New Comp Allocation & ADP refund

[pmacduff]

ok - I'm sure there was a thread on this but as usual I can't find it...

Owner defers $15999.88 for 2006 (is over age 50). There are other HCEs, and ulitmately owner has to take refund to correct ADP of $3,035.26 (includes gains).

Owner is getting $93.86 in ps forfeiture reallocation. New comp formula, profit share has not yet been declared for 2006. Originally, I was allocating a profit share of $28,916.14 to bring owner to total allocations of $44,999.88.

So....can I give the owner $31,941.40 in ps allocation to "make up" for the refund he will be taking? His actual total allocation in 2006 would then be $48,035.14 which is still under the $49,000 (if you consider catchups), but he didn't make the full $5,000 catchup; I'm thinking he is limited to an overall allocation of the $44,999.88.

Any input appreciated.

[pmacduff]

bringing this back up front....

is this a dumb question so no one wants to answer or is everyone EXTREMELY busy like I am????

[Jim Chad]

FWIW My thinking goes like this:

The individual dollar limit under 415 is $44,000 for 2006. Catchup contributions are on top of this.

If I understand you correctly, the only part of the $15,999.88 of deferrals that bumps into a limit and can be recharacterized as a catch up is the $3,035.26 ADP correction, so far. So this means his limit is $47,035.26.

This much I feel pretty confident in.

But I'm pretty sure that since you have at least $5,000 of deferrals, your limit should be $49,000. Look at it this way: If you were allocating a non elective contribution and some one under age 50 was getting too much for 415, would you cut down on this person's allocation or would you refund some of the deferrals. I would refund part of the defrrals to correct the 415 failure. I think a 415 failure herre lets you go all the way to $49,000.

[Bird]

I agree with Jim Chad; this guy's total allocation limit is $49,000.

If you allocate $33,000.12 for PS, that forces $5,000 of his deferrals to be catchup. But let's back up, because I think your post contains some contradictory language. First you say he has to take a refund, then you say he hasn't made the full $5,000 catchup. Well, an ADP failure is one way to create catchups, so before you do any refunds you should apply the excess to catchups.

Here's how I see it:

We know he has catchups of at least $999.98 due to exceeding the 402(g) limit.

If the plan fails ADP and his excess is $3,000 excluding gains, then you apply another $3,000 to catchup and don't need to refund.

His "regular" deferrals are now down to $12,000.

There are $1,000.12 potentially available for catchup but not used as yet.

I believe you can now allocate $33,000.12 to PS. Since we were at $12,000 of regular deferrals, this pushes him over 415 by $1,000.12. That amount is recharacterized as catchup.

So you have $33,000.12 of PS and $10,999.98 of regular deferrals for a total of $44,000, and $5,000 of catchups for a total allocation of $49,000.

[pmacduff]

OK - I didn't provide all the info; sorry

owner's original refund amount was actually $6,668.74; he already used $999.88 of his catchup, so I backed off an additional $4000.12 in catchups to leave him still with an ADP refund of $2,668.62 plus earnings of $366.64 for a total refund of $3,035.26 AFTER catchups.

His total allocations for 2006 (before any refund) would look like this...

Total 401(k) contributions = $15,999.88

Forfeiture realloction = $ 93.86

Profit Share allocation = $ 31,941.40

Total allocations = $48,035.14

Still ok?

[Tom Poje]

what the issue boils down to is if you are permitted to allocate a profit sharing causing an ee to go over the 415 limit, and therefore end up treating some of the deferrals as catch-up.

having sat in with the IRS during the Q and A pre session, they expressed 'reservations' about such a strategy, but there is no definitive word on it.

[Bird]

I understand your thinking a little better now. I don't believe that there is any hint of a problem with this whatsoever. You're using up the catchups before even reaching the 415 limit.

FWIW, I think you were applying an artificial constraint by "shooting for" a total of $45,000 in the first place. Maybe there was some other reason for it, but if you were trying to maximize overall it's as simple as:

401(k) after catchups - $10,998.88

Available for PS/forf - $34,001.12

[AndyH]

Tom, wouldn't it be nice to work for the IRS and not have to provide answers? Maybe you are secretly aspiring to that?

