than a breach of fiduciary duty arising from failure to remit contributions to the plan). However, payments made to a plan to make up for losses due merely to market fluctuations and other payments that are not made on account of a reasonable risk of liability for breach of a fiduciary duty under Title I of ERISA are contributions that give rise to annual additions and are not restorative payments.

Interesting discussion. The following two items are from Rev. Proc. 2000-20. Prototypes are not allowed to test for 401(a)(4) using benefits. (Section 8, .03 7) Standardized plans and nonstandardized safe harbor plans are required to satisfy design-based safe harbors described in the regulations under §401(a)(4) (Section 3, .09 1) If the IRS issued a favorable opinion letter for a standardized prototype, they made a determination that the document satisfied all of the requirements for standardized prototypes. The reasoning in this thread leads to a conclusion that our standardized prototypes do not satisfy the 401(a)(4) SH requirement. If this is true, they should not have received favorable Opinion Letters. If the IRS made a mistake when they issued the Opinion Letters, can we still rely on the Opinion Letters?

See new reg section 1.401(k)-3©(4). (4) Limitation on HCE matching contributions. --The safe harbor matching contribution requirement of this paragraph © is not satisfied if the ratio of matching contributions made on account of an HCE's elective contributions under the cash or deferred arrangement for a plan year to those elective contributions is greater than the ratio of matching contributions to elective contributions that would apply with respect to any eligible NHCE with elective contributions at the same percentage of safe harbor compensation. The reg isn't effective until 2006, but the same type of restriction was in Notice 98-52. Even if you could amend the SH match formula, if you had an NHCE who terminated before the formula increase, I don't think you would be satisfying this limitation. If you use a discretionary match for only the last half of the year I think you would have a problem with the same restriction in 1.401(m)-3(d)(4). That could put your ACP safe harbor at risk.

I went through this discussion in late 2003 with our prototype document provider. The only source they could give for the 3% SH being exempt from Top-Heavy was an IRS informal comment made at the 2002 ASPA annual conference in DC. I was at that ASPA conference in 2002 and attended the IRS Q&A session along with two co-workers. None of us remembered any reference in the session to 3% SH being exempt from top-heavy. They did address the examples of match safe harbor plans that were later published in Rev Ruling 2004-13. Maybe the 3% issue came up in a different session, but I didn't hear anyone mention it during the conference. You would think news that big would have had the whole conference buzzing. Hopefully, they will answer Tom's question at the Q&A session this year. It might help if ASPPA gets this question submitted from several people. I submitted the same question last year, but it didn't make it into the Q&A session.

R. Butler, Don't feel bad about it. Sal changed his mind (and his book), too after the proposed regs came out.

I agree with Tom. If there are no NHCE's in 2003, the NHCE ADP for 2003 is not 0. The average of zero items is not zero, it is indeterminate. To take the average, you would have to divide by zero. Notice 98-1 spells out the prior year testing rules. It also says that the existing regs only continue in effect to the extent they are consistent with the new guidance. Under the prior year method, you are testing prior year data for NHCE's against current year data for HCE's. If you apply the exemption for having no NHCE's to mean no NHCE's in the current year, then you are actually using data for both the current and prior years for NHCE's in the test. I don't see that as being consistent with the rules of Notice 98-1. On the other hand, I think looking solely at the prior year NCHE population to determine if the exemption applies under prior year testing is being consistent with Notice 98-1. Even though we can't rely on them yet, it also doesn't hurt that the new proposed 401(k) regs support the position that under prior year testing having no NHCE's in the prior year is an exemption.

We deal mostly with prototype documents, both standardized and non-standardized. The standardized prototype we use allows requiring 500 hours OR employed on the last day of the year to receive the PS contribution, even if a 3% SHNEC is used. So now we have an IRS approved standardized prototype that may not have a 401(a)(4) safe harbor allocation method. But, having a 401(a)(4) safe harbor allocation method is one of the requirements to be a standardized prototype. I may be overreacting, but I think this is a huge problem, unless the IRS has rationalized another way to look at this issue.

