John A

What is the correction for granting a higher match than what is specified in the plan document (document specifies matching 50% of deferrals up to 5% of compensation, plan sponsor mistakenly granted 50% of deferrals up to 8% of compensation)? If the excess matching contributions are treated as forfeitures, would associated interest also be treated as forfeitures? Would associated interest be required to be calculated in any specific way? Would the correction fit under APRSC? Does the IRS guidance under Rev. Proc. 2000-16 cover this in any way?

Tom, Thanks for setting this straight. I did not read the reg carefully enough because I had first read the following example from Q 1:19 in the 2000 Pension Distribution Answer Book: Example I-14. Irene is an HCE of Rene's Cookie Creations, Inc. During each of the years 1992, 1993, and 1994, she earned $150,000. In 1995, she decided to cut back her hours to spend more time with her grandchildren and only earned $40,000. Since her compensation during the determination year (1995) is less than 50 percent of the average annual compensation earned in her three consecutive highest paid years ($150,000), Irene has a deemed separation year in 1995. Irene is treated as a HCFE in 1995 and future years, unless she experiences a deemed or actual resumption of employment. It seems clear upon rereading the reg noting your emphasis, that the Pension Distribution Answer Book example is incorrect - Irene would be an HCE in 1995 and would only be an HCFE after actual termination of employment. Do you agree that the Pension Distribution Answer Book example is wrong? Even with the ERISA Outline Book example you cited, it seems to me at this point that the HCFE designation is never important. I do not understand why the designation was created. Thanks again for pointing out what I missed in the reg.

IRC401 and Tom, Please read the following example from IRS Reg. 1.414(q)-1T Q&A 5: Example (1). Assume that in 1990 A is a highly compensated employee of X by reason of having earned more than $75,000 during the 1989 look-back year. In 1987, 1988 and 1989, A's years of greatest compensation received from X, A received $76,000, $80,000 and $79,000 respectively. In February of 1990, A received $30,000 in compensation. Because A's compensation during the 1990 determination year is less than 50% of A's average annual compensation from X during A's high three prior determination years, A is deemed to have a separation year during the 1990 determination year pursuant to the provisions of paragraph (a) of this A-5. Since A is a highly compensated employee for X in 1990, A's deemed separation year, A will be treated as a highly compensated former employee after A actually separates from service with the employer unless A experiences a deemed resumption of employment within the meaning of paragraph (B) of this A-5. Based on this example, it still appears to me that the #7 HCE in my question would be a Highly Compensated Former Employee (HCFE), NOT an NHCE. After reading the example, would you agree? IRC401, regarding your other points: 2. I'll check the regulations again, but my understanding is that a plan can choose to use the top-paid group election as long as the plan is amended to conform to actual practice by the end of the remedial amendment period. 3. My apologies for not including ownership info. For purposes of the question, assume that the top-paid HCE is a 100% owner who is not related to any of the other employees. 4. I agree that determining HCEs is a very important matter - it is important for all plans, not just 401(k) plans. That is why I am trying to be sure I understand the rules pertaining to Highly Compensated Former Employees (HCFEs) and when those rules affect the determination of HCEs. Tom and IRC401, would your above responses now change?

Employer has 21 active employees as of 1/1/98. 7 of these employees are HCE for 1998 and 14 are NHCEs. One of the 7 HCEs, who is age 40, has a compensation history of $150,000 in 1995, 1996 and 1997, and $74,000 in 1998 and 1999. The other 6 HCEs have comp. over $100,000 in 1998. The 14 NHCEs have comp. under $80,000 in 1998. The employer decides to use the top-paid group election for 1999. There are no new employees and no terminations of employment. Is the following correct: The HCE in 1998 with $74,000 comp. in 1998 has a deemed separation year in 1998 and so is an HCFE for 1999. Number of ees considered for top-paid group = 20. The number in the top-paid group will be 4 (20% of 20). There are 5 HCEs for 1999: the 4 employees with the highest compensation in 1998, plus the 1998 HCE with $74,000 comp. in 1998 (due to being an HCFE). Is the above correct?

