John A

It is my understanding that plan documents can provide that profit sharing, nonqualified matching, and some (unrelated) rollover account balances can be part of a hardship distribution. It also seems clear that there is no safe harbor for determining that the distribution is necessary to meet the hardship in this case, and so the plan sponsor would have to meet the facts-and-circumstances standard to determine if the amount was necessary to meet the need. Could the plan document still use the safe harbor for determining that the participant has an immediate and heavy financial need (medical, residence, etc.?), or would this also need to use a facts-and-circumstances standard? Are there any other considerations pertaining to hardship distributions from profit sharing, nonqualified matching and unrelated rollover accounts?

I'm confused as to whether 402(g) excess deferrals that have not been refunded by April 15 have to stay in the plan as provided by Reg. 1.402(g)-1(e)(8)(iii), or should or must be returned under APRSC as provided in Rev. Proc. 98-22, Appendix A, .04. Did Rev. Proc. 98-22 supercede Reg. 1.402(g)-1(e)(8)(iii) - which says that the excess deferral must stay in the plan until a distributable event named in 401(k)(2)(B) has occured? If the deferral has to stay in the plan, do earnings still have to be returned? The language of each section reads: 1.402(g)-1(e)(8)(iii) (not yet amended for GATT) (iii) Distributions of excess deferrals after correction period. If excess deferrals (and income) for a taxable year are not distributed within the period described in paragraphs (e)(2) and (e)(3) of this section, they may only be distributed when permitted under section 401(k)(2)(B). These amounts are includible in gross income when distributed, and are treated for purposes of the distribution rules otherwise applicable to the plan as elective deferrals (and income) that were excludable from the individual's gross income under section 402(g). Thus, any amount includible in gross income for any taxable year under this section that is not distributed by April 15 of the following taxable year is not treated as an investment in the contract for purposes of section 72 and is includible in the employee's gross income when distributed from the plan. Excess deferrals that are distributed under this paragraph (e)(8)(iii) are treated as employer contributions for purposes of section 415 when they are contributed to the plan. Rev. Proc. 98-22 APPENDIX A - OPERATIONAL FAILURES AND CORRECTIONS UNDER SVP .04 Failure to distribute elective deferrals in excess of the section 402(q) limit (in contravention of section 401(a)(30)). The permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable in the year of deferral and the year distributed. In accordance with section 1.402(g)-1(e)(1)(ii), a distribution to a highly compensated employee is included in the ADP test; a distribution to a nonhighly compensated employee is not included in the ADP test.

If a participant exceeded the $10,000 402(g) limit for 1998 and the excess was not returned by April 15, is there another deadline for returning the excess or can the excess remain in the plan? (I realize double taxation will apply, the excess will be taxed in the year of deferral and in the year of distribution.)

I've learned a few more details of the situation. The participant is not a 5% owner and made an affirmative election to start the RMD. The plan is a 401(k) profit sharing plan that is not subject to the J&S rules. However, the participant failed to return the form electing what method to use to determine the amount of the RMD, so the TPA determined the amount on single life, one-age. The TPA is now wondering if the participant should be allowed to complete a form now which changes the method used to determined the amount.

A 401(k) plan participant that is 100% vested reduces hours of service to 200 hours per year. The plan does not have any hours requirement for the match. If I am correct that termination of employment is not part of the definition of a break-in-service, then the participant does have a break-in-service. Can the participant continue to defer and receive the match indefinitely, despite having a break-in-service each year? Does the reduction to 200 hours affect the plan participant in any way?

A participant was not given any election form when the required minimum distribution was first due, so the plan administrator paid the amount based on a single life. What should be done currently? Can the participant now change the method? If the participant does change the method, can it be effective only prospectively, or would it be retroactive? Should APRSC be used due to failure to provide the participant with election forms?

Earl, I'll try to clarify. I meant, would the answer be different if the plan year was 1998 and the plan sponsor had returned deferrals during 1998 in anticipation of failing the ADP test, as opposed to the plan year being 1996 and returning deferrals during 1996 in anticipation of failing the ADP test. Greg, I'll look forward to your post on how the issue is resolved. Would you mind providing a couple of details on what actually occured (that is, did the plan sponsor actually take deferrals out of the plan, were earnings calculated and returned, etc.)? Thanks.

