SARSEP to terminate,50% for yr not met, SH 401k to replace SARSEP

[Beltane]

Client currently wishes to terminate SARSEP and establish a SH 401(k) for remainder of year. 5305A-SEP form in use, SARSEP will not meet the 50% participation requirement under IRC 408(k)(6)(ii). We would like to terminate sponsorship of the SARSEP [with notice and resolution] effective 7/15/05 and have the Safe Harbor 401(k) [using the match method] effective 8/1/05 in hopes of avoiding the concurrent plan problem of using the 5305A-SEP.

The 2005 SARSEP contributions I understand will be, due to failing the 50% rule, default to the regular IRA rules for deductibility, etc. My questions:

a) First, is my analysis above correct?

b) Is the sponsor still required to make the top heavy contribution due to partial year sponsorship of the SEP, even though all the 2005 contributions are now deemed IRA contributions rather than SARSEP contributions?

b1) Does the adoption of the Safe Harbor 401(k) eliminate the top heavy requirement for the year? [assume parallel participation]

c) If 'b' is "yes", do we base the 3% on total 2005 compensation or only through the SARSEP's date of termination?

d) If a top heavy contribution is required, can that contributatory requirement be made under the non-elective benefit structure of the (standardized) Safe Harbor plan?

e) If 'd' is "yes", can we subject the top heavy contribution to the graded vesting schedule under the SH plan? [my inkling on this is no, since this would not provide the same contractual benefit as a top heavy contribution under the SARSEP-thus 'd' would probably be "no" also]

f) If 'd' is "yes", The TH required amount I understand may not be reduced by the safe harbor match [iRS Notice 98-52]. What if we used the 3% nonelective safe harbor rather than the match?

g) Assuming 'd' is "no", would it be advised to make the Safe Harbor plan with a non calendar plan year? The concurrance issue with the SARSEP is what's rattling my brain here. Also, would the SH 401(k) plan be considered a 'successor plan' to the SARSEP? The only definition I currently know of a 'successor plan' is under Treas. Reg. 1.401(k)-1(d)(3), which, if applied, would not treat a SARSEP as a successor plan, but this is the flip of that. I believe the SARSEP is not considered a 'plan', but don't have a site.

thanks to any full or partial responders..

[Gary Lesser]

Because the 50 percent rate requirement was not met, ALL elective deferrals are disallowed deferrals. Notification to affected employees is required (see page 4 of model plan document). The elective portion of the plan no longer exist for the year and assuming no employer contributions, the plan is not treated as top-heavy for the year. The disallowed deferrals are included in box 1 of Form W-2 (and arguably subject to FICA/FUTA). Disallowed deferrals are not treated as SEP contributions. Now, forget the SARSEP (unless nonelective contributions have been made, in which case further discussion will be needed). Employer now adopts a QP. Follow the rules in the QP and forget that you had the SARSEP. Hope this helps. If employer nonelective contributions were made and the plan is top-heavy the model plan requires that a contribution be made to a SEP (i.e., this SEP, or another SEP of the employer). A prototype plan (which could be adopted as an amendment may allow for the employer to designate which plan (including a QP) is to receive any required T-H contribution. Hope this helps.

[Beltane]

No, there were no nonelective contributions made.

If I understand your post [which is really appreciated!]:

Failure of the SARSEP to meet the 50% rule has the effect of nullifying the existance of the SARSEP arrangement for 2005.

Client will formally terminate sponsorship of the SARSEP and can establish the Safe Harbor 401(k) plan for the remainder of 2005.

The 2005 402(g) limit, plus any catchups, is not reduced by the disallowed deferrals.

The (proper adoption and administration of) a Safe Harbor 401(k) will deemed not to be top heavy for 2005 assuming the only employer contributions to the plan are the SH ADP matching contributions. Top Heavy status of the SARSEP is thus ignored for 2005, and future years assuming the SH requirements are followed.

?correct?

[Gary Lesser]

Failure of the SARSEP to meet the 50% rule has the effect of nullifying the existance of the SARSEP arrangement for 2005.

This is true. The plan has notification requirements with explanations. FOLLOW THEM. Failure to do so is an addditional penalty. The elective amount is, however, reported in box 12 of Form W-2. Eventually (but not yet), the excess will turn into a traditional IRA contribution; until then it is just a "disallowed deferral."

Arguably, reporting the "disallowed deferral" on Form W-2, box 1, will avoid the cummulative 10% nondeductible employer contribution excise tax.

Client will formally terminate sponsorship of the SARSEP and can establish the Safe Harbor 401(k) plan for the remainder of 2005.

Yes, but why not for all of 2005.

The 2005 402(g) limit, plus any catchups, is not reduced by the disallowed deferrals.

I'M NOT SURE TOO SURE ABOUT THAT......and don't believe the issue has really been addressed anywhere. The plan is still described in Code Section 408(k) and the amounts were elective contributions when made. You might want to post this query in the 401(k) message board.

Hope this helps.