Otherwise excludable

A 401(k) plan is using 21, 1 YoS, and dual entry dates for all sources.  It is a calendar year plan.  They have a NHCE participant that is 42.  He was hired 4/23/16.  He had 1,000 hours in 2016 and 2017.  He entered the plan on 7/1/17.  He terminated employment on 7/14/17.  You are using the 410a4 statutory entry dates (earlier of 1/1 or 6 months after completing the statutory age (21) and service requirement ( 1YoS)) to define otherwise excludable employees.

Can you test him separately for 410b and ADP testing b/c he terminated and would not have entered the plan 6 months after satisfying the statutory service requirement?

well, if you trust the folks at the IRS. see option 1 underlined and boldfaced (emphasis mine) below. but remember, it is only the IRS interpretation. or maybe I am reading what it says incorrectly and you can't test him separately.

https://www.irs.gov/retirement-plans/treatment-of-otherwise-excludable-employees-for-coverage-and-adp-testing  Page Last Reviewed or Updated: 23-Jan-2018

Analysis

In January 2016, the Office of Chief Counsel issued an advice memorandum (CCA 201615013) regarding the treatment of “otherwise excludable employees” for coverage and actual deferral percentage (ADP) testing. The term “otherwise excludable employees” refers to a group of employees who are participants in a plan but could otherwise be excluded because the plan’s eligibility requirements are more liberal than the requirements set forth in the Code and the regulations thereunder. A plan will use special testing rules for otherwise excludable employees when it cannot otherwise satisfy the coverage requirements in IRC Section 410 and/or the ADP test in IRC Section 401(k) taking into account all of the participants in the plan.

The advice memorandum discusses an acceptable method of identifying the group of otherwise excludable employees, and identifies two additional methods that may also be acceptable. This Snapshot provides examples of plan testing methods described in the advice memorandum.

Background 

Section 410(a)(1)(A) provides that participation in a plan cannot be conditioned on the employee completing a period of service with the employer maintaining the plan that extends beyond the later of the employee’s attainment of age 21 or completion of one year of service. Section 410(a)(4) provides that a plan is treated as not meeting the requirements of IRC Section 410(a)(1) unless it provides that an employee who has satisfied the minimum age and service requirements of such paragraph commences participation in the plan no later than the earlier of the first day of the next plan year after satisfying such requirements or 6 months after satisfying such requirements.

Section 410(b) provides that a plan must satisfy certain minimum coverage requirements. For example, IRC Section 410(b)(1)(A) provides that a plan satisfies the minimum coverage requirements if it benefits at least 70% of the employer’s non-highly compensated employees (NHCEs). In determining if a plan meets the minimum coverage requirements, certain employees are disregarded. Section 410(b)(4)(A) provides that employees not meeting a plan’s minimum age and service requirements are disregarded. Section 410(b)(4)(C) provides that an employee is not treated as meeting the age and service requirements described in IRC Section 410(b)(4) “until the first date on which, under the plan, any employee with the same age and service would be eligible to commence participation in the plan.”

Section 410(b)(4)(B) provides that if a plan covers employees not meeting the minimum age or service requirements of IRC Section 410(a)(1) “without regard to subparagraph (B) thereof” and the plan satisfies the minimum coverage requirements of IRC Section 410(b)(1) separately with respect to such employees, then such employees may be excluded. That is, two coverage tests are performed: one looking at plan participants who have not reached age 21 and completed one year of service (“otherwise excludable employees”), and a second looking at all other plan participants (“non-excludable employees”). 

Section 401(k)(3)(F) allows an employer to exclude from the ADP test NHCEs “who have not met the minimum age and service requirements of section 410(a)(1)(A)” if the employer applies IRC Section 410(b)(4)(B) in determining whether the plan meets the coverage requirements of IRC Section 410(b)(1).

Treas. Reg. Section 1.410(b)-6(b)(3) provides that an employer may treat a plan benefitting otherwise excludable employees as two plans, one for the otherwise excludable employees and one for the other employees benefitting under the plan.

Treas. Reg. Section 1.410(b)-7(c)(3) similarly provides for disaggregation and separate testing of plan populations consisting of employees who have satisfied the plan’s age and service conditions but not the greatest minimum age and service conditions permitted under IRC Section 410(a), and employees who have satisfied the greatest minimum age and service conditions permitted under IRC Section 410(a).

