Restructuring

[Belgarath]

Probably a mistake to even think about this on a Friday afternoon, but I'll give it a shot.

Takeover plan, general tested allocation formula with 3 groups. Group 1, owner. Group 2, Head Honcho - (non-owner). Group 3, everyone else. Group 3 includes the owner's early 20's daughter. There are 7 total HC. There are 50 NHC, who are all in group 3.

The daughter in group 3 is blowing the tests, 'cause this plan has very few young people. Group 3 is currently slated for an allocation of, let's just say, 4%. Proposed allocations are such that Gateway will be passed regardless.

So, I wanted to see how far off base I am, because I'm sure I'm missing something.

If you separated this into component plans, where the HC daughter is the only HC in component plan 1, and you put, say, 10 of the NHC with the lowest ebars into component plan one, and test it on an allocations basis, everyone in component plan 1 would be under a safe harbor allocation method with the same 4%. Coverage for the component plan would be NHC - 10/50 = 20%, and for HC, 1/7 = (rounding up) 15%, so component plan 1 passes 410(b).

Then for component plan 2, you use the rest of the HC's (who have fairly low ebars) and use the rest of the NHC, and test component plan 2 on a benefits basis. Assuming it passes, then you just have 410(b), which gives you 40/50 = 80% for the NHC, and 6/7 = (rounding up) 86% for the HC, so you pass 410(b) as well for component plan 2.

Have I got this all wrong? No need to be gentle - I left any ego back in the 90's with my lost youth...

Thanks in advance.

[shERPA]

My ego's probably in the same rubbish bin.

I think you have it right, each component plan has to pass 70%. What about the average benefits test and the midpoint for doing the (a)(4) test on component plan 2? Or can you get the EBARs to pass at 70% as well? That's what usually gives me fits when the owner's 20 something child enters the plan.

[Belgarath]

Thanks for the response - and sorry to be dense, but can you elaborate a bit about what you mean on the testing of component plan 2? This may be the piece that I'm worried about missing - when actually doing the test, you do not include those people in component plan 1, right? So your rate group tests would be based solely on the participants in component plan 2, and the daughter wouldn't be a consideration?

[shERPA]

There is 410(b) testing. You are good there per your ratio above - 80/86>70%.

There is (a)(4) testing where each HCE's EBAR is tested as a rate group. Each rate group's "coverage" must be at least the midpoint between the safe/unsafe harbor percents in the 410(b) regs - if the plan's ABP >=70%. Otherwise if the plan's ABP<70% then each HCE rate group must pass the 70% threshold.

For purposes of the plan's ABP, I don't think the component plans are separate, it is the entire plan ABP.

[Tom Poje]

component plan testing

1 avg ben pct test. (unless I suppose you are also testing otherwise excludables separately)

after that pretend you have 2 plans

1 plan consisting of one set of ees,

2nd plan consisting of everyone else.

when testing plan 1, everyone from plan 2 is includable and not benefiting.

when testing plan 2, everyone from plan 1 is includable and not benefiting

this is no different that if you actually had 2 plans that you were testing separately.

you can not use this to avoid the gateway, all must get the gateway.

[buckaroo]

I would also change the plan design for future years. Add a group ("Indirect Owners") so that the daughter of the owner is in a separate group. Her contribution can be "shorted" or zero adn then this will not be an issue in the future. If they are adament on giving her a cont, perhaps they can give it to her as compensation outside of the plan.

[shERPA]

To @buckaroo's point, I'd recommend amending the plan to make each employee a separate contribution group. Then it is easy to avoid these situations.

Re the testing, I agree with Tom. And just to try to restate what I was saying, if the ABPT fails, then the component plan HCE rate groups have to pass at 70% instead of the midpoint. Restructuring will usually take care of the child's rate group when tested on a contributions basis, but their EBAR can kill the ABPT.

I've frequently recommended to clients that they give the 20-something kids working in the business a $5K bonus for an IRA contribution instead of a plan contribution. Then we don't get rogue EBARs crashing the test, and we have HCEs who are receiving zero benefits to actually improve the results.

[austin3515]

Why give the daughter nothing whent a few extra minutes allows her to be treated just like everyone else? My experience is that owners hate it when they can't treat their kids just like their other employees...

[Belgarath]

Ok, thanks, so let me see if I'm getting this. Assuming I'm not using the average benefits test, I'm testing each component plan separately. So component plan one is tested on an allocations basis, and passes.

Component plan two is tested tossing out all employees, either HC or NHC, that are included in component plan one. After doing this, we are left with 6 HC, and 40 NHC in component plan 2. If each rate group, of the remaining 6 HC and 40 NHC in component plan 2, can pass the ratio percentage test (which I think it can, as remaining HC EBAR's are very low) then life is good - don't need to move on to the ABPT, which will fail. And as I said in the first post, Gateway as a whole will pass anyway given the allocations.

Or, is that not allowable?

[austin3515]

That's the way to do it!

[austin3515]

Component plan two is tested tossing out all employees, either HC or NHC, that are included in component plan one.

To be more clear, you treat them as not benefitting.

