Otherwise Excludables and the Gateway Contribution

[Guest SCUDDESLER]

Assume a 401(k) profit sharing plan provides for a 401(k) contribution, a 401(k) safe harbor nonelective contribution (intended to satisfy the 401(k) safe harbor design) and a discretionary employer contribution (allocated under a new comparability formula). Eligibility for the 401(k) contribution is immediate. Eligibility for the safe harbor nonelective and discretionary employer contributions are attainment of age 21 and completion of 1 year of service.

Can the employer provide the safe harbor nonelective contribution and discretionary employer contribution only to those participants who have satisfied the 21 & 1 requirements despite the fact that everyone can make elective deferrals?

Unless I have lost my mind, it has been permissible to divide a plan into the part covering those participants who are 21 and 1 and those that are not. As is usually the case, the part of the plan covering the participants who are not 21 and 1 generally is limited to NHCEs and, as a result, automatically satisfies both coverage and discrimination testing. Suppose the part of the plan covering those participants who are 21 and 1 must be cross-tested. Can the plan provide the gateway contribution and/or the 401(k) safe harbor nonelective contribution just to this universe of participants or must the plan now provide either or both to all participants, even those who have not yet satisified the 21 and 1 conditions?

I thought the answer was an easy "yes, absolutely", but an article recently published by Aspen publishers in their 401(k) Advisor circular suggests that the answer is a definitive "no". The reasoning, as I understand it, goes like this: the 401(k) safe harbor contribution must be provided to anyone who is eligible to make an elective deferral (regardless of the application of the statutory/nonstatutory distinction); since everyone is eligible to make an elective deferral, everyone must receive the 401(k) safe harbor contribution; anyone who receives the 401(k) safe harbor contribution is "benefiting" under the employer contribution component of the plan; anyone who benefits under the employer contribution component of the plan must receive the minimum gateway contribution. Consequently, anyone who is eligible to defer, the argument goes, must receive both the 401(k) safe harbor contribution and the minimum gateway contribution (assuming the employer contribution is subject to cross testing).

Does anyone have any thoughts on this issue? Any guidance or help is appreciated. Thanks.

[Guest SAMSAM]

I believe your interpretation is correct--at least that is consistent with what we were told in a recent admin software update by our software provider. Although, there seems to be a lot of confusion about what it means to benefit under the employer contribution component, as you call it. For instance, if a profit sharing formula requires completion of 1,000 hours during the plan year, does that mean that, using the eligibility conditions you mentioned, that someone would be eligible for the S/H 401(k) contribution (since you cannot impose a 1,000 hour requirement on that contribution), but not for the P/S contribution (you clearly can impose such a requirement on that contribution). But who gets the gateway? Everyone who receives the S/H 401(k) contribution (which could mean literally everyone or just those are are 21 and 1) or just those who are eligible for the P/S contribution? Based on what we were told, everyone now gets the gateway regardless of whether they are 21 and 1 or satisfy any contribution conditions (e.g., employment on last day or 1,000 hour requirement).

[AndyH]

Based on what we were told, everyone now gets the gateway regardless of whether they are 21 and 1 or satisfy any contribution conditions (e.g., employment on last day or 1,000 hour requirement).

No way, Jose. Where is this stuff coming from? SCUDDESLER had it right. Who wrote that article? Perhaps he/she is here to refute him/herself.

[Guest STBAC4]

Well, here we go. The issue is who MUST receive the gateway contribution. I too read the article mentioned above. It suggests that if a participant is ineligible to receive a profit sharing contribution (because they have not satisifed a 1,000 hour requirement or a LDOPY requirement), they, nonetheless MUST receive the minimum gateway contribution if (1) the plan is top heavy (and the top heavy minimum contribution is greater than $0) or (2) the plan is a safe harbor 401(k) plan which satisifies the 401(k) safe harbor contribution requirement by way of the 3% nonelective contribution. What the article does not address (as if it is clear to everyone) is whether these principles apply regardless of whether the statutory/nonstatutory group division is made. The implication, at least on my reading, is that these principles apply regardless of whether the statutory/nonstatutory group division is made. The author of the article could have easily specified that the principles do not apply to a "nonstatutory group", by which I mean the portion of the plan "benefiting" those participants who are not 21 and 1.

