'Prefunding' Profit Sharing Contributions

[0AMatt]

As a TPA, I have some clients that like to provide for Profit Sharing allocations, under Each in Own Class allocation formula, during the relevant plan year. After the year ends, we receive census data and prepare our cross-testing for allocations. 

The question is, if a client contributes in excess of a minimum benefit that we calculate, would it be permitted to forfeit that money from the participant account? How about offsetting for future year contributions?

My thoughts are that this may violate the Exclusive Benefit Rule with some overlap on Anti-cutback. Essentially, once money is deposited to an employee account, it becomes a plan asset. Plan assets are for the Exclusive Benefit of employees and beneficiaries. Reasons to return plan assets need to fall into Mistake of Fact, Disallowance of Deduction, or Failure to initially qualify with the IRS. 

To me, this boils down to, is this 'prefunding' considered a mistake of fact? I would argue that it is not because they did not violate terms of the plan and no clerical or mathematical mistake was made. The sponsor decided to fund based on preliminary numbers.

Interested to hear thoughts from others.

[CuseFan]

Your thoughts are correct and the employer should either stop making contributions until final numbers are provided or live with giving some employees more than they needed to pass testing, it's as simple as that.

[BG5150]

The plan administrator should follow the procedures in EPCRS to cure the excess allocation.  It's section 6.06 if I'm not mistaken.

[John Feldt ERPA CPC QPA]

By definition, it’s not an excess if it’s simply more than the minimum they were required to provide. What limit did it exceed?

[AlbanyConsultant]

I believe that you have to show that each deposit passes nondiscrimination testing... which could be a lot of extra (billable!) work.

Actually, now that I write that out loud, I'm not so sure of it.  Take the plan that deposits a flat 2% profit sharing each pay period to ensure that they'll meet gateway at the end of the year.  Then we run the year-end calc and testing and determine it allows an extra 3% to the partners... can they not make that deposit?  That seems incorrect.

Well, anyway, I use the first part of this logic to prevent a lot of during-the-year-deposits.

[John Feldt ERPA CPC QPA]

The timing of the contribution is subject to the Benefits, Rights, and Features requirements described under 1.401(a)(4). Easy to determine if it passes “current availability”. When audited, you’ll find out if it passes “effective availability”.

[Paul I]

Consider whether any of the following comments and observations are applicable to this situation:

• There are regulations addressing what is or is not a "mistake of fact", and this term very likely is not applicable here.
• Contributions are explicitly defined in plan documents and they are are funded or accrued, and there is no such thing as a "pre-funded contribution" unless it has been defined in the plan document. If there are allocation conditions that are not determinable at the time the deposits are made, then the plan would also need to address how amounts that do meet the allocation conditions could be removed from an account.
• If the amounts are not uniform (e.g., @AlbanyConsultant 's plan that puts in 2% of pay each pay period) then there should be evidence that the disparity in amounts is nondiscriminatory.
• If the profit sharing account is subject to vesting, then the plan should address if and when the pre-funded amounts could be included in the calculation of the participant's vested benefit (keeping in mind that vesting has its own set of rules for counting service).
• If the pre-funded amounts are as @0AMatt comments "in excess of a minimum benefit that we calculate", this does not necessarily make part of the pre-funded amounts excess allocations if more or all of the pre-funded amounts do not violate any regulatory limits or nondiscrimination tests.  If the plan does not set a non-discretionary limit on the allocations and there are no violations, then the removal of the amounts from a participant's would be discretionary and likely prohibited.  The should specify how to determine the amounts to be removed.

There are many aspects of this that can result in operational errors, which leads to the question of why does the client wish to do this?  A common motivation is the participant wants to capture the investment income on the contribution (optimistically expecting a positive return every year). 

The participant likely is a fan of the Fear and Green Index: https://www.cnn.com/markets/fear-and-greed