Safe Harbor 401(k) and Top Heavy Issue

[chris]

Employer's current 401(k) plan provides for dual entry dates and compensation is counted from a participant's date of participation. Employer constantly has a top-heavy contribution issue every year and is considering going the safe harbor route (3% nonelective contribution) to remedy the top heavy issue. It appears to me that recognized compensation under the plan will need to be amended to include full plan year compensation instead of just compensation from effective date of participation. Otherwise, employer will still be dealing with a top-heavy issue at year end, albeit half of the top-heavy contribution will already have been satisfied by virtue of the 3% safe harbor contribution on compensation from the effective date of participation assuming the participant enters the plan mid-year, ie., 7/1..... End result would be to amend the definition of compensation to full year compensation in order for top-heavy issue to completely go away, correct?? Thanks.

[Blinky the 3-eyed Fish]

I am not entirely clear what you are trying to do. Are you trying to have the only employer contribution be safe harbor 401(k) contributions, thus the plan is exempt from TH (details spelled out in Rev. Rul. 2004-13)? If so, then the fact that compensation from date of plan entry is used still meets the criteria for the plan to be exempt from providing additional TH contributions and you don't need to amend the compensation definition.

If this is not the case, then please say so, because then I really don't know what you are trying to accomplish.

[Tom Poje]

I wouldn't think you would need to amend the plan - the document should already contain top-heavy language, and if an ee entered midyear you would simply provide an additional contribution to someone entering midyear (subject to vesting)

as to whether the plan is considered 'not top heavy' is unclear to me.

EGTRRA said that a plan that consists solely of a cash or deferred arrangement that meets the ADP safe harbor

AND (emphasis mine on the word 'and')

the ACP safe harbor will not be considered top-heavy.

Certainly the non elective satisfies the ADP safe harbor.

But if there is no match, how has the ACP safe harbor been satisfied?

EGTRRA could have said

consists solely of a cash or deferred arrangement that meets the ADP safe harbor

then a SNHEC or a SHMAC would have satisfied that, and in addition the SHMAC would have gone further and satisfied the ACP safe harbor.

Is the reading too much into the law?

I don't know. It used to be a frozen DB plan had to provide a minimum benefit.

In the DC world, if a key ee deferred, even though there were no other contributions you had to provide a top heavy.

If you use the otherwise excludable option you still have to provide a top-heavy, so I have my leanings toward thinking you have to provide a top heavy in this case as well.

[Guest Boilerburm]

Tom -

your post brought up a point of concern for me. If I am writing a new plan, in order to get the pass on top-heavy, do I need to state that I am intending to satisfy both the ADP and ACP safe harbor provisions, even though I am using the SHNEC and have no intention of making any matching contributions? This doesn't seem to make sense - there is no additional employer contribution of any kind.

It seems to me in Chris' case that if the only contribution to be made will be SHNEC, they should get a free pass on the top-heavy test, and should be able to make the SHNEC based on the mid-year compensation. What am I missing?

[R. Butler]

If Tom is saying that you have to make a matching contribution to get the pass on top-heavy, I don't agree. I read §613(d)(ii) as requiring that any matching contributions that are made must satisfy 401(m)(11). I don't read it as requiring that they be made.

I will say though that the I didn't immediately accept the otherwise excludible issue either. It still seems nonsensical to me.

[Tom Poje]

I simply do not no for sure.

It would seem to me if I used the otherwise excludable option I shouldn't have to provide the top heavy either, but the IRS was clear that you have to.

If the document contains language for a discretionary match(limited to 4% of comp) and no discretionary match has been made, have you satisfied ACP safe harbor? and if so, why would that be any different than a plan that contained no such language?

As I noted, the regs clearly say a plan has to satisfy both ADP and ACP safe harbor. They could have simply said satisfy ADP safe harbor - but they didn't. Perhaps the IRS figured if you satisfied the ADP safe harbor by providing the 3% SHNEC you would have provided an amount equal to the top heavy anyway - without realizing you could have participants entering mid year.

I like your comment 'it doesn't make sense' - that is what people said for years about providing a top heavy in a frozen DB plan - yet you still had to do that. so making sense has little to do with anything.

[R. Butler]

I see your point, but I still don't see the reg. that way. You state that the reg. could have provided that just the ADP safe harbor be satified. True enough, but that would also cover plans that meet the the ADP safe harbor and that provide matching contributions not meeting the ACP safe harbor. That result is quite different from the apparent intent of the reg.

I am very big on just reading the reg. and applying the words. I generally don't like to look for any hidden meaning. Having said that I do not see that I violate the plain meaning by interpreting the phrase in question to mean merely that any matching contributions provided satisy 401(m)(11).

Still an interesting point of view.

[Harwood]

ERISA Outline Book 2004:

"A safe harbor plan is deemed not to be a top heavy plan (even if the top heavy ratio, if calculated, would exceed 60%) if:

(1) the plan consists solely of a safe harbor 401(k) arrangement, as described in IRC §401(k)(12), and,

(2) to the extent there are matching contributions made to the plan, all of the matching contributions satisfy the ACP safe harbor prescribed by IRC §401(m)(11). See IRC §416(g)(4)(H), as added by EGTRRA §613."

[chris]

The following language at p. 11.414 in the ERISA Outline Book (2003) raised the question in my mind.....

