Cross tested plan uses High 3 average compensation

[Richard Anderson]

We are using high 3 average compensation to test in a cross tested plan.

Plan Specs: YOS for eligibility, dual entry, 1/1 and 7/1. Comp from entry for contribution calculation.

A participant hired on 5/1/07 had the following data:

2007 total annual compensation = $20,000.

2008 total annual compensation = $30,000.

2008 compensation from 7/1/08 entry date = $15,000.

What compensation is used for testing? In other words, what is the "high 3 average" for this participant?

[rcline46]

I bet your document says for periods under 3 years, use the months involved (definition of average compensation). Its fun reading the document.

[Richard Anderson]

Thanks,

But our document says little about 401(a)(4) testing, and nothing as to a definition of average comp.

[Mike Preston]

I suggest you read 1.401(a)(4)-3(e) in its entirety, along with the definition of "Section 414(s) compensation" in 1.401(a)(4)-12.

Assuming your plan does not provide for benefits on the basis of compensation earned before the year of plan entry (that is, you ignore the entire 2007 compensation when determining actual benefits under the plan) you have an option to exclude the 2007 compensation from the average as a drop out year because the period of time that the individual worked in 2007 was exactly 2/3 of a year (assumes that this individual worked no more in that last 2/3 of the year than 2/3 of the regular hours that someone working full time for the year would have worked).

If you take that option, then since you are using an average compensation, your average would be $30,000. If you don't take that option, the average would be $25,000.

The option that I'm talking about is the definition of "drop out years". See the reg cite above. Keep in mind that the definition of compensation used in testing must be consistent from one year to the next. The IRS does not like it when you use different definitions of, say, drop out years, from one year to the next. I've actually seen them attempt to force a plan into audit cap for doing so.

If you were NOT using average annual compensation (3 or more years), then you would have the option of using compensation while a participant, which in this case would be only $15,000.