[Belgarath]

Thanks Austin. This just might work - particularly given that for the ratio percentage test, 401(k) elective deferrals and matching are not included, which in this case helps.

[Belgarath]

Hi Austin - I think I was posting this morning while you had already replied. So just to be SURE I understand what you are saying, when you say treating them as not benefiting, you are talking ONLY about 410(b), right? But for purposes of doing the rate group testing (and to be precise, the Ratio percentage test, NOT the ABPT) for component plan 2, I'm looking ONLY at those people in component plan 2. Not looking at any one in component plan 1. Agreed?

If I seem paranoid, it's only 'cause everyone is out to get me...

[Mike Preston]

People in component plan 1 are treated as not benefiting when testing component plan 2.

[Belgarath]

Yes, for 410(b). But once I get past 410(b), which passes with flying colors, then when I test component plan #2, and I'm passing nondiscrimination testing using rate groups, and passing the Ratio Percentage Test, (not the ABPT test) I'm considering only the HC and NHC in component plan #2, and not considering anyone in component plan #1. Right? that's what I was trying to get at, but I probably stated it poorly.

[austin3515]

We;re not talking about coverage when we talk about component plan testing. The plan still needs to pass coverage the old fashioned way. We're only talking about 401a4 nondiscrimination.

Each rate group in Component plan 2 must pass the ratio percentage test, and because as you mentioned you can't pass ABPT, each group needs to be at least at 70%. If there are 10 people in Component plan 1 who are NHCE's you are already starting 10 in the hole because they are all treated as not benefitting.

If any of the rate groups were under 70%, you would need to pass the average benefits test, which as you know would include the entire plan.

[Mike Preston]

Austin, care to edit your response? Your second paragraph doesn't seem right. It mentions not being able to pass ABPT and then the third paragraph contradicts that. Maybe a numeric example would clarify things.

[Belgarath]

Groan! I'm so confused now. I think this is what I misunderstood, and why I was concerned about getting better results than was warranted. So, going back to a numerical example - if the total employee population is 50 NHC, and 7 HC, and component plan 1 is going to cover 1 HC and 10 NHC:

When testing for (a)(4) in component plan 2 - when I do the Ratio Percentage Test, I use ALL 50 NHC employees, and ALL 7 HC, and NOT just the 40 NHC and 6 HC actually in component plan 2?

So, for garbage numbers to illustrate the point, suppose the EBARS of the HC's are: 1, 1, 1, 1, 3, 4, and 15. 15 (daughter) is in component plan 1. When I look at component plan 2 for (a)(4) testing, for the HC ratio, for rate group EBAR 3, I use 2/7, and NOT 2/6? And if I have 15 NHC in EBAR 3, (considering only those not in component plan 1) I use 15/50, and NOT 15/40?

Again, my thanks, and my apologies for my confusion.

[Mike Preston]

When testing for (a)(4) in component plan 2 - when I do the Ratio Percentage Test, I use ALL 50 NHC employees, and ALL 7 HC, and NOT just the 40 NHC and 7 HC actually in component plan 2?

Shouldn't it be?:

"and NOT just the 40 NHC and 6 HC actually in component plan 2?"

In any event, your conclusion is correct.

The example is made more clear, IMO, if you replace 15 with 9. Now the rate group's ratio percentage is: (9/50) / (2/7) = 63%. And while you can't use the ABT to allow use of a ratio percentage of less than 70% when testing component plans under 410(b), you *can* use it to allow a rate group's ratio to drop to the mid-point. So, in this case, if the ABPT is 70% or more, 9 NHCE's in this rate group "works".

[austin3515]

I think I said everything correctly.

because as you mentioned you can't pass ABPT, each group needs to be at least at 70%.

This was something he had said earlier.

If any of the rate groups were under 70%, you would need to pass the average benefits test, which as you know would include the entire plan.

This is a true statement. I think in his particular situation the point is moot because he mentioned he cannot pass it, but I was just trying to be thorough.

Let's keep it really really simple. Component Plan 1 has just 1 NHCE (C1 NHCE). Component plan 2 has 1 HCE (C2 HCE) and 1 NHCE (C2 NHCE). C2 HCE is getting a 5% EBAR and C2 NHCE is as well. The ratio percentage for the only rate group is 50% because only 1 of the 2 total NHCE's is getting at least as much as the only HCE. This is true even if C1 NHCE is getting a 7% EBAR because you have electively chosen to test based on component plans, which requires that you treat C1 NHCE as not benefitting.

I think the fact that no one would ever use component testing in my example is besides the point. I fancy it was a very illustrative example...

[Mike Preston]

You said:

"This is a true statement. I think in his particular situation the point is moot because he mentioned he cannot pass it, but I was just trying to be thorough."

Ahhhh, I see the confusion. I'll just pretend you said:

"This is a true statement. I think in his particular situation the point is moot because he mentioned he DOES NOT pass it, but I was just trying to be thorough."

I usually use "cannot" in the context of one never being able to satisfy the test, not in the context of this plan's actual demographics not satisfying the test.

[Belgarath]

By George, I think I've got it! Many thanks to you all!