We are providing the following information for the benefit of subscribers to the Corbel, PPD and FDP volume submitter cross-tested plan documents. This information concerns options for amending an employer’s plan to provide under a top-heavy or 3% nonelective safe harbor 401(k) cross-tested plan, the “minimum gateway” allocations generally required under Treas. Reg. § 1.401(a)(4)-8(b), (the “cross-tested regulations”).

Allocation Conditions May Cause Nondiscrimination Failure
A practitioner, in designing certain types of cross-tested plans with allocation conditions for the cross-tested nonelective contributions, inadvertently may cause the plan to fail nondiscrimination.

A plan may use cross-testing to test for nondiscrimination only if the plan satisfies either the “broadly available allocation rates” or “minimum gateway allocation” requirements in the cross-tested regulations. Most cross-tested plans will rely upon satisfaction of the minimum gateway allocation requirement. Under the gateway requirement, all nonhighly compensated employees (“NHCEs”) who receive any type of nonelective contribution must receive a minimum gateway allocation. Generally, the minimum gateway allocation is 5% of compensation, or if less, one-third of the highest allocation rate for any highly compensated employee (“HCE”).

A top-heavy cross-tested plan or a 3% nonelective safe harbor 401(k) cross-tested plan that imposes allocation conditions for the cross-tested nonelective contribution, likely will not, in form, provide for the minimum gateway allocation to all NHCEs who must receive it. Certain NHCEs in these plans may receive either a top-heavy minimum contribution or a safe harbor contribution, but will not receive the cross-tested allocation made for the NHCE group, because they fail to satisfy the plan’s allocation conditions applicable to the cross-tested allocation.

Example 1
X maintains a calendar year, top-heavy cross-tested plan. Joe is a nonkey/NHCE who is employed on December 31, 2002, but Joe worked only 850 hours of service (“HOS”) in 2002. Plan X requires both 1,000 HOS and employment on the last day of the plan year for a participant to receive an allocation of the nonelective cross-tested contribution for the NHCE group. All X NHCEs who satisfied both allocation conditions in 2002 received a 5% allocation. HCEs under the plan who satisfied the allocation conditions in 2002 received a 20% allocation. Plan X would satisfy nondiscrimination testing in 2002 using cross-testing. However, Joe received only a 3% top-heavy minimum allocation since he worked less than 1,000 HOS. Since Joe is benefiting in the X nonelective contributions, X may not use cross-testing to pass nondiscrimination unless it provides an additional 2% contribution to Joe, satisfying the 5% minimum gateway allocation requirement.

Example 2
Assume the same facts as in Example 1, except Mary, a nonkey/NHCE, terminated employment with X on July 10, 2002. Mary is not entitled to a top-heavy minimum allocation or to the 5% NHCE cross-tested allocation. Since Mary does not benefit in any X nonelective contributions for 2002, she is not entitled to a minimum gateway allocation.

Example 3
Assume the same facts as in Example 1, except that Plan X is a 3% nonelective safe harbor 401(k) cross-tested plan. Both Joe and Mary must receive the 3% safe harbor nonelective contribution. As such, both must receive an additional 2% allocation for Plan X to satisfy the minimum gateway requirements.

Note: This is not an issue for safe harbor 401(k) plans using a basic or enhanced match to satisfy the ADP test safe harbor, since the plan administrator disaggregates matching contributions from nonelective contributions for nondiscrimination testing.

Corrective Amendment for 2002 and Beyond
The cross-tested regulations (and the gateway requirement) became effective in the 2002 plan year. An employer should amend its cross-tested plan for the 2002 plan year (and future years) if: (i) the plan utilizes the gateway rules; (ii) the plan is or may become top-heavy or is a 3% nonelective safe harbor 401(k) plan; and (iii) the plan’s allocation conditions in 2002 caused any NHCE receiving a top-heavy minimum or safe harbor nonelective contribution, to fail to receive a greater minimum gateway allocation (or may do so in future years). Under Treas. Reg. §1.401(a)(4)-11(g), an employer, within 9 ½ months after the close of the plan year, may amend its plan to correct a nondiscrimination failure. An employer acting within this timeframe (by October 15, 2003 for a calendar year plan) may amend its plan retroactively to provide for the 2002 plan year, the minimum gateway allocation. This amendment will permit the plan to use cross-testing for 2002 to satisfy nondiscrimination. The allocation of the additional gateway amount may not result in the reduction (cut-back) of any participant’s accrued benefit. The gateway allocation will result in an additional allocation to eligible NHCEs who receive a top-heavy minimum or safe harbor nonelective contribution, but who do not satisfy the plan’s allocation conditions applicable to the cross-tested allocation. The additional allocation would be just enough to “top-off the tank” of those NHCEs who otherwise under the plan terms, would not receive the required minimum gateway allocation. If the amendment applies to 2003 and succeeding plan years, the employer also will avoid having to make future retroactive corrective amendments under Treas. Reg. § 1.401(a)(4)-11(g).

Possible IRS Blanket Approval of "Topping-Off the Tank" Amendment
We have contacted the IRS Volume Submitter Coordinator regarding the possibility of receiving “blanket IRS approval” for employers to use the above “topping-off the tank” amendment approach. The IRS has commented favorably on the concept and we now are submitting proposed amendment language for approval. If we obtain approval, an employer’s use of this language will not jeopardize reliance on the plan’s advisory letter and the employer would not need to file the amendment with IRS for a determination letter to insure reliance. We will post updates on this website regarding progress in obtaining IRS approval, and ultimately, regarding the steps an employer should take to adopt the approved language. We hope to receive approval in less than 60 days.

Note: We expect that the IRS will permit use of the “topping-off the tank” amendment both as an “11(g)” amendment for 2002 and also for future years as an ongoing plan provision. If so, the employer only needs to adopt the amendment once. The employer would need to adopt the amendment within 9 ½ months after the end of the 2002 plan year, and would make the amendment effective commencing in the 2002 plan year.

Other Methods To Insure Compliance
An employer may make other types of amendments to provide the required minimum gateway allocations. For example, an employer with a 3% nonelective safe harbor 401(k) plan could increase its safe harbor contribution to 5%. An employer also might eliminate the allocation conditions applicable to the cross-tested contribution that trigger the problem (1,000 HOS in a top-heavy plan and both the 1,000 HOS and “last day of employment” conditions in a safe harbor 401(k) plan). Under any of these approaches, the employer will (or may) need to contribute more for the NHCEs than the “topping-off” amendment would require. This might occur, for example, where the employer eliminates the plan’s allocation conditions for the cross-tested allocation and the amount of that allocation exceeds the minimum gateway amount.

Another way that an employer might “top-off the tank” is to re-design the plan’s allocation groups (classifications). However, this method would require the practitioner to design and use different language, depending upon each employer’s existing allocation groups and upon whether the plan is top-heavy or is a safe harbor 401(k) plan. This could prove cumbersome and increases the chances for design error in implementing the corrective amendment.

Although it may be possible for an employer to avoid “reliance” issues, by using any of the above (or other) alternative amendment methods, as noted, these other methods are subject to possible drawbacks. On balance, we feel that an IRS-approved “top-off the tank” amendment is the best approach for an employer to amend its cross-tested plan, if necessary to comply with the gateway requirements.