Salary Reduced Due To Top Heavy Payment

[Guest matt2002]

I am an employee (salaried) at a small (10 employees) engineering company. It is my understanding that the company’s 401(k) plan was found to be top heavy for the plan year ending 12/31/2001. As a result, the company is being required to deposit an additional $2,500 (employer contribution) into my 401(k) account this year (2002). However, in order to offset this additional expense, my employer has reduced my salary for the year by an equivalent amount. My employer has documented these steps in a memo to me. My question is, is this legal? I would think that skirting the top heavy rules so easily would not be allowed. Thank you.

[Mike Preston]

Whether the employer chooses to "blame" the salary decrease on the top-heavy contribution or not, the fact is that an employer is free to set your salary at any level they think is appropriate. Aren't you free to quit? If you don't like the salary level or the combination of salary and benefits, go eslewhere. At a salary of more than $80,000, you would think you would have a better grasp of the dynamics of the workplace.

Benefits have always been and always will be a part of total compensation.

Unless you have a compensation agreement with your employer which ties the employer's hands in this type of situation, and as long as your employment is characterised, I think, as "at will", then you are free to reject your employer's offer by finding another job. And if you do it early enough, you get the satisfaction of receiving the additional top-heavy contribution for last year, without having worked very long for your employer at a compensation and benefits level that the employer actually expected. How wonderful for you! [Oops, I just noticed that your employer is adjusting your 2002 compensation for a contribution that you will not earn unless you are employed on 12/31/2002, as top-heavy minimums aren't typically paid unless one is employed on the last day of the year. So, you don't even get the satisfaction of sticking your employer with the extra compensation. Sorry, no wonderful for you.]

Somebody else will probably respond in kinder and gentler terms.

[Kirk Maldonado]

I seem to recall that there was a court case involving an employer that reduced an employee's salary by the amount of the contribution on the employee's behalf to a Simplified Employee Pension. The court upheld the action of the employer.

[david rigby]

Are all employees being treated the same?

[Mike Preston]

pax, does it matter? Salary is individually determined. The basis for that determination needn't be applied to all employees in the same manner.

[david rigby]

I agree, it may not matter. Just curious about whether this owner is applying the same standards to all employees. Also curious whether the owner actually understands what plan he really has. One of the worst scenarios is a top-heavy 401(k) plan (unless there is another plan to absorb the minimum).

[Guest merlin]

Unfortunately for you matt, Mike Preston's comments are right on ,as usual.The top heavy rules say that your employer has to give you the contribution.They don't say he acn't make you py for it.But look at the positive side . Your employer has reduced your taxable income by $2500. What does this translate into as a tax break? Think of it as an involuntary deferral. But at the same time bear in mind that had it been a real deferral you would be fully vested in it.If your employer had not reduced your salary you would have had the $2500 in your paycheck. Are you fully vested in the employer's contribution? If not you may have to wait to

you exercise your option to quit.

[Guest merlin]

Unfortunately for you matt, Mike Preston's comments are right on ,as usual.The top heavy rules say that your employer has to give you the contribution.They don't say he acn't make you py for it.But look at the positive side . Your employer has reduced your taxable income by $2500. What does this translate into as a tax break? Think of it as an involuntary deferral. But at the same time bear in mind that had it been a real deferral you would be fully vested in it.If your employer had not reduced your salary you would have had the $2500 in your paycheck. Are you fully vested in the employer's contribution? If not you may have to wait to

you exercise your option to quit.

[Guest cgodfrey]

Can you start a 401k in mid year if you have an simple IRA

[BFree]

Watch out, if you don't do something about this, and the plan remains top-heavy, you will be working for half your current salary in 25 years.

You should clarify what is going to happen next year asap.

[MWeddell]

cgodfrey, considering posting your question in a new thread rather than a reply to this one.

