Catch ups Without Regular Deferrals

[lkpittman]

Consider this. We've got a client that employs HCEs only (physicians). They've currently got a PSP and they contribute the max each year. We are restating their plan to include a CODA to take advantage of the catch-up amounts, but they do not intend to contribute any funds by salary deferral. They will continue to hit the 415 limit with employer contributions each year,thus hitting the 415 limit as of the last day of the limitation year (as required under the proposed regs), so deferrals will only be $1,000 for each eligible over 50 participants. Any comments?

[pjkoehler]

lkpittman: You said "...but they do not intend to contribute any funds by salary deferral. . . so deferrals will only be $1,000 for each eligible over 50 participants."

Seems simple enough, but I'm not sure if you're suggesting that the employer can kick-in the extra $1000 for the attained age 50 group without the formality of actual salary deferral agreements. That probably doesn't square with sec. 414(v)(6)(B). It incorporates the definitions of elective deferral set forth in sections 457(B) or 402(g)(3).

[Mike Preston]

I think the intent is clear and I think the result is equally clear. It works fine.

[lkpittman]

No, Phil. I just meant that there would be no "regular" (other than catch-up) deferrals. The physicians would elect to defer only $1,000.

Thanks for the input.

[Alan Simpson]

I am doing this with a few of my plans too.

Just as a side note, the $1,000 contribution would be considered a deferral until the participant reached the maximum contribution. It only would switch to a catch-up contribution after the employee has reached the maximum available contribution.

[pjkoehler]

Alan: You've put your finger on an important issue. As I read Code Sec. 414(v), the catch-up contribution is an "additional elective deferral" that increases the 402(g), 457(B) (and similar limits) by the "applicable dollar amount" for participants who attained age 50. May an eligible participant make an "additional elective deferral" if his cumulative elective deferrals for the plan year do not othewise exceed the limit for participants who have not attained age 50? In otherwords, can the employee choose to characterize his first dollar elective deferrals as "addtional deferrals" for purposes of Code Sec. 414(v). We know that the objective of the plan design advanced by lkpittman is to get relief from the 415 and 401(k) nondiscrimiantion limitations with respect to this "additional elective deferral." But have we glossed over this issue?

[lkpittman]

PJK: Under the proposed regs, deferrals aren't to be categorized as "additional" or "catch-ups" when the election is made by the participant. Whether the deferral is a "catch-up" deferral or not is determined as of the end of a plan year, when applying the applicable limits. So, the correct way to do it would be for the participants to simply elect $1,000 for their elective deferral. At the end of the year, the 415 limit would be reached with the employer contribution, so, the $1,000 would have to be designated as "catch-up." That's what we're planning, anyway.

[pjkoehler]

lkpittman: The proposed regs define catch up contributions as "elective deferrals made by a catch up eligible participant that exceed any of the applicable limits set forth in paragraph (B) of this section ...." Prop. Reg. Sec. 1.414(v)-1(a)(1). Paragraph (B) defines "applicable limit" as including a statutory limit on elective deferrals provided in section 401(a)(30). Prop. Reg. Sec. 1.414(v)-1(B)(1)(i). Isn't one way of reading this that a precondition on finding that the employee made catch up contribution is that the participant's cumulative elective deferrals for the plan year exceeds the "applicable limit," which would not be the case in your plan design example.

Take a look at Example 2 under Prop. Reg. Sec. 1.414(v)-1(h)(2)(v) with specific reference to catchup eligible Participant C, whose "elective deferrals for the year do not exceed an applicable limit for the plan year." The reg says that his elective deferrals must be taken into account in performing the ADP test.

I gather that your position is that an elective deferral by a catchup eligible participant is "the source" of the excess annual additions for Sec 415 purposes whenever the aggregate annual additions from all other sources equals the dollar limit. Therefore, the deferral exceeds an "applicable limit" There's a logic to this argument. But I'm somewhat troubled by (1) the lack of any examples in the proposed regs that treat cumulative deferrals less than the 401(a)(30) limit as "catchup contributions," (2) that you're importing a tracing principle into the proposed regs for which I see no support in the proposed reg (i.e. it's the $1000 of elective deferrals that caused the excess annual addition, when in all likelihood the elective deferrals were deposited into the trust well before the nonelective employer contribution) and (3) what are the other ramifications to a plan that is subject to the ADP test if you have "catchup contributions" that enjoy a free pass from 415 concerns, but still fall within the ADP test as would seem to be the import of the example I cited.

[lkpittman]

PJK: 1.414(v)-1(B)(i) states that an "applicable limit" includes a statutory limit, which specifically includes a limit on anual additions with respect to an employee under section 415. I read 1.414(v)-1(B)(2) as including the section 415 limit on annual additions as an "applicable limit." Just because the employee hasn't hit one of the applicable limits (402(g), as in your example), it doesn't mean that none of the other "applicable limits" will apply. Help anyone?

