Do Individual Allocation Groups always need to be Cross-Tested?

[12AX7]

This is the language in Plan Document regarding the allocation of nonelective contributions:

Nonelective Contributions.A discretionary amount to each Participant, which amount, if any, shall be a Nonelective Contribution. The Employer shall provide the Administrator with written notification of the amount of the contribution to be allocated to each Participant.

Gateway Contribution.In addition to any Nonelective Contribution described above, the Employer may make an additional Nonelective Contribution ("Gateway Contribution") in an amount necessary to satisfy the minimum allocation gateway requirement described in Section4.4(b)(8).

Is there a requirement that I must Cross-test and provide gateway allocations, if the plan otherwise meets 410(b) and 401(a)(4)?

For example, assume I have many HCEs in a plan and I only want to benefit a few with a nonelective contribution and the plan otherwise meets the ABPT on a benefits basis, can this be done without having to meet gateway or other requirements?

I know of another firm that is doing it this way and not providing a gateway minimum. A few HCEs are getting a 13.2% allocation, while others NHCEs are getting as low as 1%.

Thanks.

[rcline46]

If you read the Gateway section, the process you mention absolutely fails gateway. Unless there is something not being mentioned that the 'other' firm is doing, what you heard and repeated here does not satisfy gateway. However, if they are using smoothly increasing bands or are not using corss-testing tot satisfy 401a4, then gateway does not apply.

Testing is a huge and varied field full of land mines for the un-wary and opportunities for the savvy.

[12AX7]

The allocation doesn't appear to use smoothly increasing bands to meet the test, but your last question gets back to my main point. It seems the other firm is not using cross-testing to pass (a)(4). If anything, they are using the ABPT, but I want to make sure that this doesn't fly in the face of the Plan Document.

[Guest GeerTom]

You are meeting ABP on a benefits basis? Would the plan pass ABP on a contributions basis or not?

Tom Geer

[12AX7]

It seems to me that it's being met on a benefits basis, but would that would make a difference compared to the test being met on an allocation basis? If coverage is to be met on a benefits basis, I know there is no required gateway.

What I cannot get a lock on is that it still seems you have allocation group(s) that must meet (a)(4). I think I'm answering my own question that if you need to cross-test, then the entire plan must meet gateway. However, the other firm that did the allocation (a good law firm to my knowledge) insists that no gateway needs to be allocated and will not reveal how (a)(4) was met.

I'm thinking that perhaps the plan was restructured into component groups and the allocation within each component group otherwise meets 410(b) and (a)(4) without cross-testing. The question - can you avoid cross-testing based on the document language that I posted below? The other firm is saying "Yes". The allocations are not comp-to-comp or permitted disparity.

[Mike Preston]

I'm with Reed (and the others) on this one. It sounds like the other firm is just plain doing it wrong.

However, your description doesn't make any sense, either:

"It seems the other firm is not using cross-testing to pass (a)(4). If anything, they are using the ABPT, but I want to make sure that this doesn't fly in the face of the Plan Document."

First, there is nothing in the document that ties your hands one way or the other.

Second, if they are not using cross-testing then no gateway is required.

Third, one cannot "use the ABPT" to satisfy a4. If you pass the ABPT you get a lower threshold when testing your rate groups. That's all. No matter what the ABPT says you still need to pass a4 by testing your rate groups.

Fourth, I have serious problems with people being completely eliminated from receiving a contribution along with use of the ABPT at all. It seems to me that the IRS has stated on many occasions that use of language like you have in your plan to eliminate one or more people who would otherwise qualify for a contribution is the same thing as eliminating them by name and hence would disallow use of the ABPT.

Are we having fun, yet?

[Mike Preston]

"If coverage is to be met on a benefits basis, I know there is no required gateway."

This sounds like nonsense to me.

"benefits basis" = "cross-testing"

Maybe I just got up on the wrong side of the bed.

Is there a DB plan hiding in the background that satisfies one of the other tests (benefits being primarily DB in nature, for example)?

[Mike Preston]

"I'm thinking that perhaps the plan was restructured into component groups and the allocation within each component group otherwise meets 410(b) and (a)(4) without cross-testing. The question - can you avoid cross-testing based on the document language that I posted below? The other firm is saying "Yes". The allocations are not comp-to-comp or permitted disparity."

Now, this is starting to make some sense. Yes, you can create as many component plans as you like and if each and every one of them passes a4 without use of cross-testing then there is no gateway required.

However, I've never seen a plan broken into component plans for testing that didn't end up using cross-testing on one of the components.

[Guest GeerTom]

This includes the ABP test being on a contributions basis. That is, if, as the question says, ABP is met on a benefits basis, then the entire test is on a benefits basis and the gateway rules apply.

I have seen plans with multiple allocations formulas/groups pass on a contributions basis. Usually, though, you're right, they do end up cross-testing to improve the spreads available between higher and lower allocations.

Tom Geer

[Mike Preston]

Sorry to be so disagreeable, but you are wrong.

Cross-testing the ABT does not subject you to gateway.

If I recall correctly, there is a Blue Book Q&A directly on point, as well as an ASPPA Q&A directly on point.

This is something that comes up every once in a while and needs to be quashed.

Maybe somebody else (like Tom - hint, hint) can post the Q&A's.

[12AX7]

Mike, there is absolutely no DB plan. But I'm a little confused on the difference between these two statements:

"If coverage is to be met on a benefits basis, I know there is no required gateway."

This sounds like nonsense to me.

"benefits basis" = "cross-testing"

Maybe I just got up on the wrong side of the bed.

and this one:

Sorry to be so disagreeable, but you are wrong.

Cross-testing the ABT does not subject you to gateway.

If I recall correctly, there is a Blue Book Q&A directly on point, as well as an ASPPA Q&A directly on point.

