cross testing the last deposit

[AlbanyConsultant]

I had a co-worker bring me this question, and the say she worded it made me reconsider what I thought I knew...

For plans that use cross testing, each deposit is supposed to pass testing. We generally get past that by telling the client to make level deposits during the year and then they do the profit sharing after the end of the year. In her example, a plan does just the 3% safe harbor all year long for all participants, and then after the end of the year, they put in 6% for the owners so it passes gateway, 401(a)(4) passes on an annual basis, and we're all happy.

Except... do we have to test that last deposit separately? Which would fail, of course, since it is just 6% of compensation for the owners as profit sharing and nothing for the NHCEs. That can't be right, can it?

[Bill Presson]

"each deposit is supposed to pass testing"

This phrase confuses me.

[WDIK]

While there may be a concern with a possible disparity in potential earnings between the NHCEs and HCEs if deposits are not made proportionally throughout the year, I am not aware of any requirement that a single deposit must satisfy benefits testing.

[Tom Poje]

1.401(k)-3(h)(2)

...A safe harbor MAY also be taken into account for purposes of determining whether the plan satisfies section 401(a)(4). Thus these contributions are not subject to the limitations of QNECs under 1.401(k)-2(a)(6)(ii), but are subject to the limitations generally applicable to nonelective contributions....except for purposes of satisfying permitted disparity)

ao, if it was purely a QNEC, then yes, you would have to satisfy a(4) with and without the QNEC.

But since this is a SHNEC then you may combine with all other nonelctives, as the regs point out

there is nothing in the regs that mentions everything has to be made at the same time. If the HCES were receiving the SHNEC early in the year (e.g. 3% of max comp) and everyone else at a later, then you have an issue, because the HCEs have a chance to earn gains over the whole year and others don't, clearly discriminatory, but you do not have that in the case you described

[AlbanyConsultant]

OK, so let's remove the safe harbor piece.

Clearly, it's discriminatory if the owner deposits $25K into his profit sharing account on January 1 and doesn't deposit the contribution for the rest of the participants until September 15th of the following year. If those deposits aren't meeting a safe harbor allocation, then maybe that's what we have to test, which is why we try to get our clients to not deposit during the year (good luck).

But it sounds like we're all saying that, barring something that is clearly discriminatory, it's just one test for the whole year. Is that correct?

[david rigby]

If the owner "deposits $25K", doesn't the plan define how that is to be allocated among all the participants?

[duckthing]

If the owner "deposits $25K", doesn't the plan define how that is to be allocated among all the participants?

It's not explicitly stated in the question but I think we're talking about a 401(k) plan here. He's talking about a contribution for the year of $X, with the owner's share being $25K. The owner contributes his piece on 1/1 and contributes the piece for everybody else (presumably NHCEs) as late as possible. The overall test passes but the timing is certainly discriminatory in favor of that owner.

I'm with everybody else here. I can think of a couple good reasons not to fund a nonelective contribution throughout the year but "you have to crosstest every deposit individually" isn't one of them I've heard before.