Individual HCE allocation groups in XT 401k

[Guest NiceGuyMike]

We have a client which is a law partnership in which they would like to have separate allocation groups for each of the partners, because some want to maximize their contributions, and others don't. The plan is a cross-tested 401(k) plan, and most partners maximize their deferrals (and do catch-ups where possible). The NHCEs share one allocation group.

There appears to be no way to separate partners by age, comp, service or ownership percentage, so we are now exploring whether to set up separate classification groups by name. I've seen some indications on these boards that this is a big no-no, and other places it seems to be OK.

Does anyone have some good cites or guidance or IRS and DOL opinions about this kind of situation? I'm starting to get really confused if we need to tell them to just live with it, or if we can really do this type of design.

[Tom Poje]

you might try looking at #3 at

http://www.abanet.org/jceb/2001/qa01irs.html

again, any time you see a q and a with a response from the IRS, it represents an opinion of the IRS agent and not necessarily the stance of the Treasury. in other words, it is an unofficial view, but based on their unsterdanding of the regs.

[TBob]

What about putting everyone (NHCE's and HCE's) in their own class? It sounds like this has the same effect as separating by name but I have heard that the IRS has approved some plan doc's doing it this way.

[Guest NiceGuyMike]

Tom and Tbob, thank you for your replies. We use Datair, which can handle only up to 10 allocation groups. There are quite a large number of NHCEs, and several partners. I don't think anyone wants to do a zero allocation for themselves or for the NHCEs, but the possibility is always there in a PS component.

Michael

[Earl]

although you have 300 NHCEs that define separate rate groups, if they all get 5% of pay they are effectively one group in the allocation model in the software. Similarly the partners can be agregated in to groups in the software if they have the same allocation in any one particular year.

maybe that will work, maybe not. i guess it could blow up the software if you had 15 partners all of diff ages and thus diff benefit rates. my software handles 100 rate groups so i haven't had the issue.

[QDROphile]

To me this sounds like you are trying to set different profit sharing amounts for each partner based on the partner's choice of amount for each year.

What happens if an auditor asks each partner how that partner's profit sharing allocation was determined. If the partner were truthful, the answer would be that the partner decided how much the partner wanted to defer that year up to the statutory limit, and the only thing that might change that number is that all the inidvidual partner numbers had to be reconciled for testing purposes (and I bet that none of the numbers would be adjusted upward). The greater the profit sharing contribution, the smaller the current compensation.

Does this smell like a CODA? I doubt that you are using 402(g) as the statutory limit. Do you think you have any professional responsibility to tell your clients that this is not within the spirit of the law, even if you think you can get away with it for any number of reasons?

[Mike Preston]

Of course they wouldn't be adjusted upwards. Adjusting an HCE's benefit upwards will never help a test. Downwards on the other hand, is helpful.

The "spirit" of the law? Appropriate word. If the spirit comes forth, ask him or her to call me. I would like to arrange a discussion with that spirit and another spirit, Judge Learned Hand.

The IRS has said that separate groups do not constitute a problem from the definitely determinable perspective. The only issue that naysayers can come up with is the deemed CODA issue. And if the decision is vested not with the individual, but with the plan sponsor, that issue is not sustainable.

Can a lazy practitioner that doesn't communicate clearly so that each participant understands that the plan sponsor is the one making the decision as to level of benefit create a situation where the IRS may sieze upon the case and make "bad law"? Sure.

But not if done properly, IMO.

[k man]

niceguy,

i have 100 cross tested plans and i amended them all to contain language stating that each hce is in his or own classification. the irs says you can do this and it will not violate definately determinable as long as the employer gives the trustee a letter of direction each year. there is authority that directly supports this. i have received determination letters approving this language for all of my plans as well.

[Guest NiceGuyMike]

QDROphile, your comments were more than a little insulting, suggesting as they did professional incompetence or pandering. I believe the fact that I am asking these questions shows a concern for doing things correctly, as well as my responsibility to my client.

And, as a matter of fact, at least one of the partners did adjust their numbers upward on the last allocation. This meant a higher allocation to all the NHCEs as well, but the partnership was willing to pay it.

What we have ended up recommending to the client is that they do *not* set individual rate groups by name, as a matter of fact. We made this recommendation based on review of the information we could find on this issue, which suggested that it is permissible, but not particularly preferred.