A profit sharing plan lost stock certificates worth approximately $70,000. The insurance bonding fee to replace the certificates was about $700. Can this fee be paid out of plan assets?

What are the consequences and what corrective action needs to be taken if a plan sponsor refunds a deferral during the year of the deferral (rather than doing the refund after the end of the plan year) in anticipation of failing the ADP test? Does it matter which of the following 2 actions the plan sponsor took; 1) left the deferrals in the plan, reduced subsequent deposits of deferrals by a certain amount, and paid that amount as salary; changed the accounting for the deferrals appropriately 2) paid the deferrals out of the plan, just as would have occured after the end of the plan year?

What are the consequences and what corrective action does the plan sponsor need to take in the situation Greg describes in his 11-30-99 1:35 post (refunding a deferral in 1996 during the plan year of deferral in anticipation of failing the ADP test)? Would the answer be different if it occured in 1998?

Wessex, What is the consequence of a trust not having an EIN number and thus using the plan sponsor's EIN number as the trust number? I have seen many Schedule Ps filed using the plan sponsor's EIN number as the trust number, and I do not recall ever hearing that it created a problem.

My understanding of this from previous threads on these message boards and from other research I've done is that there is a “needs” test (distribution is needed to meet the hardship) and an “events” test (event creating an immediate and heavy financial need). The plan can use a “safe harbor” standard for one and a “facts and circumstances” standard for the other. (Reg 1.401(k)-1(d)(2)(iii), 1.401(k)-1(d)(2)(iv) ) Suspension of 401(k) deferrals for 12 months is part of the safe harbor for the needs test. As long as the needs test is met through the "facts and circumstances" test (also called the general standard), you should be o.k. Be careful of the terminology. I have sometimes seen both tests referred to as the "needs" test. That was a rather long way of saying that I agree with Hoard1. However, if the safe harbor is not used, then the determination must be made with nondiscriminatory and objective standards set forth in the plan document. (Reg. 1.401(k)-1(d)(2)(i)). Check Reg 1.401(k)-1(d)(2)(iii)(B) for other rules pertaining to the "facts and circumstances" test or "general standard". Also, be sure the plan document specifies how to handle the events test.

If preliminary testing makes it clear that the ADP test for 1999 will fail, is it possible to do anything currently to change the outcome? For example, would it be acceptable to return deferrals in 1999 and adjust the 1999 W-2 earnings to reflect the return? Would it be acceptable to leave the deferrals in the plan, reduce future deposits of deferrals by a certain amount, and have the plan sponsor pay that amount as salary, changing the accounting for the deferrals appropriately? If either of these would be acceptable, how would earnings be treated? Or is the only acceptable course of action to be sure that the affected HCEs do not defer any more, and wait to return the excess contributions until an actual ADP test can be completed?

What can and can't a plan sponsor do regarding suspending distributions from a defined contribution plan when the plan termination is submitted to the IRS? Can distributions be stopped (pending IRS approval) as of the date of plan termination, as of the date the 5310 is filed, or any date the plan sponsor chooses? Can a plan sponsor refuse to pay the distribution until IRS approval to a participant that terminates employment after the suspension of distributions (does this depend on the document)? Does a plan sponsor have to adopt a plan amendment and/or a written policy in order to suspend deferrals? If all participants terminated employment due to the business closing down and the plan document contained a provision calling for distribution as soon as practicable after termination of employment, can the plan sponsor suspend distributions until IRS approval is obtained? Are there any other issues a plan sponsor should consider prior to deciding to suspend distributions until IRS approval is obtained?

10,500.

I am not a 401(k) expert by any means, but I believe that, as a practical matter, I would have the former participant reenter on the date of rehire and allow them to make deferrals as of the date of rehire. I believe you technically could require a year of service to reenter but would have to make the participation date retroactive, which is impractical in a 401(k) plan. I'm not sure you can use an entry date later than the rehire date for a former participant with a 1-year break in service. What do others think?