A participant is an HCE if either of the following is true: 1.a greater than 5% owner (including by attribution) in the current or lookback year, or 2.greater than $80,000 (as indexed) comp in the 12 months prior to the current plan year. An employer can amend the plan document to use the top-paid 20%. If a non-owner employee earns $81,000 in 1997, and $35,000 in 1998 and 1999, is it correct that the employee is an NHCE for 1998 and an NHCE for 1999? If an employee terminates employment prior to the determination year, is there any reason the employee could be important in determining HCEs and NHCEs? When and/or why would Highly Compensated Former Employees (HCFEs) be important in relation to ADP/ACP testing and/or determining HCEs and NHCEs that matter?

I'm having a hard time believing that there is any situation, including this one, in which it could be o.k. for an HCE to get a higher rate of match than an NHCE. In KJohnson's example, the HCE gets 5% of comp. and the NHCE gets 3.67%. I don't have a cite to point to, but it sure doesn't seem to pass the "smell test" to me. Please clarify.

lucie, thanks for the response. I agree with you on 1. - I should have double-checked what I typed. The point is, an employee can go back and forth between being an HCE and an NHCE. So if the non-owner employee had comp. of $81,000 in 1997, $35,000 in 1998, and $90,000 in 1999, the ee would be an HCE in 1998, an NHCE in 1999, and an HCE again in 2000, correct? Regarding HCFEs, are you saying that post-family aggregation rules, HCFEs are irrelevant in all situations?

There is an announcement in the Federal Register that the revised 5500 will be (has been?) released today. However, I have not been able to download the PDF files (connection timed out errors, probably due to size of the files). Anyone else have any luck? The revised form is not on the DOL website yet, perhaps it will be by the end of the day. Anyone know of anywhere else I should be looking?

My apologies. Bill and Greg Self are correct. I did not reread Q2 and was thinking it was asking if the loan was still o.k., rather than if something had to be increased.

I agree with dsilver

It seems to me like this question should (has?) to be answered by the plan document, but if the plan document seems to be silent: How is life expectancy calculated for purposes of determining the period for installments in a defined contribution (DC) plan? In many DC plans, I see one of the distribution options as: "installment payments over a fixed term not to exceed the life expectancy of the participant or the joint lives of the participant and beneficiary. However, this is the first time I can remember a participant inquiring about this option. Is the life expectancy always determined under IRS Reg. 1.72-9 Tables V and VI? Is there a choice based on IRS Notice 89-25 Q&A 12? The participant in this case is about 50, so I am not asking about a required minimum distribution situation. Also, are ages based on Age Last Birthday or Age Nearest Birthday? Is any type of interpolation necessary? If the plan document is silent on this issue, is it a plan defect? Or could I just refer to the rules for required minimum distributions in the document and use the life expectancy definition from that section? Thanks for help with any part of this question.

In your case, when are/were participants made 100% vested (due to the plan termination) and why are there forfeitures?

Are there any instances where a 401(k) plan can accept deferrals after termination of employment? For example, if an employee terminates tomorrow, but receives their last paycheck 2 weeks from tomorrow, can a plan accept deferrals from that paycheck? Can a plan acceprt deferrals from late commissions paid after termination of employment? How about severance pay? Has this been discussed at any professional meetings?

jlf, where did you get $31,500 in 1979? The hypothetical employee would be earning $73,500 at the end of each 35-year accumulation period, including 1945-1979. My calculation used $73,500 for 1979 when it was the end of the 35-year accumulation period. If you will provide the returns for the S&P 500 and the Lehman Brothers Bond Index for each year from 1/1/1945 to 12/31/1999, I would be happy to redo the calculations using the 60%, 40% mix.

Throwing out all years prior to 1945: The 35 year accumulations (based on the Dow returns) ending in 1979 through those ending in 1990, followed by withdrawals of 41,000 per year, would have been gone by the end of the eighth year of withdrawals. The accumulation ending in 1991 would be less than $50,000 at 12/31/99. Accumulations ending in 1993-1999 would have increased even with the withdrawals. If the retirement benefit is based stictly on what contributions accumulate to, then the 1981 retiree gets gets 19% of the benefit te 1999 retiree gets. The 1990 retiree gets 37% of the benefit the 1999 retiree gets. The 1993 retiree gets 46% of the benefit the 1999 retiree gets. The 1994 retiree gets 45% of the benefit the 1999 retiree gets. the 1998 retiree gets 85% of the benefit the 1999 retiree gets.

