Catch-up Contributions

[Fred Payne]

Two questions about 401(k) Catch-up Contributions and cross-testing.

#1: Assuming there are no problems with passing the ADP, for the various crosstest cacluatlions I undertake, I can ignore all catch-up contributions. Correct?

#2: This question assumes the answer to #1 is that I can ignore the catch-up contributions. But what if the ADP test fails? For example, Participant A deferred $14,500. For the initial ADP test, I assumed deferrals of $13,000 and $1,500 of catch-up. My ADP correction calcs results in a refund of $3,300 for a net 401(k) contribution of $11,200, $3,000 of which deferrals were reclassified as catchup contributions.

When I run the crosstest, do I include only $8,200 in deferrals ($11,200 minus $3,000)? Or do I assume $11,200?

Thanks.

[Tom Poje]

Fred,

I don't know if the answer is real clear.

In the old days you included excess deferrals in the test and then calculates the refund.

Interestingly enough, there is a section in the ERISA Outline book that discusses what to do when you have both excess deferrals and excess contributions involving the same person, and the discussion talked about the results if you did one refund first or did the other one first in regards to testing.

I'd like to think that still holds true.

Consider a plan that fails testing if excess deferrals are immediately counted as catch up. this would require an additional refund.

On the other hand, it is entirely possible for a plan to fail testing, and the refund amount to pass is, for example less than $3000 in 2004. Plan failed because a diferrent HCE had a higher percentage, but the refund went to the HCE who was catch up eligible.

Thus the refund could be treated as an excess contribution. Now that HCE was still over the deferral limit, so an additional amount was treated as an excess deferral to bring him down to 13,000 for the year.

Logically to me it would seem you could still do this.

[Fred Payne]

Tom,

Your answers always make my brain hurt. I need to work through this one.

I think your answer is geared more to my second question. But what about the first question? In those situations in which the ADP is passed--whether or not it's a safe harbor plan--the catchup contributions are not included in the crosstest calculations, i.e, no part fo the Ratio Percentage Test or the Average Benfit Percentage Test. Is this correct?

Thanks.

[Tom Poje]

my understanding is that catch-ups would not be included in testing (I suppose prior year catch ups would be included if one was using accrued to date) I believe it is buried in the regs or one of the notices, but I am too lazy to research at this time.

as for an example of a plan failing testing and whether to refund excess deferrals first....

suppose

HCE 1 14,000 def 200,000 comp 7%

HCE 2 10,000 def 100,000 comp 10%

Avg = 8.5%

NHCE avg = 5.8%

therefore plan fails

If I first treated excess deferrals as catch up before running test I would have

HCE 1 12,000 def 200,000 comp 6%

HCE2 10,000 def 100,000 comp 10%

avg = 8%, plan fails, must return additional excess contrib

However if I run test first, my refund to bring average to 7.8% I must reduce HCE 2 to 8.6%

HCE 1 14,000 def 7%

HCE 2 8,600 def 8.6%

avg 7.8% plan passes, refund =$1400

so 1400 = excess contribution for HCE 1

this leaves him at 12,600, so still has 600 in excess deferral.

so it looks like I leave all 2000 in the plan as catch up, as oppossed to having to refund an additional amount.

[Earl]

My take on your question is you would use the lesser number because you are not refunding catch-ups. The $3,000 is catchup whether the guy is able to defer $16,000 or $3,001.

My question about this issue is suppose there is no ADP or 402(g) or plan limit problem and the Sole 55 yr old HCE defers $8,000.

Can you call $3,000 of that catch-up and exclude from cross testing (and potentially enhance the disparity of rates).

Could you declare amounts to the HCE and NHCE group that fail and consider that "hitting a limit under the plan or code"? Or would you have to have an administrative provision that somehow limits the HCE to $5,000 so you have a plan limit?

[Tom Poje]

I dont think you can simply declare or treat an amount of deferral as a catch-up and therefore not use it in cross testing.

Catch up was for hitting a limit (402(g)) or failing ADP test, or even 415 limit.

Failing nondiscrimination was not one of the options listed. Now, the plan could have a cap on deferrals, but at that point you are really guessing - what happens the following year with a different census population. Now you have a plan imposed limit that might make no sense.

[Fred Payne]

Tom:

So that I understand your comments:

Assume the correction for an ADP failure is that, from his gross deferrals of $14,000, an HCE gets a refund of $1,600, has $2,000 classified as a catch-up and has 402g limit deferrals of $10,400. When the cross test is run, all that is included in the various test is the $10,400. Correct?

THanks.

[Tom Poje]

Fred:

I got lost a bit.

ee deferred $14,000

so he has 2000 in excess

but plan also failed ADP test and correction is $1600.

now, it looks like I can refund excess deferrals first or I can refund corrective contributions first.

In the example I was talking about, was a scenario with the question

"Do I automatically count excess deferrals as catch up before running the ADP test"

If I do, plan still failed the test and I would have additional contributions to make.

If I don't treat the excess deferrals as catch ups 'immediately' but rather run my test, I have the situation where the corrective measure is less than the amount of excess deferrals. Therefore, I treat 1600 as excess contribution - I now pass my ADP test.,I then treat the remaining 400 as excess deferrals, so I end up at 12000 in deferrals to be tested.