[pmacduff]

I see what you are saying Bird. I was taught that catchup contributions do not become catchup contributions until a limit is exceeded and we determine that at the end of the plan year. For example, the person who contributed $12,000 in 401(k) deferrals at age 55 did not make any catchup contributions over the individual limit of $15,000 specifically, however if the ADP discrimination testing fails, then the participant's refund due can be recharacterized as catchup.

I went to a seminar and was told that if a participant did not take advantage of the whole catchup amount in any given year, then their overall individual limit was reduced. The speaker stated that catchup contributions only make the individual limit on contributions increase to the extent that they are utilized.

Said another way...if I'm age 50 or over and I put in $17,500 in 2006 for my 401(k), then my individual limit is the base limit of $44,000 plus what I did for catchup ($2,500) for a total of $46,500.

In my client's case, (disregard that there was any refund due), since he contributed only $999.88 in catchup, I understood that to mean that his individual max is only $44,999.88 for 2006, not $49,000.

I thought the speaker was telling us that you can't use participant catchups toward the limit on the Employer non-elective side if the participant did not make the full catchup.

I'm going to go back and try to find the seminar materials I brought back, I think the materials tie in with what Tom is mentioning....

[Bird]

pmacduff-

Unless the speaker gave examples similar to the ones you just gave, I don't think s/he was wrong.

The speaker stated that catchup contributions only make the individual limit on contributions increase to the extent that they are utilized.

In your client's case, he DID utilize the full $5,000 catchup when you converted some of his deferrals to catchups as a result of a failed ADP test. You seem to be distinguishing between the 999.88 that exceeded 15,000 and the 4000.12 that became catchup as a result of a failed ADP test. I don't believe there's a difference.

Tom is talking about a different situation, BTW. He's saying that if an over-50 participant defers 15,000, and then is allocated 34,000 as PS, the IRS "has reservations" about converting 5,000 to catchups as a result of exceeding 415. I disagree with their reservations, although I can sort of see where they're coming from. I just don't see any issue whatsoever with your situation resulting in a total of 49,000 to the participant.

[Tom Poje]

I have enough work to do, but also am trying to throw some notes together for my talk at the Western benefits Conference - this one on 401k testing.

and I was looking through what I have together so far.

ah yes, there it is - to run your ADP test, you do not include catch-ups as a result of statutory or plan imposed limits (1.414(v)-1(b)(1) (i) and (ii)). this is found in 1.414(v)-i(d)(2)

the statutory limits would be the deferral limit or 415 limit.

then you run your test.

if you fail and have a refund, you can treat part of this refund as catch up as well.

now you want to allocate the profit sharing (exceeding the 415 limit) and create more catch up

wait, you can't do that - otherwise you ran an incorrect adp test to start with, and calculated a refund due to a failed test that was run incorrectly because you included amounts that violated a 415 limit.

or put another way with you initial example (using rounded numbers)

ee deferred 16,000, so 1000 in catch up. ADP test run with 15000 deferral.

due to failed test had refund of 3000 as well.

if you were to treat all of this as 415 limit violation

then your initial ADP test should have been run with 12000 deferral. now determine the refund. if you have more than one HCE it would make a big difference.

oh well, wandering thoughts of an idiot.

[pmacduff]

ok Tom - I can't follow that at all, my brain is mush right now, but would like to ask...

Do you agree that the owner participant in my original post can be allocated the $48,035.14? or are you saying it is up to interpretation?

[Tom Poje]

if I understand things correctly, I believe you are ok. since catch ups don't count toward 415. speaking of which, it is close to my 4:15 limit. time to stop thinking pensions. (of course I am here hours before anyone else, so ...)

but I don't think you could allocate more than that and therefore create an additional 415 violation, thereby creating more catch ups.

if you did that, then your initial adp test would have been incorrect, because it would have used deferrals in excess of the 415 limit.

[Mike Preston]

The reason that this issue tugs at our logic strings is that if the IRS' draconian interpretation is correct, a plan that has a lower threshold for allowable deferrals is a more inviting arena as far as HCE deferrals go. That makes no sense to me. Consider two plans, where the ADP limit is $10,000 in the first plan and is $11,000 in the second one. Assume that an HCE deferred $12,000 in each. In the first, there would be $2,000 of catch-ups and in the second there would be $1,000 of catch-ups.

