401(k) SNHEC and Integrated PS Allocation

[buckaroo]

I have a client with a Safe Harbor 401(k) plan utilizing the 3% SHNEC to satisfy the SH requirements. It also has an integrated profit sharing allocation with a last day requirement. Based on the client's request, they will make the 3% SHNEC and they want to make an additional integrated allocation. The integration level is 81% of the TWB. The additional allocation will be 6% of total comp and 5.4% above the integration level. Additionally, there are a number of NHCEs who terminated during the year. They will receive the 3% SHNEC, but not the additional intergated profit sharing allocation.

Based on the above and my understanding, the rules dictate that if both allocations would essentially be design based safe harbor allocations and they had the same allocation requirements (1000 hours, last day, etc.), then no 401(a)4 testing would be required. However, in this case, the SHNEC cannot have any allocation conditions and the integrated profit sharing allocation has a last day requirement. In this case, I believe that I have two options that I can use for this plan:

(1) Component Plans - If I am able to split the plan into component plans (by passing 410(b) for each of the component plans), I could split the group of terminated NHCEs who only receive the 3% SHNEC into one component plan and all of the other participants who receive both the 3% SHNEC and the integrated allocation into the other group. Based on this method, my thought is that the allocations in each of the two component plan groups would essentially be design based safe harbor allocations and no 401(a)4 testing would be required.

(2) Cross Test the Plan - The terminated participants who only received only the 3% SHNEC could have their allocaiton percentages increased to the gateway minimum allocation (permited in the plan doc) and the plan could be cross tested for 401(a)4.

I would like to confirm that the above is correct and that I am able to utilize either of these methods. (If so, I will utilize the first option as it is the more cost effective.) Any comments are greatly appreciated.

[Kevin C]

What kind of document is it? If it's prototype or VS, what does the opinion letter say about 401(a)(4)?

For example, if it's a standardized prototype and the opinion letter says you can rely on the opinon letter with respect to the nondiscriminatory amounts requirement under Code section 401(a)(4), I think you have an option 3. Option 3 being rely on the opinion letter.

[Mike Preston]

Are any of the HCE's making more than $194,645?

[buckaroo]

The answer is yes. There are HCEs making more than 401(a)17 limit.

[Mike Preston]

Well, that means that you have some folks over 9%, so the 3% won't satisfy the gateway. It sounds like the gateway would be about 3.16%. Oops. Sorry, that doesn't count the 3% SH. OK, ignore this line of thought, as the gateway would be nearly 4% of pay.

Also, I don't think you can restructure around gateway, except for statutorily ineligible.

Another option is to limit the PS contribution so that no HCE gets more than 9%. That sounds like about 3.6% + 3.6% if the integration formula in your document ratchets down according to the normal 2 for 1 rule.

[KJohnson]

Mike, why don't you think option 1 works. Both allocations are design based safe harbors. If each passes coverage why would you need to cross-test? Are yous saying that any time you have a SHNEC and an additional profit sharing contribution with an allocation condition you are stuck with cross-testing? Does the fact that the profit sharing is integrated have anything to do with the analyis?

[buckaroo]

I am hoping that option #1 will work. If I can re-structure the plan into component plans and I cna pass 410(b) using the ratio test for both component plans, then based on the premise that the allocations in the component plans meets the design base safe harbor allocation (Component plan 1 is SH cont ptps only; Component plan 2 is SH and regular integrated NEC), then I do not have to perform the 401(a)4 testing. Therefore no cross testing and no gateway.

Agree?

[Mike Preston]

Of course if no crosstesting, no gateway. I read what you were trying to do as restructure into component plans in order to avoid 401(a)(4) testing. I don't think it works that way. I think you can restructure but then you have to do your 401(a)(4) testing on each restructured plan. In re-reading what you originally wrote, I think you are in agreement with me; or better I should say, me with you.

But there is a subtle nuance here that I'm not sure I'm communicating well.

What you end up with is two component plans that you test under a4, separately, other than the gateway issue, which is never separate, unless you have actual separate plans (and a few other things that shall remain nameless here, but if you want a list, go to -9©(3)(i) of the a4 regs).

As you have pointed out, if you choose to restructure like this, since the formulas are not available on the same terms to all employees, you end up not satisfying the rules needed to be classified as a safe-harbor. This means that you have to do a general test on that portion of the plan.

