Why include 401(k) & match in cross testing?

[Guest SDS]

I am under the belief that when doing 410(B) and 401(a)(4) testing only the employer discretionary contributions are tested. I don't include 401(k) or match in testing contributions. I have been told before by Corbel that I am wrong but when given reg's to support their position, I don't agree. Isn' that what the ADP and ACP tests are for?

[mwyatt]

Really stupid question here concerning this post. In determining the ABP, you have your discretionary (cross-tested) contribution converted to accrual rates. Do you also convert the Deferral and Match to accrual rates or do you leave these as is (contribution rates). What do you view as the correct answer for ABP? In one sense adding the Deferrals and Matches into the equation should tend to make it EASIER to pass the ABP as the ADP and ACP tests tend to limit the wild disparities (on a contribution basis) that you see in the Cross-tested discretionary contribution.

[Guest]

there is a test that only looks at profit sharing numbers.

that is the 401(a)(4) test. It involves rate groups, etc. That is the test which has its 'equal' in the 401(k) and 401(m) test.

However, there is still the avg benefits % test. That is the one that tests all benefits/contributions. Remember, not only must a plan pass ADP test, it also must pass 410(B). that is what the avg ben % test is for - if a plan fails the ratio percentage test it can still pass the avg ben % test.

and since deferrals are counted as an EmployER contribution, they are included in the avg ben % test. (and since you can't integrate a deferral, you can't impute permitted disparity on the deferral or match portion of the test.

[Guest]

never a stupid question, only the ones that don't get asked. and unfortunately, I fall into that category too often!

anyway, yes, you convert all contributions to an accrual basis, and yes, it usually makes it a lot easier to pass the avg ben % test.

however, but remember - when you test your rate groups (the (a)(4) test your wild disparities return! that portion you don't get the advantage of deferrals.

the biggest problem with 401(k) is bumping up against the 15% limit.

putting in a money purchase to cover top heavy helps, but you have to be careful if you impute permitted disparity because you can only impute on one of the plans.

[AndyH]

Just to elaborate, you don't have to "cross test" by using equivalent benefits. You can also test on a contributions basis.

[mwyatt]

Just a followup to clarify the testing procedure:

First perform Ratio Percentage Test using CT contributions converted to accrual percentages only. Usually fails.

Second, perform Nondiscriminatory Classification Percentage Test again ONLY on CT contributions converted to accrual percentages. Adjust contributions until you pass this test. (Aside: passing this test is required before you proceed to Average Benefits Test).

Third, perform Average Benefits test using ALL sources determined on accrual basis. This means adding in deferrals and matches to equation. If fail, go back to square one.

Anything I missed here? (Again, I usually look at the Average Benefits Test before and after adding in deferrals and matches. Usually adding in deferrals, etc. makes results better - but for comfort I want to make sure that my CT allocation could pass on a "stand-alone" basis).

[Guest Thom Heaney Jr]

This question has been a thorn in my side for several weeks now. I have gotten many conflicting answers from various professionals on the inclusion of 401(k) and match in cross-testing. The final answer I have latched onto based on my interpretation of these conflicting answers combined with a thorough reading of the regs is different than what is being posted here.

Based on my reading, it seems to me that 401(k) and match are excluded from the general test when testing on a contributions basis. But by virtue of the method specified in the regs for calculating the Equivalent Accrual Rate, either on an annual or cumulative basis, it would seem to me that 401(k) and match are included in ALL aspects of the general test when testing on a benefits basis.

HELP! Again, the interpretation seems to conflict with what is being posted here. I have a borderline New Comp plan that is hot right now. Can anyone give me a solid cite or flow of logic as to why 401(k) and match would be exluded from the ratio % test, and the nondiscriminatory classification part of the Average Benefits Test, but not from the Average Benefits Percentage Test?

Follow-up Question: Does it make any difference if the plan is a Safe Harbor 401(k)?

[Guest]

1.410(B)-7(d)(5)(e)

Determination of plans in testing group for average benefit percentage test

"For purposes of applying the average benefit PERCENTAGE test of 1.410(B)(5) with respect to A plan, ALL PLANS of the testing must be taken into account.For this purpose, the plans in the testing group are the PLAN being tested AND all other plans of the employer that COULD be permissively aggregated.... (EMPHASIS MINE)

there are a few examples given.

