Bottom Up QNEC

[Guest Frank Jackson]

As a correction for and ADP or ACP Test does the Bottom Up QNEC method need to be specifically stated in the plan document? The document I am using for this plan only states QNEC not Bottom Up QNEC. If so, can I restroactively amend the plan to the year that test failure occured? Any regulations that you may have would also help.

[MWeddell]

I researched this topic for a client recently, so I think I've got your answers.

You can't amend retroactively the existing QNEC allocation after a participant has satisfied all of the allocation conditions (which typically occurs no later than the last day of the plan year). Treas. Reg. 1.411(d)-4 (Q&A-1(d)(8)).

I believe that you can add a new contribution type called Bottom Up QNEC (or whatever you want to name it) with a different allocation formula. This is similar to the situation approved in the March 13, 1998 IRS Field Directive.

However, the deadline for amending the plan to add in the new Bottom Up QNEC (because it is being used to correct a discrimination test) is 10-1/2 months after the end of the plan year. Treas. Reg. 1.401(a)(4)-11(g)(3)(iv). Looking at Treas. Reg. 1.401(a)(4)-11(g)(2) and 1.401(a)(4)-1(B)(2)(i)(B) makes me think that that same deadline applies to ADP testing too, not just 401(a)(4) testing.

[Guest Gary Wyatt]

I agree with MWeddell generally. However, if you go through a correction program with IRS, things may be different. When I faced the same situation in VCR about a year and a half ago, the National Office of IRS let me not only put in bottom-up retroactively for several years, they didn't care whether I went through the formality of actual plan amendment. Finally, they allowed the "dollar-in, dollar-out" combination of QNECs and disgorgement, as well. Bottom line...The client would have had $40,000 of contributions (with earnings makeup) to contribute under the straight QNEC under the plan, but they got off with $1,300.

[MWeddell]

To Gary Wyatt,

I don't understand this comment:

Finally, they allowed the "dollar-in, dollar-out" combination of QNECs and disgorgement, as well.

Sounds interesting, but would you please explain it a bit?

[Guest derek]

I think what Gary may be referring to is the correction method that IRS has been allowing through VCR....basically, if you have ADP/ACP excess, you can make a QNEC equal to the amount that should have been distributed to the HCEs (and still have to make distributions to the HCEs) even though the statutory correction period has expired. I've also seen this in VCR where the method IRS pushed for (the "dollar in dollar out" method)was actually less expensive than the other QNEC correction methods specified in the plan document and regulations.

[LCARUSI]

Derek,

At the risk of belaboring the point,I don't understand your posting.

If the sponsor contributes a QNEC equal to what should have been distributed to HCEs, what happens then? Who shares in this QNEC? Is it then immediately distributed from the Plan?

[Scuba 401]

I just located this thread and have the same question - does the plan need to be amended to add the bottom up qnec and if so how do you go about doing this when you are using a prototype. the correction procedure clearly authorizes the method but in order to use it do you need service approval?

[MWeddell]

Yes, the plan needs to state a definite allocation formula for any contributions. It's likely that this will convert your prototype to a custom-designed plan, but since (i) I don't work with prototype plans much and (ii) that depends on the plan document and adoption agreement which of course I haven't read, I can't answer that question with much certainty. An IRS determination letter isn't required but may be prudent.

[Archimage]

Some prototypes do have the bottom-up QNEC language in them. If your protoype does not contain this language then your plan cannot do it.

[Guest Kconsultant]

I still have a few Q's:

1. If 6 HCE's (total $ amount of refund is $1,000) are getting money back for failed '02 testing then the company has the option to do a QNEC to the non-HCE's?

2. Would the total amount to be allocated be the $1,000?

3. Do the HCE's still have to get refunds if they go this route, or can the money remain in the plan?

Finally, if a plan has no company match, what is the best way to prevent a failed test in the future?

Thanks!

[Archimage]

1. Yes.

2. If that is the amount necessary to pass testing, yes. The QNEC is usually a much larger figure.

3. If you use the QNEC method of correction then you do not have to issue refunds.

[ccassetty]

The so called "dollar in-dollar out" QNEC option is meant for plans that failed to make required corrections of failed ADP tests prior to the final deadline for doing so. This was a compromise option added by the IRS. Originally they had said the only option available was a QNEC.

Under this "dollar in-dollar out" option the required refunds must be made to the HCEs and an amount equal to the refunds must be made to the NHCEs as a QNEC.

There is no new option to make a QNEC to the NHCEs equal to the amount of the required refund and then not have to make the refund. Any QNEC made in place of a refund must be equal to an amount that will bring the ADP of the NHCEs up to the require level to pass the test.