At that point I have to look up and see how to handle or actually report things on the 1099. I believe the ERISA Outline Book has a real good explanation.

But in my example I never end up at 10,400.

[Fred Payne]

Tom:

I'm still struggling. Please help me interpret the content of a Correction Methods Report I get from Relius, and some of my other confusions might clear up as a result.

PER RELIUS: For year 2003 Paricipant X, one of three HCEs, deferred $13,455.09. The SBJPA Distribution Amount Prior to Catch-up is determined to be $4,797.37. $2,544.91 is recharacterized as a Catch-up contribution, resulting in a distribution to Participant X of $2,252.46 (prior to allocable income). So net deferral for Participant X is $11,202.63.

You stated earlier that your "understanding is that catch-ups would not be included in testing (I suppose prior year catch ups would be included if one was using accrued to date)." When I perform the cross-test for Participant X, do I include $11,202.63 as Particpant X's deferrals because it is less than Year 2003's 402(g) limit? Or do I only include $8,950.17 (the $11,202.63 minus the $2,544.91 recharacterized as Catch-up per the Correction Method)? I am assuming the amount of the corrective distribution does not enter into the cross-test calulation at all.

I'll have a follow up question, but I don't want to "muddy the waters."

Thanks.

[Tom Poje]

Fred:

According to the Erisa Outline Book (8.48, 2003 edition)

corrective distributions should be included in the avg ben % test

excess deferrals, recomended to include

(I'd go by that, rather than what limited knowledge I have oicked up along the way

basically, the logic is that you include them in the ADP test, at least initially.

Of course, it is possible that an NHCE would have excess deferals and you dont include those in the ADP test, so then what should you do.

[jquazza]

Tom, I think you missed Fred's point. Catch-up contributions should be excluded when you calculate the ABR%. So, if the participant in question got in effect $3,000 catch-up, $2,000 from an excess 402(g) and $1,000 from a recharacterization of his deferrals to catch-up CTs due to ADP failure, in the ABR, you will only take into consideration the deferrals that are not catch-up (whether the catch-up CTs are from 402(g) excess or ADP failure.)

I think that's what Fred wanted to know.

[Tom Poje]

Agreed, though

I couldn't follow from Fred's example exactly what was going on, and I didn't have time to research further (Talk about being swamped with work again!) except for pointing to The ERISA Outline Book. I would certainly agree, any deferrals not counted as catch ups would be included in the test. The question is 'how much is treated as catch up.

The example was total deferrals of 13455.09.

Fred asked if the amount used was

11,202.63 (deferrals after excess contributions) or 8950.17

I am not sure how the system arrived at a catch up of 4797.37. that makes no sense since, if the plan year was 2004 the maximum catch up was 3000.

Maybe that is where the big problem is, the software is producing a value which is a sum of excess deferrals and excess contributions and it didnt cap it at 3000. I simply cant tell from Fred's numbers. (Or maybe its a non calendar year plan and then I gracefully bow out and throw my hands up in the air and say good luck!)

Lets suppose plan fails ADP test and refund for corrective contributions was 2300.

One check is cut. for tax purposes, 455.09 is excess deferrals and the remainder is excess contributions. it looks like ee doesn't reach 3000 in catch up. I base this on the examples from the ERISA Outline Book, noted below. The examples are not even talking about catch ups, but simply what is going on in the test.

the example from the ERISA Outline Book 11.249 and 11.250 (2003 edition)

in example 4.b.1

plan year 2002

ee deferred 11,600.

so, and I will use my terminology, the smart administrator immediately refunded $600 in February, because he knew he might not get to the ADP test until later.

Later in the year he runs the ADP test (and includes the excess deferrals, even though they have been refunded). he discovers plan fails and the excess contribution is 1000. Well, of that amount, 600 has already been refunded, so only 400 remains as excess contributions. EE received 2 separate checks.

in the 2nd example 4.c.1

test wasn't run until March. Of course same results, plan failed, 1000 excess contribution. One check is cut. But 600 is still treated as excess deferrals.

[Guest Ron Sevcik]

Fred and Tom,

You are somewhat misinterpreting the results that Relius is producing and contrary to Tom's comment, the software is doing it correctly.

First, since the actual deferral is $13,455.09, immediately $455.09 is a catch up because it is in excess of $13000. Then once the ADP test is run, the deferrals need to be reduced another $4,797.37. Since $455.09 has already been characterized as catch up, only another $2,544.91 ($3,000 - $455.09) can be recharacterized as catch up and the remaining $2,252.46 needs to be distributed to the participant.

As Fred states, the net deferral for the year is $11,202.63. However, this consists of an actual deferral of $8,202.63 and a catch up of $3,000.

Thus, it seems to me that Fred's question should whether to use $8,202.63 in his calculation ($11,202.63 - $3,000) or $10,455.09 ($13,455.09 - $3,000). Based on the rest of the discussion, I believe he should be using $10,455.09.

[Tom Poje]

Ron:

Thanks for your explanation. It was clearer than what was put forward earlier.

As indicated, I was unclear by his explanation and thought he indicated the system calculated a catch up greater than $3000.

...........

As a side note,

I did finally find in the preamble where it states "the ADP limit is determined after taking into account all deferrals (other than elective deferrals that are catch up contributions because of an employer provided limit or statutory limit)"