Off Calendar Year Catch-Up Contributions

[Kevin C]

Forget my example. Everyone (but me) seems to think that if you fail the ADP test for the 9/30/06 plan year, and reclass all of your refunds as catch-ups (to the tune of $5,000), that you should be limited to $15,000 of 401(k) for all of 2006 (i.e., $10,000 of regular 401(k), plus the $5,000 of catch-ups that were used up during the ADP test.

I'm saying that whether that person can defer $15,000 or $20,000 for 2006 depends on the amount he deferred between 1/1/2006 and 9/30/2006. If he deferred at least $5,000 from 1/1 - 9/30, then he can contribute a total of $20,000 for the year because $5,000 of his 2006 deferrals are re-classified as catch-up. His contributions for the remainder of the year would all be regular deferrals.

If he deferred $0 from 1/1 - 9/30, then he used up his 2006 catch-up before making any 2006 deferrals. He is limited to $15,000 in regular deferrals for the remainder of 2006, because he had no catch-up available at the time he made his 2006 deferrals. I don't think you can re-classify any of his 2006 deferrals as catch-up if he has not made any 2006 deferrals at the time the catch-up limit is used up by the ADP test.

I think the answer is to either time your deferrals better or go Safe Harbor.

[austin3515]

I beg to differ. While I agree that that is what the regs say, I still think it is an error in the regs that leads to this conclusion. Applying this dictates that this lucky HCE received two catch-up limits. We all agree that the ADP test was failed, and he averted refunds to the tune of $5,000 by reclassifying them as catch-ups. Now, you are suggesting that he should be able to exceed 402(g) AS WELL AS the ADP limit by an additional $5,000. How is that two separate limits can be exceeded by the full $5,000 in one calendar year?

The answer is simple: A math error in the regs.

[austin3515]

I should point out that in practice, I am only allowing one catch-up limit per calendar year for each participant. In other words, I'm limiting people to the full $15,000 PLUS $5,000 LESS Catch-ups consumed in ADP testing. So if $3,000 was consumed in ADP testing, calendar year deferrals are liminted to 17,000 (because only $2K of catch-ups remain).

[Kevin C]

Austin,

If you do that in all situations, you will violate the universal availability requirement for the catch-ups.

For example:

1/1 – 3/31/06 deferrals of 4,000

ADP failure at 3/31/06 with the 3,000 refund reclassified as 2006 catch-up.

You are saying this person can only defer a total of 15,000 + 5,000 - 3,000 = 17,000 for 2006.

Example 5, paragraph (v) of the regs refers to catch-up due to an ADP test failure and says that the catch-ups are not taken into account in applying 401(a)(30). In the example above, since he deferred at least 3,000 in 2006 by 3/31/06, then 3,000 of his 2006 deferrals are reclassified as 2006 catch-up due to the ADP refund. Now, as of 3/31/06, he has 4,000 – 3,000 = 1,000 of regular deferrals and has used up 3,000 of his 2006 catch-up limit.

His remaining available regular deferrals are 15,000 – 1,000 = 14,000. He also has 5,000 – 3,000 = 2,000 of his 2006 catch-up limit still available. So, when his deferrals from 4/1-12/31/06 exceed 14,000, the next 2,000 of deferrals become 2006 catch-up. He can defer a total of 16,000 from 4/1 – 12/31/06. That makes a total of 20,000 for calendar year 2006.

But, you only let him defer 17,000 for the year. After the 3,000 ADP refund was reclassified as catch-up, you would be limiting his regular deferrals to 14,000 for the year. You would only let him do a catch-up of 3,000, which would violate the universal availability requirement because other participants would have the effective opportunity to do the full 5,000 in catch-up.

Now, change the example to:

1/1 – 3/31/06 deferrals of 0

ADP failure at 3/31/06 with the 3,000 refund reclassified as 2006 catch-up.

He has not made any 2006 deferrals as of 3/31/06, so I don’t think you can treat any of his 2006 deferrals as catch-up. He can still make 15,000 in regular deferrals for the remainder of the year and he has 2,000 of catch-up remaining. So, he can defer 17,000 for the rest of the 2006 year.

[austin3515]

My well thought out response is this: I disagree.