There is a rule in the 401(k) regulations that says that an employer (with few exceptions including matching contributions) cannot make other aspects of an employee's compensation package contingent on whether or not the employee elects to make 401(k) contributions. However, that rule only applies to 401(k) elective deferrals. In general, an employer is free to consider the cost of benefits when deciding how much employees should be paid.

[Guest Kathleen Meagher]

Isn't there an ERISA 510 problem here? It appears the employer is "fining" or "discriminating" against the employee because he is exercising a right--i.e., receiving a contribution--to which he is entitled under the plan.

[Mike Preston]

Once you get into ERISA 510 you are dealing with purely legal theory and not IRC. So, while that subject is technically the purview of attorneys, in my opinion, it would be a total and complete travesty to interpret ERISA 510 in that manner. ERISA 510 has 3 major clauses. The first deals with a participant exercising a right. That isn't happening here. The second deals with a participant being precluded from exercising a right. That isn't happening here. The third has to do with testifying and that isn't happening here.

If taking into account the sum total of an employee's compensation and benefits is not allowed when setting prospective compensation levels then ERISA has, plainly and simply, been extended beyond what is rational.

[Kirk Maldonado]

The case that I mentioned in my earlier post held that there was no Section 510 violation. The case is Garatt v. Walker, 10th Cir. 1997 LEXIS 19291.

[Mike Preston]

I think it is garratt.

http://www.law.emory.edu/10circuit/july97/...6-1470.wpd.html

[actuarysmith]

I was following this thread and all of the sudden somebody threw in a question about starting a 401(k) mid year when they already had a simple.

Pardon my French, but what the HE-- !! does that have to do with this thread???????

[Guest Kathleen Meagher]

The Garratt case dealt with a discretionary contribution. The court said that the plaintiff did not have a "right" to a contribution under 510 because the employer had no obligation to make any contribution at all. That is not the case in the situation we are discussing. Here, the employer had a legal obligation to make a top-heavy contribution, and the employee was entitled to receive it. Why is this not a "right" under the plan, which undoubtedly contains top-heavy language? The Garratt court did not say legal entitlement to a contribution was not a "right."

I think there is a reasonable chance that a court would say that this is an ERISA violation, and I think it would not be good legal advice to tell the employer that a 510 claim is a "travesty." It may be just a legal theory, but one person's theory is another person's money judgment (plus attorney's fees).

[Mike Preston]

If the employer was reducing 2002 compensation in order to essentially pay the company back for an unanticipated 2001 top-heavy contribution I agree that it is a potential 510 violation. That isn't the case here. In this case, the employer has just been notified that the cost of employee benefits for the year will include a specific amount, probably 3% of compensation. The employer is prospectively modifying compensation so that the combined expense associated with the employ of this individual is consistent with what they believe this individual is worth to the organization.

If we take the point you make about legal entitlement and examine it under the facts of the case, it is possible, although unlikely, that the entire 3% top-heavy contribution for 2002 has already been established at the point in time that the reduction to compensation was implemented. It is also possible that the 3% top-heavy contribution has not yet become a legal entitlement because the top-heavy contribution is the lesser of 3% or the amount that a key-employee has been allocated as of that date. If this weren't a 401(k) plan, then the legal entitlement on the date in question would probably be zero. Given that this is a 401(k) plan, even if we find that a key employee has made a deferral during 2002 it still becomes difficult to establish what the legal entitlement is as of a given date, before the end of the year. Is it the greatest percentage deferral (plus match) to date for any key employee? Or should there be some recognition that top-heavy minimums are not determinable until the end of the year in question, and are based on full-year compensation? Throw in the possibility of a key employee terminating early in the year and maybe being rehired before the end of the year and I find it very difficult to establhish what a top-heavy minimum will be before the last day of the year. But maybe a key employee has deferred more than $6,000 on the date in question, thereby ensuring that the top-heavy minimum for 2002 is at least 3%. Around and round we go.

