Coverage Testing in a 401(k) Safe Harbor Integrated Profit Sharing Plan

[Guest rmwright]

Fact pattern:

* 4 participant plan - Ee A is owner, Ee B is wife of owner, Ee C and D are staff

* Contribution allocation requirements are last day of employment and 1000 hours

* Safe harbor is 3% nonelective

* Plan is top heavy

* Ee C and D terminate during the year with more than 1,000 hours; each receive 3% safe harbor contribution but not the profit sharing contribution

Is there a requirement to disaggregate the profit sharing allocation from the safe harbor nonelective contribution when testing for coverage?

Thanks for your help!

[Brian Gallagher]

Don't you have to? I thought different contribution types were tested seperately. In this case, Safe Harbor non-elective (which I'm sure is being used as the top heavy minimum) and Profit Sharing would be tested seperately.

[Tom Poje]

SHNECs, like QNECs are still treated as nonelectives for purposes of coverage.

[Guest rmwright]

So, obviously they fail coverage in the profit sharing component. We are not able to use any of the three methods to pass - restructuring, offset or rate group testing. What is the recommended method for passing coverage when it is a nondiscrimination issue? Can we bring in the last terminated participant and allocate a profit sharing contribution or do we have to bring in both participants?

[Tom Poje]

I thought they passed coverage.

All receive SHNEC, so all received a nonelective.

However you now have some receiving 3% only and others receiving additional non elective. that fails 401(a)(4)

Nondiscrim testing must be performed. and depending on how much the HCEs received you might have to increase the contribution to the NHCE to satisfy gateway minimum. oh wait, if document doesn't contain language for it then you also need an amendment.

[Brenda Wren]

Tom, I agree with you regarding the coverage testing. I learned recently from Relius Support that if someone receives a safe harbor 3% nonelective contribution, they are considered "benefiting" for coverage purposes, contrary to receiving a 3% top heavy benefit only. Doesn't sound right, but I guess it is! Six of one, half dozen of the other if you ask me!

However, I believe the question pertained to an integrated plan, so gateway is not an issue nor 401(a) nondiscrimination testing.

[Guest rmwright]

My head is hurting!!!!

Ok - yes, they do pass coverage and now we need to do nondiscrimination testing.

Can we restructure into 2 component plans and then each component will pass nondiscrimination testing - correct? Do we then have to go back and have each component satisfy coverage separately?

If the profit sharing component does not pass coverage separately, then what do we do?

I am obviously very confused!!!

[Guest rmwright]

P.S. Plan is integrated.

[Blinky the 3-eyed Fish]

Brenda, you have it incorrect concerning the top heavy minimum. Is someone receives ONLY a top heavy minimum, you are still allowed to treat the plan as having a safe harbor formula if you can pass coverage by treating the person as not benefiting. See 1.401(a)(4)-2(b)(4)(vi)(D)(3).

That is purely a nondiscrimination provision. For actual coverage testing, everyone who benefits under the nonelective portion of the plan is benefiting.

Rmwright, you can use component plan testing to pass nondiscrimination. In your case, the husband and a staff employee would be in one component plan and the wife and the other staff employee would be in the other. This is needed so each component plan passes coverage.

Your last question is moot. The profit sharing component does pass coverage. You just need it to pass nondiscrimination.

[Guest rmwright]

Blinky, thanks but I forgot to tell you one more fact. Ee B (the wife) did not receive a profit sharing allocation either as she had <1000 hours.

So, it is my understanding we can not restructure into component plans since each component on its own does not pass coverage - correct? I don't believe any of the other methods of testing will work either - correct?

What's the next step? Thanks so much!

[Blinky the 3-eyed Fish]

I don't think you are getting the component plan concept. If done as I suggested, both component plans would pass coverage. But now that you mention the wife will not get a PS contribution (did she get a safe harbor nonelective?), component plans won't help you anyway.

You just need to run the general testing and give the husband an amount that will pass. If the amount to the husband is above 9%, then you definitely will have to increase the NHCE's to a higher amount, at least, to meet gateway.

In other words, this has turned into a simple cross-testing example. Of course, heed Tom's advice to ensure your document language is appropriate.

