404(a)(7)-25% deduction limit

[Guest joe22]

We have a DB Plan covering 2 HCE participants and a DC that covers 3 additional (2 HCEs) for a PSP allocation. The 25% compensation combined limit does not apply since there are mutually exclusive employees covered by each plan. If the 2 HCE covered under the DB Plan also have 401(k) deferrals in the DC Plan, does this change the result such that the 25% limitation would apply for both plans?

Any thoughts.

[Guest Carol the Writer]

What happens when there are HCE's and NHCE's in the DB plan, and NHCE's in the 401(k) Plan. However, assume that any given NHCE is in one plan or the other, but not both.

If we need to make a safe harbor contribution (or perhaps a QNEC) in order to satisfy the 401(k) testing, does that run afoul of anything? I would really appreciate your thoughts on this one. Thanks!

[WDIK]

Are only elective deferrals contributed to the defined contribution plan?

If so, then I don't think the paired plan deduction limit applies (but it doesn't matter anyway). Otherwise I think it does apply. This is only based on my reading that such an opinion has been expressed by some (unnamed in the text) IRS representatives.

EDIT: This was in response to the first post.

[Blinky the 3-eyed Fish]

I agree with WDIK's assessment. The exclusion to 404(a)(7) applies when there are only 401(k) contributions made to the DC plan. This is obviously not the case here because the NHCE in the DC plan needs a nonelective contribution to have any hope of passing nondiscrimination.

Now to extend it further, the new rules, as far as I can see, don't even override the fact that the IRS will consider the mutually exclusive rule to be violated if the DB participants even have a pre-existing balance in the DC plan (PLR ruling # not handy).

[Guest Carol the Writer]

Thanks. Not to belabor the point, but . . . .

If only QNEC's to the NHCE's who participate in the DC plan but not the DB plan (in order for the 401(k) plan to pass), then does 404(a)(7) apply? I had a client who established a very rich DB plan for a few selected people (the 40%) and the remainder were in a previously existing 401(k) Plan. I think he was overreaching to make any deferrals for himself for 2003, realizing that he had to pass 401(k) anti-discrimination. But he did it anyway.

I told him to make 3% across-the-board safe harbor contributions to the NHCE's who participated solely in the DC plan and to hold his breath on the 25% of pay issue.

By the way, I do acknowledge the pre-existing account balance issue to be a problem, but it seems to be one that nobody cares about.

Thanks!

[Blinky the 3-eyed Fish]

If only QNEC's to the NHCE's who participate in the DC plan but not the DB plan (in order for the 401(k) plan to pass), then does 404(a)(7) apply?

Absolutely. A QNEC is not a deferral and the DC plan needs to have deferrals ONLY.

By the way, I do acknowledge the pre-existing account balance issue to be a problem, but it seems to be one that nobody cares about.

What experience have you had on this for you to make this statement?

[Guest Carol the Writer]

I have only read about plans going back to the late 1960's. I heard that the IRS had been convinced that - in order to set up an arrangement that did not violate 404(a)(7) - the DC plan would need to be terminated and a new one with exclusively non-DB participants set up. The IRS was successfully convinced that that was an awful lot of paperwork to achieve the same end result. I do not remember the cite. It may have been in a recent ASPA publication, or something like that.

[Blinky the 3-eyed Fish]

I wonder if you are thinking of comments that if the plan had only deferrals, then 404(a)(7) is not triggered if there are existing balances. This of course is a different situation.

[Guest penman]

I have read seminar notes from at least one ASPA or EA meeting presenter that contends that since that law now excludes deferrals from 404, as long as the "DB people" do not receive an ER allocation in the PS plan, then they are not benefitting in the PS plan and so 404(a)(7) does not apply, in other words, each plan has it's own 404 limit and the DB people can make deferrals.

That being said, the law does say that the 25% overall limit will not apply as long as no employee receives ER contributions. I have heard arguements on both sides. I know which way I'd like it to be.

I think this has been raised before, what if you added a third separate plan which was deferral only, would that be a way to allow the DB people to make deferrals but side-step the overall 25% limit for the DB/DC? I realize ADP testing would apply.

[david rigby]

Does this help? GrayBook Q&A 2002-4.

Funding: Treatment of 401(k) Plans under Combined Limit of 404(a)(7)

In 2001 an employer adopts a defined benefit plan covering 5 of its 10 employees. A profit sharing plan is adopted covering the other 5 employees. Since there is no overlap of participants between the plans, 404(a)(7) does not apply.

The employer would like to add a 401(k) feature to the profit sharing plan for 2002 and allow all 10 employees to make elective deferrals. The defined benefit plan participants would only be able to defer – they would not receive PS contributions or matching contributions. Are the defined benefit participants considered to be participating in the defined contribution plan such that 404(a)(7) now applies to the combination of the DB plan and the DC plan? Or does new 404(n) mean that elective deferrals are not counted for this purpose, eliminating any overlap of participants between the plans?

RESPONSE

404(a)(7) applies to the combination of the DB and DC plans, since the DB plan participants are allowed to make elective deferrals under the 401(k) plan. A technical correction has been proposed that would reverse this result and eliminate the 401(k) plan from consideration in this application of 404(a)(7).

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