Now, presume that the employer would allocate whatever the absolute maximum is under 415. In the first case, where the ADP limit was $10,000, an allocation of $10,000 less than the 415 limit seems appropriate. Let's assume that is $34,000. In the second case, where the limit was $11,000, an allocation of $11,000 less than the 415 limit seems appropriate. Let's assume that is $33,000. Hence, with an ADP limit of $10,000, the HCE can be allocated $34,000; while with an ADP limit of $11,000 the HCE can only be allocated $33,000.

It hardly seems right that a plan with a lower allowable HCE deferral should have a greater allowable employer contribution.

I have poured over the 414(v) regulations and the code over the last few days and I am amazed that the examples are devoid of 415 references. And the code and regs aren't much better. The relevant phrase that seems to be the deciding factor is in 1.414(v)-1(b)(1)(i): "A statutory limit is a limit on elective deferrals or annual additions permitted to be made (without regard to section 414(v) and this section) with respect to an employee....".

That, combined with the fact that the regulation makes it clear that the determination of what is, and is not, a catch-up is determined as of the end of the year (see 1.414(v)-1©(3), which specifically mentions section 415) sure does make it seem like any deferral which is made that would, when added to an employer allocation for the year, exceed the annual additions limitation ($44,000 in 2006) should be treated as a catch-up contribution.

But I can see that the regulation and the code, by not specifically referencing employer contributions under Section 415 as being included in the determination under 414(v) might (just might) be read to mean that limitations must be exceeded solely by deferrals to give rise to catch up contributions.

That is, if a deferral exceeds 415 before consideration of employer contributions then it most certainly is a potential catchup. If a deferral exceeds 415 only after inclusion of the employer contribution the reg can be read to not offer catchup status to that deferral.

Just barely.

Maybe.

The only way this would make sense would be if the language bolded above has the potential for establishing a catchup contribution without consideration of any employer contribution. Can it? The only circumstance it can be talking about is when the deferral limit is not reached, but the annual additions limit *is*. That means specifically for a participant with compensation that is less than the 402(g) limit. So, take an example of a participant with 415 compensation of $10,000. In such a case, we look to the code (414(v)(2)(A)(ii)) and find that if the participant defers $10,000, the maximum catchup is zero. That is, EGTRRA not only gave us catch-ups, but it also increased the 415© limit to 100% of pay.

The only way one can interpret all of this to preclude consideration of employer contributions in the determination of catch-ups is if the drafters made a mistake and included the language in bold because they thought that the 415© limit was still 25%. Once the 415© limit became 100%, it became fundamentally impossible to create a catchup with deferrals alone, when focusing solely on the 415 limit. Sure, $10,000 in deferrals with $10,000 in compensation can certainly give rise to catch-up contributions relative to the ADP limit. But here we are trying to focus on the annual additions limitation.

[Added later]

Isn't it much more logical to conclude that the inclusion of the bolded language instead was intended just as it is written? That is, that the determination of what is, and what is not, a catch-up must be made after consideration of not only deferrals, but also the employer contribution (i.e., annual additions)?

[/added later]

With all that said, I think that in the case being discussed here, the fact that the ADP limit is low enough to cause $5,000 of deferrals to be treated as catchup contributions means that only $10,999.88 + $93.86 + $31,941.40 is taken into account under 415 an an annual addition and that adds up to only $43,035.14. Hence, an employer contribution/allocation of $32,035.26 works.

Just to drive home the point, assuming the plan had no ADP limit and therefore only $999.88 would end up as a catch up contribution, the employer limit would then be $44,000 less $15,000, which is $29,000; and in such a case, an employer allocation of $32,035.26 would exceed the 415 limit by $3,035.26. Most importantly, since it couldn't give rise to additional catch-up contributions, it would need to be handled as a 415 excess.

Knowing what we know about this case, can it possibly be that the HCE in question discouraged NHCE's from contributing to the plan so that the allowable deferrals were reduced so that his profit sharing allocation could be increased?

If it were true doesn't that seem like a result that is against public policy?