I still belive that if a court decided to extend 510 in this case that it would be a travesty. But it is fact dependent. My original comment was that the employer should be ok only if there wasn't some document tieing the employer's hands. For example, if the employee was offered a job at $83,333.33 per year plus benefits and now the employer is deciding to reduce compensation because benefits are higher than anticipated. Even then, the employer should, IMO, be able to present evidence relative to the permanency of the original document.

In the end, though, in this case, the employee was entitled to a certain amount of compensation and that compensation didn't carry with it any top-heavy contribution for 2001. Now that the employee is entitled to a top-heavy contribution in 2002, the aggregate that the employee is entitled to should be something subject to a new negotiation.

[Kirk Maldonado]

I disagree with Kathleen Meagher. Garratt did not involve a discretionary contribution. Because of its nature, the SEP was required to cover everybody, including the plaintiff in that case. In fact, the court expressly held that the amount of the contribution was no discretionary.

[Guest Kathleen Meagher]

Kirk--

Are we reading the same case? This is a quote from the 10th Circuit case I believe everybody is referring to--I went to the link Mike Preston provided.

Whether an employer contributes in a given year to its simplified employee pension plan is at its discretion. See 26 U.S.C. 408(k)(3); Lesser, supra, at 1-6. Thus, at the time Dr. Walker informed Ms. Garratt of her compensation options and she chose to resign, whether Dr. Walker would make any pension contributions that year was completely and utterly at his discretion. See 26 U.S.C. 408(k)(3); Lesser, supra, at 1-6. In such a case, where the "right to which [a] participant may become entitled" is thoroughly contingent on the employer's discretion and entirely within the employer's control, the "right" is too speculative for any alleged interference with its attainment to support a 510 action.

Was there an en banc decision that had a different view of this issue? (I confess I didn't check the cite.)

At any rate, I think we should agree to disagree about this issue. I would still advise a client that asked me whether or not to do this that there was some risk involved--especially in our wacky 9th circuit! I also wonder, if this happened in California, if there might be some problem under the state Labor Code. Anyway, for $2500, it probably isn't worth suing about.

[Mike Preston]

"especially in our wacky 9th circuit! "

Now there is something everyone can agree on!

After Michael v. Riverside Cement Co. Pension Plan how can anybody possibly disagree?

Kathleen, I don't disagree with you that there is the possibility that some court will find the facts in a similar situation to be an ERISA 510 violation. I would hope that they wouldn't, though.

[Kirk Maldonado]

Kathleen:

I was referring to the fact that, if the employer does make contributions on behalf of an employee, it must make it on behalf of all employees. Here is a quote to that effect from the opinion:

Notably, if in a tax year the employer makes a contribution to any participating employee's pension account, the employer must do so for all participating employees in amounts of the same percentage relative to each employee's compensation.

[EGB]

The Garratt case, on rehearing en banc in 1998, held that an employer with a SEP could not offer an employee a reduced salary, with a SEP benefit, or alternatively, no SEP benefit with a higher salary.

What about this similar situation - An employer makes profit sharing contributions each year. Then, in the following year, certain employees' compensation (mostly the highly compensated employees) is reduced by the amount of the profit sharing allocation that is made to the employees in the prior year. This seems to be a potential 510 problem.

At the same time, whether right or wrong, I know that there are a lot of companies out there that treat certain employer contributions to qualified plans as expenses to certain employees. For example, I believe this is common practice in many doctor group (PCs). The reduction/expense is not elective - it is a condition of employment. The doctor's compensaton is reduced by the profit sharing allocations made to him/her. Usually, this is all done in the same plan year. In my example above, the profit sharing allocation is made in one year and the reduction is not made until the next year (which may make a difference).

Any thoughts would be appreciated.

Kathleen:

I was referring to the fact that, if the employer does make contributions on behalf of an employee, it must make it on behalf of all employees. Here is a quote to that effect from the opinion:

Notably, if in a tax year the employer makes a contribution to any participating employee's pension account, the employer must do so for all participating employees in amounts of the same percentage relative to each employee's compensation.