Clarification on Catchup Contributions

[MBCarey]

Can someone tell me if it is acceptable to reduce a catch-up eligible participant's deferral amount before running the ADP Test.

i.e, I have an HC who is eligible to make a catch up contribution, but is limited by the prior year ADP Test. He is only deferring a total of $11,000, but this amount would make the group fail the ADP. Can I reduce the $11,000 to $10,000 and then test in which case it passes ADP or must I wait and see what the correction and then recharacterize.

[MWeddell]

If the plan document authorizes you to set a plan limit of $10,000 maximum deferrals for all HCEs, then what you suggest is possible. More likely, you've got to first run the ADP test, compute corrective refunds, and then if the the refunds are owed to those age 50 or older who've not maxed out their catch-up contributions, you can reclassify as catch-up contributions instead of refunding them.

[MBCarey]

If I am using the prior year NHCE average percentage to limit my HCE's can I reduce his percentage to that amount and make the remaining amount catch up.

i.e, the group as a whole is limited to 4.66%. If I test this one participant and include the extra $1,000, the test will fail.

[E as in ERISA]

This raises an interesting issue.

Let's say a plan has two HCEs -- one making $200,000 and one making $100,000. The prior NHCE ADP is 5%. So the two HCEs are advised that they can each contribute 5% ($10,000 and $5,000, respectively). The individual making $100,000 is over age 50, and he desires to make a $1,000 catchup in addition to his 5% contribution.

How can he do this? Under the leveling method, won't the excess ADP will be attributed to the guy who is contributing $10,000?

Or can you take out the catchups first?

[Blinky the 3-eyed Fish]

A deferral becomes a catch-up for a 50 or over participant when either: a plan limit is reached, the 402(g) limit is reached, or if the plan fails ADP testing. You can't consider it catch-up otherwise.

So in your example, Katherine, the plan would have to specify a limit of 5% of deferrals for the lower paid employee to reclassify any amounts over $5,000 as catch-up.

In your example MBCarey, you would have to have a document limit, which could be imposed on HCE's only, of 4.66%.

[MWeddell]

I'll stick with my first answer but try to explain it.

If the plan document authorizes the plan administrator to restrict deferrals by HCEs as is considered necessary or desirable to ensure passage of the discrimination tests, then you have authority for limiting HCEs (in MBCarey's example to $10,000, in Katherine's example to 5%). That's a plan limit, which is an applicable limit for catch-ups so catch-up eligible participants who reach that limit can make catch-up contributions.

If your plan document doesn't authorize this type of restriction, then you're not allowed to do it at all and certainly not allowed to call some of those contributions as catch-ups. Instead, you've got to wait until the end of the year, run the ADP test, determine the ADP test limit, and money that would have been refunded instead may be reclassified as catch-up contributions.

[E as in ERISA]

So for HCEs and catchups if you fail the ADP test, then you do leveling first and then catchups? (Is that clarified somewhere?)

So if the prior year NHCE ADP is 3% and a 50 year old with $100,000 comp defers $6,000 and a 40 year old with $200,000 comp defers $10,000 (for an HCE ADP of 5.5%), then you do leveling by dollar amount and reduce the 40 year olds deferral to $9,000 and no one has catchups?

Are you sure that once you fail ADP, then you can't apply the catchup rules and designate $1,000 of the 50 year olds contributions as catchups and avoid leveling?

[2muchstress]

I agree that the testing needs to be done first. The only cite I can reference at this point is the 11/19/01 ASPA ASAP. This was before ASPA sent the ASAPs as an attachment to an email so I cannot attach the file.

However, it can be found on their website.

[2muchstress]

Here's what the ASPA ASAP said with respect to a failed ADP:

Actual Deferral Percentage (ADP) Limit: The ADP limit is imposed on §401(k) plans, with similar provisions applying to SARSEPs under §408(k)(6)(A)(iii). The Actual Deferral Ratio (ADR) for a participant is calculated without regard to the amount treated as catch-up under either the Statutory Limits or the Employer-Provided Limit. If a plan fails the ADP test, the amount to be refunded to catch-up eligible participants is first offset by the amount of the dollar catch-up limit. The catch-up amount due to the ADP limit is calculated after the ADP test has been performed; all amounts eligible for disbursement under §401(k)(8) or §408(k)(6)© must be re-categorized as catch-up contributions, up to the dollar catch-up limit.

For example, suppose that ABC Company's 401(k) Plan has adopted the catch-up provisions for its plan year ending February 29, 2004. It is determined that the plan is failing the ADP test. An HCE who will be turning age 50 on August 31, 2004 would normally receive a refund under §401(k)(8) in the amount of $3,200; however, because she is a catch-up eligible participant as of January 1, 2004, her distribution of excess contributions equals $200 (the amount in excess of the $3,000 catch-up limit for 2004).

[MWeddell]

This excerpt from the prefatory discussion to the proposed 1.414(v)-1 regulations makes clear (to me anyway) that one allocates ADP test refunds by leveling by dollar amount before determining which of those refunds may instead remain in the plan reclassified as catch-up contributions:

"For a section 401(k) plan that would fail the ADP test of section 401(k)(3) if it did not correct under section 401(k)(8), the ADP limit is the highest dollar amount of elective deferrals that may be retained in the plan by a highly compensated employee after the application of section 401(k)(8)© (without regard to section 414(v)). For example, if after ADP testing, elective deferrals by highly compensated employees in excess of $8,000 would be required to be distributed or recharacterized as employee contributions under the statutory correction set forth under section 401(k)(8)©, then the ADP limit is $8,000..."

[2muchstress]

I agree. As much as I disagree with the logic, I agree with the conclusion.