Safe Harbor (Non-elective 3%) - HELP!

[lkpittman]

This may be a problem on several levels. Client added a CODA to existing PSP effective 1/1/01. CODA included a safe harbor non-elective 3% contribution and notices were provided by the TPA to the client with instructions regarding timely notice.

Sole shareholder (and the only HCE) dies during the plan year. Several NHCEs deferred small amounts--but HCE did not defer any amount prior to death (intent was obviously to fully fund to $10,500). The office manager is now trying to sort out what needs to be done--we advised that they are on the hook for the 3% non-elective; HOWEVER, she advises that the notices were never provided to the ees!

1) So, are they "off the hook" for the 3% non-elective becuase proper notice wasn't given? I realize ADP must be performed, but that's obviously no problem.

2) Now aren't we looking at a plan operational failure (failure to operate plan in accordance with its terms to provide the notice and safe harbor contribution)? Wouldn't correction include providing the 3% non-elective anyway?

Obviously, they'd like to avoid providing the 3% contribution at this point. Any insight?

[Guest And another thing ...]

If effective date of the amendment, however, is contingent on the notice, then I would say they are off the hook. If there is no contingency, then I think they are on the hook for the 3% contribution because the plan document was amended to provide that, but don't get safe harbor on ADP because the notice wasn't provided.

[MWeddell]

If the plan was amended to allow for the 3% contribution, one can't retroactively get rid of the feature due to 411(d)(6). Depends what's in the amendment, but the client is probably obligated to contribute the 3%.

In other words, I agree with the above post.

[lkpittman]

Thanks--I think we're on the hook for the contribution, as well. So, what's the "penalty" or downside for not providing the notice timely?

[Tom Poje]

the penalty is that the plan will not be considered safe harbor, even though you may have made a 100% vested contribution.

Thus ADP testing would have to be performed, ees who might normally not receive a contribution would, etc. Its like having all the downsides of a safe harbor, but you still have to test.

The ERISA Outline Book has an interesting note that says the IRS has informally indicated it may permit correction of untimely notice through one of the correction programs. I would guess if the safe harbor had been a match for 2001 it wouldn't be allowed since you would have to defer to receive the match. Since you are talking about the 3% nonelective, then the notice has less effect on someone's decision to defer or not. (Ok, that would be my reasoning). Tough call, without guidelines if you could rely on self correction at this point in the game.

[lkpittman]

Thanks, Tom.

With the wording of this plan, I believe they are going to have to make the contribution (contribution isn't "contingent" on notice). Testing won't be a problem, since HCE did not defer. I think we're going to "self-correct" this (without any kind of IRS approval) and let the chips fall where they may. Plan is terminating now since HCE died. I think we'll be okay as long as they make the contribution.

[MWeddell]

The penalty isn't just that the plan isn't safe harbor. If the contribution is not made, it sounds like the client is not following the plan document. That's an ERISA violation (no specific penalty is prescribed) and the IRS views it as a disqualification issue (loss of tax advantages).

[Blinky the 3-eyed Fish]

I think the lesson here is definitely to have language that only requires the safe-harbor contribution IF the proper notification is made.

[lkpittman]

MWeddell, I realize that we've got an operational error--but I believe the failure to provide the notice in this situation is an "insignificant operational error" under 2001-17 and that we can self correct (SCP). Obviously there is no specific guidance on this type of operational failure, but under the guidelines for "correction principles and rules of general applicability" of 2001-17, I'm not too worried about it, so long as we've provided the 3% non-elective contribution.

And yes, Blinky, we've definitely learned a lesson here with respect to drafting any individually designed plans/amendments for safe harbor provisions.

Thanks, all.

[MWeddell]

I agree that as long as the 3% contribution is provided and the ADP / ACP tests pass, then you've done all you can to correct the situation.

I misread your earlier question -- I thought you were asking what the penalty was for not providing the 3% employer contribution. I must have read it too quickly.

[lkpittman]

MWeddell,

Thanks for your input! I think the employer (successor, in light of the death of the sole shareholder) would rather not put in the 3%--but I think they're stuck, or they've got a bigger "correction" problem--as you've indicated.