You still need more clarification. It is possible you do not yet have a problem. For example, let's say the HCE was defering 5% of salary so when he or she reached $160,000 in compensation, the deferrals were $8,000. The HCE is still under the $10,000 limit, so deferrals can continue on further compensation, provided the 25% of compensation, the $30,000, and/or any limit set by the plan document has not been exceeded. On the other hand, if the plan document limited deferrals to 5% of compensation and deferrals continued, then there would be a problem. So, please clarify what the problem is: has a plan document limit been exceeded, has the $10,000 402(g) limit been exceeded, has the 25% of compensation or $30,000 limit been exceeded? An HCE is not required to stop deferrals solely because the HCE's compensation has exceeded $160,000 for the year. Anyone else agree of disagree?

jlf, In your post of 11-15-99, you state that you would choose a $300,000 lump sum over a life annuity of $41,000 per year. I might make the same choice, but let me analyze the numbers a bit first: In the scenarios that follow, I am assuming that the $41,000 would be paid at the beginning of each month in the amount of $41,000/12. When I mention a an annual rate of say, 12%, I am applying that as 12/1=1% per month. So to determine what rate of return I would need to not touch the prinicpal of $300,000, I am solving for i in the equation: ((300,000-(41,000/12))*(1+i)=300,000. Solving for i in this equation, the interest rate need to never touch the principal would be a bit under 14%. Using my calculation methodology above, it the investment return was 13%, the $300,000 would be gone in 22 years. At 10%, the $300,000 would be gone in 13 years. If it is not necessary to use the money for income, then the comparison is between investing a $300,000 lump sum and investing monthly payments of $41,000/12. If the investment return is 10%, the annuity will overtake the lump sum in 13 years. If the return is 13%, it will take 22 years. If the return is near 14%, the annuity will never overtake the lump sum. The same type of analysis could be applied to taking $30,000/12 per month and investing the $11,000/12 per month and the results would be the same. This would also be a way of hedging against inflation. It seems pretty clear to me that if you expect to earn 10% and expect to live more than 13 years, you would be better off taking the annuity. If you expect to earn 13% and expect to live more than 22 years, you would be better off taking the annuity. The reasons I can validly see for choosing the lump sum would be: 1) You are not in great health. 2) You expect to get an investment return of almost 14%. 3) You require a death benefit in the first few years following age 65. 4) You do not need the money for retirement income and have a need or desire to spend the amount sooner rather than later. 5) You expect investment returns to be very high in the first few years and low in following years. On the other hand, even with the "guaranteed loss of purchasing power", the annuity provides a lifetime retirement income, part of which can be saved as a hedge against the loss of purchasing power, at little or no risk of being reduced to zero, which the lump sum can do if used as a source of retirement income. Are annuities evil and lump sums the hero of the person being paid? If the payee receiving an annuity dies after one year, or if investment returns are high, the payee will probably take that view. A payee who is still living at age 99 who has seen a bear market or two during the 34 years of being paid may take the opposite view. By the way, jlf, what I find inherently unfair about the plan you describe is the possiblity that two employees will contribute vastly different amounts and receive the same benefit. This would be the case if two employees have vastly different salaries for 32 years, but have the same final average salary (for example, one employee is as you described above - 5,500 initial salary increasing by 2,000 each year, compared to an employee who has an initial salary of 5,500 increasing by 1,000 each year until the last 3 years are increased to match the first employee). On other subjects, I fully admit that I do not know how much the state is contributing compared to employees. If the state is misrepresenting the benefit that is being provided, I would see that as a problem. jlf, if you are not already aware of it, you would probably be interested in the current discussions and legislation involving employers converting their traditional final-pay type defined benefit plans to cash balance plans. Cash Balance plans are defined benefit plans that are designed to look and act more like defined contribution plans - younger employees accrue benefits much faster and are shown a "lump sum" cash balance on the annual statement of benefits. The problem with the conversions has been that some conversions have ended up giving employees who are currently older the worst of both worlds - smaller accruals when they were younger and now smaller accruals while they are older. Employers have been accused of much less than full disclosure in this reduction of benefits for older employees. In terms of the compulsory savings account and the ratio you accuse the plan administrator of knowing, I would be very surprised if the plan administrator had ever tried to determine either. Both the employee's contributions and the employer's contributions go into a pool of assets that are not assigned to any particular employee. The pool of assets is compared to the expected liabilities of the entire group of participants, using assumptions determined by the actuary. The pool of assets will be affected by investment returns, employer and employee contributions, plan expenses, and benefit payments. The liabilities will be affected by mortality experience and turnover, among other things. The employee and the employer can calculate the benefit that is due to the employee at any point in time, and that benefit is unaffected by the experience of the plan. There is no reason for a plan to attempt to calculate how much a savings account would be because the assets are not assigned as accounts to participants. It is worthwhile for a participant to compare the benefit being purchased with the 5% contribution to what the participant believes could be accumulated by saving 5% of compensation outside of the plan. If the participant is free to decline participation in the plan and believes that an accumulation outside of the plan would be a superior use of the money, the participant may do so.