I'll try to be more specific. From Notice 98-52: B. Use of Safe Harbor Nonelective Contributions to Satisfy Other Nondiscrimination Tests A safe harbor nonelective contribution used to satisfy the nonelective contribution requirement under section V.B.2 may also be taken into account for purposes of determining whether a plan satisfies §401(a)(4). Thus, these contributions are not subject to the limitations on qualified nonelective contributions under §1.401(k)-1(b)(5)(ii), but are subject to the rules generally applicable to nonelective employer contributions under §401(a)(4). See §1.401(a)(4)-1(b)(2)(ii). However, pursuant to §401(k)(12)(E)(ii), to the extent they are needed to satisfy the safe harbor contribution requirement of section V.B, safe harbor nonelective contributions may not be taken into account under any plan for purposes of §401(l) (including the imputation of permitted disparity under §1.401(a)(4)-7). My understanding of the general test is that all employer contributions are tested together in total. Are you saying that you apply permitted disparity to one piece of the total and not the other in the same test? From Rev Proc 2000-20, Section 3: .09 Changes to General M&P Plan Requirements --This revenue procedure makes several changes and clarifications to the requirements that apply to all M&P plans. Significant among these are the following: 1 Rev. Proc. 89-9 and Rev. Proc. 89-13 prohibited the issuance of opinion and notification letters for plans that contain or may contain multi-tiered benefit structures. This prohibition has been reformulated as a general requirement that the allocation or benefit formula in a nonstandardized M&P plan must satisfy the following uniformity requirements of the regulations under §401(a)(4) pertaining to safe harbor plans. In the case of a nonstandardized defined contribution plan, the allocation formula must be a uniform allocation formula, within the meaning of §1.401(a)(4)-2(b)(2) of the regulations, or a uniform points allocation formula, within the meaning of §1.401(a)(4)-2(b)(3)(i)(A). In the case of a nonstandardized defined benefit plan, the benefit formula must satisfy each of the uniformity requirements of §1.401(a)(4)-3(b)(2). In addition, each nonstandardized plan must give the employer the option to select total compensation as the compensation to be used in determining allocations or benefits and each nonstandardized defined benefit plan must automatically or by option allow the adopting employer to satisfy one of the design-based safe harbors described in §1.401(a)(4)3(b)(3), (4), and (5). (Of course, standardized plans and nonstandardized safe harbor plans continue to be required to satisfy design-based safe harbors described in the regulations under §401(a)(4).) Thus, for example, an M&P plan, other than a uniform points defined contribution plan, may provide for disparity in the rates of employer contributions allocated to participants' accounts provided the plan satisfies §401(l) in form. Exceptions to the uniformity requirements are provided for Davis-Bacon plans, plans that would fail to satisfy the requirement only because of the plans' top-heavy provisions, and plans that have continued to apply certain limitations under the Code that were repealed by GUST. I read that to mean that non-standardized prototypes are required to use 401(a)(4) safe harbor allocation methods. I also noticed that the prototypes we use do not have general test language in the base document. Most of our plans use prototype documents. My comment about about the 3% SH contribution possibly being considered a part of the CODA was not intended to imply that they are deferrals or that they should be treated as such. With mandatory disaggregation of 1) CODA, 2) match and 3) everything else, I'm just wondering if the IRS thinking is that the 3% SH belongs in the CODA portion for testing, not in the portion for everything else. It may be a little far fetched, but it would eliminate the problem with some standardized prototypes having to be general tested. If the IRS didn't miss the boat on this one, they had to have a reason for thinking it isn't a problem.

Interesting thread!!! Sorry, but I feel the need to stir the pot just a bit more. 1. With the 3% non-elective safe harbor contribution included in the general test, doesn't Notice 98-52 prohibit you from using imputed permited disparity in the general test? 2. Aren't standardized AND nonstandardized M&P plans required to use 401(a)(4) safe harbor allocation methods? The situation being discussed easily fits into the adoption agreements for the both the standardized and NS protoype documents we use. When the logic starts telling us that we have to 401(a)(4) general test some plans using standardized prototypes, it seems a good time to step back and look at the big picture. Did the IRS make a huge mistake in how they integrated safe harbor 401(k) provisions into the M&P program? Or, did we miss something in getting here? I have a difficult time accepting the idea that we can have a standardized prototype plan that can possibly fail 401(a)(4). I'm starting to wonder if the IRS considers the 3% non-elective safe harbor contribution as a part of the CODA. Consider the following: 401(k)(12)(A) IN GENERAL. --A cash or deferred arrangement shall be treated as meeting the requirements of paragraph (3)(A)(ii) if such arrangement -- 401(k)(12)(A)(i) meets the contribution requirements of subparagraph (B) or ©, and 401(k)(12)(A)(ii) meets the notice requirements of subparagraph (D).