401(k) Out-of-compliance in Plan's first year

[Guest KAGEM]

As Pension Administrator for a TPA, I have made a serious error in analyzing a new plan's first-year testing. It may cost me my job, but since my boss won't explain it to me. I am asking a board expert to explain. Here goes: The 401(k) plan was effective 04/01/00, plan year end 03/31/01. Assume deferrals began 04/01/00. HCEs are 4 Owners/Officers and 1 Employee who earned more than $80k in prior year; he did not defer. I tested top heavy for the beginning of the 04/01/01 PY. but since it was the first plan year, I should have tested as of 03/31/01; the plan was top heavy for the 03/31/01 PYE. The ADP Test may have also failed because we are not sure what comp the client used (I am not allowed to call the client and clarify). Plan's definition of comp is W-2 wages from entry date (dual entry). The Client did not make a Match or Discretionary contribution. Can a 3% Safe Harbor Match be made retroactive to the 03/31/01 PYE to NHCEs to satisfy both the ADP Test failure & the Top Heavy status? By what date do employees need to receive the Safe Harbor Notification? Today I received the census data for the 03/31/02 PYE. And again the client states no employer contribution. He does not know that the plan is top-heavy. I appreciate any guidance! Thank you!

[Mike Preston]

Does a prior plan exist? You determine the top-heavy ratio as of 3/31/01, in part, by adding back any distributions that have taken place over the last x years for both key and non-key employees. Look up in the 416 regs exactly what years to add back if a prior plan exists.

If it does and the prior plan's distributions were heavily weighted to key employees such that any reasonable person would have predicted that the plan would be top-heavy no matter what the new contributions were during the 4/1/00 - 3/31/01 year, then at the least you can blame it on the person who designed and installed the plan!

Is there another plan of the employer? I know it is unlikely, but I have to ask. If so, aggregate to determine top-heavy.

Are there any union employees? If so, is there a union plan? Can the union plan be aggregated? I haven't looked this up lately, because I haven't needed it, but I seem to recall there were some circumstances where it was possible.

Now, to your questions.

The employer contribution Safe-Harbor Notice needs to be given in advance. So, I'm afraid the 4/1/00-3/31/01 and the subsequent two plan years aren't able to take advantage of that.

However, if the plan was at all close to passing, then it wouldn't require a full 3% contribution at this point to make it pass, either, I wouldn't think. It is not too late to contribute for the 3/31/01 year and come under the EPCRS' self-correction mechanism.

If you determine the plan is top-heavy, the sooner the client is made aware of the issue, the better off your firm will most likely be.

Good luck.

[Guest KAGEM]

Thanks for the info. Unfortunately, there is no prior plan, no other plan, no Union employees. There are some issues about the plan installation, but I have no control over that, This is a new job for me - less than one year. Though I have done plan administration for 7+years, my prior experience was with the Trustee, not a TPA. Bottom line is, I am accountable. I really appreciate you input!

[Mike Preston]

Let me get this straight. You admit to never having worked as a Plan Administrator for a TPA before and yet the testing for the year was subject to review only by you? If you are solely responsiible for this, then your employer is completely and totally out to lunch. Strong letter to follow. The fact that you have taken the initiative to come here and try and resolve this issue speaks volumes. If you get fired for this, or any other error which is the direct result of your organization not having an effective review procedure in place, you are probably well rid of THEM and most likely will be welcomed by another organization.

Now, do the right thing by this client and suggest to the firm that the client be informed as soon as practicable (I fully recognize that the delivery of this news is something that needs to be handled delicately).

Here's an off the wall suggestion. Take a look at Q&A T-24. In the first year of a plan, unlike other years, the top-heavy determination INCLUDES all amounts allocated as of "a date in that first plan year." There is absolutely no limitation on the timing of when the funds are actually contributed.

Soooooooooooooooooo, let's assume that your 5th HCE is a "favored employee". Let's assume that by now, he or she has become quite valuable to the company. Maybe they would like to provide for an allocation to that individual for the 3/31/2001 plan year. In fact, an amount which takes the plan out of top-heavy status???? Can this actually be done? I don't know. It would depend on the plan's language and how an ERISA attorney might advise in light of all the facts and circumstances.

Maybe the firm could actually end up making lemonade out of lemons??????

[Tom Poje]

I agree with Mike, if I understand the facts correctly.

This was a brand new plan, and you were assigned it. You also indicated you had no control over the installation of the plan. Therefore, you had no control over the plan being top-heavy. So that would have been a problem anyway. In other words, even if you had 10 years experience, and knew all the ins and outs of admininstraton, a top-heavy contribution would be required once a 'key' employee deferred. so unless you had contact with the client before the start of the year, there is little you could do.

But that is water over the dam at this point. I am sure I speak for many when I say 'I wish I knew back then what I know now'

As for a solution, Mike points out

'Take a look at Q&A T-24.' He is referring to 1.416 of the regs.

Mike also referred to correcting under the EPRSC program:

If the plan allows for it, then you could correct by making a QNEC (not safe harbor contribution) see Rev Proc 2001-17, Appendix A.

The QNEC would also satisfy top heavy.

but be aware, an HCE, who is not 'key' would also be required to receive a minimum, though not necessarily a QNEC.

[R. Butler]

See Revenue Procedure 2001-17 for correction possibilities. As Mike pointed out it is too late for Safe Harbor, but any QNEC used for ADP can also count towards top heavy requirement.

Good luck.

[Guest KAGEM]

Gentlemen, Thank you! I have sent my boss an e-mail with your suggestions and asked for guidance.

I received the 03/31/02 PYE census and was told to fax my client contact a notice that there will need to be an Employer contribution since the plan is top-heavy. The client stated -0- contribution for 03/31/02 PYE.

My boss delivers the annual administration reports, and I did indicate the plan would be top-heavy, but I do not know whether she advised the client.

The ADP test is also failing because the formerly HCE is no longer because his prior plan year comp was less than $85,000. I notified the client refunds would need to be made by 06/15/2002.

I didn't mean to mislead you - we do have a review process. Reports are reviewed by the other office benefits administrator and also by our boss (especially 401(k) plans).

I have few reference sources - only an old 401(k) Answer Book. No internet or email access at the office. So I try to research at home.

Do you know of inexpensive but good references? I am working on the QKA.

Thanks again!

[mbozek]

Before you go overboard with all of the bad things consider self correction for prior year contributions. IRS does not want to know about failed TH contributions. Solution is to make any contributions retroactively. Some clients who find out that their plan has been TH for years back choose to make TH contributions for the current year and ignore the prior years as a business decision. For the plan year ending 3/31/02 you should be able to make a QNEC/TH contribution by the date the employer's tax return is due a self correction contribution. The TH contribution should also satisfy the safe harbor contribution. As has been discussed in prior threads there is no known date for making a TH contribution for a discretonary ps plan. Look there two ways to analyze this problem 1. this a mistake or 2 this mistake is correctible by making up the contributions that were due. Fixing up the problem with back contributions will provide an audit position if the IRS ever reviews the plan.