In a plan that does not allow in-service withdrawals, a participant with a 1998 Required Minimum Distribution of $190 received a $2,000 distribution during 1998. The 1999 Required Minimum Distribution (based on the actual 12/31/98 account balance) was $750.00. The participant was paid $3,000 during 1999. What are the consequences and correction for this? Should the 1999 Required Minimum Distribution have been based on the 12/31/98 account balance increased by the amount of the excess payment in 1998 (increased by $2,000- $190)? Is this a Prohibited Transaction requiring the employer to file a Form 5330? Is the proper correction to have the participant repay the amount of the excess? If the participant refuses to repay the excess, may the plan sponsor reduce the year 2000 Required Minimum Distribution amount by the amount of the prior year excesses? Can APRSC be used or is there another IRS correction program that would be more appropriate?

The plan year is 9/30/99. The plan document specifies that employees can defer between 2 and 5%. Everyone is within this range except for one employee who earned 165,000.00. He deferred 5% of 165,000.00, and should have been limited to 5% of 160,000. His contribution should have been limited to $8,000, but he contribed $8,250.00. The excess contribution is $250.00. 1. Should the money be a)shown on the allocation report and b) included in testing, or should the money be taken out like it was never there? 2. Does the client have an option to do a 1099-R or W-2, since the 1999 calendar year is not yet over? 3. Should the money stay in the plan and be advanced to the next plan year, or be refunded? 4. Should this be handled through APRSC? Our thoughts at this point have been: 1). Take the money out of the plan like it was never there 2). Tell the plan sponsor to refund the money to the participant. 3). Give the plan sponsor a choice between issuing a 1099-R, or adjusting the W-2 form. Thanks.

jlf, Does the member have a choice between the $300,000 lump sum and the $40,915 single life annuity? If so and you were the member, which would you choose? Is the $300,000 account balance based on actual investment returns or a guaranteed return stated in the plan? If the account balance is based on actual investment returns, who had control of the investment decisions? Whether or not the benefit is good relative to the member's contributions is a matter of opinion and perspective. One way of getting (approximately) to your scenario would be to assume a starting salary of $19,175, 4% annual salary increases, and an 8.75% investment return. (Is my math correct? - I did not check it very carefully.) One could argue that the benefit was not good because the employer should be expected to fund more than 27% of the benefit. One could argue that the benefit was good because the member was offered an annuity that is more than the full economic value of the member's contributions (assuming the $300,000 balance is based on actual investment returns). One could argue that the benefit was not good because, if actual investment returns were higher, say 10.5%, the member could be funding more than 100% of the annuity offered. One could argue that the benefit was good because, if actual investment returns were lower, the employer would have funded a higher portion of the benefit, and the employer took the investment risk. One could argue that the single life annuity is a bad option because, if the member dies after one year, the member forfeits a considerable amount of money that should have belonged to the member, and the annuity will lose its purchasing power due to inflation (of course, some of each payment could be invested to help cover this). One could argue that the single life annuity benefit is a good option because it provided the member with a defined benefit that the member could plan on rather than with an account balance that would fluctuate with the market, and the annuity would also provide an income source that the employee would not outlive (although inflation could make the last years of this guaranteed income source not meaningful). What percent of a benefit should an employer fund, and what percent should an employee fund?

An employer wishes to allow a 401(k) plan participant access to their money. The participant has reached the Normal Retirement Age of 55 under the plan, but is not yet 59 1/2. The adoption agreement and prototype do not seem to allow for choosing to grant in-service distributions from any source prior to 59 1/2. Our thoughts have been: 1) Be sure the participant is terminated and then wait to rehire the participant until after the check is cut. Is it necessary to wait until the check is cut before the rehire? 2) Amend the plan to allow for in-service distributions prior to 59 1/2. Are we correct that this could only be done for non-elective contribution sources? Would the amendment make the plan an individually-designed plan? Any suggestions as to the best course of action for the employer? Thanks.

