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Employment contract - just poor wording or a larger problem


Kansas401k
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I am in a very preliminary discussion with a new plan. Just discovered that they have an employment contract with one HCE employee that states that the HCE will receive X% compensation annually to be contributed to his 401k. The amount is going into his gross pay and then to the plan as employee deferrals. It is not going in as employer contributions. I'm not comfortable but haven't quite worked out how big of an issue, if any, this is. 

On the one hand, they are just giving the HCE funds that he can choose to put into or not put into the plan. But since they clearly labeled it as "pension funds" (they have a 401(k) not a pension) it concerns me as a possibly discriminatory issue. 

I would welcome any input. 

 

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I think employment contract language has no bearing on the qualified plan (e.g., when such contracts try to provide immediate entry into a plan that has eligibility requirements). 

The real question is whether or not this is an employee election which can be modified or if pursuant to the contract it is irrevocable. If it is the latter, then I do not think it is a salary deferral, which opens up other potential issues.

If the compensation is being properly subjected to FICA et al and then deferred to the plan pursuant to the employee's election and ongoing discretion, no issue. Has a separate salary deferral election been executed for this or are they relying on the contract for such?

 

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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Where is it labeled "pension funds"? In your first paragraph, you say that the employment agreement says that the amounts are to go into the 401(k). Did you misspeak? Also, 401(k) plans are a type of "pension plan" (using the ERISA definition), so it is technically not incorrect to refer to 401(k) funds as pension funds, even though that is not consistent with how most people use the term "pension". 

I agree that employment contract language has nothing to do with the plan. Your client needs to comply with the plan terms to the extent consistent with law, and they also need to separately comply with their employment contract obligations (at least to the extent that those terms are consistent with law). Is your concern that your client may have contradictory obligations, which are guaranteed to result in a breach of at least one duty? Generally, if you breach a contract, the remedy is that you have to pay the person the monetary value of what they should have received but did not due to your breach. So, worst case scenario, your client has to pay this employee cash rather than putting money into the plan. Perhaps they have to pay him a bit extra to account for the value of the tax advantages that he would have had if he had received the promised tax advantaged benefits rather than the cash. 

Setting aside the employment contract, it seems like the main question you are asking is whether the plan can comply with both the employment agreement and the plan terms simultaneously without running into tax qualification issues. 

401(k) plans are permitted to offer one-time irrevocable elections provided that they meet certain strict requirements. If the requirements are met, the amounts are treated as employer contributions rather than employee contributions, and they do not count against the 402(g) limit. However, they can still raise nondiscrimination issues, the same as any other employer contribution that is going to some employees and not others. 

However, in this case, it appears that the client wants to treat (or has been treating?) these amounts as elective deferrals, notwithstanding the fact that they are subject to an irrevocable election. If the client has not been trying to take advantage of the one-time-irrevocable election rule (and it isn't provided for in the plan document), then I think it is pretty unlikely that they have conformed to those difficult rules by accident. I'm not saying you shouldn't look into it, but my guess is that treating the amounts as elective deferrals is probably correct. 

For reference, here's the text of the one-time irrevocable election rule from Treas. Reg. section 1.401(k)-1: 

(v) Certain one-time elections not treated as cash or deferred elections. A cash or deferred election does not include a one-time irrevocable election made no later than the employee's first becoming eligible under the plan or any other plan or arrangement of the employer that is described in section 219(g)(5)(A) (whether or not such other plan or arrangement has terminated), to have contributions equal to a specified amount or percentage of the employee's compensation (including no amount of compensation) made by the employer on the employee's behalf to the plan and a specified amount or percentage of the employee's compensation (including no amount of compensation) divided among all other plans or arrangements of the employer (including plans or arrangements not yet established) for the duration of the employee's employment with the employer, or in the case of a defined benefit plan to receive accruals or other benefits (including no benefits) under such plans. Thus, for example, employer contributions made pursuant to a one-time irrevocable election described in this paragraph are not treated as having been made pursuant to a cash or deferred election and are not includible in an employee's gross income by reason of § 1.402(a)-1(d). In the case of an irrevocable election made on or before December 23, 1994 -

(A) The election does not fail to be treated as a one-time irrevocable election under this paragraph (a)(3)(v) merely because an employee was previously eligible under another plan of the employer (whether or not such other plan has terminated); and

(B) In the case of a plan in which partners may participate, the election does not fail to be treated as a one-time irrevocable election under this paragraph (a)(3)(v) merely because the election was made after commencement of employment or after the employee's first becoming eligible under any plan of the employer, provided that the election was made before the first day of the first plan year beginning after December 31, 1988, or, if later, March 31, 1989.

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Maybe there is more to this, but to me, if the participant does not have the option to receive the amount in cash, then it is not a 401(k) contribution.

What would happen if they told the employer tomorrow that they want to stop contributing and they want cash instead?

On 1/24/2023 at 6:07 PM, Kansas401k said:

But since they clearly labeled it as "pension funds" (they have a 401(k) not a pension)

While the IRC distinguishes between pension and nonpension retirement plans (with 401(k) plans being an example of the latter), colloquially the term "pension" is often used to refer to any retirement plan, including a 401(k) plan.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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I would just point out the poorly worded (unnecessary!) language and move on. Having said that, I suppose if the participant did try to change the election and not make the 401(k) contributions, and the employer tried to force it, then they have a problem. 

Ed Snyder

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I agree with Bird and add that a similar confrontation would occur if the employee asserts that a non-deferral employer contribution should be made. They seem to be on the same page, and that effectively establishes an interpretation of the contract even if we outsiders don’t have the same interpretation. If one or the other steps outside of the interpretation, that is a contract matter, not a plan matter. I am curious about the enforceability of a promise (implied or express) to make a particular deferral election (in this case the employer might not care unless the amount is meant to limit the deferral). My first thought is not, because then it would not be elective. Or if it is, then it is not elective and the plan has a problem with treating the deferrals as elective deferrals.

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All good cautions.  Here is mine:  Don't engage with this potential client; too many red flags.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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Pressures about a lawyer’s fee work in an opposite direction. Bad writing results when a lawyer presumes a client won’t pay for the time needed for good writing.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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I think the concern with engaging with the client is not getting involved in matters that are not within the scope of the services and expertise of the service provider, and knowing the boundaries and limits.  This is a problem that many service providers have. It is very tempting to try to be everything to a client for the sake of client loyalty and respect and the client is not likely to appreciate limits by themselves. The client will go to the perceived least cost provider for as much as possible.

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