"...if the safe harbor 401(k) plan satisfies the safe harbor contribution requirement through the nonelective contribution formula, the top heavy minimum contribution liability is automatically being satisfied, unless the formula is using a definition of compensation that takes into account a lesser amount of compensation than the section 415 compensation. Note that the safe harbor nonelective contribution might be based on compensation for only a portion of the plan year (i.e., the employee is eligible for the 401(k) arrangement for only part of the year), whereas the top heavy minimum contribution is always calculated on a participant's section 415 compensation for the entire plan year."

Thanks for the help thus far.

[Blinky the 3-eyed Fish]

So are you providing only safe harbor contributions or not? In other words, is there an additional profit sharing contribution or non-safe harbor match?

[Tom Poje]

interesting - just how to interpret the code!

416 (g)(4)(H) says:

The term ‘top-heavy plan’ shall not include a plan that consists solely of –

“(i) a cash or deferred arrangement which meets the requirements of section 401(k)(12), and

“(ii) matching contributions with respect to which the requirements of section 401(m)(11) are met.

As Butler pointed out it couldn't say simply (i) and not (ii) because that would eliminate the possibility of the discretionary match up to 4% of comp.

The IRS has made it clear the following should be 'added' on to the end of that statement (at least as best as I can put it in my own words)

...provided such plan does not use the 'otherwise excludable option for allocating the safe harbor contributions. In addition, a plan can have the option to make additional nonelective contributions, but if none are made the plan will not be considered top-heavy.

Harwood points out the way The ERISA Outline Book has 'modified' the code

slightly from

a plan consists soley of (i) and (ii)

into

a plan consists of (i) soley of

and

to the extent made (ii)

Chris points out that in another spot the ERISA Outline Book would seem to imply that the following should also be added:

to get the top-heavy free option, the plan must allocate the safe harbor on total comp.

you gotta love it!

My reading is that it doesn't matter what the def of comp is as long as you provide both (i) and (ii)

others hold as long as you provide (i) and if made match that satisifes (ii)

still others add that comp has to be total not date of entry.

well, as I indicated, I am really not sure, I have my leanings in one direction.

I was trying to think of an off the wall example

If I go to the ballpark and order a hot dog. in the minds of many a 'true' hot dog at the ball park consists of one in which the 'extras' consist solely of

(i) mustard and

(ii) relish

now if I only have one with mustard have I met the requirement?

(or does it matter as long as I hate the Yanks?)

[K-t-F]

Well... If you are at Fenway Park hating the Yanks is a given (go Sox!)

[chris]

There will most likely be an additional PSP contribution. Thus, the question as to changing comp. to full year comp so that top heavy testing/contriution won't have to be dealt with, i.e., the e/er makes the 3% nonelective contribution and that's it as far as dealing with top heavy. My impression from the e/er is that they continually have a top-heavy issue every year in their 401(k) and were looking at adding the safe harbor contribution (3% nonelective) to remedy that. Hence, the comp. question as raised in the above section of the ERISA Outline Book.

[R. Butler]

There will most likely be an additional PSP contribution. Thus, the question as to changing comp. to full year comp so that top heavy testing/contriution won't have to be dealt with, i.e., the e/er makes the 3% nonelective contribution and that's it as far as dealing with top heavy. My impression from the e/er is that they continually have a top-heavy issue every year in their 401(k) and were looking at adding the safe harbor contribution (3% nonelective) to remedy that. Hence, the comp. question as raised in the above section of the ERISA Outline Book.

If you have allocations besides deferrals and safe harbor contribs., top heavy minimum is based on full years comp.

The following language at p. 11.414 in the ERISA Outline Book (2003) raised the question in my mind.....

"...if the safe harbor 401(k) plan satisfies the safe harbor contribution requirement through the nonelective contribution formula, the top heavy minimum contribution liability is automatically being satisfied, unless the formula is using a definition of compensation that takes into account a lesser amount of compensation than the section 415 compensation. Note that the safe harbor nonelective contribution might be based on compensation for only a portion of the plan year (i.e., the employee is eligible for the 401(k) arrangement for only part of the year), whereas the top heavy minimum contribution is always calculated on a participant's section 415 compensation for the entire plan year."

I don't have the 2003 edition of the ERISA Outline book, but this is basically stating the rule out of IRS Notice 98-52 that you can apply safe-nonelective contributions to the top heavy minimum. I don't see that Sal is saying that you have to use full year's comp. if you have a safe harbor plan & you do not have any other allocations. On the contrary in the 2002 edition he does suggest that you do not have to use full years comp. in a plan consisting solely of safe harbor contributions.

[Blinky the 3-eyed Fish]

Chris, so we have established that you aren't trying to use a safe harbor only plan to exempt the plan from top heavy, but rather are trying to use the contribution for top heavy purposes. To that I would ask why?

The safe harbor plan should be used foremost to pass ADP and/or ACP testing or to exempt the plan from TH requirements. It should never be used to solely provide the TH minimum.

TH minimum characteristics:

- to receive it you must be employed on the last day

- subject to the vesting schedule

Safe harbor characteristics:

- no allocation requirements

- 100% vested

So by giving the TH minimum to satisfy the gateway you are effectively giving away gobs of the employer's money by providing full vesting and by giving it to participants who would otherwise receive nothing. A much better solution is to simply figure out what each person is due at the end of the year, whether it be the TH minimum or whatever, and have the employer make the contribution.