[Mike Preston]

The regs, when I last read them, left me with the impression that one tests for catch-up deferrals on a superimpostion basis. That is, one tests after the end of the year, after superimposing all of the limits under the terms of the plan: 402(g), plan imposted, and 415. In this case, there might be problems if there were any NHCE's because an HCE that terminated during the year and did not receive an allocation under the non-401(k) portion of the plan, would have his/her $1000 treated as an elective deferral under the ADP test. But, as long as there are HCE's only, it should work just fine.

[Blinky the 3-eyed Fish]

I went to a seminar by Sal Tripodi recently and Mike is right on target.

[pjkoehler]

lkpittman: I follow you're logic. You may be right. "Superimposing," as Mike suggests, the 402(g) limit on the plan is straightforward because there is only one source of "elective deferrals." Superimposing the 415 on the plan is not so straightforward. The difficulty lies in interpreting the language in the proposed reg that says:

"[C]atchup contributions are elective deferrals . . . that exceed any of the applicable limits. . . ." Code Sec. 415 doesn't limit "elective deferrals" per se, but rather "annual additions." Employer contributions, forfeiture reallocations, and after-tax employee contributions, as well as "elective deferrals" are taken into account in determining the total annual additions to the plan. So, the preeminence of Sal Tripodi's view aside, what logically compels the conclusion that the $1000 of elective deferrals in your example, "exceeds" the 415 limit, to the exclusion of the other "annual additions" for that limitation year?

I guess you could interpret the regs to say that for section 415 purposes any time there's an excess annual addition, the elective deferrals for the catchup eligible participants automatically are treated as catchup contributions up to the catchup limit. This was probably the intent, but excluding these amounts from the ADP computation (if you have such a plan) where the elective deferrals do not exceed 402(g) is a longer stretch.

[Mike Preston]

I wouldn't characterize it as a longer stretch, but one of plan document language. Different plans have different rules regarding the treatment of excess annual additions. In most cases, the plan sponsor elects to have the elective deferrals refunded. In the minority of cases, the plan document calls for the elective deferrals to remain intact, with reduction instead to the entitlement of the employer contributions. In my view, it hardly seems "fair" to do the latter, but then again, my view doesn't mean very much in this case!

But I fully agree with pjk that if the document calls for the deferrals to remain intact in the case of a 415 violation that the regulations do not allow those deferrals to be treated as catch-up.

[lkpittman]

Thanks for all your input. Document does provide that deferrals are the first to be returned in the event of 415 issues, so I think we're okay.

[Guest halka]

I've a follow-up on this thread.... Can an employer/plan mandate that participant's election to make a catch-up contribution for, say, 2002 must be filed w/ plan prior to 12/31/01?? e.g. If participant did not make the election and participant's contributions are $11,000, would employer be required to treat $1,000 as catch-up even if "early election" was not filed??

THANKS

[Mike Preston]

What would the employer's rationale be for asking that the employee make an election prior to the beginning of the year? The proposed regs give much more flexibility. I'm curious why the employer would want to limit this flexibility?

[Guest halka]

Mike: Don't really know the rationale (not all employers are rational), but I suspect it was just to quantify and/or postpone the additional recordkeeping required for the catch-ups.

Anticipating another likely question.... No, the employer does not have employees in states not complying w/ EGTRRA.

[Mike Preston]

I can certainly see a plan sponsor choosing not to implement catch-up contributions for 2002. It is only $1,000 per person over age 50 and there frankly may not be enough people in that category to justify the administrative overhead.

Nonetheless, if they decide to go forward, I think they are making more work for themselves trying to police this in advance. The regs allow the plan sponsor to do the testing first and reclassify anything as catch-up after the fact that would otherwise have violated a rule. Trying to anticipate that in advance seems like a major headache to me. It also seems like it won't necessarily work. That means they go through the effort and don't really have anything to show for it. I'd advise against it unless I heard a good reason for it.

[Guest jsample]

If the plan's intent is to only provide for "catch-up" contributions, state the deferral percentage contribution limit in the adoption agreement as "0%". Since employees have reached their deferral limit, as defined by the plan, the first and only money contributed would be the "catch-up" money. This way, a participant's contributions are always "catch-up" money, irregardless of if they have reached their 415 limit or not. This eliminates the worry of first calling money deferral contributions, and they subsequently catch-up contributions.

If you are uncomfortable about a 401(k) plan stating in the adoption agreement that the maximum deferral percent is "0%"; define the maximum deferal as one cent. If you test a one cent deferral contribution in the ADP test, the result would be so small you would not fail. There is nothing that says you have to allow deferral contributions up to the 401(g) limit, so make the limit very small, that you basically only have "catch-up".

If a company with HCE's and NHCE's currently has a straight profit sharing plan and wants to add the catch-up provision only, would this plan design work?

[Mike Preston]

Setting up a 401(k) plan just so folks who are older than 50 can make a $1,000 contribution seems a bit extreme. I hope there are enough of them to make it worthwhile.

