Coverage Failure, no correction action needed?

[John Feldt ERPA CPC QPA]

Controlled group: 2 employers with their own 401(k) plans. No Profit Sharing. 401(k) coverage for 2017 fails.

Plan 1 is safe harbor match, covers only 1 HCE and a lot of NHCEs.

Plan 2 is not safe harbor, has no match, no PS, but covers 5 HCE owners and 1 NHCE, prior-year tested.

The plans fail ratio percent test (result is under 10%). The plans cannot be aggregated for coverage testing. Seem that plan 2 needs to open up coverage to some of the plan 1 NHCEs by providing QNECs to until enough NHCEs are above the safe harbor percent and then run ABT. That QNEC is based on the 2017 ADP for the NHCEs in plan 2.

The problem is that the NHCE in plan 2 did not defer in 2017, so the NHCE ADP for 2017 for plan 2 is 0% and thus the QNEC is 0%. Therefore, is there a reasonable argument that no action is needed for plan 2 to pass coverage for 2017?

Note: the NHCE ADP in 2016 was also zero.

[Kevin C]

Well, an -11(g) amendment has to have substance [1.401(a)(4)-11(g)(4)]. If you can't correct by giving additional allocations to only non-vested terminated participants, I wouldn't feel comfortable trying to argue that giving a zero allocation has substance.  I think I would be inclined to use either the NHCE ADP from plan 1 or the NHCE ADP calculated by combining both plan 1 and plan 2.

You should also note that 1.401(a)(4)-11(g)(3)(vii) includes a specified QNEC for correcting a 410(b) failure in a 401(k) plan.  I had the IRS point this out in a VCP filing and tell me that you don't get to use the reduced QNEC allowed under EPCRS to correct an improper exclusion from a 401(k) when you are correcting a 410(b) failure.

[John Feldt ERPA CPC QPA]

Yes, I am aware that the 50% (or less) QNEC does not apply. The reference to 'substance' by the regulation is in the header of 1.401(a)(4)-11(g)(4). This seems similar to the header to -11(g) which is "corrective amendments" but nowhere in the body of the requirements does the IRS say that a failure must have occurred in order to apply -11(g). I know I may be stretching things there, but the requirement of 1.401(a)(4)-11(g)(4), other than the BRF section, is this:

• A corrective amendment is not taken into account in determining whether a plan satisfies section 401(a)(4) or 410(b) to the extent the amendment affects nonvested employees whose employment with the employer terminated on or before the close of the preceding year, and who therefore would not have received any economic benefit from the amendment if it had been made in the prior year.

The NHCEs in the Plan 1 are incented to defer due to the safe harbor match. The deferrals for the HCEs in Plan 2 will be refunded since the NHCE ADP was zero. In these circumstances, what actual substance is required by these rules, which are designed to prevent discrimination in favor of HCEs?

[PensionPro]

The QNEC is 0 according to the regs.

[Kevin C]

2 hours ago, PensionPro said:

The QNEC is 0 according to the regs.

The regs also say:

Quote

1.401(a)(4)-1(c)(2) Interpretation. The provisions of §1.401(a)(4)-1 through §1.401(a)(4)-13 must be interpreted in a reasonable manner consistent with the purpose of preventing discrimination in favor of HCEs.

What is considered to be a reasonable interpretation will vary by person.  As I mentioned, I don't feel comfortable with a position that a zero allocation for those added to a plan to correct a 410(b) failure is a reasonable correction.  It looks like you disagree.  If the plan loses in audit lottery, the IRS will decide whether or not it was a reasonable correction.

[PensionPro]

Minimum Coverage Requirements.  In the case of a section 401(k) plan, a corrective amendment may only be taken into account  for purposes of satisfying § 1.410(b)-3(a)(2)(i) under this paragraph (g) for a given plan year to the extent that the corrective amendment grants qualified nonelective contributions within the meaning of § 1.401(k)-6 (QNECs) to nonhighly compensated nonexcludable employees who were not eligible employees within the meaning of § 1.401(k)-6 for the given plan year, and the amount of the QNECs granted to each nonhighly compensated nonexcludable employee equals the product of the nonhighly compensated nonexcludable employee's plan year compensation and the actual deferral percentage (within the meaning of section 401(k)(3)(B)) for the given plan year for the group of NHCEs who are eligible employees. [§ 1.401(a)(4)-11(g)(3)(vii)(A).]

I believe the bolded portion of the citation provides the formula for calculating QNECs.  We had the approval of legal counsel in a similar situation and had no fears about defending our position under audit.  I am just narrating our experience and hope it is helpful and no pressure to agree with my position!

[John Feldt ERPA CPC QPA]

To place the plan into a form that satisfies coverage, the regulation is saying that the plan should adopt an amendment under -11(g) to state something like this:

• Resolved, for purposes of satisfying IRC 410(b) for the plan year ending December 31, 2017 for Plan 2, the NHCEs of Employer 1 shall become Eligible Employees for purposes of elective deferrals under Plan 2 solely for 2017 and a QNEC will be allocated to each such affected Participant equal to the product of A) such Participant's Compensation and B) the actual deferral percentage for the plan year for the group of NHCE Participants who are Eligible Employees with Employer 2.

And with that in place, the written plan requirement is satisfied for being able to use -11g for a coverage failure. This places us into the debate about the literal interpretation, see 1.401(a)(4)-1(a) "In making this determination intent is irrelevant. This section sets forth the exclusive rules ..." vs. the subjective interpretation under 1.401(a)(4)-1(c)(2) that you quoted above. Since this is a coverage issue rather than nondiscrimination, does that help us? In the Carol Gold memo, the issue was covering short-service low paid employees.

Let's argue that this hinges on the subjective interpretation of -1(c)(2). Let's analyze the statement: "The provisions of §1.401(a)(4)-1 through §1.401(a)(4)-13 must be interpreted in a reasonable manner consistent with the purpose of preventing discrimination in favor of HCEs".

As stated, all of the HCEs in plan 2 will get their deferrals refunded because the prior ADP is 0%. So, with or without a 0% QNEC, where is the discrimination? If a $1, $10, $100, or $1000 QNEC was provided, how does that change the "discriminatory" nature of the plan?

[Kevin C]

Now, you are making me read all of the reg.  Did you notice the fourth sentence of 1.401(a)(4)-11(g)(1)?

 

Quote

Paragraph (g)(4) of this section provides a rule prohibiting a corrective amendment from being taken into account to the extent that it does not have substance.

To me, a literal interpretation is that the correction must have substance.