I have heard practitioners argue that the safest course of action is to disregard the statutory/nonstatutory division for purposes of making the gateway contribution, i.e., provide the minimum gateway contribution to everyone. The software package we use provides an option for doing just that--they are apparently not clear on this rule either.

[AndyH]

Well put. I have also read articles that omitted this critical factoid about statutory exclusions. Lots of "experts" out there that do not have command of the facts. All you need to do is read the introduction to the amended cross-testing regulations.

Explanation of Provisions.

B. Gateway for Cross-Testing of New Comparability and Similar Plans

....Thus, if the plan is treated as two separate plans in this manner, cross-testing the portion of the plan benefitting the nonexcludable employees will not result in minimum required allocations under the gateway for the employees who have not met the section 410(a)(1) minimum age and service requirements."

[Guest SAMSAM]

I think you hit the nail on the head, SCUDDELER. The cross testing regs say each NHCE must receive the gateway. This makes a lot more sense to me now. I atleast understand where some of the other administrators are coming from now. Regardless of whether the 21 and 1 and not 21 and 1 thing is used, each participant who is an NHCE must receive the gateway--that seems pretty clear to me. If the IRS had wanted to limit the group of NHCEs that received the gateway, they could have done so right there in the regs. We will probably continue to provide all of the NHCEs with the gateway consistent with the regs and advice from our software provider.

[Blinky the 3-eyed Fish]

Uh, wrong on many levels Samsam. Was the cite by Andy not good enough? Let me try and explain the rules of who needs to receive the gateway. Follow these rules and your path will be straight. Deviate from them and watch how mad your client gets if he finds out what could have been done.

Q: Who must receive the gateway in a cross-tested plan?

A: Each NHCE that benefits under the nonelective portion of the plan, EXCEPT those participants that do not meet the statutory age and service requirement AND that component of the plan is not cross-tested.

The nonelective portion of the plan is from any source, i.e. profit sharing, safe harbor nonelective, top heavy minimums and QNECs.

Of course your document must allow for this. I have seen some language that does not have the availability to not give the statutory excludables the gateway.

[Guest STBAC4]

I disagree with SAMSAM. I don't think the IRS applies the phrase "each nonhighly compensated employee" in the cross testing regs as broadly as you suggest samsam. I will admit that the IRS didn't do a very good job of indicating which NHCEs must receive the gateway contribution--hence all of the confusion in this discussion thread and among administrators.

The basic idea, as I understand it, is that you start with the 410(b) rules. After applying the mandatory disaggregation and permissive aggregation rules (I'm not sure I understand them either), you end up with plan components which must independently satisfy both the minimum coverage and nondiscrimination tests. Let's take SCUDDESLER's example, a 401(k) profit sharing plan consisting of three contribution sources: (1) the 401(k) contribution source, (2) the 3% safe harbor 401(k) contribution source and (3) the profit sharing contribution source. The 410(b) rules, at least in my interpretation, would carve these three contribution sources into two plan components for testing purposes: (A) the 401(k) component and (B) the 3% safe harbor/profit sharing component (really the "employer contribution" component). If any of the contribution sources which make up the employer contribution component must be cross-tested, then any participant who benefits under any of those contribution sources must receive the gateway contribution. I admit, this is not intuitively obvious (at least not to me). But this has nothing to do with whether a plan subject to the top heavy minimum requirements or a plan that is divided into a statutory and nonstatutory group must satisfy the gateway--those are different questions to me and are not affected at all by the IRS's unfortunate use of the phrase "each NHCE" in the cross testing regs. While some NHCEs must receive the gateway contribution, only nonkey employees are entitled to the top heavy minimum and we all know that some nonkeys may be HCEs.