Note that in the general test, you are pointed to a4-7 for the rules on permitted disparity. Those rules are less flexible than the rules under 401(l). Basically, you have to use 5.7% and the full wagebase in your calculations; you can't use the 80% of the taxable wage base and 5.4% you have in your formula.

So, while you most likely will still pass, you do have to do the a4 general test on the combination of the 3% and the integrated allocation.

If you pass on a contributions basis, great. If you have to resort to cross-testing, then you have the gateway rules which come into play. And, if they come into play on this group, they apply to everybody in the plan, not just those in this restructured component.

Confusing, I know.

[Mike Preston]

KJ, in the second paragraph of buckaroo's original post, he details why the restructured plans are not considered a safe-harbor plan under the regs. Does that, combined with my slightly different explanation above answer your question?

Personally, I think the IRS would, if they were crafting the a4 regs today include a SH formula as an exception to the uniformity requirement and then the restructured plan WOULD be a safe harbor.

[Kevin C]

Personally, I think the IRS would, if they were crafting the a4 regs today include a SH formula as an exception to the uniformity requirement and then the restructured plan WOULD be a safe harbor.

Mike, haven't they sort have done that by allowing the SH non-elective and PS to have different requirements in a standardized prototype?

The Opinion letter for our VS 401(k) plan says "Employers that elect a safe harbor allocation formula and a safe harbor compensation definition can also rely on an advisory letter with respect to the nondiscriminatory amounts requirement under Code section 401(a)(4)." If a plan using this VS document uses an allocation formula and a compensation definition allowed under a standardized prototype, I would say they have elected a safe harbor allocation formula and a safe harbor compensation definition. After all, standardized prototypes are required to only allow safe harbor options. If you can rely on the opinion letter with respect to 401(a)(4), why would you need to general test?

Of course, that doesn't help if your document is individually designed.

[Guest Sieve]

What am I missing? Don't we have 2 allocation formulas which each are SH allocation formulas: (i) 3% 401(k) SH (i.e., comp-to-comp SH), & (ii) integrated PS (i.e., permitted disparity SH)? If each passes 410(b)--taking into consideration, for the PS allocation, the end-of-year requirement--then what's the problem?

[Kevin C]

Sieve,

The issue is 1.401(a)(4)-2(b)(4)(vi). Under that, (D)(1) requires that the formulas be available under the same terms to all employees.

[Mike Preston]

To both Kevin C and Larry, the response is the same: I wish it were so, but it is not.

The safe-harbor regulations under 401(a)(4) make it crystal clear (and they even have an example on point) that if you have two SH formulas, you end up not being eligible for SH treatment if the allocation conditions are not identical. Since the formulas in question provide for disparate allocation conditions, the mere fact that you elected two SH formulas doesn't insulate you from the need to test under 401(a)(4).

Kevin, I don't disagree with what your VS document says: if you elect a SINGLE safe harbor formula you have reliance.

It is the combination of the two employer sources that causes the problem. So, even though you start with a single source that, if the only source of employer funds, provides reliance and then you add a vanilla 3% SH contribution on top, you lose the ability, under the regs, to rely on SH treatment.

Get back to me if this still doesn't make sense to you.

I have seen all sorts of anomalies in approved documents over the years. So I certainly believe you that a standardized prototype shouldn't allow an allocation formula, in conjunction with a SH formula, if said allocation formula doesn't automatically pass the general test unless the allocation formula has the same conditions for an allocation.

If the IRS has made an exception for standardized plans in this instance, I would hope they would extend the exception to VS plans, too.

[Kevin C]

If the IRS has made an exception for standardized plans in this instance, I would hope they would extend the exception to VS plans, too.

Mike, my point is that they have done this. Standardized prototypes allow a PS formula requiring 500 hours or last day to be paired with a 3% safe harbor. I understand that the regs say doing so requires general testing. But, we are supposed to be able to rely on the plan's opinion letter that says we satisfy 401(a)(4). There is similar language in the NS prototype and, as I quoted above, the VS opinion letters. This isn't something new. Our GUST NS and Standardized prototype opinion letters had the same language.

[Mike Preston]

I know we are approaching the point where people start talking about angels and pins, but I'm just not quite on board with your conclusion. Let's stipulate that we aren't talking about Standardized plans, because if the plan in question uses a Standardized plan of course there is no general testing - ever.