[lkpittman]

Wouldn't you think that if the IRS were to analyze such a plan (on audit) that they may deem that a CODA doesn't exist if no one is allowed to defer? (Similar to IRS asserting that a CODA exists where a class based cross-tested formula changes year to year, etc.) Also, if maximum deferral stated in plan is 0% of comp, seems that no one is "eligible" to defer and therefore would not be eligible to contribute catch-up. Thoughts?

[Guest jsample]

I know that it is only $1,000, but the catch-up limit goes to $5,000 fairly quick.

How about this plan design:

Employees can defer up to 0% of compensation, so only catch-up money can be contributed. I match $10 per $1 deferred into the plan, and I also match catch-up contributions. Now my $1,000 catch-up contribution gives me a total of $11,000.

Further, I am age 51 and all of my employees are in their 30's. When the catch-up provision expires in 10 years, I can remove it from my plan without any other employee ever taking advantage of this.

I know that this is extreme, however I have heard this talked about (I couldn't make this stuff up on my own). My point is that when you have law makers who do not participate in or understand the private sector's retirement plan industry, things like this can happen with provisions intended to help everyone.

[pjkoehler]

jsample: I think lkpittman raises an important point. Under the proposed regs, "catch-up contributions" do not pose a risk of disqualification in the case of an "applicable employer plan." Prop. Reg. Sec. 1.414(v)-1(a)(1). An "applicable employer plan" means a section 401(k) plan or other tax-advantaged arrangement for making "elective deferrals." Prop. Reg. Sec. 1.414(v)-1(a)(2). Since all qualified plans other than 401(k) plans in effect provide for "elective deferrals" of 0%, how does your hypothetical 401(k) plan with an employer-provided limit of 0% on "elective deferrals" satisfy this definitional requirement?

Furthermore, a catch-up contribution must be an "elective deferral" within the meaning of Code Sec. 402(g)(3) or 457(B). If you drill down through the X-refs, you'll find that "elective deferrals" must be made pursuant to a "qualified CODA (as defined in section 401(k)." Again, it's seems like quite a stretch to argue that a plan that on the one hand forbids "elective deferrals" also includes a "qualified CODA," because you could essentially say that about any non-401(k) plan. The IRS could well apply the form-over-substance doctrine to disregard the 0% CODA feature, which would mean it is NOT an "applicable employer plan" and "catch-up contributions" would not be permissible.

That said, however, I suppose a bona fide 401(k) plan could impose an unusually low deferral limit of, e.g. $1.00. (Although the risk of a form-over-substance attack doesn't go away.) If the plan covers only HCEs, it might work. Of course, if NHCEs also participate, it is unlikely that they would be willing to participate in this ruse to the extent necessary to satisfy the ADP test.

[Guest jsample]

That is an excellent reply, thank you.

Playing devil’s advocate - If you set the deferral limit at $1 and no Nonhighlys participated, the HCE's could contribute the $1 deferral and $999 as a catch-up contribution. Then when the plan fails the ADP test, reclassify the $1 deferral as a catch-up contribution.

[pjkoehler]

jsample: The $999 "elective deferral" is potentially a "catch-up contribution" because it exceeds the $1 "employer provided limit." But, the plan's CODA is not a qualified CODA if not enough NHCEs make "elective deferrals" of $1 or less to satisfy the ADP test. If the plan doesn't maintain a qualified CODA, then - yep, you guessed it - the plan is not an "applicable employer plan," and the $999 is not a "catchup contribution." The 401(k) ADP test limitation on HCE elective deferrals is NOT a " statutory limit" for purposes of the definition of "catchup contribution" unless the HCE is catch-up eligible. See Prop. Reg. Sec. 1.414(v)-1(B)(1)(i). So you'd have to make corrective distributions to the other HCEs, if any, most likely refunding the $1 elective deferral to each non-catchup eligible HCE, assuming that none of the NHCEs would participate in this charade. If the IRS doesn't mount a form-over-substance attack, you may have an arrangement that achieves the catch-up contribution of $1000.

[Guest ubpMR]

What about top heavy issues? I believe that the deferral catch up is not included in the top heavy test but what about matches made on the "catch up" amount?

[Guest jsample]

You are right - the plan would more than likely be top heavy - so more and more this kind of "absurd" design would not work.

However, under normal plan design, I thought that if you exceeded the ADP limit (Prop. Reg. §1.414(v)-1(B)(1)(iii)), you could "reclassify" deferrals as catch-up to the extent that:

the person is eligible to make them

the plan allows for them, and

they do not exceed the total catch-up limitation for the year

For plans that use current year testing, the catch-up portion may not be known until after the end of the plan year. Am I wrong to think that after the end of the plan year, you fail ADP and must return $2,133 to the only HCE in the plan; you can return $1,133 and reclassify $1,000 as their catch-up contribution?

[pjkoehler]

jsample: I think your understanding is correct. Excess contributions under 401(k) with respect to the catch-up eligible HCEs may be reclassified as "catch-up" contributions up to the catch-up limit. So corrective distributions to correct an ADP test failure would be in order to the extent any of the HCEs with excess contributions are not catch-up eligible and to the extent the excess contributions with respect to the catch-up eligible HCEs exceed the limit.