Until the IRS better clarifies what "each NHCE" means, though, I cannot refute your conclusion entirely samsam. As for using the preamble as definitive guidance on this issue lets remember that the preamble is simply the IRS's interpretation at a specific point in time and any of us who are involved in IRS audits are aware of the fact that the IRS's interpetation of its own rules varies from IRS agent to IRS agent and institutionally from time to time--I wouldn't bet the farm on the preamble.

[Archimage]

Correct me if I am wrong but I believe the IRS addressed this at the 2002 ASPA Q&A session with the conclusion that you do not have to give the gateway minimum to disaggregated portions of the plan.

I think you will also find helpful guidance under 410(b) concerning disaggregation of the plans. I am too lazy to provide any other cites. However, as Blinky pointed out, the reg referenced by Andy is pretty clear to me. I think you will find that most leading experts in the country will agree with this position.

[Guest SAMSAM]

Well, Blinky and STBAC4, I thought I understood it. Blinky, is a discretionary profit sharing contribution a "nonelective contribution" or an "elective contribition". Since it involves an election (whether a contribution will be made), I would think it would be an elective contribution. If it is an elective contribution why is it lumped together with nonelective contributions? In fact, if it is lumped together with nonelective contributions, what is the point of the distinction--isn't it all the same?

And what about the phrase "each NHCE". I didn't make that up, did I? Where in the a4 regs does the IRS limit the reference to each NHCE as you suggest? Not that what you suggest is nonsensical, just that it is as arbitrary as other views (or so it seems to me). The plain language is that each means each, right. What's wrong with the plain language? I ask not to be argumentative, but so that I can finally bring my understanding of these rules to a conclusion that makes sense to me. As SCUDDESLER said, each means each unless the IRS says each means something else.

I just would like a citation to something concrete. Blinky and Andy didn't reference the regs they reference, as another poster noted, the regs' preamble. Thanks

[Mike Preston]

Samsam, two points:

1) A PS contribution is a non-elective contribution. That is, the participant shares in the contribution without making any election. The reference is with respect to the EMPLOYEE making an election or not. 401(k) salary deferrals are therefore: elective deferrals.

2) The key to your understanding of this admittedly arcane and difficult subject is the basic definition of a "plan". It is not an easy study, but the place to start is 1.410(b)-7. Once the "plan" is defined, as you correctly point out, the regs say that a participant in such a "plan" must receive a gateway contribution if otherwise benefitting and a gateway contribution is required under 401(a)(4).

But for this purpose, if the Plan Administrator decides to disaggregate the statutorily excludable from the rest, you have two, honest-to-goodness, bonifide PLANS as far as the IRS is concerned.

Once you view it that way, you can see that the reg you cite is supportive of the ability to NOT provide a gateway contribution to those who are statutorily excludable. And, just in case the language of the reg is too obtuse for a normal human to follow (which I wholeheartedly believe that it is!) the preamble to the reg spells out the effect quite clearly.

In other words, you won't get a better cite than what you have already been provided.

[Guest SCUDDESLER]

Thank you all for passing along your ideas with respect to this issue. I will check the 2002 ASPA IRS Q&As for further guidance as one of the respondents suggested. I guess the main issue is whether the term "each NHCE" as contained in the cross testing regulations means (1) each NHCE period or (2) each NHCE in the plan being tested (which, as Mike pointed out, may mean only the statutory employees). The author of the article I referred to does not draw this distinction. Perhaps because he didn't think of it or perhaps because the answer is obvious one way or the other (at least to him). SAMSAM interprets the regulation to mean (1). Mike, Andy and others interpret the regulation to mean (2). I hope I have not mistated anyone's position. Since the IRS has not, to my knowledge, amended the 410(b) regulations, I believe that Mike and Andy's position is most justifiable if not correct. Consequently, despite the position taken in the article (or at least one reasonable interpretation of it) and the apparent confusion as expressed during this discussion, our firm is going to continue applying the statutory/nonstatutory testing technique until the IRS publishes definitive guidance eliminating it. Thanks again for everyone's input. It is much appreciated.