Moving to a VS plan the language that you cited doesn't give me comfort when dealing with the combination of a 3% SH and a separate ER allocation formula. Sure, the note says that if you elect JUST the separate ER allocation formula mentioned, you have reliance. But it doesn't explicitly say that adding a 3% SH to what would otherwise be a formula you can rely on does not obliterate your reliance (as specified in the regulation).

I think we have drilled down to the crux of the matter and people will just have to make up their own mind, if they have a VS plan, whether they want to go one direction or the other.

[Kevin C]

Mike,

I agree the statement in the VS opinion letter isn't as detailed as it could be. I think the description in Rev. Proc. 2005-16 is a little more precise.

Rev. Proc. 2005-16, Section 19.02 (4) A VS plan may give an adopting employer the ability to select an allocation formula for the employer non-elective contribution which satisfies one of the designbased safe harbors in §1.401(a)(4)-2(b)(2) or a benefit formula which satisfies one of the design-based safe harbors under §1.401(a)(4)-3(b)(3), (4), or (5), and the ability to select a safe harbor compensation definition for such formula which satisfies §1.414(s)-1©. If the adopting employer selects (utilizes) such formula and compensation definition, then the adopting employer may rely on an advisory letter with respect to the nondiscriminatory amounts requirement under §401(a)(4).

I'm still having trouble with the concept that a PS/3% SH combination is 401(a)(4) safe harbor using a standardized prototype, but identical provisions in a NS prototype or VS are not 401(a)(4) safe harbor.

[Belgarath]

Kevin - maybe I'm misreading what you are saying, but it seems like Mike is talking about TWO separate ALLOCATION formulas, and you are talking about a safe harbor allocation formula combined with a safe harbor definition of compensation, but not TWO safe harbor ALLOCATION formulas? If you read the document language you cited, it seems to me that it is not discussing two separate allocation formulas?

[Kevin C]

I'm referring to a single PS allocation formula, that by itself would be 401(a)(4) safe harbor paired with a 3% non-elective 401(k) safe harbor contribution. For example:

PS contribution integrated at the TWB, 500 hours or last day worked required to receive the contribution.

3% Non-Elective Safe harbor contribution, all eligible to defer receive.

Compensation for both is 415© compensation.

These provisions are allowed in our standardized prototype document. Since standardized prototypes are required to only allow 401(a)(4) safe harbor allocations, either the IRS decided the combination is 401(a)(4) safe harbor, or they made a BIG mistake. Either way, the standardized prototype has an opinion letter that can be relied on with regard to 401(a)(4), because that's what the letter says.

Now, take these same provisions and put them in a NS prototype or VS document. With the statements I quoted from the opinion letter and Rev. Proc. 2005-16, I read it as saying the combination is still 401(a)(4) safe harbor. Mike's position is that this combination must be general tested.

So, I see two possibilities:

1. The 401(a)(4) rules on multiple formulas apply here AND the IRS made a huge mistake with the GUST and EGTRRA standardized prototypes, OR

2. The IRS decided this combination is still 401(a)(4) safe harbor.

[Mike Preston]

I see the same two possibilities, except I'm not sure I'd describe it as a huge mistake. The fact is, that in most circumstances, the allocations will satisfy the general test on a contributions basis.

[buckaroo]

Thank you for all of the replies. I have continued my reseach and I found the following example in the 2010 EOB. Please let me know if this changes any opinions:

Chapter 11 - 401(k) and 401(m) Testing, Section XIV, Part G, Nondiscrimination testing of employer nonelective contributions under safe harbor 401(k) plan or other plan maintained by employer

2.e.1) Preserving design-based safe harbor. Restructuring might be a means of preserving the IRC §401(a)(4) design-based safe harbor rules with respect to the employer’s nonelective contributions, and avoiding the rate group test.

