hce with no contribution

[Guest Codi]

I have an employee that made $93K last year so he was clasified as an HCE when conducting payroll bi-weekly ADP testing. This July we received a letter saying that our ADP tesing failed becuase they are putting this employee under the NHCE classification since although a participant, he did not make any contribution to the plan.

Are they correct in making this $93k/yr employee a NHCE?

[Guest Lex]

Codi,

The key is what was his compensation in the look back year (12 months prior to plan year)? Are you saying that in July you got a letter that the Plan failed ADP testing for the 2001 Plan year (I am assuming a calendar year plan)? If that is the case and he made more than 80k in 2000, he is an HCE.

Please clarify.

The determination of HCE has nothing to do with whether or not he deferred. (It would help the testing if he were an HCE with a 0% deferral.)

[Guest Codi]

Lex; thanks for the response

Yes, Calendar Year Plan

The Plan was started in March 2001 so we don't have any look back year. He made $93K in 2001. The letter was received in July 2002 and the test failed for 2001.

I thought the same you are saying;

a) he is an HCE

b) although he is not contributing he would be and HCE with 0% contribution.

c) he will help the testing.

The company doing the testing and putting him under NHCE is Trustar. I called them and they say that he did not contributed so he is NHCE. I think they are wrong so I'll continue to argue.

what is my next recourse if they continue to disagree?

[Guest merlin]

The lookback year is the 12-month period preceding the current plan year. So if he made more than $80,000 in 2000,he's an HCE for 2001. The only way Trustmark could possibly be right is if the company was started in 2001,then there is no lookback year,and the only HCEs will be the 5% owners. But their reasoning is off,no matter what. If they can't get something as basic as who's an HCE right they're not going to get anything else right.Get rid of them and hire a professional TPA who knows what they're doing

Disclaimer:I'm a TPA

[Guest Lex]

Codi,

I agree with Merlin's advice. Ultimately, you as an employer/plan sponsor (I assume) has the fiduciary responsibility for the Plan, not Trustar. I would insist they do the test right (ask them for proof of their HCE determination- they will not be able to support it unless it is a Merlin said- based on ownership if the company started in 2001). If they refuse, I would get someone else to do the test. If it passes using the right HCE determination, I would in writing instruct Trustar to not process refunds. Keep good records of this in your files. Additionally, why are they informing you in July of a 2001 failure?

[rcline46]

The first part of the problem is that if the ee were employed in 2000 and made more that $85,000 with your company, he/she would be an HCE for 2001 regardless of pay in 2001.

The second part of the problem is use of TOP PAID GROUP determination, which may take an otherwise HCE and make them an NCE.

Third part of problem is if the ee owned or was deemed to own more that 5% of the company in 2000 or 2001, then they would be an HCE regardless of pay or Top Paid Group.

I think we need a bit more information to make the determination. However, the reason given is just plain wrong.

[Guest Codi]

thanks all;

I think they are just wrong. no ownership what so ever given to any one other than myself. this gentleman just singed into the plan as a "just in case" type deal since when we open the plan everyone could sign in but if they did not then they would have to wait a year. he signed in but contributes nothing. he is the highest paid employee we have, and the only other HCE is me becuase of ownership since I only made 43k last year. there are 4 NHCE employees for 2001 year and their average contribution is 5.5% if this guy is left out. Of course the HCE also gets reduced to 5.25% if he gets correctly placed into the HCE group. Then the HCE group would be just me and him and I contribute 10.5% which puts the average HCE contribution to 5.25% and the test would pass. From what I see, if the HCE vs. NHCE distribution is done correctly I should be able to almost contribute 15% for an average HCE of 7.5% which would still be ok @ 5.5% + 2% rule. All other test pass as is.

[Guest Codi]

sorry, I forgot to mentioned, this gentleman was employed approximately 15 days before the plan was started so we have no record of previous income unless we request for a w-2. is that necessarry or do we just stick with what we know? It should not be a problem anyway since I know he made in excess of $130k in 2000.

[Guest Codi]

ok, last time I reply to myself ,

the $93k was only a partial year incomo since he did not work for us a full year. His yearly salary in 2001 was based on $120k. this years salary will be $126K

[Mike Preston]

Codi, from what you have described, it looks like the test is not passing. You say the plan was started on March 1, 2001. Further, you state that the employee that makes $93,000 in 2001 was first employed fifteen days before March 1, 2001. This would mean that his compensation from your company was zero in 2000, as he wasn't employed in 2000.

When determining somebody's compensation in the lookback year, one only takes into account compensation paid from the plan sponsor. In this case, your company. It doesn't matter what his W-2 was from the company where he worked before he started with your company.

Hence, for purposes of the test, his lookback year compensation in zero. That means that unless this individual qualifies as an HCE by virtue of owning more than 5% of your company (either stock or, if not incorporated, capital or profits interest) he is treated as an NHCE in your test.

By the way, the fact that he signed up for the plan or didn't sign up for the plan is not particularly relevant. If he was an eligible employee at any time during the year (2001) then he gets counted in the test. Do you have any employees in this category who might have been eligible but did not sign up? They count as zeroes in your test. I know that isn't what you wanted to hear.

Now, what to do, what to do......hmmmmm.......

I would suggest that you find out whether the test is being done correctly and whether it is being done in a manner that is most beneficial to you. First, see if doing the test based on 401(k)(3)(F) works to your advantage. I'm giving you the cite so that you can repeat it to your provider. Basically, it groups you only with those NHCE's that have more than 1 year of service and are age 21. This would exclude the individual you are mentioning. So, if all the other participants are long service employees, you can at least exclude this individual from the test, thereby leaving the average at 5.50%.