Would it sway you at all if I told you that I spoke to Derin Watson on this very issue, who affirmed my position (he would not conclude that the regs were in error, just that my intepretation of the regs was off a little). But without a doubt he indicated that letting someone defer the full $20,000 even after failing the ADP test was a double counting of catch-ups.

[rcline46]

I keep trying to follow, and I STILL have a fundamental problem. 402(g) Says I can defer $15,000 in 2006, and catchup says if over 50, I can put another $5,000 away. So I put away $20,000 in 2006.

I cannot believe in any way that a 'problem' in the 401(k) plan (failed ADP test reclassified as catch up) can in ANY WAY stop my deferral amount. I might have to have some deferrals returned on a 1099 from a failed test, but I cannot see how you can limit my deferrals.

Suppose YOU say I am limited to $17,000 and I do $20,000. What do you do with the extra $3,000? Under what rule can you return the money?

[austin3515]

Forget that for a moment: Do you not agree that if someone can defer 20,000 despite failing the ADP test that the failing the test is of zero consequence?

I would suggest that it is returnable under some combination of 402(g) and 414(v) because you used $8,000 of catch-ups in 2006 - $3,000 to exceed the ADP limit, and $5,000 to exceed 402(g). Does nobody else see it this way???

[Mike Preston]

Why do you say it is of zero consequence? It is a mandatory usage of an individual's catchup limitation. Try the numbers with a refund of $6,000. Surely we both agree that the most that can be treated as catchup is $5k and that therefore this person would get a $1,000 refund.

It seems to be a timing issue. I, for one, have no problem with considering a portion of an individual's deferrals as catchup for failed test purposes and then allowing that person to defer up to a total of $20,000. From my perspective, then the first few dollars were classified as catch-ups they fell off the "regular 401(k) deferrals" bandwagon and therefore the person can move all the way to $15,000 (or $15,500) from the "remaining 401(k) deferrals" platform before again eating away at their catchup limitation.

But I admit to being a tad confused as I just don't see the issue. Care to restate in simple terms?

[Mike Preston]

OK, I needed a break from what I was doing, so I looked at this again. Austin, you are correct that FOR PURPOSES OF 401(a)(30) the regs make it clear that: "Catch-up contributions for the TAXABLE YEAR ARE NOT TAKEN INTO ACCOUNT in applying the section 401(a)(30) limit" and that phrase appears in both Ex. 5 and Ex 6 in subparagraph (v).

However, that doesn't mean that the subsequent catch-up contributions resulting from 401(a)(30) are ignored for purposes of future ADP testing. Looking at Ex 6, we find that there is a $1,000 amount that is treated as a catch-up "as they are deferred" since that is contributed in excess of the a(30) limitation for the calendar year on 9/1/2006. Hence, in your example in Post 31, as we begin to test the 3/31/07 year, we find that the we were both wrong, and that the $20,000 contributed on 9/1/2006 gives rise to a $5,000 catch-up right then and there because it exceeds a(30)'s limitation and when we test the allowable deferrals at 3/31/2007 and find that they are only $10,000 we must issue a refund of $5,000 at that point. That is, we can't use the 2007 catchup limitation at that point.

Great example to analyze in depth.

I await anybody saying my analysis above is incorrect for one reason or another (nothing would surprise me - even to find that there is a contradiction in the regs somewhere).

[austin3515]

I don't have time now for in depth analysis of the regs, but I will be looking into this more for my 3/31/08 plan year client...

The only thing I will say is that if you are right, I'm going to find any plan I can that has an age 50 owner and ADP troubles and amend them to a fiscal year plan ASAP. Because through all of this legalese if you're telling me that the owner can still defer $20,000 every year, even though the ADP test is failed (assuming refunds are < CU Limit), then that is a safe harbor plan without the high contributions (ok, and w/o the TH exemption, but you get the idea).

[Kevin C]

Mike,

In your last post, first paragraph, I think you were referring to my post, not Austin’s.

I think there is a problem with your example. The 20,000 deferred 9/1/2006 results in a 2006 catch-up. (Of course, that assumes that he still had the full 5,000 of 2006 catch-ups available at 9/1/2006.) When you get to 3/31/2007, the refund is classified as 2007 catch-up. In the example he didn’t defer again until 9/1/2007, so he had not used up any of his 2007 catch-up limit by 3/31/2007. The 5,000 refund would be classified as a 2007 catch-up.