[Guest rmwright]

I am so confused at this point, I am obviously not understanding the component plan concept. I thought 1 component plan would be the profit sharing allocation and the other would be the safe harbor allocation - is that correct?

And, I'm confused about the cross testing. This is a non-standardized prototype plan. Is it that I can test on allocation rates without any problem but to go to testing on benefit rates, this skips to the cross testing where the gateway minimum would have to be satisifed? I did not think you could cross test on this type of document?

How would I allocate a contribution to the 2 NHCE participants that are not eligible based upon the allocation requirements?

Thanks for your patience!

[Tom Poje]

lets try to get the terminolgy straight.

cross-test - concentrate on the second word 'test'. thus, the term cross test only refers to testing, it really has nothing to do with the formula.

you are 'crossing over' into another world.

thus, if allocations in a dc plan are converted to an equivalent accrual, you have crossed over.

likewise, if accruals in a db plan are converted to an equivalent allocation rate, you have crossed over.

Lets say you have a ps plan that allocates 10% to 1 HCE. 6 NHCE receive 10% and 4 NHCE receive 3% top heavy only.

for coverage purposes, how many received a non-elective? ALL. On the 5500 sched T you indicate all benefit.

However, at this point, some employees have received one rate and others another rate. therefore you need to test to make sure you haven't favored the HCEs.

Ignoring the average benefits test completely, how many NHCE received the same allocation rate as the HCE? 6 out of 10 or 60%. Plan fails ratio % test.

so now you cross test to see if converting the contributions into accruals will give you 70% of the NHCE greater than the HCE.

if one of the NHCE who received top heavy only is 16 years younger than the HCE you have the following(assuming 8.5% interest rate):

3% * (1.085^16) = 11.066%

since this is greater than 10% you are on your way.

This is rather a simplified way of looking at, I am ignoring imputing disparity, only trying to pass ratio % test, and also assumed the 6 NHCE who received 10% are not older than the HCEs.

[Guest rmwright]

Tom, I understand the coverage which I was thought all along but once you get in the whirlwind, all sane thoughts leave you!

I also understand the cross-testing in this connotation.

In this scenario, cross testing will not work since the 2 HCE's are the only ones who deferred (of course).

If I am still understanding all of this correctly, in order to pass nondiscrimination, I will need 1 NHCE to receive a profit sharing allocation. If I allocate a PS contribution to 1 NHCE, then I can restructure into component plans and pass coverage - correct?

How do I allocate the PS contribution to 1 of the NHCE's - do I allocate it to the last NHCE who terminated?

[Brenda Wren]

Tom, I was anxiously awaiting your input. But I still cannot grasp why I would need to test the plan under 401(a)(4) in a safe harbor designed plan, i.e. integrated, after I have passed coverage under 410(b). What if I had 2 out of 10 NHCE's not benefiting? Obviously, this passes the ratio test under 410(b), but I have 2 NHCE's receiving 3% and 8 HCE's receiving 10%, therefore, 2 allocation rates. Am I still required to test under 401(a)(4) in this scenario?

[Tom Poje]

if the document has fail safe language, it would indicate how to handle the situation.

however, fail safe language has the disadvantage of eliminating the avg ben test.

thus, in your case if only 1 of 2 nhces benefit at the same rate as the hces you would still fail ratio % test. (There are some poorly worded documents that have fail safe language that says you can use the avg ben test, but they are incorrect)

The advantage to fail safe language is that no amendment is required.

If you have no fail safe language, then you simply allocate an additional contribution to an individual(s) using a corrective emenment..1.401(a)(4)-11(g)

it must be meaningful, so it might have to include vesting.

[Guest rmwright]

So I would use the fail safe language for failure of the coverage test? Assuming I use this and it says to bring in the last terminated participant, then couldn't I restructure into 2 component plans - 1 being the participants who received the PS & SH allocation and the other being the participants who received only the SH allocation? I would have:

PS & SH: 1/2 divided by 1/2 = 100%

SH only: 1/2 divided by 1/2 = 100%

Is this correct?

Otherwise, if no fail safe language, I would need to amend the plan - let's say all participants who work 500+ hours would receive the allocation. Then I would allocate the ps to all 4 participants. Would I still need to vest the contribution at 100%?

Thanks again!

