Compensation Ratio Test

[Guest mol]

A plan excludes overtime/bonus from the defintion of compensation. The comp ratio tests fails because the disparity between HCE and NHCE is 5% - more than a deminimus amout. The only contributions are 401(k) and discretionary match, no profit sharing.

The ERISA outline book (chapter 9 page 9.12) states that if the comp. ratio test is failed the employer has 2 choices:

1. Amend the definition of comp. to satisfy section 414(s) and continue to rely on the design based safe harbor.

2. Allocate the contribution under the plan's definition of compensation and satisfy 401(a)(4) under rate group testing.

I could understand #2 for a profit sharing allocation but can you rate group test a 401k and match contribuiton?

If the plan is amended - under #1 above - does the plan just have to run the ADP and ACP testing using a safe harbor comp. definition? Does the employer have to make some sort of additional contribution?

[MWeddell]

None of the above.

You don't need to change the plan's definition of compensation to be a 414(s) definition because you aren't using a design-based safe harbor to show that your contribution allocation is non-discriminatory. Note that I am using your assumption that there are no employer nonmatching contributions in the plan document.

You have to use a 414(s) definition of compensation when you perform ADP and ACP testing. Since the plan definition is not 414(s), you need to use something else. Note that the plan document often specifies what must be used, so you'll need to comply with the plan document. If the plan document requires you to use the plan's compensation for contribution purposes in the ADP and ACP tests, now you really might have a problem.

In sum, this should be good news for you or your client: no additional contributions and most likely no plan amendment. Also, you probably don't need to bother trying to perform the 414(s) test for future years: just use something that clearly is a 414(s) definition in the ADP and ACP tests.

[Guest quinn the car fixer]

but you can use a non safe harbor 414(s) def of comp for the ADP/ACP test--providing it is non-discriminatory and reasonable. mol says it fails comp ratio test fails so it is not non-discriminatory. so now what? I would say number 1. although you can modify HCE(s) comp to pass the test.

[Blinky the 3-eyed Fish]

Quinn, I am not sure what you mean by your post as there is no such thing as a non-safe harbor 414(s) definition. The definition of compensation either meets 414(s) or it does not. In this case, because the definition of comp excludes bonuses/overtime, it does not meet the definition of 414(s) UNLESS it can pass the compensation ratio test. It does not, so it doesn't meet 414(s).

MWeddell, has the right answer. You don't need an amendment (document language notwithstanding) to just use a compensation that meets 414(s) definition in the ADP/ACP testing.

[Guest quinn the car fixer]

i meant that if you can pass the non-discrim def by excluding B OT & C you don't need to use the def of 414s that includes them. i thought that was mweddel's post was saying.

could you modify an hce's comp to pass the comp ratio test to exclude b ot & c?

[Guest mol]

So if Im understanding this correctly - becuase the plan did not satisfy 414(s) when I ran the comp ratio test - the compensation used for calculating the individual deferral percent (ADP) and individual contribuiton percent (ACP) would INCLUDE the bonus and overtime.

I would not need to amend becuase my doc. says ADP / ACP is tested with 414(s) comp. & 414(s) in this case has to include the bonus and overtime becuase it is not 414(s) without them.

Do I have to add back both bonus and overtime? What if the comp. ratio test was passed by just adding back the overtime?

[Blinky the 3-eyed Fish]

Mol, you understand correctly. As to your last question, I believe you can just add back one component and run the compensation ratio test on that. You just need a compensation definition that is reasonable and that would fit the criterion in my book.