This is something that comes up every once in a while and needs to be quashed.

I think you you are nailing down as to what I cannot understand what was done by the other firm in this statement:

However, I've never seen a plan broken into component plans for testing that didn't end up using cross-testing on one of the components.

I cannot see how they are otherwise making this allocation with a good spread between HCEs and NHCEs and not cross-testing. That was my original question since the other firm was so adamant that what they are doing is correct by not providing the gateway. I thought I was missing something, but apparently not.

[Mike Preston]

You are right. I misunderstood what you meant when you said that coverage testing was being satisfied on a benefits basis. Technically, one doesn't satisfy coverage on a benefits basis. Technically, one runs the ABPT on a benefits basis and then uses the results to determine what the required coverage percentages are. If that is what you meant when you said that coverage testing was being satisfied on a benefits basis, then I withdraw my comment.

This stuff gets confusing because each part of a plan (401(k), 401(m), employer contributions) winds their way through the same language with slightly different twists. For the sake of simplicity lets keep it to employer contributions.

First, they have to satisfy 410(b) which is coverage. There are two heavily used options in the 410(b) regs. The first is benefiting NHCE's to the tune of 70% of the % of HCE's benefiting. This is the "ABOVE" test I'll reference later. In this context benefiting means getting 1 cent in employer contributions (some people are uncomfortable with 1 cent so they insist that in order to be counted you have to get $1 or $100). So if there are 100 people total of which 50 are HCE's and 50 are NHCE's then if 20 HCE's benefit you only need to see that 14 NHCE's benefit and you would pass coverage using this test.

Assuming you have less than 14 NHCE's, the second option to satisfy coverage is to satisfy the Average Benefits Test (ABT). This is a two part test that consists of the ABPT and the non-discriminatory classification test. The ABPT is (usually) an employer wide test (there are some exceptions) but it basically requires that the "benefits" of the NHCE's average 70% of the benefits of the HCE's. Note that in this test it is all contributions of the employer including 401(k)! In this context benefits can be measured as contributions or cross-tested (and if cross-testing you can test either annual or accrued to date). No matter what you use here you DO NOT TRIGGER GATEWAY.

If you pass the ABPT then you basically re-do the 70% from "ABOVE" with a lower threshold of the "safe-harbor percentage" (which is a high of 50% and a low in the low 20% range, see the regs for a chart). Again, all you are doing is counting bodies that "benefit" and comparing the percentage of NHCE's to the percentage of HCE's. In the example cited above the safe-harbor percentage is 50% so you would only need 10 NHCE's to benefit rather than the 14 shown above to satisfy coverage.

When performing the non-discriminatory classification test for coverage purposes you might have a resulting percentage which is not quite the safe-harbor percentage, but still exceeds the un-safe harbor percentage. If that is the case, you can still say you pass coverage if the facts and circumstances warrant. Best to avoid this, though, as it is usually easy to cover the safe-harbor percentage.

There are a few more options to satisfy coverage but they apply in limited circumstances so I'll ignore them.

Satisfying coverage is usually the least of your worries.

Then we have to do it all over again for non-discrimination testing under (a)(4). Here, we establish a testing method (contributions basis, cross testing on an annual basis, accrued to date) and we establish rate groups (which I assume you know how to do). The percentage of NHCE's that must be in each rate group is either: 1) 70% (just like "ABOVE"); or, if the ABPT is satisfied (usually the exact same ABPT we used when we determined whether the plan satisfied the coverage requirement of 410(b)), 2) the mid-point between the safe-harbor and un-safe-harbor percencentages.

When establishing the testing method under 401(a)(4) we are subject to the gateway requirements if the testing is cross-tested.

There are a gazillion options and safe-harbors not discussed above as the above is the barest of descriptions regarding coverage and non-discrimination testing.

[Tom Poje]

there are 2 basic tests every plan must satisfy

1. coverage - and one way of passing coverage is by the average benefits test. there is nothing under 410(b) requiring the gateway. the gateway is under 401(a)(4). thus one can pass the avg ben test without worrying about the gateway minimum. The IRS confirmed this in at least one Q and A session, but sorry, at the moment I am too lazy to look it up.

2. 1.401(a)(4)-9©(3)(ii) restructuring not available for certain testing purposes

......in addition the minimum alloaction gateway cannot be satisfied on the basis of component plans.

so if you are going to test at least one HCE on an accrual basis, then before you even get to that point, each NHCE who has received a nonelective must receive a gateway. then you are able to use whatever means at your disposal to pass nondiscrim.

[BG5150]

Is everyone considered to be in his/her own group?

If so, I believe you do not pass the classification test and therefore cannot rely on the ABPT.

Am I right in this?

[Mike Preston]

No. Go fish.

[BG5150]

No. Go fish.

Mike, I've been going with this over the years. From the EOB (Chap. 8, Sec. V.)

In a question posed in 2001 by the Joint Committee on

Employee Benefits of the American Bar Association (www.abanet.org), the IRS was asked whether it

would be acceptable to name each participant as a separate allocation group under a profit sharing plan

and have the employer declare a separate discretionary contribution to each participant (with a view

toward using cross-testing to prove the employer contribution is nondiscriminatory). The IRS noted that

if a 0% allocation were made to a participant, it might be interpreted as excluding a participant by name,

in which case the plan would have to satisfy the ratio test for this to be acceptable[/b.]

(emphasis mine)

[Mike Preston]

You went from merely having individual allocation groups (which doesn't preclude use of ABPT) to declaring that at least one individual would get ZERO. I'm not sure I agree with the IRS on their interpretation, but I am aware of it and let clients know that giving somebody zero might subject them to the 70% rule on coverage AND non-discrimination.