(Special rules apply if you have a DC and a DB plan)

There is Nothing that says 'it makes a difference if you test on a contribution basis or an accrual basis' - or as a co-worker summed it up

"so the average benefit percentage test is an 'annual addition test'" maybe thats a good, simple way of looking at it -and you don't want to forget to include forfeitures.

(so with safe harbor you include all contributions).

The average benefits percentage test is jsut one test that you may have to perform.

There is the ADP test (Deferrals and maybe QNEC/QMACs), the ACP test(Matches, maybe QNECs/QMACs,after tax), and 401(a)(4) (Profit Sharing)

the 401(a)(4) is not usually performed if the plan is simply comp to comp or integrated at maximium 5.7%. Those are deemed to pass 401(a)(4).

sort of like the new safe harbor 401(k). because of the formula those are deemed to pass ADP and ACP tests.

if the 401(k) safe harbor has a non-elective contribution [NOT the match safe harbor] then that contribution may also be used in the 401(a)(4) under terms of the regs.

that is a brief explanation, hope that helps.

[Guest Thom Heaney Jr]

Tom, thanks for your quick response. I think what I was getting hung up on is the method for determining the "account balance" for purposes of calculating the "equivalent accrual rates" described in Treas. Reg. sec 1.401(a)(4)-8(B)(2)(ii)(A) where the account balance seems to include (in a roundabout way via several cross-references) all "annual additions" as described in 1.415-6(B)(2)(i).

Despite the fact that 401(k) and 401(m) plans are deemed to satisfy 1.401(a)(4)-1(B)(2), it seemed to me that the definition of "account balance" as all "annual additions" wrapped 401(k) and 401(m) back into all aspects of the 401(a)(4) testing.

I think what I was missing is the mandatory disaggregation of the 401(k) and (m) portions of the plan. Since these portions of the plan are treated a separate plans for both 401(a)(4) and 410(B), then the profit sharing portion by itself would have only the profit sharing (and 3% safe harbor if applicable) and forfeitures as "annual additions". I see how 1.410(B)-7(e)(1) then adds 401(k) and 401(m) back in for purposes of the ABP test.

I realize this just restates what you have essentially already said, but I wanted to make sure I have the logic right. Can you confirm. Thanks again, Tom.

[Guest beth klinger]

Inorder for a 401(k) plan to satisfy the ACP test, must I test the sum of employee contributions(vol.or mandatory designated or treated as after-tax employee contributions) and matching contributions or can a test each type of contribution separately?

[Guest]

matching and after tax are tested combined for the ACP test. If plan has 1000 hrs requirement (or last day provision for match)

normally ees in that category are are excludable, but if you have after tax then you have to include everybody in the ACP test since evryone 'could' have made an after tax contribution.

[Guest HarveyC]

When performing the general test on a benefits basis for a DB plan can one permissively aggregate 401(k) deferrals, employer match, and QNEC's? A lot has been said previously about the 410(B) provisions relating to this but what about 401(a)(4) (or did I miss something)? My belief is that these latter 3 items may not be aggregated with the DB plan for general testing purposes and only profit sharing or money purchase conts may be.

[Guest HarveyC]

1.401(a)(4)-9 indicates that plans permissively aggregated for 410(B) coverage testing must be so aggregated for 401(a)(4). Since 401(k) & 401(m) plans are mandatorily disaggregated for 410(B) they need not be aggregated for 401(a)(4). But CAN they be permissively aggregrated for the general test?

[AndyH]

No, then cannot be permissively aggregated.

And with regard to QNECS, you must test by both including and excluding them.

[Guest HarveyC]

Andy, I am in agreement with you that any 401(k) & 401(m) portion of any plan must be mandatorily disaggregated prior to both 410(B) and 401(a)(4) testing.

What was puzzling me was a recent favorable determination letter on a case that I was looking at in which a DB plan was aggregated with a profit sharing plan for the general test. The profit sharing plan has a 401(k) feature with employer matching contributions and a profit sharing component (QNEC). The combined account balances for each participant of this profit sharing plan were used to determine accrual rates to be added to the accrual rates for the DB plan. The response from the IRS was that the DB plan had been permissively aggregated with a profit sharing plan.