2.e.1)a) Example. The additional nonelective contribution made to a safe harbor 401(k) plan is allocated under a permitted disparity formula, as illustrated in 2.c.2) above. Due to differing accrual requirements (i.e., there is a last day employment requirement on the additional nonelective contribution), some employees qualify only for the safe harbor nonelective contribution. To perform IRC §401(a)(4) testing, the employer divides the employees who benefit under the plan into two component plans. Component Plan #1 includes those employees who qualify for an allocation of both the safe harbor nonelective contribution and the additional nonelective contribution. Component Plan #2 includes those employees who qualify for an allocation of only the safe harbor nonelective contribution. Each component plan is able to satisfy coverage under IRC §410(b). On a restructured basis, the plan still satisfies the IRC §401(a)(4) design-based safe harbor with respect to the nonelective contributions. The employees in Component Plan #1 satisfy the §401(l) permitted disparity safe harbor. The employees in Component Plan #2 receive a uniform rate (3%) of allocations with respect to the nonelective contributions made on their behalf.

[Mike Preston]

I think you'll have to talk to Sal about why he thinks the already cited section, which deals with different allocation requirements, doesn't apply to the restructured plan in question.

[Guest Sieve]

Mike -- Restructuring is specifically utilized in order to allow a plan to pass 401(a)(4). For that purpose, each component plan is treated is an independent/separate plan for 401(a)(4) purposes. So, each component plan can meet a SH allocation requirement separately from consideration of the other componenet plan (since each component plan has only 1 allocation formula). (Treas. Reg. Section 1.401(a)(4)-9©(1).)

As to the quoted material, I don't have the EOB so I can't confirm whether the EOB also includes other material not specifically quoted . . . But hasn't Tripodi (in the quoted material) ignored the requirement that each component restructred plan must also pass IRC Secton 410(b)? (Treas. Reg. Section 401(a)(4)-9©(4).) That's necessary, here, because his Component Plan #1 excludes those not employed at year-end, and his Component Plan #2 includes only those not employed at year-end. So, if each component plan doesn't pass 410(b), then restructuring doesn't work for purposes of permitting the use of the 2 SH allocation provisions--and you'll have to pass 401(a)(4) without restructuring.

[Mike Preston]

Thank you for all of the replies. I have continued my reseach and I found the following example in the 2010 EOB. Please let me know if this changes any opinions:

.......Each component plan is able to satisfy coverage under IRC §410(b)......

[Mike Preston]

Mike -- Restructuring is specifically utilized in order to allow a plan to pass 401(a)(4). For that purpose, each component plan is treated is an independent/separate plan for 401(a)(4) purposes. So, each component plan can meet a SH allocation requirement separately from consideration of the other componenet plan (since each component plan has only 1 allocation formula). (Treas. Reg. Section 1.401(a)(4)-9©(1).)

My 1.401(a)(4)-9©(1) doesn't say anything of the sort. Where is the language you cited "since each component plan has only 1 allocation formula" found?

[Kevin C]

It seems like this might be a good question for an IRS DC Plan Q&A session.

[Guest Sieve]

Let me state it differently. Each component plan is treated as a separate plan, so that each componenet plan--if it passes 410(b)--can pass 401(a)(4) separately. Therefore, if a component plan passes 401(a)(4) by dint of having a SH allocation formula, then that componenet plan is treated as passing 401(a)(4). If each component plan passes 401(a)(4) following the restructuring, then the entire plan will be treated as passing 401(a)(4).

Treas. Reg. Section 401(a)(4)-9©(1): "A plan may be treated . . . as consisting of two or more component plans for purposes of determining whether the plan satisfies section 401(a)(4). If each of the component plans of a plan satisfies all of the requirements of sections 401(a)(4) and 410(b) as if it were a separate plan, the the plan is treated as satisfying section 401(a)(4)."

In the Tripodi example--and the OP--each component plan has only 1 allocation formula which meets a SH allocation formula: component plan #1 has an integrated formula for those there at year-end, ancd componenet plan #2 has a comp-to-comp allocation formula for those not there at year-end. So, if each component plan passes 410(b), then the entire plan passes 401(a)(4) as a result of the restructuring.

[buckaroo]

Based on my analysis, all of the employees in the component plan that only received the SHNEC are NHCEs. Therefore, this will automatically pass 410(b). The other component plan will easily pass 410(b) via the ratio test. Therefore, both pass 410(b). As this is the case and both of them have safe harbor allocations under 401(a)4, then testing stops and no additional 401(a)4 testing is required. Therefore, no cross testing and no gateway. FYI the allocations for the component plans are

(a) 3% SHNEC

(b) 3% SHNEC + an additional integrated allocation on 81% of wage base (6% of total comp + 5.4% above) - Not integrating on the 3% SHNEC

Agree? Thoughts?