What we have suggested is that they set rate groups by title. That way, as each person in the company cycles through job responsibilities, they can have steadily increasing allocations. We have not yet received a response from them, but we believe it is a better course to go in the long term.

kman, can you post authority, please? I'd like to see what you've got on this issue.

[jquazza]

I was also under the impression that designating groups by name was not acceptable, however, I have seen a lot (maybe a dozen) of plan documents that did just that and that were approved by the IRS, which seems to support k-man position.

There are few issues you have to be very wary about, one of them, mentioned by QDROphile (maybe with a little lack of tact,) is that the fact the contribution could be construed as disguised CODAs. There is also the issue of not being able to run the ABT if some groups have a zero contribution rate, which in most cases, would defeat the purpose of setting up rate groups.

[Blinky the 3-eyed Fish]

The IRS is fully aware of how the cross-tested plans work for partnerships and they are fully aware of document language that puts everyone in their own rate group. The spirit of the law is not going to contact Mike because it was run over by the truckloads of people that didn't see it.

The short of it is that if the IRS wishes people not to design and administer plans like this, then they will issue guidance to stop it. For now, they are okay with it, so I say have at it if you want.

[k man]

from the cch pension plan guide. the document is an irs memorandum and rescinds an earlier field directive. I would not include individuals names in the classifications. i would make them generic.

In a March 13, 1998 memorandum the IRS said a July 30, 1996 field directive completely rescinded a September 30, 1994 field directive that concerned whether a profit-sharing plan that provided for employer discretion to determine amounts allocated to particular groups of employees satisfied the definite predetermined formula requirement under the Code. Since the 1994 field directive was completely rescinded, the 1996 field directive applies to all plan designs. A plan would not violate the definite predetermined formula requirement if the employer has discretion to determine the amount of the contributions to be allocated to particular groups of employees defined under the plan and the plan specifies the method for allocating these amounts among the employees in each group. The memoranda for July 30, 1996 and September 30, 1994 are reproduced at ¶17,201M.

Internal Revenue Service Memorandum

Date: March 13, 1998

To: Robert Padilla, Chief, EP/EO Cincinnati Key District

From: Director, Employee Plans Division, CP:E:EP

Subject: Requirement for definitely determinable allocations

On September 8, 1994, we issued a field directive concerning whether a profit-sharing plan that provided for employer discretion to determine amounts allocated to particular groups of employees satisfied the definite predetermined formula requirement under section 1.401-1(b)(1)(ii) of the Income Tax Regulations. The field directive concluded that this requirement was not satisfied for such a plan.

On July 30, 1996, we issued a second field directive which rescinded the prior field directive and illustrated several plan designs that satisfied the definite predetermined formula requirement.

You have asked whether the first field directive was rescinded in its entirety or was limited to the illustrated plan designs. The first field directive was revoked in its entirety. Consequently, the second field directive should not be interpreted as applying only to the illustrated plan designs, but rather to all plan designs. A plan would not violate the definite predetermined formula requirement if the employer has discretion to determine the amount of the contributions to be allocated to particular groups of employees defined under the plan and the plan specifies the method for allocating these amounts among the employees within each group. The number of people in each group or the number of groups is immaterial provided that each group is identifiable under the plan and the identity of particular employees in each group is not subject to employer discretion. It is also immaterial that the purpose for forming the groups is to satisfy the cross testing requirements under section 1.401(a)(4)-8. For example, a plan with defined groups including a group with one person (i.e. 100% shareholder) would not violate the definite predetermined formula requirement.

Although the plan can provide for employer discretion to determine the amount of employer contributions for each group, the plan must require that the employer notify the trustee, in writing, of the amount of contributions for each group. This requirement does not mean that the plan must provide the specific amount of contributions for each group. Instead, the plan must provide that the trustee be given written notification from the employer as to the amount of the contribution to be allocated to each group.

If you have any further questions regarding this matter, please call Mr. Al Reich of Technical Branch 5 at (202) 622-7976.

Date Published: 03-13-1998

[WDIK]

The number of people in each group or the number of groups is immaterial provided that each group is identifiable under the plan and the identity of particular employees in each group is not subject to employer discretion.

This section of the memorandum seems the most pertinent to the discussion of assigning each individual, by name, to a group. Minds far superior to mine can interpret what that actually means.