A plan sponsor did not make their total Top Heavy contribution for a PYE in ‘98. As TPA, our firm completed Form 5330 for them and instructed them to deposit the additional amount and file the Form 5330 with the IRS. The plan sponsor signed the form in 1999 and sent it to the IRS along with the penalty. The IRS is now asking for the date the deposit was made (Part IX- Form 5330). In conversation with the plan sponsor, it appears the plan sponsor never deposited the amount to make up the Top Heavy contribution. What should we as TPA do now? What should the plan sponsor do?

jlf, your 11-22-99 post was: Let's now assume the $300,000 is reality; do you agree with me when I say it is bad public policy to say to an emloyee "you must annuitize your $300,000 ($30,000 a year for life) in order to receive an additional lifetime annuity of $11,000 a year financed with an employer contribution of $110,000? Pax’s response: It is bad policy to discuss it at all. That is not the purpose of the plan! If you insist on viewing the 300K as "yours" (it is not), then perhaps you should consider that you are getting free money. That is, for putting up 30K per year, are getting that back with an additional 11K annual bonus. My response now: jlf, even if I accept the whole premise of the employer “making up the difference” between the accumulation of the participant contributions and the value of the annuity (a premise I do not completely accept), I still do not believe it is bad public policy to provide the annuity rather than a lump sum. jlf, in the DC plan you describe as the hero of the employee, does the employer do the investing or do participants get to self-direct? I reviewed the Dow returns from 1/1/1896 to 12/31/99 and applied the returns to the 35 year accumulation for the participant with a starting salary of 5500, increasing 2000 per year, and 5% of salary contributions. For convenience, I assumed that the entire contribution was made on January 1 (before the salary was actually earned). Before I mention some of the results, I’d like to bring up 3 principles of money accumulation and withdrawal that I do not think are discussed nearly enough: 1. When money is being saved on a periodic basis for a certain number of years, the investment return at the end of the period is much more important than the early investment returns. 2. When money is being withdrawn from a lump sum on a periodic basis for several years, the investment returns at the beginning of the withdrawal period are much more important than later returns. 3. If returns are applied to a lump sum with no added contributions and no withdrawals, then the order of the annual investment returns makes no difference. The first 2 principles really just mean that the investment return (positive or negative) on a large amount has a much greater effect than the investment return on a small amount. To some of the results I found (and if anyone would like to check my calculations, please do): The highest annualized return over a 35-year period was 7.6% from 1965-1999. The lowest annualized return over a 35-year period was 0.6% 1898-1932 (the end of the depression). The accumulation assuming a constant 8.75% return would be approximately $270,000. (jlf, please check my math as I believe you came up with $300,000 rather than $270,000). The accumulation assuming the Dow returns through 1999 would be approximately 487,000, well above the 410,000 present value of the annuity. The accumulation for the 35 years ending in 1994 would have been appoximately $216,750. The accumulation for the 35 years ending in 1981 would have been approximately $91,500. The accumulation for the 35 years ending in 1932 (the end of the depression) would have been about $42,500. From 1955 (the first year the accumulation would have been above $200,000) through 1999, the accumulation would have been less than $200,000 24 times and more than $200,000 21 times (9 of which were in the 1990’s). Taking 41,000 annually from the lump sums that accumulated and continuing the Dow returns on the accumulation, the money ran out within 10 years almost always until the 1990s. Even with the wonderful accumulation at the end of 1999, if the returns for 2000 and 2001 happened to match the returns for 1973 and 1974, it is likely the money would run out within 10-12 years. In studying this topic I have (for now) come to the following conclusions (and please keep in mind that I am a fan of both DB and DC plans and would prefer a situation in which every employer could provide both): 1. DC plans as retirement vehicles are a form of Retirement Roulette or Retirement Lottery. In other words, there are major winners and major losers. If a participant is fortunate enough to have an environment like 1991-1999 (not a single losing year, 20%+ returns 5 of the years) at the end of their DC plan accumulation and the beginning of their withdrawals for retirement use, the DC plan certainly would be considered a hero to that participant. If a participant is unfortunate enough to have their 35-year accumulation in the DC plan experience investment returns like the Dow returns ending in 1981, the participant will probably curse the day the DC plan was created. A DB plan would have provided the same benefit defined in the plan to each of these participants, despite the large difference in accumulation. 2. DB plans are inherently fairer since they do not reward or punish participants because of the vagaries of the market. A DB plan does not discriminate based on what calendar year a participant retires. 3. If you want the employer to do the investing for the DC plan, then you are in favor of some form of paternalism. 4. If you want participants to be able to self-direct (as is the case with most current 401(k) plans, then the rich will get richer and the poor will in general get poor investment returns. If you do not believe this, I would urge you to read a 9/98 article in Worth Online called “Disaster in the Making.” 5. The biggest problem with DB plans is the portability issue, which is only partially solved by the greater ability of a DB plan to provide for a meaningful retirement benefit in the last few years before retirement. jlf, in your 12/3/99 post, you say: Based on my assumptions of 11-12-99 a participant who retired at age 65 after 10 years of service credit financed 64% of his own lifetime pension? You see, an "irrational exhuberance" generated an average annual return of 14.3% over the past ten years. Irrational exuberance does not refer to what has happened for the past 10 years but to what expectations are for the future. The 1990s were just about the best of all possible worlds for investors. Suppose 2000-2009 duplicates the returns of 1965-1974? That said, here’s hoping 2000-2009 more closely resembles 1990-1999. Anyone who is counting on withdrawing from a lump sum for retirement income needs to know that even if the annualized investment return for the next 20 years is 10%, the lump sum may quickly disappear if the first few years of the 20 years are substantial investment losses and the high rate is due to substantial gains near the end of the 20 years. Also note that "excess gains" in DB plans, if used properly, act as a "rainy day" source to be sure assets are sufficient for future retirees. pax, any idea what the added value of the 60% COLA (jlf, 60% of what?) would do to change the $410,000 present value? If anyone is still reading at this point, I apologize for the length. I hope you found something worthwhile in my discussion. [This message has been edited by John A (edited 01-21-2000).]