If there is another of the 4 employee participants, though, that are recent hires (like the gentleman making 93k) and their contribution is similarly low (or zero) then excluding that person from the test, too, will bring the average up even further.

Keep in mind that it is an all or nothing type of test. You either exclude everybody who is short service/under age, or you include everybody in the test.

Also, was there a match? If so, consider whether the plan provides for turning those matches into what are called QMAC's (qualified matching contributions). If so, then those monies can be counted as deferrals and maybe your ADP test will pass. Can't hurt to do the calculations.

Good luck, but is sounds like you have some refunds coming from the plan if none of the facts are changed.

[Guest Codi]

Mike; thanks.

gosh! I don't know why this country ( who always talks about the foundation being the small business owner ) continues to punish us in every direction possible. I never thought that bringing a 401K plan to my employees was actually going to be a limitation on my ability to create a retirement account. All this regulation is simply going to bring me back to $3000 IRA that I had before the 401K plan was set up. I really don't get why if my employees don't want to plan for the future I have to pay for it.

ok, enough clomplaining.... thanks for the advice

Ivan:confused:

[Mike Preston]

I really do feel your pain. The problem is not with the system, it is with those that either sell or must accept the system. I've seen it all, Codi. I've seen plans put in place where there is absolutely no attempt to communicate what the real results will be. I've seen attempts to communicate met with belligerent irrationality on the part of the client that either refuses to or just can't grasp the complexities. I'm not alone. Any advisor in this industry for a substantial period of time has no doubt seen the same.

If you want to send me the details on the 4 other employees you had during 2001, I will be glad to tell you whether the exception I referenced before is in play or not. Feel free to email me at mike.preston@prestonactuarial.com.

These boards aren't to be used for direct solicitation so I want you to know up front that I will not attempt to bill you for anything I do on your behalf, nor will I accept payment.

What can I say? Your candor and attempts to do things "correctly" makes you a "good guy" in my book (whether you are male or female!).

If you decide to do it, I need date of birth, date of hire, number of hours worked in 2000 and 2001, W-2 compensation, and deferral amount. There might be other pieces of information needed, in case you have anybody that is not clearly a full time employee.

It won't bum me out if you decline, either. Just wanted to give you options.

[Brian Gallagher]

Maybe I missed something in the posts above (there's a LOT of stuff there).

I think the crux of the matter is: How much did this (non?)HCE make in 2000 if he was working for your company? If it was more than 80k, then yes, HCE. If not, then no. (I remember reading that he is not a 5% owner). Current year compensation doesn't figure into HCE determination.

I am making one assumption here: the company was in existence in 2000, not the plan.

...bg

[Guest Codi]

Brian;

the company was in existance in 2000 but he was not our employee until march of 2001

Codi

[mbozek]

Codi: Somewhere in the materials you recieved from Truststar is a reference to top heavy plan contributions. Under the TH plan rules an employer is required to make a minimum contribution of up to 3% of compensation for all non owners if more than 60% of the assets of the plan are allocated to the account of the owner (you). Owner contributions by salary reduction to a 401(k) plan count toward this threshold. For example, if your account balance as of the end of 2002 is more than 60% of all the assets in the plan then the employer is required to make a contribution of up to 3% of compensation to the accounts of eligible emplyees in 2003. This is a separeate requirement from the ADP testing and I have had several clients who were not aware of the TH requirement at the time the plan was adopted. If you are aware of the TH reqirement then disregard my comments.

[Mike Preston]

Let's do the math before we start scaring the plan sponsors! Given the statistics previously posted, it is not very likely that the plan is top-heavy, unless the average compensation of the non-key employees is something like $14,000/year. While I guess it is possible, it isn't on the radar in a plan like this. Here we know, based on the postings of Codi, that there is one key employee making around $43,000 who, in the first year of the plan, deferred 10.5%, or around $4,515. You would have to have the other participants, whosse ADP is already identified as 5.25% with respect to the 4 NHCE's that are deferring into the plan, defer a grand total of less than $3,010 in order for the plan to be top-heavy. For $3,010 to be less than 5.25%, the salaries would need to be less than $57,333.33 for those four employees, in total, or less than $14,333.33 on average. Yes, I know that it is theoretically possible that a very low earning employee has a high deferral percentage and that would skew the numbers significanlty. So, the post isn't entirely off-base. But, mbozek, this guy is already going through hell, let's not make it worse than it already is!

[Guest SPOT]

Are your sure that the TPA said he was a NHCE because he was not contributing? Whether or not a participant is contributing has nothing to do with the determination of HCEs. He definitely is a NHCE for 2001 because he did not receive comp. in excess of $85,000 in the 12 preceding months and he was not a more than 5% owner in 2001 or 2000.

[mbozek]

Thanks for the math tutorial but I thought TH status is determined by account balances not amount of contributions. A plan with a single owner can become TH because of a divergence in investment returns between the owner and non owners. I have represented several plan sponsors who were surprised to discover several years after establishing a 401(k) plan that they had granted 3% raises to all non owners under the plan and that the only way to avoid future raises was to have a steep decline in the net worth of the owners accounts.

[Mike Preston]

I don't disagree with the thought. It is just that in this case the numbers are too far from crossing the line to be close to the mark.

Maybe in a few years, especially with the lookback being only 1 year after EGTRRA.

But for now, he told us this is a new plan in 2001, hence the top-heavy determination is based on the account balance at the end of that first year. And, yes, it is theoretically possible that if his investments have gone up, while others have gone down, the plan could end up being top-heavy.