ADP Test & Catch-up Contributions

[Danny CPA]

I have a plan that is subject to the ADP Test, and it is going to fail the ADP Test this year. Here are the facts:

3 HCEs

HCE 1 – under 50, Compensation $184,933.34, deferrals of 10,113.72 (5.47%)

HCE 2 – over 50, Compensation $139,516.62, deferrals of $13,445.60 (9.64% with extra 5500, 5.70% without)

HCE 3 – over 50, Compensation $131,000.00, deferrals of $12,654.30 (9.66% with extra 5500, 5.46% without)

Plan is using Prior Year testing, and the maximum amount they can contribute for 2010 is 5.42%. The company tried to have them contribute the 5.42%, and then added an additional $5,500 for catch-up contributions for the 2 HCEs over age 50. Plan document has no deferral limit, and says that the participants can contribute up to the maximum amount it will not cause the Plan to violate the ADP Test.

My question is concerning when I take out the Catch-up contributions. Since the participants have not deferred $16,500, do I have to calculate their ADP based on total deferrals (which would be the $13,445.60 and $12,654.30), or, can I take out the 5,500 BEFORE I run the ADP Test since they reached the ADP limit first, exclude the Catch-up contributions and then run the ADP Test using deferrals of $7,945.60 and $7,154.30.

Here are the results of both ways:

1. If I keep the full deferral in the ADP Test, there are total excess contributions of $11,528.23, and the excess is allocated $1,885.25 to HCE1, $5,217.14 to HCE2, and $4,425.84 to HCE3. Because HCE2 and HCE3 are over 50, their contributions get re-classified as catch-up, so they have no refund, while HCE1 is stuck with a refund of $1,885.25 before allocable income.

2. If I take out the $5,500 before we run the test, there are total excess contributions of $528.23, and the entire amount goes to HCE 2 (before allocable income). Both HCE2 and HCE3 get to use the $5,500, and HCE1 is not stuck with a big refund.

Please let me know what you think. Thanks.

[PensionPro]

Your # 1 is the correct approach. The ADP test will be run with all of the deferrals. Unfortunately HCE1 will have a big refund.

[Tom Poje]

you are confusing an already mixed up individual.

under one breath you said the plan had no deferral limit, but under another breath you said the document says participants can contribute up to the amount that will not cause the plan to fail.

you further said last year's NHCE was 3.42 so this years HCE is 5.42.

so how do you handle that (and still be definitely determinable?)

suppose I have 1 HCE who doesn't defer then can the other 2 defer more than the 5.42? e.g. 8.13 because (8.13 * 2 )/3 HCE = 5.42??? but, as this years plan shows, you don't know what each HCE will defere until after the fact.

or do you take the stance the max deferral by any HCE is 5.42???

since deferrals are made up until the end of the year I don't see how you can hold a policy 'contribute up to the point that will not cause the plan to fail, and then count the rest as catch-up', because you don't know how much one can defer until after the fact.

unless one indeed establishes a policy the max one can defer is 2 points above last year's NHCE.

ugh, how do you follow the terms of the document of limiting the people so the plan doesn't fail? again, the only way I know would be to ignore what any other HCEs may do and limit an HCE to 2 plus last years NHCE.

all that being said I don't think option 2 is a choice, while that might be nice for HCE1 you are now penalizing HCE 2

Pension Pro indicated how I would handle things if you didn't have the clause "that the participants can contribute up to the maximum amount it will not cause the Plan to violate the ADP Test."

I'm not a document expert, so I'm not sure how you handle that when you have multiple HCEs deferring at different rates. Again, I lean toward a policy of 2 point plus last years NHCE across the board for all HCEs, but who knows?

[Danny CPA]

Thanks, I was afraid that was the answer. I had told them at the beginning of the year (in multiple e-mails) that the maximum they could put in was 5.42%, yet they still put in the 5,500 additional for the 2 over age 50.

I hate the fact that HCE1 is going to have to get such a large refund since he is the only one that actually followed my instructions (and because he is the CEO). He is getting penalized for the over-contributions of the other two HCEs.

Thanks for the input.

[PensionPro]

The plan language does not create a hard limit, it merely provides that excess contributions will be refunded. The employer has the option to create an annual plan limit for the HCEs if the document permits. As Tom points out, an automatic NHCE + 2 points will not work in all situations, for example where not all HCEs are deferring the limit will be higher than 2 points for deferring HCEs.