KB, Thanks for the response. Does that apply to both HCEs and NHCEs? Also, on what do you base your opinion (formal written guidance, informal guidance at a conference, etc.)? Thanks again.

Ineligible employees were allowed to make salary deferral contributions and received matching contributions. The amounts have been returned or forfeited under APRSC. Do the contributions have to be included in the ADP and ACP tests?

Can a participant choose to have his required minimum distribution calculated using his spouse for the J&S calc if someone other than his spouse is his beneficiary? In other words, can they be different people?

A plan sponsor, through a paperwork error, transferred a participant's account to the wrong fund. The sponsor now wants to correct the error by contributing the $10,000 (earnings lost by participant)to the right fund. Does this correction fall under any correction program (APRSC, VCR, etc.)? Are there any problems associated with 415 limits, deduction limits, etc. (that is, is it possible the $10,000 correction has to be considered a plan contribution and/or an annual addition, etc.)?

You are correct. The employee is wrong. You say that the document reads, "The Employer shall not match Participant Elective Deferrrals in excess of 4% of the Participant's Compensation." If the employee was correct, the document would simply say that Employer matching contributions are limited to 4% of compensation. There would be no need to mention the deferrals.

I'm still unclear on what consequences there are to the participant (and it stilll seems like there should be some) after the participant is hit with the taxation issues for the deemed distribution. I'm thinking of a situation in which the plan sponsor did proper due diligence, but the participant, unknown to the plan sponsor, never had any intention of paying back the loan. Could the employer implement payroll deduction at this point even if it had not been in place previously? If the employer can force the participant to still pay back the loan, then the consequence seems just. If the participant manages to not repay the loan at all, it still seems as if there is no further consequence to the participant and the participant has essentially gotten away with getting a distribution that should not have been allowed.

Once the loan has been treated as a deemed distribution (and assuming that payroll deduction is not used for the particular plan), what further consequences does a participant face if repayment is never made? If a participant really just wants a taxable distribution (and again assuming the plan has not been set up to repay loans by payroll deduction), does taking a loan and refusing to make payments meet the objective? It seems like the participant should face some type of further penalty, but I am not aware of any.

Is there an exception for government plans? At least for some state defined benefit plans, I believe that an employee is required to participate in the plan as a condition of employment; since the plans are mandatory contribution defined benefit plans, the employee essentially is required to agree to contribute x% of his/her salary to the plan in order to be hired.