If a participant “retires” and is rehired each year for several years in a plan that grants an allocation to participants who retire, should that person get an allocation each year, even if the person does not meet the requirements for an active participant (hours and/or last day)?

IRS Regulation 1.411(a)-5 (shown below) says that for a plan that uses computation periods, service within a computation period during which an employee attains age 22 must be taken into account for vesting. Should this regulation be used for guidance as if it had been updated to replace "age 22" with "age 18"? Or should the regulation be ignored since it has not been updated? 1.411(a)-5 Service included in determination of nonforfeitable percentage. (a) In general. Under section 411(a)(4), for purposes of determining the nonforfeitable percentage of an employee's right to his employer-derived accrued benefit under section 411(a)(2) and § 1.411(a)-3, all of an employee's years of service with an employer or employers maintaining the plan shall be taken into account except that years of service described in paragraph (B) of this section may be disregarded. (B) Certain service. For purposes of paragraph (a) of this section, the following years of service may be disregarded: (1) Service before age 22. (i) In the case of a plan which satisfies the requirements of section 411(a)(2) (A) or (B) (relating to 10-year vesting and 5-15-year vesting, respectively), a year of service completed by an employee before he attains age 22. (ii) In the case of a plan which does not satisfy the requirements of section 411(a)(2) (A) or (B), a year of service completed by an employee before he attains age 22 if the employee is not a participant (for purposes of section 410) in the plan at any time during such year. (iii) For purposes of this subparagraph in the case of a plan utilizing computation periods, service during a computation period described in section 411(a)(5)(A) within which the employee attains age 22 may not be disregarded. In the case of a plan utilizing the elapsed time method described in § 1.410(a)-7, service on or after the date on which the employee attains age 22 may not be disregarded.

The IRS Code provides that a plan can "buy back" the 1.0 for 415(e) by providing a 4% DC contribution. See 416(h)(2)(A)(ii)(II) below. IRS Regs say that a plan can "buy back" the 1.0 for 415(e) by providing a 7.5 DC contribution. See IRS Reg 1.416-1 M-14. Can the Code be used or does the IRS Reg have to be used? Does anyone have experience using the 4% in the Code to do the buy-back? Does anyone have experience using 7.5% to do the buy-back? Can anyone tell me if there are specific situations that call for one or the other? I realize 415(e) is going away soon, but I'd still appreciate any information on this. I have been curious for a long time. Section 416(h)(2)(A)(ii)(II) is as follows: (h) Adjustments in Section 415 Limits for Top-Heavy Plans.* (1) In general. In the case of any top-heavy plan, paragraphs (2)(B) and (3)(B) of section 415(e) shall be applied by substituting ``1.0'' for ``1.25''. (2) Exception where benefits for key employees do not exceed 90 percent of total benefits and additional contributions are made for non-key employees. Paragraph (1) shall not apply with respect to any top-heavy plan if the requirements of subparagraphs (A) and (B) of this paragraph are met with respect to such plan. (A) Minimum benefit requirements. (i) In general. The requirements of this subparagraph are met with respect to any top-heavy plan if such plan (and any plan required to be included in an aggregation group with such plan) meets the requirements of subsection © as modified by clause (ii). (ii) Modifications. For purposes of clause (i) -- ... (II) paragraph (2)(A) shall be applied by substituting ``4 percent'' for ``3 percent''. IRS Reg 1.416-1 M-14 Q. says: M-14 Q. What minimum contribution or benefit must be received by a non-key employee when he is covered under both a defined benefit plan and defined contribution plan (both of which are top-heavy) of an employer and the employer desires to use a factor of 1.25 in computing the denominators of the defined benefit and defined contribution fractions under section 415(e)? A. In this particular situation, the employer may use one of the four rules set forth in Question and Answer M-12, subject to the following modifications. The defined benefit minimum must be increased by one percentage point (up to a maximum of ten percentage points) for each year of service described in Question and Answer M-2 of the participant's average compensation for the years described in Question and Answer M-2. The defined contribution minimum is increased to 7-1/2 percent of compensation.