ADP testing compensation and controlled groups

[Guest lforesz]

I understand that if a controlled group maintains seperate plans, that for HCEs, the ADR is run combining compensation and deferrals from both plans. However, what about NHCEs? It doesn't appear that we combine deferrals. Does that also mean that we do NOT combine compensation. HELP.

[Archimage]

You would treat all the participants in both plans just as if they were in one plan and you would use all deferrals.

[Mike Preston]

I disagree with the assertion that one combines 401(k) plans for testing ADP and ACP results solely because there is a single entity, such as a controlled group, that maintains the plans.

There are two situtations where aggregations is required.

The first is IF the plans are combined to satisfy 410(B). If they are, then you combine them into one and test as if there were only one. However, if the plans independently satisfy 410(B), one does not need to aggregate them. Just to round out this paragraph, if the plans indeed stand on their own, you CAN still combine them voluntarily under 410(B). In any event, if they are combined under 410(B), you test them as one.

In the case where you have separate plans that each satisfy 410(B) one is still required to count all deferrals and compensation to all plans for each HCE in each of the plans where the HCE participates. This is a participant/employee level aggregation, not a plan level aggregation.

Perhaps a simple numeric example will make it clear why the IRS decided to impose this rule. Assume you have 1 HCE and 4 NHCE's. Assume you set up 4 401(k) plans, each of which has one NHCE in it and each of which allows the HCE to participate. For now, let's assume that each plan satisfies 410(B) [it can be done under the right circumstances]. Now, imagine that each NHCE puts in 1%. If the HCE were allowed to avoid aggregation, the HCE could put in 2% in each plan. This would provide the HCE with an ability to defer 8% of pay. As you can see, if there were only one plan, the HCE would be limited to 2%.

In this example, in each plan, the HCE's compensation and deferrals are aggregated and tested against the NHCE's percentages. In this manner, the HCE would be limited to 2%, in the aggregate, in order for all of the plans to pass.

You can still get a little (and I really mean the word "little" here) mileage by having multiple plans. For example, if you know that there will be a significant group that will always defer a very small percentage of their pay, it is best to have them in a separate plan so that the HCE's would be supported by the NHCE group that, hopefully, defers a larger share of their income.

Again, going to the example with 4 NHCE's, if 2 of them were known to be people who would defer 0.50% of pay, and the other two were known to be people who would defer 3% of pay, if you had two plans you could put the HCE in the latter plan and he/she could defer 5%. If there were only one plan, the HCE would be limited to 3.5% of pay.

I think you will find that the advantage one gains by multiple plans is more imaginary than real. While it is theoretically possible to construct these examples where the HCE's are better off by having multiple plans, in real life the advantages are few and far between.

[MWeddell]

Responding to the original question, assuming that one is testing the plans separately for ADP and 410(B) tests (and other tests), then one does not combine the deferrals and compensation for nonhighly compensated employees. See Treas. Reg. 1.401(k)-1(g)(1)(ii).

Responding to the last portion of the above post, I've helped a client split their 401(k) plan into two plans using reasonable classifications, one plan had 100% of the HCEs and 25% of the NHCEs, and the other plan had 75% of the NHCEs. Because we could predict in advance which NHCEs based on past behavior would contribute the most, this very substantially increased the amount that HCEs could contribute and still pass both the ADP test and the average benefit percentage test. A more ordinary example is found when there is one plan covering salaried employees and the other one covering hourly employees, at least some of which are nonunion. Once again, having multiple 401(k) plans typically helps the ADP test. In sum, in my experience the benefit of having multiple 401(k) plans is real, not imaginary. For large employers, the testing advantages more than offset the added cost for having an extra plan.