Owner of a corporation wants to take back deferrals in current plan year

[Guest terric]

I have a client who adopted a 401(k) plan in 2003 administered by another TPA. They have a separate profit sharing plan which my company does the third party administration.

The 401(k) plan has immediate eligibility - the profit sharing plan has age 21, 1 year of service eligibility.

When we prepared the combined top-heavy testing for both plans - they are top-heavy for the 2004 plan year.

The owner of the company has already deferred the maximum in 2004. When I explained that the company would be required to make a 3% top-heavy contribution for the 2004 plan year to everyone who is eligible to participate in the 401(k) plan and the profit sharing plan, they said that their 401(k) TPA told them that the owner would be able to take back his deferrals that he has already deposited into the plan in 2004.

Isn't this a prohibited transaction? Does anyone have anything in writing that states you cannot do this?

Thank you for any input.

[Guest FormsRmylife]

You are trying to prove the basic underlying tax principle to your client. The meaning of deferral is to put off to a later time. Taxes are deferred in exchange for surrendering the right to immediate payment. By the terms of the plan document, the deferral election, and 1.401(k)-1(a), the employee has elected to defer receipt of his compensation. Once he has done this, he cannot get it back until the plan document, the deferral election, and the 401(k) regulations say he can. Although he in one sense is the employer, he cannot have the funds returned as a mistake of fact or excess contribution under 404, because he made this contribution as an employee making a salary deferral.

By statute, the salary deferral can only come out if there is a 402(g) dollar violation, an ADP test failure, or a 415 failure. The plan document cannot provide otherwise and still be a qualified plan. Perhaps the prior TPA anticipated a major ADP failure that would support the return of the deferral.

[Blinky the 3-eyed Fish]

Since any returned deferrals due to ADP failure are still annual additions, I don't think that helps any should that occur.

[Guest Smitty848]

So, even if deferrals are returned to the highly compensated employees as a result of failing 401(g), ADP or 415, thos amounts are still counted as annual additions, therefore the plan would be top-heavy anyway. In a small plan, top-heavy is kind of like a fact of life. It happens, and there aren't too many ways to avoid it.

[david rigby]

The TH status for 2004 is determined as of the last day of the prior plan year.