Paul I

If there is no explicit language or example in the plan document, then the Plan Administrator needs to step up and provide an interpretation. This can be one of those interpretations that says the entry date is 1/1 because the eligibility computation period was not completed until the stroke of midnight on December 31. Another Plan Administrator may decide that the ECP ended at close of business on December 31 and says to use the compensation earned on that one day. Or not. Whatever the interpretation, document and communicate it.

I agree. Roth elective deferrals in the 401(k) plan are subject to a limit of the lesser of compensation and the annual deferral limit, so the employee can defer up to $10,000 (paying payroll taxes is a whole other topic). The contributions to the plan come out of the employee's paycheck. Contributions to the Roth IRA are subject to the lesser of compensation and the annual IRA contribution limit which has a phase-out depending on adjusted gross income. The employee does not have a high enough income to be affected by the phase-out, so the employee's IRA limit is $6,500. The contributions to the IRA can come from any source and is not limited to coming from current compensation. The employee's compensation is merely a factor in calculating how much can be contributed for a given year. The IRS has an interesting example at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits. Example 1 says the IRA contribution for the individual can be made by the individual's grandmother.

Coverage testing may seem like a bright line pass/fail, but I wouldn't look elsewhere right away. There are many different strategies to get a plan to pass coverage. Keep in mind that a "plan" for coverage testing is performed separately for elective deferrals, matching contributions and non-elective employer contributions (without getting into average benefits testing). You may be able to structure some of the benefits in a way to pass coverage at an affordable cost and provide a meaningful benefit to your client.

Depending upon the individual's perspectives and priorities on taxes, generational wealth, Social Security and current income level: Elective deferrals are not included in the calculation of the deductible limit on contributions to the plan, so an individual with relatively low net income can get a disproportionately larger tax deduction. On the other side, mega Roth deferrals/Roth conversions/Roth NECs start laying the foundation for no RMDs. If the entire amount in the plan is Roth, then there is no taxable income on payments. When the individual begins taking Social Security benefits, the payments will not count as income that could trigger income taxes on those Social Security benefits. Payroll taxes apply to elective deferrals which, if the individual's net income is below the SSTWB, adds to the individual's Social Security retirement benefit (and possibly to a spousal benefit. These things can work against each other, so the individual needs to decide what is more important.

Consider granting everyone immediate eligibility who is actively employed on the effective date of the plan. Anyone hired after that date have work One Year of Service. Anyone rehired after the effective date is subject to the One Year Holdout rule where they have to work One Year of Service before any past service is recognized. The tricky part is an individual subject to the One Year Holdout needs to be given an employer contribution retroactively to the point they would have been otherwise eligible, but they are not able to make deferrals during the holdout period. Arguably for testing purposes, the individual was not eligible at any time in the that first year. The retroactive contribution is a contribution made, deducted and allocated in the following year. I've never seen this done and haven't researched it, but others here with plans with the holdout rule may have addressed whether the individual was included or excluded in the ADP testing.

Double check the safe harbor notice rules. You don't need a safe harbor notice if the plan uses the SHNEC as as ADP test safe harbor. If the plan uses the SHNEC for both as as ADP test safe harbor and as an ACP safe harbor, then you need to provide a safe harbor notice. See 1.401(m)(3)(a). This is an easily overlooked requirement. The match formula can be fixed or discretionary as long as the formula used to calculate the match does not exceed 4% of safe harbor compensation and based on deferrals not greater than 6% of safe harbor compensation. See 1.401(m)(3)(d)(3).

