Targeted QNEC's

[Guest blaum8]

May a plan be designed to permit an employer to "target" specific non-highly compensated employees for receiving QNEC's? As an example, assume a plan has 20 NHCEs and 4 NHCEs. The plan sponsor wishes to design a plan that would permit the flexibility to allocate a QNEC only to "A" and "D" only, who are a NHCEs. I can't find anything in the Regs. requiring uniform allocation of QNEC's, but maybe some has already encountered this issue.

Also, same issue, but targeting a QNEC for only a HCE? Here I think you'd have to satisfy the general test as well, but has anyone designed a plan to accomplish this?

[Mike Preston]

At the moment, there are no restrictions on QNEC's other than those in the regs that require the QNEC to essentially stand on its own under a4 as a non-discriminatory allocation.

The Blue Book for EGTRRA however mentions that Congress expects the IRS to modify its regulations to preclude bottom up QNEC's. This is becasue the 415 limit is now 100% of pay, not 25% of pay. A bottom up QNEC that takes advantage of the 100% of pay limitation is not likely to be very costly, in any circumstnaces. However, until they actually come out with modified rules, the basic rule is that if your plan allows it, and your plan has a determination letter, you can do it.

You can't have a QNEC allocated solely to HCE's, as it would violate the rules mentioned in my first paragraph.

[Kirk Maldonado]

Mike Preston:

Do you believe that the plan to make a QNEC on behalf of named individuals A and D, but not on behalf of B and C?

For this purpose, I'm assuming that the decision to make the contribution on behalf of those two individuals was completely arbitrary; there was no way to objectively designate a class that only contains those two individuals.

[Mike Preston]

I'm not aware of any requirement for QNEC's that specifies one cannot use individuals as targets. The trick is getting a document that allows it. I know I've seen at least one. Maybe the IRS made a mistake in approving it. Maybe not. But the client certainly has used the provisions. It will be interesting to see whether the GUST restatement (not yet done) will be similarly approved. I sort of expect it will be, as the IRS may not focus on QNEC language until EGTRRA.

[Kirk Maldonado]

I thought that the IRS takes the position that you can't satisfy Section 410(B) (at least for purposes of the Average Benefits Percentage Test?) if the plan "names names."

[Mike Preston]

QNEC's are typically provided solely to NHCE's, thus they will not have need of the ABT to satisfy 410(B). It is only when the QNEC's are provided in some across the board mechanism (or maybe a clever allocation that is meant to provide an advantage to an HCE) that one has to be concerned. Picking and choosing a couple of NHCE's over others will not run afoul of the non-discriminatory allocation issue. Just like a bottom up QNEC won't. At least as the regs are currently drafted.

[Kirk Maldonado]

Mike:

I agree; if the QNECS only go to the non-highly compensated employees, there is no problem under Section 410(B).

[MWeddell]

Yes, QNECs can target specific NHCEs as long as the plan document contains a definite predetermined allocation formula for the QNECs. As long as employer nonmatching nonelective portion of the plan passes coverage testing using the 70% ratio percentage test, then there's nothing that prohibits the plan's allocation formula from listing individuals by name. Given that QNECs are designed to go to NHCEs, if those are the only employer nonmatching nonelective contributions, as the prior posts point out there's highly unlikely to be a coverage testing issue. Note though that that idea might cause problems in future years because one can only change allocation conditions under 411(d)(6) prior to the time the first employee has satisfied all of the QNEC's allocation conditions, so think twice before specific individuals' names are incorporated into the plan document.

The Congressional conference committee report for EGTRRA said: "With respect to the increase in the defined contribution plan limit, the conferees intend that the Secretary of the Treasury will use the Secretary's existing authority to address situations where qualified nonelective contributions are targeted to certain participants with lower compensation in order to increase the average deferral percentage of nonhighly compensated employees." While the IRS is widely rumored to be considering outlawing bottom up QNECs altogether, in the meantime one can keep relying on the current regulations, which don't prohibit their use.

[Mike Preston]

I'm not sure that a definite pre-determined allocation formula is necessary with respect to QNEC's. Just like a definite pre-determined allocation formula is no longer necessary in cross-tested plans. I agree one has to follow the terms of the plan document. If the plan document has a letter of determination, then I would think a QNEC allocation that conformed to its terms would be ok, even if it didn't fit the definition of a definite pre-determined allocation formula.