[Tom Poje]

based on your numbers even HCE1 went over the limit of 5.42!

you will of course have to live with whatever decision is made this year. after that I would definitely establish a policy defining what the max for the HCEs is (no matter what other HCEs defer)

If you had something in writing that said the max you could defer was 5.42 and they signed off on it I would say that is pretty enforcable. You really don't want to get in the position of being a 'ref under the hood' and deciding which way to go.

by the way, despite the fact that only HCE1 followed the rules so to speak, things like this happen. If you pretend real hard that we are living under the 'old rules' then you refund by who deferred the most by %, which is what you want in this case, but the IRS changed that to $ leveling so you probably can't get away with it.

Last year I had an HCE that deferred 20% the first few weeks, looking to hit the max deferral limit early in the year. Then he up and quit, with only about $4000 total deferral. His 20% caused the plan to fail big time, and he doesn't get a refund because its who deferred the most $ amounts. so the test is simply not fair at times.

[austin3515]

Our document (corbel 401k prototype) says "If during a plan year it is projected that the aggregate amount of Elective Deferra;s tp be allocated will fail the APD test, then the administrator may automaically reduce the deferral percentage until it is anticipated that the ADP test will pass."

My interpreation of that (I believe from the EOB), is that it is a plan imposed limit. Therefopre, anythiong over the plan imposed limit, which in your case was 5.42% is indeed a catch-up, and may be excluded outright from the ADP test. The key here is that the document must give the plan admin the ability to impose an administrative limit necessary to pass the APD test,.

If I must, I will dig out the reference in EOB

[Guest Sieve]

I don't necessarily disagree with you, austin. But, in your scenario, if one HCE does not defer, do you think the plan then can administratively raise the target for the other 2 HCEs at some point during the year, thus allowing them more deferrals and a higher starting point for the catch-up? If so, what happens if the HCE at 0% all of a sudden decides to defer? (I assume, by the way, that a plan-imposed administrative limit cannot be imposed after the fact (i.e., after someone over 50 already has surpassed the limit).)

[austin3515]

The key words in the document are "projected" and "anticipated." So if new information changes the projection, then what they anticipate as necessary I do believe is subject to change. I woulodn't change it every month, but my document does not appear to mandate the number of times they run the projection.

Bottom line is the document gives the flexibility and the outcome, as demonstrated by the facts here, is quite desirable. So why not adopt some reasonable method and consistently apply it? I have a big plan on prior year testing, and we do this calculation once a year, about 2 or 3 months into the plan year, and we adopt limits that we project will pass. If the test does NOT pass, no big deal, because it was a good PROJECTION. That does not negate the catch-up status of anyone's contributions, as they DID exceed a valid plan imposed limit - oine that was imposed operationally.

[ombskid]

In general, could a plan limit only participants over 50 to something like "greater of xx% or $XX?

[Kevin C]

In general, could a plan limit only participants over 50 to something like "greater of xx% or $XX?

No, you can not have a limit that only applies to catch-up eligible participants.

1.414(v)-1(e)Universal availability requirement

(1)General rule

(i)Effective opportunity.—

An applicable employer plan that offers catch-up contributions and that is otherwise subject to section 401(a)(4) (including a plan that is subject to section 401(a)(4) pursuant to section 403(b)(12)) will not satisfy the requirements of section 401(a)(4) unless all catch-up eligible participants who participate under any applicable employer plan maintained by the employer are provided with an effective opportunity to make the same dollar amount of catch-up contributions. A plan fails to provide an effective opportunity to make catch-up contributions if it has an applicable limit (e.g., an employer-provided limit) that applies to a catch-up eligible participant and does not permit the participant to make elective deferrals in excess of that limit. An applicable employer plan does not fail to satisfy the universal availability requirement of this paragraph (e) solely because an employer-provided limit does not apply to all employees or different limits apply to different groups of employees under paragraph (b)(2)(i) of this section. However, a plan may not provide lower employer-provided limits for catch-up eligible participants.

[austin3515]

Bt you could impose such a limit on owners

[ombskid]

Bt you could impose such a limit on owners

Why different for owners?

[austin3515]

Because you can impose a limit on deferrals that applies only to HCE's or a gorup of HCE's (such as a limit applicale only to the owners). For example, there's a lot of talk about limiting owners/key employees to $1 of deferrals so the Top Heavy Minimum will be essentially nothing, but the owner can still defer the 5,500 of catch-ups.

So for example, if there is an HCE deferring $16,500, and the HCE limit will be 5%, and the owner only makes $100,000, you might impose a limit of 5% of pay. That way, the HCE can defer 5,000 in the ADP test, PLUS the $5,000 of catch-ups. Without the plan imposed owner limit of 5% of pay, had the owner deferred $10,000, the refunds would have gone to the non-owner HCE first.

Not sure if that is what you are trying to accomplish, but if it is, then you're welcome