Administration of catch up contributions

[Guest Diane DuFresne]

Hoping someone can help me understand the "process" of allowing participants the ability to defer catch up contributions.

We have not yet updated our prototype plans for GUST (removing the deferral limit for NHCE's) so most of the plans that we administer still have a deferral limit (typically 15% but sometimes 10%). We did provide for a prototype plan sponsor EGTRRA amendment that allows for catch up contribuitons. I understand that the law allows for participants to exceed this plan stated limit to allow for catch up contributions.

The problems I am having is how to calculate the amount to defer? As compensation is a moving target (dependent on number of hours worked) how do we advise on the correct deferral rate to allow for catch up contributions? Is 12%, 13%, 14% the right number? What happens if the amount the participant defers is actually more than the stated limit, plus $1,000.

Or does it even matter......If by December 31, 2002 I amend the plan for GUST and remove the deferral % limit, only those deferrals in excess of $11,000 for 2002 deemed to be catch up?

How are plan sponsors notifying their participants of this availability? Any suggestion on a revised deferral election form until the plans are amended for GUST?

Any thoughts would be appreciated.

Thanks!

[Archimage]

I recommend limiting the deferral percentage to somewhere around 70%. This will keep someone from deferring 100%. The reason you do not want to do this is because of payroll taxes. Social security and medicare taxes have to be deducted. It also gives the participant the opportunity to deduct other pretax programs such as cafeteria plans.

[Guest dmj1998]

i agree with archimage about still keeping some limit for EE's - your payroll dept. will be very happy with that. 70% might still be a little high (we are looking around 20%-30%) - not many workers earning less than $20K have the ability to save so much.

with regard to your statement about "how do we advise on the correct deferral rate...", i am a little uncomfortable with that. your plan design should allow participants to save as much as possible, but you shouldn't be looking for guidelines to show to EE's. in an ideal world, participants would select one rate and your payroll dept will cut them off at $11K for EE's under 50 and cut them off at $12K if they are over 50. that way, the participant decides how much they want to contribute - this is especially important since you cite that compensation is a moving target. on a participant level, catch-up contribs are treated the same way as pre-tax contribs for tax purposes. on the plan level, you only need to designate contribs as catch-up if they exceed the plan's/irs limits at the end of the year.

[david rigby]

Allowing a very high percentage deferral (say 50%) is a plan design that should be considered by any sponsor who has concern about passing the ADP test. The likely users of such high percentage are "second wage earners". If someone earning 20K wants to defer 10K, why not let them? It helps them and it helps the ADP test.

[MWeddell]

I've recommended and had clients adopt an 80% limit, so I disagree with the poster that said 70% is too high.

One wants to raise the percentage so high that one doesn't ever expect an employee to contribute at the maximum percentage for the whole year and still not have hit the 402(g) limit first. That way one only has to worry about catch-up contribution eligibility based on the 402(g) limit or when the recordkeeper runs the ADP test.

[Guest dmj1998]

pax/ mwaddell - i don't disagree with your reasoning, but it depends on the demographics of your employee population. most "second wage earners" we have are not working to sock away a nice retirement fund so much as trying to put food on the table for the family because the economics of today require it. i've yet to meet the employee bringing home $15,000 who has complained about the 402(g) limit.

with regard to adp testing, i don't think your max rate matters much at the levels we are talking about. since all employees count equally in the test, the 0's from eligible non-participants are just as important as those 50% people. i'm just as worried as having to pass the acp test now that more people will be spilling over into the after tax contribs.

[Mike Preston]

"i'm just as worried as having to pass the acp test now that more people will be spilling over into the after tax contribs."

Huh?

[MWeddell]

It strikes me as very unlikely that raising the maximum contribution percentage from 20% to 80% would hurt the ADP test because the vast majority of the time HCEs will find the $11,000 402(g) limit more restrictive than the plan's maximum contribution percentage. Even if relatively few NHCEs increase their contributions over 20%, this will still help the ADP test.

[Guest ndt123]

If a plan does not set seperate limits for HCEs vs. NHCEs, the ADP test can most certainly be affected by an increase in pre-tax contribtion rate maximums.

