Is it possible to do anything when "pre-test" indicates ADP

[John A]

If preliminary testing makes it clear that the ADP test for 1999 will fail, is it possible to do anything currently to change the outcome?

For example, would it be acceptable to return deferrals in 1999 and adjust the 1999 W-2 earnings to reflect the return? Would it be acceptable to leave the deferrals in the plan, reduce future deposits of deferrals by a certain amount, and have the plan sponsor pay that amount as salary, changing the accounting for the deferrals appropriately? If either of these would be acceptable, how would earnings be treated?

Or is the only acceptable course of action to be sure that the affected HCEs do not defer any more, and wait to return the excess contributions until an actual ADP test can be completed?

[david rigby]

No expert on 401k admin, I offer a comment.

It is my observation that most decent payroll systems will accept a negative amount as a deduction, and that most recordkeeping systems will also recognize a negative deduction. If so, then you have the option of making the correction directly in the payroll system BEFORE the end of the year. This seems to me to be ideal.

It may not be exact, or perfect, but it holds open the possibility of simplifying the process.

Probably others can offer more details.

[This message has been edited by pax (edited 11-29-1999).]

[Guest GregSelf]

Can someone give me a site which specifically says (including the circumstances) that you can refund excess contributions during the plan year in which they occur? Everything I'm reading says these refunds MUST be made after the end of the plan year for which they are attributable. I'm currently auditing a plan that made this type of refund in '96, only to realize they refunded too much. Any feedback is appreciated.

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[david rigby]

If you are "refunding the excess during the plan year", then you are not "refunding" anything. You are correcting. There is no need for a "refund" until the plan year is over, so if you can correct it, you should do because you may avoid the (more cumbersome) refund process.

[Guest GregSelf]

pax: DO YOU HAVE EVIDENCE SUPPORTING YOUR OPINION?

My concern is that this scenario constitutes a distribution with no distributable event. Or are you saying this method involves some voluntary correction program (APRSC, etc.)?

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[Guest]

If it is a 'corrective distribution', it must take place after the plan year end.

see 1.401(k)-1(f)(4) which clearly states after the close of the plan year.

and you cant call it a corrective distribution before plan year end cuz no such thing exists at that point.

you can suggest to the HCEs to stop deferring, but that is about all you can do.

sorry, the regs are still the regs.

[IRC401]

You may not make a corrective distribution before the end of the year because you can't fail the test before the end of the year.

You may stop deferrals from HCEs IF the plan document so permits.

If the plan document permits changes in elections, you may go around and encourage HCEs into reducing their contributions on the grounds that they are going to get refunds anyway.

[John A]

What are the consequences and what corrective action does the plan sponsor need to take in the situation Greg describes in his 11-30-99 1:35 post (refunding a deferral in 1996 during the plan year of deferral in anticipation of failing the ADP test)? Would the answer be different if it occured in 1998?

[Earl]

Unclear on John's question. If the 1996 deferral was corrected in 1998 and after the 12 months following period?

Also, you could fail a test in the year if you are using prior year data.

[Guest GregSelf]

We have their attorneys chewing on this right now. I think we're going to end up trying a self correction (via APRSC). Regarding the potential prohibited trx issue: I haven't a clue at this point. I'll post another message when the issue is resolved.

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[John A]

Earl, I'll try to clarify. I meant, would the answer be different if the plan year was 1998 and the plan sponsor had returned deferrals during 1998 in anticipation of failing the ADP test, as opposed to the plan year being 1996 and returning deferrals during 1996 in anticipation of failing the ADP test.

Greg,

I'll look forward to your post on how the issue is resolved. Would you mind providing a couple of details on what actually occured (that is, did the plan sponsor actually take deferrals out of the plan, were earnings calculated and returned, etc.)?

Thanks.

[david rigby]

I believe that correcting during the year of deferral such as by the use of a negative deduction in the payroll, in order to not fail the ADP test, is not a distribution. Anyone have a different opinion?

[This message has been edited by pax (edited 12-01-1999).]

[MWeddell]

Pax,

I think you're in the minority this time. Refunds during the year (except for HCEs >= 59-1/2) violate the 401(k) distribution restrictions. Doing it with a negative contribution makes it harder to detect but doesn't solve the compliance problem.

[Guest John Grace]

I am fairly confident that you cannot refund HCE contributions on the basis of "a projected test failure". You may only distribute funds from participant accounts if a distributable event occurs, an actual test failure would constitute a distributable event, the possibility of failing does not constitute a distributable event. I believe all you can do is cut back the HCE's future deferrals for the remainder of the plan year.

[david rigby]

So you contend that the "negative deduction" is a distribution? Is that in all cases, or only when it is done in anticipation of passing the discrimination test?

For example, it is easy to imagine that the payroll dept. made a mistake and deducted $2000 from a paycheck instead of the correct $200. Would you have a problem if this clerical error were corrected by altering the subsequent deduction, say by using a negative $1600?

I probably need to do some reading on this point, but it seems to me to be a very impractical perspective to say that we cannot correct something in advance when we know it will need to be corrected later. I take the approach that there is no excess until the end of the plan year, so if I can fix the problem before it is a problem, then the plan (and the entire administration process) is better off.

Although I have just skimmed the regs, it looks to me like the correction described in 1.401(k)-1(f) is based entirely on the assumption that the year-end has passed, as does the definition in 1.401(k)-1(g)(7).

But I continue to read. Any other opinions or comments would be welcome.

[This message has been edited by pax (edited 12-03-1999).]

[Guest GregSelf]

Now you're talking about refunding "mistake of fact" contributions, rather than pre-correcting an ADP test. Read Rev. Proc. 99-31.

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[Guest John Grace]

Pax:

The problem with your logic on this issue is that you cannot correctly determine who should be receiving returns of excess contributions until the year end. Returns are calculated starting with those who deferred the most during the plan year, which cannot be determined until the plan year is complete.

Your scenario involving the payroll error is not analogous to this situation, that is an insignificant operational failure, where as return of excess contributions is the result of failing the ADP/ACP test.

[Guest John Grace]

Pax:

The problem with your logic on this issue is that a plan administrator cannot correctly determine who should be receiving returns of excess contributions until the year end. Returns are calculated starting with those who deferred the most during the plan year, which cannot be determined until the plan year is complete.

Your scenario involving the payroll error is not analogous to this situation, that is an insignificant operational failure, where as return of excess contributions is the result of failing the ADP/ACP test.