Meaning of "Discretionary"

[MSN]

I have a feeling that this question has a really simple answer, but I haven't been able to find it yet so I hope someone out there has run into this before:

A sponsor has a 401(k) PSP that allows for discretionary nonelective contributions. The applicable period for determining compensation is each payroll period. Would the sponsor have the ability to change the allocation rate for their profit sharing allocation each payroll period?

I've always thought that the rate was discretionary on a plan year basis, not a payroll basis, but have been unable to substantiate this with the plan document or regulatory guidance. It seems to hinge on what "discretionary" really means, and it's not defined in the document. 401(a)(4) could obviously be a hurdle here, but is there any known guidance on whether this type of change is permitted in general? Any insight you might have on this would be appreciated.

The plan uses the PPD N/S Prototype document if you are curious.

Thanks!

[Jim Chad]

Does the Plan doc allow it to be on a per pay basis? Does the pLan have an IRS approval letter?

If no to either of these questions, I would operate it on an Plan year basis.

Also, any last day or hours requirement? That would require operation on an annual basis.

One other thought, Would you have to test for coverage or nondiscrim every pay period?

[Bird]

Are you sure that definition of compensation doesn't just apply to matching contributions? I can't imagine trying to allocate contributions based on each pay period, and then testing would have to be done on annual comp...I have to think that's flawed language or maybe a misinterpretation.

[MSN]

Jim,

Maybe and yes. There is an opinion letter and whether or not the plan allows it is the question I'm posing. Allocation conditions are not a concern on this particular plan. Let's suppose the sponsor uses his "discretion" to determine that the allocation rates for the first 6 months of the year will be 3% and then will be 10% for the last 6 months of the year. Only persons satisfying the allocation conditions would get the contribution, but allocation rates would vary. This may or may not be nondiscriminatory, but does the sponsor have the discretion to make the midyear change?

Bird,

The section in the AA specifically refers to nonelective contributions. There is another section with a similar election for the match. The specific wording in the AA is as follows:

"In determining the amount of the Employer Nonelective Contributions to be allocated to an Eligible Participant under this Part 4C, Included Compensation is determined seperately for each: (a) Plan Year (b) Plan Year quarter © calendar month (d) payroll period"

The Employer Nonelective Contribution is stated as "discretionary" without any meaningful commentary. I'm certainly capable of misinterpretation and open to what a correct interpretation might be here.

[Bird]

You're right to question it; I don't get it either. Maybe there is a simple answer that we're missing, but, while you could at least in theory have that in a document, I think you'd have to do annual testing and I can't see it in a N/S prototype. I think I'd call the document provider and ask what we're both missing.

[John Feldt ERPA CPC QPA]

"Would the sponsor have the ability to change the allocation rate for their profit sharing allocation each payroll period?"

I think a plan document could be written to provide for that. But keep reading. Let's look at nondiscrimination. If the rate of profit sharing changes just one time during the plan year, then you may easily end up with a nonuniform allocation when you consider the whole plan year. Remember, the discrim testing is for the entire plan year, not for each allocation period within the year. What about terminees or those who

Thus, someone must test the resulting allocation (be sure to charge extra for that). Hopefully, your document will also have some provisions to help you pass in some fashion that won't be too expensive to your client (like a big QNEC). Maybe the average benefits test will be good to you, or the client will be happy to pay you for each test until they finally pass (Ed Burrows would say to keep testing until you pass or the client runs out of money to pay for more testing).

We took over a plan near the end of last year where they told us they had a uniform allocation formula: pay to total pay (that's what their document said too). They did not allow participant investment direction and they did quarterly valuations.

When doing the 2006 valuation, we saw that they had made nonelective profit sharing contributions each quarter. The allocations were not even close to uniform for the year (which is what the document required). They then told us that they decided each quarter what amount to contribute and allocate for that quarter! Boy, we hadn't expected that!

The HCEs earned most of their pay during the first quarter of 2006, so they decided that the allocation for the first quarter would be 15% of pay, then the next quarter was less (5%) and so on, until nearly nothing was allocated in the last quarter. "Well that's how we've always done it!" Oh, so that must mean it's alright... Well, it sure makes for a fun story, if you're a plan geek.

[MSN]

Thank you all for the feedback.

I spoke with Corbel with regards to this question. The document does permit the allocation to be determined on a payroll basis. The individual I spoke with was as skeptic as I am as to whether this is the "right design" for a plan, but it is permitted in that specific document nevertheless. He did caution that this particular design could have a difficult time passing the general test, which many of you have also pointed out.