Treas. Reg. Section 1.401(k)-2(a)(1)(iii) provides that if a 401(k) plan covers employees before they have completed the minimum age and service requirements of IRC Section 410(a)(1)(A) and the plan applies IRC Section 410(b)(4)(B) in determining if it meets the minimum coverage requirements of IRC Section 410(b)(1), then the plan can either perform one ADP test pursuant to IRC Section 401(k)(3)(F) or perform two ADP tests, one on each group of participants determined under IRC Section 410(b)(4)(B).

Treas. Reg. Section 1.401(k)-1(e)(7) requires a plan to provide which of the alternative methods of satisfying the nondiscrimination requirements of IRC Section 401(k) will be used and, if with respect to that alternative there are optional choices, which of the optional choices will apply. The regulation permits a plan to incorporate by reference the provisions of IRC Section 401(k)(3) and Treas. Reg. Section 1.401(k)-2, relating to the actual deferral percentage test, if that is the nondiscrimination test being applied. The Commissioner may, in guidance of general applicability, specify the options that will apply under the plan if the nondiscrimination test is incorporated by reference. 

CCA 201615013

CCA 201615013 describes an acceptable interpretation of “otherwise excludable employees” that complies with the Code and applicable regulations (see Option 1 below), and briefly describes two other interpretations that may also be acceptable (see Options 2 and 3 below). Please contact Division Counsel if you have questions about Options 2 and 3.

• Option 1: The group includes participating employees who have not satisfied the IRC Section 410(a)(4) entry date period applicable to them – in other words, they are treated as otherwise excludable employees until the earlier of the first day of the next plan year after attaining age 21 and completing one year of service or 6 months after satisfying such requirements. This is the maximum waiting period under the Code. 

• Option 2: The group includes participating employees only until the plan’s entry date after they attain age 21 and complete one year of service – in other words, they are treated as otherwise excludable until the date they would have entered the plan, using the plan’s entry dates, if the plan required age 21 and one year of service to participate. 

• Option 3: The group includes participating employees until the actual date on which they attain age 21 and complete one year of service – in other words, no waiting period is tacked onto the maximum age and service conditions.  

  When will a plan want to identify otherwise excludable employees?

  As noted above, a plan will use special testing rules for otherwise excludable employees when it cannot otherwise satisfy the coverage requirements in IRC Section 410 and/or the ADP test in IRC Section 401(k) by taking into account all of the participants in the plan. See IRC Sections 401(k)(3)(F) and 410(b)(4)(B), and Treas. Reg. Section 1.410(b)-7(c)(3). Plan language is required to perform this testing methodology. See Treas. Reg. Section 1.401(k)-1(e)(7). Also, although not the subject of this Snapshot, a plan can also perform the Actual Contribution Percentage (ACP) test using the special testing rules for otherwise excludable employees. See IRC Section 401(m)(5)(C) and Treas. Reg. Section 1.401(m)-1(b)(4)(iv).

  Examples of plan designs and testing methods

  Example 1: Employer A sponsors a 401(k) plan which requires attainment of age 20 and no service for eligibility, with entry dates on the first day of the plan year and a date 6 months after. The plan would fail the ADP test if it ran a single ADP test using all participating employees. Instead, the plan provides for Option 3 and tests those participating employees who have attained age 21 and completed one year of service separately from those who did not, but were otherwise eligible under the terms of the plan. In other words, Employer A runs two ADP tests, one for each group of employees. Each group must also satisfy the coverage test in IRC Section 410(b). The plan satisfies the ADP tests using Option 3’s criteria for identifying otherwise excludable employees. 

  Example 2: Same as example 1, except the plan provides for Option 1. The group of otherwise excludable employees now includes participating employees until the earlier of the first day of the next plan year after they attain age 21 and complete one year of service or 6 months after satisfying such requirements. Employer A runs two ADP tests, one for each group of employees. Each group satisfies the coverage test in IRC Section 410(b). The plan satisfies the ADP tests using Option 1’s criteria for identifying otherwise excludable employees.

   

So, you agree you can test him separately?  The fact that he terminated makes that possible.  Had he not terminated, then he would not be tested separately.

correct, because the plan could have had entry dates of 1/1 or 6 months after completing 1 year and thus he never would have entered

Tks.  The termination caught me off guard.  I always just thought 21, 1 YoS, and 1/1 or 7/1 entry.  So, he would count b/c he came in on 7/1.  I was asleep at the wheel...or texting that day.  lol