If an HCE front loads their contribution at an extremely high rate, but terminates prior to hitting the 402(g) limit, the ADP test can be dramaticly affected (depending on the number of HCEs).

[Guest dmj1998]

preston - hce's are more likely to contribute on an AT basis. we have a "traditional" plan with a 15% cap. raising this to something like 50% will allow the "haves" to put more in than the "have nots" because nhce's are usually not hitting the existing limits right now.

[MWeddell]

Dmj1998 -- If we're talking about a plan with after-tax contributions, then raising the maximum contribution percentage to 80% instead of 20% for all employees certainly will hurt the ACP test. I agree with that.

ndt123 -- I understand how it could happen and flukey things can handle with small companies. But for a medium or large employer, the percentage of NHCEs who contribute > 20% on a pre-tax basis is likely to be larger than the percentage of HCEs who contribute > 20% on a pre-tax basis due to the $11,000 dollar limit. Your situation -- an HCE terminates early in the plan year and foreseeing this increased his/her contribution rate up really high -- just doesn't strike me as that likely.

[Mike Preston]

dmj, sorry but I don't agree with the logic. If one is an HCE and is allowed to contribute 15%, they will almost definitely exceed the 402(g) limit, along with the catch up. It is only the NHCE's that will benefit from a provision where the cap is increased. Also, most plans don't even allow for anything other than deferrals and match. I would call that a traditional plan. A plan that allows for after-tax contributions these days is anything but traditional.

[MGB]

dmj,

How can changing from 15% to 50% provide more for the HCEs?

85000*15%=12750

They can't even put in 15% with a $11,000 limit.

[MGB]

Sorry, I did not realize dmj switched the discussion from pre-tax to after-tax (AT).

The original discussion was about raising the pre-tax percentage to very high amounts so that second-(low)wage earners could help the ADP test.

[Richard Anderson]

Some HCEs have less than $85,000 in comp.

[Guest ndt123]

MWeddell -

I only work on medium (1,000-10,000) and large (most over 50,000) size plans, and for plans in the 10,000 and under range, I think there is a valid risk that you are underestimating.

I just pulled a 2001 test for a company w 300 HCEs and 6000 NHCEs. One HCE who gets caught at 80& would move the HCE ADP .30%. If it's a couple, your ADP test could be drasticlly different than expected. Additionally, the HCEs at the high %s may not be the ones getting the refunds, since dollar-wise, they may be less.

It is true that more NHCEs will increase, but there are many more NHCEs than HCEs, so the affect may not be as substantial.

I wouldn't want to be the consultant who didn't even mention the risk, but to each his own...

[MWeddell]

ndt123,

I guess we'll just have to agree to disagree since we're both making conjectures about what the data might look like when 2002 or 2003 ADP tests are run. Also, we're not even disagreeing about what is likely but rather disagreeing just how unlikely it is that raising the contribution percentage to 80% for everyone will hurt a plan's ADP test.

Note that while you are throwing out a possible scenario if only 1 or 2 HCEs change, you are also assuming that (1) those 1 or 2 HCEs change all the way up to 80% and (2) there are exactly 0 out of 6,000 NHCEs who raise their contribution rates despite the fact that a much higher proportion of NHCEs are eligible to contribute at the higher percentages due to the 402(g) limit.

Just to clarify, while I called the risk "highly unlikely" I don't believe I said that I wouldn't even mention the risk as part of discussing the issue with clients.

[Guest 401kproman]

First, worry about those under age 50. That means take off the plan limit so all can put in $11,000. Second, once you have a limit; 15% 30% or 70% somebody is going to be limited to less than $11,000 and the combination of catch-up and regular may be in excess. You have to control those HC that would not be at 5.5% (11,000/200,000) from putting in everything up-front. These should be the easiest people to control since they should care about the company. Third, the payroll systems will tell you when someone reaches $11,000 and almost all I know order the deductions and report to you if in any payroll period a person's deductions would go negative. They thereby give you the chance to make an adjustment to that payroll and subsequent ones to avoid the negative condition.