Did the IRS analyst simply miss the boat on this one and was just focusing on the fact the plan was called a profit sharing plan?

Thoughts?

[AndyH]

Yes, sounds like they missed the boat. But, it is true that the ps was permissively aggregated. It's just that the k component should have been backed out of the test.

A couple of years ago I saw the reverse situation in a takeover plan. The actuary who designed the plan submitted a test as part of an FDL application for a DC/DB combo including DB, PS&K. The k deferrals were incorrectly included in the NCT component of the a(4) test, and the IRS reviewer caught it and required that the test be corrected! The actuary agreed that he had made a mistake.

P.S. By QNEC, do you mean safe harbor nonelective? If so, that is in the test absolutely because it's actually a ps contribution with certain characteristics.

[Guest HarveyC]

The document under employer's profit sharing contribution reads that this amount is discretionary and the employer has discretion to declare any or all such contribution in a plan year to be "a qualified nonelective contribution as defined in Section 401(m)(4)...".

It appears to me (with my limited knowledge of the subject) that the profit sharing contribution, if made, could, if the employer elects, be a QNEC. It seems as if this provision is only there as a safety net to ensure passing of the ADP test.

Could you please explain to me the relation of this to the safe harbor nonelective and how if it is such that it is deemed a PS contribution (and then can be aggregated with a DB plan)?

Thanks in advance.

[AndyH]

Here's how I understand it.

A QNEC could be to all participants or only to selected participants. If it is to all participants, and allocated in the same manner as a ps contribution, there is no difference. It is uniform and must be tested only if there are other employer contributions that must be general tested.

If it is a separate contribution to select participants, it must pass 401(a)(4), and if it goes to any HCE, it must be general tested because it is not uniform and does not meet the "no HCE benefits" exemption.

A SHNEC is by definition uniform. It therefore passes a(4), but the regulations say that you may use it for 401(a)(4) testing purposes.

So, in your plan, Harvey, if a uniform percent of the ps contribution is treated as a QNEC, there is no difference between this and a ps contribution for testing purposes. Only if it is non-uniform does it differ. Does this make any sense?

[Guest HarveyC]

Thanks for your help, Andy. Making more sense now.

One more thing, just so I will be able to sleep. I do agree with you that 401(k) deferrals and 401(m) matches may not be permissively aggregated with a DB plan for coverage testing and the general test. However, I'm having a hard time finding anything in the regs to back this up regarding the general test.

1.410(B)-7 deals with permissive aggregation and mandatory disaggregation for coverage testing. 1.401(a)(4)-9(a) says that plans aggregated for coverage testing must also be tested under 401(a)(4).

What about plans aggregated for passing the general test? There appears to be no provision for mandatory disaggregation here nor can I find anything saying that plans aggregated for nondiscrimination must also be tested for coverage. In other words, mandatory disaggregation seems to be a one way inference.

Am I making any sense? Been thinking about this too long.

[Tom Poje]

I have only been vaguely following this thread, but lets see...

2 plans exist, one a DB and one a DC (401(k)) which to make things more complicated had a QNEC.

The general test is basically the 410(B) test except each HCE is treated as a separate plan.

There is an option whereby you do not aggregate the plans, but if that option was chosen you can not cross test either plan, and in this discussion, it appears that was not a choice.

plans were aggregated, and it sounds like at least one HCE failed the ratio % test, so the average benefits test is being used.

this consists of two parts.

1. average benefits % test - for this everything is aggregated.

2. rate group test - this should only include the db and profit sharing contribution. this test is an amounts test. the defrrals and match would not be included because their amounts test consist of the ADP and ACP test, and you don't have to test them a second time. The QNEC throws a wrinkle into things (especially if it went to HCEs as well) For purposes of satisfying rate groups, the test must be satisfied when the profit sharing contributions are tested alone AND ALSO when the QNECs are added with the profit sharing contribution. (See ERISA Outline Book 9.38 -2001 edition)

In this case, I would also include the DB 'cuz I have to aggregate the db and dc plan.