annual compensation limit in profit sharing formula

[parks777]

It has been stated many times that employer matching formulas must cap the match at the annual compensation limit ($265,000 for 2016). However, I cannot find any guidance as to whether a formula for a discretionary employer profit sharing contribution can consider compensation in excess of that limit.

Our plan documents do not address this issue either way.

I apologize if this question has been asked and answered previously, but I could not find it in my search. Thanks for any help that you can provide!

[401king]

It's the same as the Match. Earnings in excess of $265k are, essentially, disregarded from the 401k.

[ESOP Guy]

Read your plan document again. Some where the definition of allocation compensation is limited to that limit. It has to be written that way by law.

[parks777]

Thanks for these responses. We are a small firm and have always done the allocation calculations internally in past years. This is the first year that I've been a part of those calculations. We did always use the appropriate maximum each year (i.e., the $53,000 for total contributions for 2015), but I think our allocation formula for profit sharing among employees used compensation above the $265,000 limit. If so, do we need to go back and correct this somehow?

[TPAJake]

Of course it needs to be corrected, but good luck getting the HCE's to agree with that!

[Mr Bagwell]

Is the profit sharing a 2 or 4 tier formula?

[parks777]

Is the profit sharing a 2 or 4 tier formula?

Not sure about this terminology, but the past formula that we have used is x% of total compensation + y% of (total comp minus SS wage base).

[Mr Bagwell]

Wouldn't the comp + excess comp be above the 265,000 limit in these cases where HCE's compensation is capped at 265,000?

[Tom Poje]

under EPCRS you could reduce the overage (as someone indicated getting HCEs to agree might be difficult)

the alternative under EPCRS (example 25 under Appendix B) this particular example was a money purchase formula so had to be amended under VCP to correct things this way. if it is profit sharing I imagine you simply follow the guidelines and allocate more the NHCEs without VCP

Correction:

Employer J corrects the failure under VCP using the contribution correction method by (1) amending the plan to increase the contribution percentage for all eligible employees (other than Employee W) for the 2003 plan year and (2) contributing an additional amount (adjusted for Earnings) for those employees for that plan year. To determine the increase in the plan's contribution percentage (and the additional amount contributed on behalf of each eligible employee), the improperly allocated amount ($2,400) is divided by the § 401(a)(17) limit for 2006 ($220,000). Accordingly, the plan is amended to increase the contribution percentage by 1.09 percentage points ($2,400/$220,000) from 8% to 9.09%. In addition, each eligible employee for the 2006 plan year (other than Employee W) receives an additional contribution of 1.09% multiplied by that employee's plan compensation for 2006. This additional contribution is adjusted for Earnings.

[parks777]

I have had discussions with the HCEs and all are agreeable to do whatever it takes to get things in compliance.  However, we are a small (10 person) firm and don't have anyone on staff who is a benefits specialist.  Any suggestions on getting help in processing the corrections under EPCRS to make sure that it gets done right?

[401king]

16 hours ago, parks777 said:

Any suggestions on getting help in processing the corrections under EPCRS to make sure that it gets done right?

Hire a benefits specialist (or a TPA for a lot less money). 

[Tom Poje]

if you are simply talking about last year's allocation, start by simply rerunning  the thing (allocating the same $ amount) and see what needs to be moved.

then of course an adjustment needs to be made for earnings.

under self correction there is nothing to 'file' with the IRS, you really want to have some type of documentation on what was done in case there was an audit.

did the people above the comp limit make that much more or are you talking about a small amount of comp above 265,000?

Note: If you are talking about a number of years that need corrected then as I recall you may have to use VCP, but again without knowing actual amount involved and time period it is hard to say.

still, good catch on your end to recognize this as an issue

[parks777]

I'm still getting past records together, but it might be a multi-year issue.  Another complicating factor is that we have had three TPAs over the life of the plan, so it might be tougher to get our current TPA's assistance to correct things going back in time.

[parks777]

Again, I am a total newbie to this, so hopefully this is not a stupid question.  Do we have an option under the EPCRS rules to reallocate the overage paid to the HCEs to other participants so that the total contribution for each year is the same, or are we instead required to simply force out the overages from the HCEs as non-qualified money?

Is there any way to avoid a taxable event to either the firm or the participants?

[Tom Poje]

 this one is real simplethis one has an example under EPCRS

Example 24:

Employer J maintains a money purchase pension plan. Under the plan, an eligible employee is entitled to an employer contribution of 8% of the employee's compensation up to the § 401(a)(17) limit ($220,000 for 2006). During the 2006 plan year, an eligible employee, Employee W, inadvertently was credited with a contribution based on compensation above the § 401(a)(17) limit. Employee W's compensation for 2006 was $250,000. Employee W received a contribution of $20,000 for 2006 (8% of $250,000), rather than the contribution of $17,600 (8% of $220,000) provided by the plan for that year, resulting in an improper allocation of $2,400.

Correction:

The § 401(a)(17) failure is corrected using the reduction of account balance method by reducing Employee W's account balance by $2,400 (adjusted for Earnings) and crediting that amount to an unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to reduce employer contributions in succeeding year(s).

 

so the excess $ are simply held is suspense  and used in a future year.

the example above was for a money purchase but could apply to a ps as well.

so really I guess you have 3 choices

1. simply reduce the contribution as indicated in this example and allocate in future years

2. take the total amount allocated as a whole and reallocate using correct comp across the board

3. possibly increase contribution to others - this works with a required formula as in a money purchase plan because you could amend the plan to a higher % as indicated in example 25. in your case probably not viable, unless you were talking about a 2016 ps contribution, because obviously it is not to late to change that.

 

I hardly see asking something like that a 'stupid' question.

remember, under EPCRS you are trying to put the plan in a position as if the error hadn't happened. so in #1 reducing the contribution works because if correct comp was used the person would have received less.

#2 works because now you are simply using the same total contribution but reallocating it based on correct comp.

[parks777]

Thanks for the guidance and help!