Austin,

What example did you give Derin Watson when you asked? If you gave him an example where nothing was deferred in the calendar year until after the ADP test failure at PYE, then I understand why he would agree with you.

Also, the ADP refund is of consequence. It forces the HCE to use up his catch-up limit earlier than he otherwise would. Plus, catch-up resulting from ADP refunds is not excluded from the ADP test. He would be better off having the catch-up result from exceeding 402(g) or a plan imposed limit, so the catch-ups would be excluded from the ADP test.

[Mike Preston]

I don't have time now for in depth analysis of the regs, but I will be looking into this more for my 3/31/08 plan year client...

The only thing I will say is that if you are right, I'm going to find any plan I can that has an age 50 owner and ADP troubles and amend them to a fiscal year plan ASAP. Because through all of this legalese if you're telling me that the owner can still defer $20,000 every year, even though the ADP test is failed (assuming refunds are < CU Limit), then that is a safe harbor plan without the high contributions (ok, and w/o the TH exemption, but you get the idea).

I'm not. I'm saying that the "big" contribution at the end of the 2006 calendar year, gives rise to an amount treated as a catchup contribution for both a30 and 402g. a30 allows it to stay in at the end of 2006. 402g allows it to stay in, also, but it also precludes adding any more as a catchup at that point (assuming we are talking about a $5,000 a(30) catchup). Hence, if the adp limit is $10k at 3/31/07 and the $20,000 contributed in late 2006 is reduced to $15,000 for testing purposes against that adp limit, we find that there is a $5,000 overage that must be refunded because, at 3/31/2007, there are no more catchup contributions available. See Example 6.

[Mike Preston]

In your last post, first paragraph, I think you were referring to my post, not Austin's.

Could be. But post #31 was Autin's not yours. If he restated your example, then so be it.

I think there is a problem with your example. The 20,000 deferred 9/1/2006 results in a 2006 catch-up. (Of course, that assumes that he still had the full 5,000 of 2006 catch-ups available at 9/1/2006.)

No disagreement.

When you get to 3/31/2007, the refund is classified as 2007 catch-up.

Let me stop you there. I think the regs draw a distinction that is missing in your analysis. They talk about catchups for calendar year (401(a)(30)) and for the fiscal year (401(k)(8) I think)). The amount treated as a catchup for 401a30 purposes gives rise to a catchup for fiscal year purposes. So, at 3/31/2007, all of the catchups that were originally available have been used up.

In the example he didn't defer again until 9/1/2007, so he had not used up any of his 2007 catch-up limit by 3/31/2007. The 5,000 refund would be classified as a 2007 catch-up.

I think that Example 6 says that this is not true.

Of course, I could just be wrong on all of this if I'm misreading Example 6.

[austin3515]

My head is spinning at about 1,000 rpm's. Generally, I learn from these boards, but I know less today than I did yesterday. Does anyone have a link to clear explanation of how this works, like a Corbel/TagData/McCay Hochman article?

[Kevin C]

Mike,

The catch-up limit is determined on the basis of taxable years. The plan year comes into play when you are determining whether deferrals exceed a plan year based limit to determine the amount of catch-up.

Prior to the ADP refund on 3/31/07, why do you say his catch-up limit for 2007 is already used up? He is in his 2007 taxable year and has not deferred yet for 2007. Or, are you saying his 2007 catch-up limit is not available as of 3/31/07 to use towards the ADP refund?

Example 6 expands upon example 5. In both, the participant deferred 16,000 from 1/1/06 through the 10/31/06 PYE. Nothing in either example addresses someone who did not defer at all from 1/1/06 - 10/31/06.

In example 6, the person has the following catch-up amounts:

600 - paragraph (i) - from deferrals 11/1/05 - 12/31/05 in excess of 402(g)

1,000 - paragraph (ii) from deferrals 1/1/06 - 10/31/06 in excess of 402(g)

200 - Paragraph (iv) from ADP refund at 10/31/06

3,800 - paragraph (v) allowable catch-ups 11/1/06 - 12/31/06 in excess of 402(g)

That's a total of 5,600 in catch-ups for the plan year. That can't happen unless both unused 2005 and 2006 catch-up limits are available for the 10/1/05 - 10/31/06 plan year.

