QNECs and catch up contributions

[Guest phyphy]

If an ADP test fails and refunds are due even after the recharacterization of the HCE contributions for participants who did not defer the maximum, how are QNECs calculated to prevent refunds?

It seems that any recharacterized catch up contributions are disregarded and the QNEC to non-HCEs is the total amount that would be needed if there were no catch up provision. Is this correct?

Thanks!

[Blinky the 3-eyed Fish]

I am not sure what you mean when you ask if recharacterized catch up contributions are disregarded. Perhaps a little example will help.

Initial testing

HCE ADP 5.50%

NHCE ADP 3.00%

Result is that the plan fails, so eligible HCE deferrals are recharacterized as catch up contributions

Testing after recharacterization

HCE ADP 5.25%

NHCE ADP 3.00%

Now you calculate the QNEC according to the terms of the plan document to bring the NHCE ADP% up to 3.25%.

[Guest phyphy]

Here is an example of the situation:

The only HCE deferred $9,000 total, for an ADP ratio of 7.5% ($9,000/$120,000). The HCE is over age 50. The non-HCE average is 3.00%, so the plan fails ADP testing.

In calculating the refund, the total refund amount (not including interest) is $3,000. Of this amount, $2,000 is recharacterized as "catch up", leaving a net distribution amount of $1,000.

However, in calculating the non-HCE amount needed as a QNEC, the non-HCE's new average is 5.50%. Therefore, the calculation is not taking the amount that could be recharacterized instead of distributed into consideration.

We've gone round and round here in the office, and the feeling is that the QNEC contribution is being calculated for the plan to pass. If the QNEC were calculated based upon 5.83% (the revised percent if the HCE's $2,000 is recharacterized), then the plan would still fail the ADP test, but no distribution would be necessary due to the recharacterization.

I think that it is always safer to err in favor of the non-HCE's, so we are calculating to the percentage needed for a passing test, not to the percentage needed to avoid refunds.

[Blinky the 3-eyed Fish]

However, in calculating the non-HCE amount needed as a QNEC, the non-HCE's new average is 5.50%. Therefore, the calculation is not taking the amount that could be recharacterized instead of distributed into consideration.

What is the 5.5% from? As you state below, his new percentage is 5.83% after recharacterization.

We've gone round and round here in the office, and the feeling is that the QNEC contribution is being calculated for the plan to pass. If the QNEC were calculated based upon 5.83% (the revised percent if the HCE's $2,000 is recharacterized), then the plan would still fail the ADP test, but no distribution would be necessary due to the recharacterization.

Huh? If the QNEC brings the NHCE average to 3.83% how do you fail?

I think that it is always safer to err in favor of the non-HCE's, so we are calculating to the percentage needed for a passing test, not to the percentage needed to avoid refunds.

I don't know what this means.

[Guest phyphy]

The 5.50% is the non-HCE average needed to pass the ADP test with an average of 7.50% for the HCE. If the non-HCE average is increased to 3.83%, the plan will still fail the ADP test, but no refunds will be necessary.

[Blinky the 3-eyed Fish]

I follow your train of thought now. But why would giving a QNEC to bring the NHCE's to 5.5% even be a consideration? Does the employer want to give away money?

Bringing the QNEC to 3.83% means that the HCE recharacterizes $2,000 in catch-ups. I know this is semantics, but the plan does not fail the ADP test. So I am not sure of the dispute why just giving a QNEC to bring the NHCE % to 3.83% is not the plan here.

[jquazza]

It's a little hard to follow you Blinky, but I am not sure I agree with you and I think Phyphy has the right idea.

First, you should not rerun the ADP test once you've recharacterized some deferrals as catch-up due to the ADP test failure. So, the idea here is to add QNECs sufficient enough to bring your plan, not to a passing level, but to a failing level that would produce refunds that equal the catch up amount available to the HCE who gets the refund. I don't see anything wrong with that.

[JanetM]

If the HCE did not exceed a plan limit what can you recharcterize? I understood that you can only recharacterize contributions the exceed plan limit (like 8% or 10%) or 402(g) limit.

[Brian Gallagher]

Janet,

There are three thresholds for applying money as a catchup. If and when the participant:

1) Hits the 402(g) limit

2) Hit the plan's deferral limit

3) An HCE has contriuted the maximum allowed to satisy ADP

[Blinky the 3-eyed Fish]

Jquazza, again, I think we are talking semantics, but I am not sure. Do you agree that the QNEC needs to bring the NHCE ADP to 3.83%?

[jquazza]

Yes, my contention had to do with rerunning the test. I don't think you should rerun the test excluding the recharacterized contributions.