Counting hours for non-hourly employees

[Santo Gold]

I have an odd situation that maybe someone has had before and can provide some advice on how to proceed.

A small business was started in November, 2003. When the company began, there was the owner and 2 other salaried employees. On March 31, 2004, employee #2 left, leaving just the owner and employee #1, and it has stayed that way since. Employee #1 will make over $90,000 in 2004. Employee #2 did not make over $90,000 (and would not have even if still employed).

The owner would now like to start a DB plan for the business, effective 1/1/04. The plan is intended to cover only owner and employee #1. I want to arrange eligibility to keep employee #2 out. Can the plan require a year of service, but allow for immediate entry for employees employed on 4/1/04?

Alternatively, if there is no way to keep employee #2 out of the plan, then the next question is keeping him from getting a contribution. Since there are no other NHCE's, I would need him to work 500 or less to be able to keep him out of the 410(b) test. But him leaving on 3/31/04 is right near the 500 hour breakpoint. How should hours worked be counted for him? If we use 37.5 hours as a standard work week, that would produce 487.50 hours worked (37.5 * 13). If we use 40 hours, then we get 520 hours worked (40 * 13). I have a hunch that I should not be able to arbitrarily pick between 37.5 vs 40, but if they are all salary ee's, how should hours be counted?

Thanks

[david rigby]

Do you care about all that? In creating the plan, is there any reason that you cannot begin counting vesting service at 1/1/04?

[Santo Gold]

Not sure if my first reply made it through, but the departure of E#2 was not pleasant with lawyers now involved, etc. So, the owner does not want E#2 in the plan at all, regardless of whether he never vests. Also, the owner would not be keen on starting a plan and he himself not being vested in it right away. I'm sure if there was no other way, he would accept it, but that will not be his first choice.

[Blinky the 3-eyed Fish]

If you didn't keep track of hours, then you must use DOL equivalents, which will put you in excess of 500 hours, so that doesn't work.

Pax's solution works if there is no predecessor plan, but I guess it doesn't work for the client. As for the owner not being vested, that shouldn't matter since he will eventually become 100% vested by service or when the plan terminates.

Another solution is if the plan is effective 4/1/2004, but watch out that the amendment may be considered discriminatory under 1.401(a)(4)-5.

[Santo Gold]

Couldn't he also use say a 7/1, or 10/1 effective date, still using full year comp?

I understand the 401(a)(4)5 issues, but would this really be considered an amendment? Its actually a plan adoption.

Would it really be applicable in this case anyways? The employee #2 has been gone since 3/31, the plan will not be signed until 12/29 or so. The paper trail shows that it was only in August, 2004 that talks of a retirement plan first came about. Making the the effective date a few months away from ee #2 DOT should help too? And, the plan is open to other NHCE's if any were to be hired.

I guess I'm doing a good job convincing myself that this would all be OK, but would anyone else agree with me?

[Blinky the 3-eyed Fish]

Couldn't he also use say a 7/1, or 10/1 effective date, still using full year comp?

Yes, and to avoid 401(a)(17) proration the compensation period should be defined as the calendar year or other 12-month period.

I understand the 401(a)(4)5 issues, but would this really be considered an amendment? Its actually a plan adoption.

I consider it an issue in principal, but you are probably correct that in this case you are okay. I just thought I would throw it out there.

[Bird]

I think you might want to look at an end-of-year entry date (12/31) and count comp for the whole year. That might bring in future employees sooner than you want but solves the immediate problem.

[Santo Gold]

One last thought on this.....for eligibility, require a year of service with retroactive entry date back to 1/1/04. So, the owner and employee will have 1 YOS on 11/01/04, bringing them into the plan 1/1/04. Employee #2 will not have 1000 hours and will not be employed on 11/1/04, so he never enters. I think this will work. Would the employer still be entitled to a full year of funding the plan since entry is 1/1/04?

Another question related to this. For determining HCE's, can I simply look at 2004 compensation since for 2003 there were only 2 months? Is there a cut and dry way to determine HCE status when the lookback year is only 2 months?

[Guest quinn the car fixer]

the lookback year is always the preceding 12 months--you can never pro-rate the limit

[Santo Gold]

Since the business was not around for the prior full 12 months, would the look back year be 1/1/03 - 12/31/03, or 11/01/03 - 10/31/04?

[Santo Gold]

Quinn - I did some research on your response via the 2004 Erisa Outline Book which served to further amplify your comments. It seems pretty clear that in the case of a business that was not around for a full 12 months before a plan is adopted, you either use the "short period" - in this case 11/1/03 through 12/31/03 without pro-rating the HCE comp. limit - or in the case where a plan and business are both started on the same date (eg 1/1/04), then there simply are no HCE's via compensation for the 2004 year. Mr. Tripodi did caveat his information by saying that this is the case unless subsequent guidance is provided. I have not heard of any though.