ADP Calculation for first year of a plan

[Stevo-PDX]

I have a new 401(k) plan with an effective date of 1/1/2001. The first date that participants could actually defer into the plan was September 2001. When calculating the ADR's for the participants, do I include only their compensation paid from September through December or the enitre plan year?

I was curious if anybody knew of a cite or reference on how to properly handle this. I would lean to the more conservative approach and use the full year compensation, but this seems unfair to the two HCE's in the plan. Particularly considering there were a few employees that would have been eligible to defer if they hadn't terminated before September 1st.

Thanks

Steve

[actuarysmith]

There are two responses-

1. As far compensation is concerned, what does the document say? Compensation from entry, Compensation for full plan year?, etc.

2. Remember that in the first year (only) of a new plan you can deem the ADP of the Non-HCE's to be 3%, thus allowing the HCE's to contribute 5%. Code section 401(k)(3)(E).

I believe that in order to use this rule number you have to be using the prior year testing rule.

[Tom Poje]

actuarysmith is correct, the plan document rules.

hopefully, if it is like the new documents I have seen (due to restatements) in the definition section for 414(s) it simply says any definition that satisfies 414(s)....or something similar to that.

If you use full year comp, you have shot yourself in the foot if you want to use prior year results. You would easily pass this year using the 3% prior year rule, but next year you are out of luck.

[KJohnson]

Tom,

In a similar vein, couldn't you set up a 401(k) plan in late November 2002 specify prior year testing and first year ADP. Also in your document specify current year testing beginning in 2003, a safe harbor for 2003, and give your "maybe notice" by December 1 2002.

That way HCE's could defer 5% of a total year's comp in December 2002 and still have the ability for a deferral up to the 402(g) limit in 2003? Do you see anything wrong with this (other than having to stick with current year for five years which shouldn't matter anyway if you make the safe harbor).

[Fred Payne]

I've always understood the scenario KJohnson described is permitted and is the "solution" to Tom's warning about the inevitable failure of ADP in the next Plan Year.

But what if KJohnson's scenario is even more aggressive? With only one payroll left in the Plan year and on the same day, notice is given to participants for a Safe Harbor 401(k) for the NEXT Plan Year AND a traditional 401(k) is set up for CURRENT year.

Can this be done?

Regs allowa new Safe Harbor 401(k) feature to be added to a Plan without a 401(k) provided Notice is given no later than the 1st day of the Plan's 10th month. Also, a Sponsor could give notice on December 20, 2002, for instance, that a Safe Harbor 401(k) is being established effective January 1, 2003, IF THERE IS NOT AN EXISTING 401(K) FEATURE TO THIS PLAN (NOR HAS THERE EVER BEEN).

But what would prevent a Sponsor on 12/15/2002, for instance, establishing for the current year a traditional 401(k) and giving notice of the Safe Harbor for the next plan year?

Is there a "drop dead" date similar to that of establishing Safe Harbor 401(k) plans for adding a traditional 401(k) feature in the curent year?

[Fred Payne]

I called my attorney on this one because I had a client call me with a 10/31 Plan Year End and wanted to set up yet this month a traditional 401(k) for current year and a Safe Harbor for next year. My atty says to do one or the other but not both.

KJohnson's scenario is certainly permissable, however.