RESTRUCTURING FOR ADP/ACP. 7 ELIGIBLE PARTICIPANTS.

[Lori H]

A 7(5 NHCEs/2HCEs) participant 401(k) with no service requirement and age 21 eligibility, quarterly entry dates, failed adp miserably in 2004 HCE ADP 6.84% NHCE ADP 2.80%. however, 2 eligible participants did not meet the statutory minimum service elibility conditions under Section 410(a). excluding them from the test, the plan still fails, but rather than an NHCE ADP of 2.80%, it is now 4.67%, which would afford the HCE's to avoid a deferral/yield refund of appx. $6400 plus excise taxes and would pass the test with a QNEC of appx a few hundred dollars. Question is: would the QNEC go to all 5 NHCE's or just those 3 NHCEs who met the statutory conditions?

[Guest Midas]

Lori, see Sal's explanation below:

5.c. Allocation of QNECs. If the employer has elected disaggregation, and the employer wants to make qualified nonelective contributions (QNECs) to boost the percentage of the NHC group, which NHCs receive the allocation of QNECs? Under the early participation rule testing option described in 1.a. above, the employer might want to make the QNECs only for the NHCs who are statutory employees, because the otherwise excludable NHCs are excluded from the ADP and ACP

tests. Under the disaggregated plans testing option described in 1.b. above, the employer might want to make QNECs only for the NHCs who are statutory employees, if the ADP or ACP failure is with respect to the statutory employees, or only for NHCs who are otherwise excludable employees, if the ADP or ACP failure is with respect to the otherwise excludable employees. Again, the issue arises whether the employer can simply make QNECs for a disaggregated group of NHCs, even the plan document does not expressly authorize such separate contributions. Given the operational nature of the testing election in the regulations, it would seem that separate contribution of QNECs could be made without express plan document authorization, although the IRS has not formally ruled on this issue. If the employer proceeds on the basis that a separate allocation is permissible by virtue of the operational testing election, the employer would apply the allocation method for QNECs that is stated in the plan document just to the employees included in the ADP or ACP test being corrected. A more conservative approach, however, would be to include specific authorization in the

plan document for separate QNECs for a disaggregated group of NHCs for years in which the plan is disaggregated, particularly in light of the fact that employer contributions are supposed to be allocated under a definite allocation formula, pursuant to Treas. Reg. §1.401-1(b)(1).