Can one recalculate after a ADP failure and then use shifting to help the ACP test?

[Guest JulietH]

If the ADP test fails and refunds are made, can the test be recalculated and any margin between the NHCE ADP and minimum NHCE ADP be shifted to help pass the ACP test.

For example if on recalulation the HCE is 5.5% and NHCE is 4%, can 0.5% be shifted to the NHCE ACP?

I haven't been able to find a prohibition unless the proposed regulation anti-abuse rules would squash the idea.

It has been a big year for failed tests.

[Brian Gallagher]

You can use the "extra" adp in the acp if you want. They get tested as would employee contributions (after-tax).

However, this cannot be done if a plan is using the prior year method for this test and had used current year for the previous test--that would be double counting.

[jquazza]

You should not recalculate your ADP test after the refunds. Ever since the leveling method was introduced to calculate the refund amounts, when you recalculate your ADP, you may or may not get a passing level, and at any rate, the results are truncated due to the leveling.

Also, since your plan failed ADP and you distributed refunds, you don't have any room in your ADP to shift. If you distributed too much to give room to shift, then you have an impermissible (potentially) distribution. Refunding or forfeiting the match would therefore be in order.

[Tom Poje]

This is a debatable issue. 2003 edition of the ERISA Outline Book discusses both sides of the issue, simply concluding that it is an unclear issue.

In a somewhat similar related issue:

A few weeks ago I was working on adding some stuff to the Coverage/Nondiscrim Answer book and had Amy (coeditor of the book) pose the following to Sal

Q and As

Ran the ADP test with the following results:

ADP % ACP%

HCE 4.11 2.06

NHCE 2.17 .70

So plan passes ADP and fails ACP. Because plan passes ADP no limit has been reached, so catch-up contributions are not permitted.

But now suppose .33 of NHCE deferrals are shifted to the ACP test.

ADP % ACP%

HCE 4.11 2.06

NHCE 1.84 1.03

Now plan passes ACP but fails ADP. Since plan fails, is it now permissible to treat some the deferrals of the HCEs as catch-up contributions?

My response: It is unclear but it does appear to be an acceptable correction method. The regulations simply indicate that any amount of elective deferrals may be included in the ACP test as long as the ADP test is satisfied both before and after the shift of deferrals is determined. In this case, the ADP test fails after shifting, but a legitimate correction is to then treat a portion of the deferrals by the HCEs as catch up contributions. The regulation seem to indicate that all testing (emphasis on ‘all’) before it is determined how much of the deferrals are available to be treated as catch up contributions.

Sal's response

The way the regulations are written, I would have to agree with the other person. Originally, I was of the view that when you shifted the deferrals to the ACP test, you couldn't cause a failure on the ADP side. But I became convinced that, so long as you end up passing the ADP test (i.e., through correction), that the shifting is still okay. Assuming that's true, then the catch-up recharacterization on the refund being generated on the ADP side necessarily follows. Supporting this view is that the 401(k) regulations simply require the ADP test to be run without taking into account the elective deferrals that have been included in the ACP test. It doesn't require that the plan must be able to pass the ADP test without need for corrective action. Thus, if corrective action is needed, and the action taken is to refund excess contributions, then you can use the catch-up rules to recharacterize the refund as catch-up contributions. This, of course, assumes that the plan includes catch-up provisions and that they were in the plan for a sufficient portion of the plan year to satisfy the effective availability requirement (i.e., the catch-up rules are not added after the close of the plan year for the sole purpose of recharacterizing refunds).

.........

Scares me to death I start thinking like Sal! Again, I would emphasize this is an unclear issue. You are only hearing opinions voiced by fools like me!

[Guest Boilerburm]

I would challenge Jerome in that you may have instances where you would benefit by shifting after correction.

Example:

Original HCE ADP = 5.0, ACP = 3.75

NHCE ADP = 2.5, ACP = 1.75

Both tests fail. First, correct the ADP by determining your amount to return through reduction of HCE ADP to 4.5. From there you make your distributions, but who gets that $ doesn't matter.

Your resulting Numbers:

HCE ADP = 4.5, ACP = 3.75

NHCE ADP = 2.5, ACP = 1.75

Note no recalculation.

You can then shift .5 from ADP to ACP for both HCE and NHCE:

HCE ADP = 4.0, ACP = 4.25

HNCE ADP = 2.0, ACP = 2.25.

Now you pass both tests by using the shifting method.