Failed ADP Test - how to correct?

[Francis]

If a 401k plan fails the ADP test, how in general is it corrected? Let's suppose there are 20 HCEs with various salaries and deferral percentages. Do the highest paid HCEs take the largest refunds or do those with the largest percentage contributions take the largest refunds? Or is it on a percentage basis or dollar amount across the board? Or something else?

[WDIK]

In general, you correct an ADP test failure by

1) recharacterizing excess contributions;

2) restructuring the portion of the plan attributable to elective contributions;

3) making QNECs or QMACs that are treated as elective contributions;

4) return the excess contributions and allocable income as described in Notice 97-2; or

5) some combination of the above.

[Tom Poje]

in regards to the direction you worded your question, the answer is 'something else'.

1. eliminate any deferrals that could be treated as catch-up (deferrals that exceed the (e.g. $15,000 limit or plam impposed limit.

2. perform your test.

3. determine amount of refund (at this point it would be based on % deferred)

4. determine who gets the refund -at this point it is based on who deferred the most, not who had the most comp or who had the largest % deferred. (leveling down to next highest deferred amount, etc, etc.

5. if this refund is available to someone who is catch up available, those amounts would be treated as catch-ups.

of course the plan might not even allow for catch ups, so refunds might be even greater.

[pmacduff]

Just to clarify for Frank, if HCE contributed $20,500 and you have already taken $5,000 out in your step #1 ($15,500) and you get to step #5, you cannot reclassify more $$ as catchup and must refund to that HCE, if applicable.

[Francis]

To clarify even further, let's say we have 20 HCEs who make $100,000 each and all 10 defer $15,500 into the 401(k). And let's say we have 2 HCEs making $225,000 each and these two $225k HCEs also defer $15,500 into the 401(k). Then there are another 30 non-HCEs.

To correct a failed ADP test, would all of the HCEs have to receive back an equal dollar amount? Is the percentage of income deferred into the 401(k) not important? It seems unfair to hit the $225k HCEs less hard from a refund percentage viewpoint than the $100k HCEs. Equal dollar refunds would hurt the $100k HCEs more than the $225k HCEs as a percentage. Is this how it's done?

[John Feldt ERPA CPC QPA]

Do all of the HCEs have enough ownership to be required to be an HCE? If not, maybe you want to adopt a top-paid group election and limit your HCEs to a smaller number - that may help your test for the next time around.

As for last year, point number 4 by Tom Poje is truly the correct step for determining who gets money back, fair or unfair as it might seem.

[Tom Poje]

as to fair or unfair, or who gets hurt the most, I'd say that is in the eyes of the tester.

200,000 15,000 7.5%

100,000 10,000 10%

lets say the refund is $1000.

now, the HCE with the highest deferral % caused the plan to fail. In the old days of leveling by % he would have gotten the refund.

now its the other way around, the guy making the most money will get the refund and, in this small example the guy who deferred the most .