washingtonpost.com How a 401(k) Loophole for the Rich Can Mean a Windfall for the Poor By Albert B. Crenshaw Sunday, July 20, 2003; Page F04
In the name of closing a loophole in the anti-discrimination rules covering 401(k) plans, the Bush administration last week issued what seems to be a nationwide invitation to businesses to take advantage of it. The loophole involves what is called "bottom-up leveling," a process by which businesses, especially small ones, can, by tossing a few dollars to a very-low-paid employee or two, allow their top executives to put more money into their own retirement accounts than the rules would otherwise allow. The laws governing 401(k) and other retirement plans are designed to keep companies from structuring their plans so that the well-paid executives can take full advantage of them while leaving the lower-paid workers behind. One key rule says that the share of pay that highly paid workers can set aside must be about the same as, or only slightly higher than, the share that has actually been set aside by the lower-paid workers. As is so often the case in regulation, however, the devil is in the details -- in this case the way workers' shares of income are calculated. And at least some companies have figured out a neat way around the barrier. It works this way: Under the law, employers are allowed to put money into a worker's account, whether the worker asks them to or not. Such contributions are called QNECs (pronounced "cue-necks") for "qualified non-elective contributions," and are normally benign, even desirable, ways for employers to boost workers' retirement savings. Under current rules, highly compensated workers' ability to contribute to their own accounts is restricted if the low-paid workers don't contribute enough, as measured by percentage of salary. If a company finds this rule is biting its top people, it can find a very-low-paid worker -- say, a guy who quit in January -- and give him a QNEC. If the worker made only $1,000 before leaving, a $250 QNEC will show up as 25 percent of pay for this worker. And since each worker's contribution rate is counted equally -- "one man, one vote," as one expert put it -- a few workers with what appear to be very high contribution rates can move a small company's average quite a bit. "It's called bottom-up leveling because you pick the guy with the smallest salary," give him a QNEC "and see whether that pushed the average up enough. If not, you pick the second-least-paid guy" and do the same thing until the numbers work, said former Treasury benefits tax counsel J. Mark Iwry. The process "enables the employer to achieve the numbers it wants at minimal cost," Iwry said. Big businesses are less able to move their averages with QNECs, simply because of the large number of people involved. They do, however, sometimes use them to avoid having to make small refunds to higher-paid workers because the company ran afoul of the anti-discrimination rules, said Robyn Credico, a senior consultant in the Washington office of benefits consultants Watson Wyatt Worldwide. Before the passage of the 2001 tax-cut bill, the value of bottom-up leveling was limited because in a 401(k) plan, worker contributions -- the worker's own plus any employer money -- could not be more than 25 percent of pay. Under the new law, though, the limit is 100 percent of pay, up to an overall dollar ceiling. Thus, if the company can find a worker who made $1,000 and give that worker a $1,000 QNEC, that worker shows up in the anti-discrimination calculations as having put 100 percent of pay into his or her account. The regulations proposed last week would treat a plan's QNECs as "impermissibly targeted" if less than half of all the company's lower-paid workers get them. It would also deem impermissible any QNEC that is more than double the QNECs that other lower-paid employees are receiving, measured as a percentage of pay. The regs would also change the formula by which a lower-paid worker's contributions are measured. It appears that the rules would accomplish their objective -- but not until they become final. In the meantime, small businesses that want to let their highly paid workers squirrel away more pretax retirement money have a handy guide to how to do so. Treasury benefits tax counsel William F. Sweetnam Jr. said the agency's only real alternative would have been a temporary regulation, but officials are uncertain about how much abuse there actually is, and in the meantime wished to proceed carefully. "We wanted to put out a proposal and get people's comments before we shut it down. We don't know what's going on out there, and we want to make sure [the proposal] is not unadministerable or would have unintended consequences," Sweetnam said. And he said the door will be closing soon. "This is not going to be a regulation that is going to sit out there in the proposed state for a long time," Sweetnam said. Until then, though, companies have a clear path around a major anti-discrimination rule.