[Mike Preston]

Maybe I'm reading too much into the specific words used by the Service. How else do you take the words I quoted above? ("as they are deferred").

Combine that with the last paragraph of Example 6, where they say that "In addition, Participant E may make additional catch-up contributions of $3,800 (the $5,000 applicable dollar catch up limit for 2006, reduced by the $1,200 ... of elective deferrals previously treated as catch-up contributions DURING THE TAXABLE YEAR [emphasis added by me])."

If you add it all together, I think something in their description goes KER FLOOEY if you say that a participant can defer monies on, for example, the last day of the fiscal year if they have previously been rewarded with the catchup limit of contributions at any time during the TAXABLE YEAR, including that portion of the taxable year which began in the prior calendar year and, during which stub period, the participant made contributions which were treated as catch up contributions AS THEY WERE DEFERRED.

Long winded, huh?

[Kevin C]

Mike,

I never said someone could make catch-up contributions after they have already used up the catch-up limit for the taxable year. Austin is the one who said he thinks the regs examples are letting people exceed the catch-up limit.

I'm taking the "taxable year" used in 414(v) and in 402(g) as being the participant's taxable year. That taxable year is generally the calendar year. I've heard there are exceptions where someone can have a non-calendar taxable year, but I've never seen one. Regardless, both the catch-up limit and deferral limit are determined based on the same taxable year. I don’t understand what you are trying to say in your comment you describe as “long winded”.

I also take that section of example 6 literally, that deferrals in excess of the 402(g) limit become catch-up “as they are deferred”, to the extent that the catch-up limit for the taxable year has not previously been used. There is a different timing rule for when ADP refunds become catch-ups.

Example 6 also makes it clear that the $200 ADP refund at 10/31/2006 is counted against the 2006 catch-up limit. It’s part of the $1,200 that you quoted. They subtract the full $1,200 from his YTD 2006 deferrals of $16,000 at 10/31/2006 when they determine how much of his 2006 deferrals count towards 402(g) at 10/31. They are treating the $200 ADP refund as being part of his 2006 YTD deferrals.

The way I read the regs, if you are catch-up eligible and have a $5,000 ADP refund as of 10/31/2006 and you have not previously used up your 2006 catch-up limit, then your $5,000 refund is classified as 2006 catch-up. The leap I am making is that this happens even if you have not deferred at all for your 2006 taxable year by 10/31/2006. Look at the second example in my post #54.

[Mike Preston]

I never said someone could make catch-up contributions after they have already used up the catch-up limit for the taxable year.

This could be the crux of our diferrent interpretations.

I think the regulation uses the term taxable year to mean the plan year.

If you re-read (iv) in both examples, it is hard to come to any other conclusion. However, notwithstanding that, in parsing Example VI, they clearly state that the "the elective deferrals previously treated as catchup contributions under Plan R for the taxable year" is $1,000. If my interpretation were correct, then that amount should be $1,600.

I would like to see the example changed somewhat so that the deferrals between 11/1/05 and 12/31/05 were larger. Something like $4,999 in excess of the 2005 a(30) limitation and the deferrals made between 1/1/06 and 10/31/06 equal to $15,002. Nobody argues that the first dollar in excess of $15,000 is not catch-up. I was previously arguing that the second dollar is not catchup because the $4,999 is treated as catchup for the plan year. However, reading (iv) more closely reveals, as indicated above, that it should state that $1,600 is the relevant amount. It doesn't. It says $1,000 and that would lead to the conclusion that in my just cited example, the second dollar in excess of $15,000 is also catchup.

However, that gets us back to right where Austin has been all along: off-calendar plan years have a distinct advantage over calendar plan years.

Example 6 also makes it clear that the $200 ADP refund at 10/31/2006 is counted against the 2006 catch-up limit. It's part of the $1,200 that you quoted. They subtract the full $1,200 from his YTD 2006 deferrals of $16,000 at 10/31/2006 when they determine how much of his 2006 deferrals count towards 402(g) at 10/31. They are treating the $200 ADP refund as being part of his 2006 YTD deferrals.