Check out the preamble to regulations regarding Retirement Plans; Cash or Deferred Arrangements Under Section 401(k) and Matching Contributions or Employee Contributions Under Section 401(m) Regulations published in the Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 page 78151 "The proposed regulations did not include any exception to the requirements for safe harbor matching contributions with respect to catch-up contributions. As part of the proposed regulations the IRS and Treasury solicited comments on the specific circumstances under which elective contributions by an NHCE to a safe harbor plan would be less than the amount required to be matched, e.g., less than 5% of safe harbor compensation, but would be treated by the plan as catch-up contributions, and on the extent to which a safe harbor plan should be required to match catch-up contributions under such circumstances. After reviewing the comments and the applicable statutory provisions (including the amendments to section 414(v)(3)(B) made by the Job Creation and Worker Assistance Act of 2002, (JCWAA) (Public Law 107–147)), the IRS and Treasury have determined that no such exception is appropriate." Basically, the safe harbor match applies to all deferrals and, the IRS having thought about it, decided not to make an exception for catch-up contributions.

The provision was added ostensibly to make it convenient for a participant to convert match and NEC contributions to Roth without having to do an in-plan conversion. It would seem logical - and that certainly is not a deciding factor on how this shakes out - that the taxation would parallel what currently is done for in-plan conversions. If so, then the company would not be involved other than to make the company contributions as they always have done. The plan recordkeeper would collect an election from the participant to treat the company contribution as Roth and also an election on whether income taxes would be paid out of the participant's account. The plan recordkeeper would know the participant's vested status and the amount of the contribution. The plan would report the taxable amount to the participant on a 1099R Code 2 (no 10% early withdrawal penalty). The amount would be taxable based on the date of the conversion which would be around the time the employer contribution was posted to the participant's account (not the plan year associated with the contribution). Withholding is optional, so the participant would need to either pay estimated taxes, or up their withholding from wages. If plan allows, the participant could an in-service withdrawal but that would be taxable and possibly subject to the early withdrawal penalty. Note that the company would not have to pay payroll taxes on these Roth amounts, and the Roth amounts would not affect compensation used by the company's other benefit plans. For self-employed individuals, the year of taxation of the Roth amount would depend upon the date the amount was funded to the plan. Note that the Roth amount would be considered as taxable income from the qualified plan and not be considered as taxable self-employed income. Thoughts anyone?

The language in the employment contract describes the how the company will determine how to calculate the compensation to be paid to the HCE. On the surface, it appears that the company is including an amount in the HCE's compensation that is equal to x% of compensation which is added to the HCE's gross pay and labeled "pension funds". Since it is added into gross pay, presumably payroll taxes are being withheld from the "pension funds". The HCE has filed an election to defer x% into the plan. Check to see if the plan definition of compensation includes this special pay. Some plans have definitions that specify certain categories of compensation are excluded from the calculation of deferrals. For example, if the "pension funds" are given to the HCE in a lump sum amount at the end of the year, the "pension funds" will look more like a type of bonus and the plan may exclude bonuses. As an aside, ask if the "pension funds" are included in compensation for purposes of the company's other benefits (for example, life insurance coverage as a multiple of compensation). Also check whether the x% is applied to compensation before the "pension funds" are added to compensation, or is the x% applied to compensation after the "pension funds" are added to compensation. Self-referential formulas are a pain. If the deferral is calculated before the "pension funds" are added and the "pension funds" are included in the plan definition of compensation, there may be an operational error for failure to follow the HCE's deferral election to defer x% of compensation. If the plan is a safe harbor plan, then hopefully the "pension funds" are included in the plan definition of compensation. The definition of compensation for calculating a safe harbor contribution likely will require the inclusion of the "pension funds" in the compensation used to calculate the safe harbor contributions (match or NEC). Since the HCE was able to negotiate this special deal, I suspect that there is a good likelihood the HCE will hit the deferral maximum. Does the contract address what happens if the HCE cannot defer x% of compensation due to the annual maximum deferral limits? Is the annual compensation limit taken into account when calculating the x% of compensation? The company and HCE should have an agreement on what happens should limits prohibit deferring the full x%. You are correct to be concerned because of the potential operational errors that could result from ambiguities in calculating this HCE's compensation and deferrals. With some good luck, none of this is an issue.