[Blinky the 3-eyed Fish]

Rmwright, your understanding of how component plans works is incorrect. It is not breaking in components the safe harbor nonelective and profit sharing. As I said before, it can't help you here so I would forget about it for now and learn it another day.

Tom, as for fail-safe language, you must be taking the position that the safe-harbor nonelective only recipients can be treated as not benefiting in order to keep a safe harbor formula akin to top heavy minimums. Of course, this in an interpretation of what is reasonable, but not in the regs.

Rmwright, to simplify it, why not just go look in the doc and see if fail-safe language exists?

[Tom Poje]

actually, I wouldn't take that position, but so much is being bandied about I have gotten sidetracked. my apologies!

you are correct the one rule only applies to people who have received a top-heavy only. (e.g. treat the top heavy as 0 and see if you can pass coverage)

so to recap:

the issue in this case is not coverage, plan passes that at 100%

thus failsafe language doesn't comp into play, that is only for passing coverage.

now, in this plan, there have been different rates of allocation, and one must prove the plan passes 401(a)(4) testing.

If the plan is tested on an accrual basis, one must make sure the NHCEs receive a gateway minimum. A really good document will allow that, I know Corbel document now have that language, it is fairly new, you may have to put that in if that is your document. I think they have snap on language or something like that.

Even the gateway may be insufficient to pass testing, all one can do is run the numbers and see what happens.

I smell a corrective amendment, but I am down wind from the Maxwell House factory, so maybe that is what I smell. I am near the Jacksonville River, maybe I will look and see if any of Blinky's relatives are swimming about.

[Guest rmwright]

Tom and Blinky, thanks so much for your help yesterday!

Blinky, on a sidenote, the info on the component plans was from another research resource and was taken from one of their examples so maybe you can direct me to another site!

Thanks again and have a great Friday!

Rhonda

[EBDI]

I have the same situation with a safe harbor non elective, integrated plan. There is no profit share to terminated employees and those who work less than 1000 hours. I have been told by the software admin people that I shouldn't give the 5% gateway to those who are only receiving the 3% safe harbor because they said it isn't a cross tested plan. I have tried to research the question through the IRS website and I haven't found anything. Does anyone have a suggestion on where I can find the answer?

[Tom Poje]

the only time you have to provide a gateway is if, to pass nondiscrim testing, you test on an accrual basis.

lets suppose for example you have 10 NHCEs and 1 HCE.

you allocate 50,000 on an integrated basis.

3 of the NHCE receive top heavy only.

That means for coverage 100% benefit. so far so good.

however, since you have one group of employees receiving at an integrated rate and another at 3%.

so you have to nondiscrim test.

if you were to take the trouble and test on an allocation basis, and impute disparity you will pass rate group testing at 70%, simply because that is the way the numbers work.

however, that is not necessary because hidden in the regs in a spot no one is permitted to look (though I will take a risk and even copy and paste it here. shhhhh. don't tell anyone )

is example 2 at 1.401(a)(4)-2(b)(4)(vi)(F)

Example 2. Under Plan B, each employee's allocation equals the greater of the allocations determined under two formulas. The first formula provides an allocation of seven percent of plan year compensation and is available to all employees who complete at least 1,000 hours of service during the plan year and who have not separated from service as of the last day of the plan year. The second formula is a top-heavy formula that provides an allocation of three percent of plan year compensation and that is available to all employees described in §1.416-1 , Q&A M-10. Plan B does not satisfy the general rule in paragraph (b)(4)(vi)(D)(1) of this section because the two formulas are not available on the same terms to all employees (i.e., an employee is required to complete 1,000 hours of service during the plan year to receive an allocation under the first formula, but not under the second formula). Nonetheless, because the second formula is a top-heavy formula, the special availability rules for top-heavy formulas in paragraph (b)(4)(vi)(D)(3) of this section apply. Thus, the second formula does not fail to be available on the same terms as the first formula merely because the second formula is available to all employees described in § 1.416-1 , Q&A M-10, as long as the plan would satisfy section 410(b) if all employees who are benefiting under the plan solely as a result of receiving allocations under the top-heavy formula were treated as not currently benefiting under the plan. This is true even if the plan conditions the availability of the second formula on the plan's being top-heavy for the plan year.

[EBDI]

Perfect! Thanks so much for the hidden explanation!