Catch-up Contributions Credited as After-Tax Contributions

[Guest rocnrols2]

A 401(k) plan allows both 401(k) and after-tax contributions and matches the first 3% of such contributions. If a participant's 401(k) contributions reach the 402(g) limit, then the participant is deemed to have elected to make after-tax contributions from that point until the 401(a)(17) compensation limit is reached. In 2002, the plan allowed for catch-up contributions. A review of some eligible participants' contributions shows that, for some of these participants, the attempted "catch-up" contribution was made on an after-tax basis. Although it is possible to recharacterize a 401(k) contribution into an after-tax contribution, the reverse is not necessarily true. Does anyone have any thoughts on how this can be corrected?

[Mike Preston]

You'd have to look to the plan document provision that implemented catch-up capability to see whether it automatically covered the first dollars above the 402(g) limit as catch-ups before it handed off responsibility to the after-tax area of the plan document. If there is any ambiguity I would tend to resolve it in favor of just that.

[Guest rocnrols2]

Mike, Catch-up contributions are subject to a separate election expressed in a whole dollar amount while 401(k) and after-tax contributions are expressed as a percentage of compensation. All three are contributed each payroll period. The section of the plan document dealing with the switch from 401(k) to after-tax says that it is subject to the section of the plan document dealing with catch-up contributions. Therefore, it was intended that catch-up contributions go in as pre-tax contributions regardless of what is happening with regular 401(k) and/or after-tax contributions. I hope this clarifies things for you.

[Mike Preston]

No, it doesn't clarify things at all for me. Maybe somebody else can take a crack at it. I think it may very well be possible that the language of the plan is such that it is consistent with the regulation. The regulations provide that you determine catchup contributions after the end of the year by superimposing the plan and statutory limits. You will have to have somebody read the actual document provisions to see whether they are compatible with the regulations. If they are, or can be made to be under advice of plan counsel, then it may very well be that the catchup contributions are as intended: pre-tax.

[Guest rocnrols2]

Assuming that the plan document is properly drafted (it was my understanding that if you exceeded the 402(g) limit during the year, you could have your catch-up contributions retain their character as such). The real bottom line issue is: What is the most appropriate correction method? (1) recharacterize the after-tax contributions as catch-up contributions, since that is what the participant initially intended; (2) make a QNEC equal to the attempted catch-up contributions and refund the mistaken after-tax contributions with earnings; or (3) make a QNEC equal to the attempted cathc-up contributions and retain the after-tax contributions in the plan. Your insignt on this would be appreciated.

[Mike Preston]

Maye I'm just not understanding what you are attempting to do. I don't understand why we would be talking about QNECs at all.

If the monies were not excluded from income, they were after-tax contributions. If, operationally, the payroll department treated everything over $11,000 as after-tax, then you need to decide whether that was consistent with the document. If it was, I don't see anything to correct. If it wasn't, then you have a payroll issue. In either event, the document controls what actions you take.

[Guest rocnrols2]

Mike,

The participants in question had made elections expecting their contributions to be pre-tax and characterized as catch-up contributions. To the extent that the plan (through payroll) did not do so, then it would be an operational violation. My preceding post was grasping at the appropriate correction method in light of these facts.

[Mike Preston]

Correct the W-2's would seem to be the right thing to do, wouldn't it?