I don't think I said anything differently.

The way I read the regs, if you are catch-up eligible and have a $5,000 ADP refund as of 10/31/2006 and you have not previously used up your 2006 catch-up limit, then your $5,000 refund is classified as 2006 catch-up. The leap I am making is that this happens even if you have not deferred at all for your 2006 taxable year by 10/31/2006. Look at the second example in my post #54.

So, do you agree with Austin that there is a significant advantage for non-calendar year plans?

[Kevin C]

I think the regulation uses the term taxable year to mean the plan year.

If you re-read (iv) in both examples, it is hard to come to any other conclusion.

I disagree. If you look at (iv) in examples 5 & 6, they both refer to the "applicable dollar catch-up limit ($5,000)". This is the catch-up limit that the 10/31/2006 ADP refund is applied towards. Sorry, but that contradicts your interpretation of "taxable year" being the plan year. The applicable dollar catch-up limit is determined by the start of the taxable year. If, as you claim, the examples used the 11/1/2005 through 10/31/2006 plan year as the "taxable year", then the applicable dollar catch-up limit would be $4,000, not $5,000. I think it is pretty clear that the "taxable year" being used is the 2006 calendar year.

Besides, if you look at 402(g), it also refers to "taxable year" limits. Example 5 has the person deferring $19,200 for the 11/1/2005 - 10/31/2006 plan year. They certainly are not using the plan year as his "taxable year" for 402(g).

I would not agree that fiscal years have a catch-up advantage. Actually, in some situations, they can be at a disadvantage. Suppose a 10/31 PYE. I defer $10,000 from 1/1/2006 - 10/31/2006 and have $5,000 reclassified as catch-up due to a failed ADP test at 10/31/2006. then I defer $10,000 from 11/1/2006 - 12/31/2006. The last $10,000 is all regular deferrals. If you look at the calendar year 2006 deferrals that are counted in an ADP test, it is $20,000. $10,000 counts in the 10/31/2006 test and $10,000 counts in the 10/31/2007 test. If this was a calendar year plan, only $15,000 would have counted in the ADP test.

There are other situations where fiscal years have an advantage.

[austin3515]

But in your third paragraph, the HCE deferred the full $20,000. How do you not see that this is a HUGE advantage over a calendar year plan--that is IMPOSSIBLE in a calendar year plan.

[Kevin C]

Austin,

I worked through some examples and decided in most cases, there is no advantage either way.

8/31/08 year end, two employees.

HCE, Comp $200,000

Deferrals for PYE 8/31/08: $20,500 deferred at 1/12 each month.

$5,000 2007 Catch-up at 8/31/2007 from failed ADP test, so his deferrals from 9/1/2007 – 12/31/2007 are regular deferrals.

Deferrals counted in ADP test = $20,500. Testing deferral rate = 10.25%

NHCE, Comp $20,000

Deferred $1,150 for PY

Deferral rate 5.75%

In the ADP test, the maximum HCE average percentage is 7.75%. The test fails and the refund amount is $5,000. He hasn’t used any of his 2008 catch-up, so his refund is classified as 2008 catch-up. Per examples 5&6 of the regs, he can still defer $20,500 for calendar year 2008, but his deferrals from 9/1/2008 - 12/31/2008 are all regular deferrals.

Now shift to a 2008 calendar year.

Two employees.

HCE, Comp $200,000

Deferrals $20,500 deferred at 1/12 each month.

$5,000 2008 catch-up when deferrals exceed $15,500 for 2008.

Deferrals counted in ADP test = $15,500. Testing deferral rate = 7.75%

NHCE, Comp $20,000

Deferred $1,150

Deferral rate 5.75%

Maximum average deferral rate for HCE’s is 7.75%, so ADP test passes.

Both HCE’s contribute the full $20,500 for the calendar year and both have $5,000 in catch-ups. How can you say either has an advantage?????

The only situation I see where they are not equal is where the fiscal year HCE doesn’t defer at least $5,000 from 1/1/2008 - 8/31/2008. In that case, the fiscal year HCE would be at a disadvantage because he won’t be able to defer $20,500 during calendar year 2008.