Topping up NHCEs, or paring down HCEs; may the employer choose?

[Peter Gulia]

Our hypothetical employer just discovered that the 2009 allocation of its profit-sharing contribution (intended to follow cross-testing rules) was incorrect because it provided only 3% for each NHCE, and this was less than one-third of the allocation rate of the HCE with the highest allocation rate.

In a self-correction, must the employer reallocate the profit-sharing contribution it made, or may the employer pay another contribution and allocate it so that each NHCE gets one-third of the top HCE's allocation rate?

Does our range of acceptable corrections change if the employer discovers that six years' allocations are affected by the same error?

[Guest Sieve]

Remember:

The correction should be reasonable and appropriate for the failure. Depending on the nature of the failure, there may be more than one reasonable and appropriate correction for the failure. For Qualified Plans, any correction method permitted under Appendix A or Appendix B is deemed to be a reasonable and appropriate method of correcting the related Qualification Failure. (EPCRS, Section 6.02(1).)

And this:

The following principles apply where an appropriate correction method includes the use of corrective allocations or corrective distributions: . . . Corrective allocations should come only from employer nonelective contributions (including forfeitures if the plan permits their use to reduce employer contributions). (EPCRS, Section 6.02(4).)

So, either of your approaches is probably OK, but the IRS would prefer that the employer put in new money for the NHCEs.

[Peter Gulia]

Sieve, thanks for your help.

[Kevin C]

Having six years worth of corrections doesn't change the available correction methods. But, it does affect whether the failure is considered significant or insignificant. With a significant failure going back 6 years, I think you are under VCP, not SCP.

[K2retire]

Because the allocation was already completed, is there an anti-cutback issue if they prefer to reduce the HCE amounts?

[Tom Poje]

according to your comments the NHCEs only received 3% which was insufficient to satisfy the gateway minimum. this means you could not cross-test, but would test on an alloaction basis, which obviously would fail. This is a demographic failure which is only correctable under VCP (9 1/2 months after plan year end)

If the document contains gateway language, can you argue it is an operational failure - e.g. failure to follow the terms of the document to provide the gateway? I'm not so sure. There is no requirement to cross test - if you are going to then you had to provide the gateway, which wasn't done. Also, if you can simply 'self-correct' at anytime then the 9 1/2 month rule is entirely tossed out the window.

.........

as a side note, at the last ASPPA Conference, posed the following question:

plan has 2 classes of employees

HCEs and NHCEs.

plan provides 5% gateway to the NHCEs and maxes out the HCEs

plan fails testing.

is the only option to increase the NHCEs (or decerease the HCEs)

The IRS officials indicated you could out in a corrective amenment an increase just selected NHCEs as well.

[Peter Gulia]

Thanks everyone for your help.

Kevin C, thank you for my confirming my hope that, although more years' errors would mean a walk into IRS-chaperoned correction, it doesn't necessarily narrow the range of corrections.

K2retire, would a concern about not doing a cutback to an accrued benefit be removed if the plan defined each HCE's benefit as the largest amount that, after knowing that every NHCE's allocation is 3%, passes cross-testing?

Tom Poje, your observation might in some ways be the flip side of K2retire's observation. One can imagine that the plan document might specify each NHCE's share of the profit-sharing contribution as a percentage of his or her compensation, and then could specify an HCE's share as an amount that results from the math of the cross-testing rules. Or one can imagine the converse: that each HCE's allocation is specified, and the NHCEs' allocations are the solve-for.

Perhaps the simplest and most straightforward correction is to restore all allocations to what the plan document provided.

[DMcGovern]

according to your comments the NHCEs only received 3% which was insufficient to satisfy the gateway minimum. this means you could not cross-test, but would test on an alloaction basis, which obviously would fail. This is a demographic failure which is only correctable under VCP (9 1/2 months after plan year end)

If the document contains gateway language, can you argue it is an operational failure - e.g. failure to follow the terms of the document to provide the gateway? I'm not so sure. There is no requirement to cross test - if you are going to then you had to provide the gateway, which wasn't done. Also, if you can simply 'self-correct' at anytime then the 9 1/2 month rule is entirely tossed out the window.

.........

as a side note, at the last ASPPA Conference, posed the following question:

plan has 2 classes of employees

HCEs and NHCEs.

plan provides 5% gateway to the NHCEs and maxes out the HCEs

plan fails testing.

is the only option to increase the NHCEs (or decerease the HCEs)

The IRS officials indicated you could out in a corrective amenment an increase just selected NHCEs as well.

For just the last statement, wouldn't this be limited to up to 9 1/2 months after PYE? Not really effective in the above case, right?

[Tom Poje]

that's correct, any corrective amendment has to be made within 9 1/2 months.