plan design help

[wsp]

I have a client that has been having ADP issues recently due to a myriad of reasons. The ADP percentage of the NHCE group has been around 5.5 - 6%. Typically one would think that's a fairly good percentage given that his company is a manufacturing facility with average wages of 30-50k. But the HCE hasn't been paying himself a whole lot of $$ over the last few years and thus his actual dollar limit is rather low.

He's upset over the expenses of the plan in relation to his benefit. You and I know that his benefit is in proportion to his compensation, but getting him to see that is tough. Especially when all he sees is the SS taxes involved in raising his comp.

His current plan is a 401(k) with a comparability test profit sharing plan. Someone (there is always a "someone" to muck things up) told him that he could terminate the 401(k) portion of his plan and start a simple 401k. Well that's not possible, nor plausible, but it got me to thinking...

If he were to start a separate entity, with just he and his spouse, and that new entity had a 401(k) plan. He could receive comp from both entities...defer into new one and receive a profit sharing contribution from the old. So long as the matching (if any) contribution were the same, the level of benefits would be as if it were a single plan....However, he wouldn't be limited by the ADP test issues that he is now. Am I missing something here?

[Archimage]

Your new plan would fail coverage.

[wsp]

Now you lost me. I know they would fail coverage if the other plan were terminated, but if it were allowed to continue how would this be any different coverage than if it were a single plan?

Of course, I'm assuming that the Average Benefits Test is passed after agregating the plans.

I see it for what it is...an end around on the non-discrimination rules. But given that coverage and all testing is satisfied prior to the creation of this new plan and ADP is tested on a plan basis while coverage is across employer wide 401(k)'s...

Sorry for asking basic questions...I've been wracking my brain for a solution for this guy and I KNOW I'm spinning my wheels now.

[Alf]

The 401(k) regs require that the ADP test is run on the same "plan" that is used for the coverage test. Either you run the new plan's ADP and coverage separately (and fail coverage), or combine the 401(k)s (assuming you can) and fail ADP.

[Guest trumpy]

Hi wsp -

You said that the plan has a cross-tested profit sharing component. What sort of contribution does the rank & file receive every year? If its 3% or more would he be willing to safe harbor the plan? I don't know about turnover, etc. but this would be a simple solution.

Also, depending on the demographics can he get more profit sharing to offset the deferrals that are causing the ADP test to fail?

[wsp]

We've been encouraging him to go safe harbor. For financial statement purposes, he's reluctant to do so. He hasn't made a profit sharing contribution for the last 2 years due to the economic downturn. This year it's better but he's a classic manufacturing company owner...stubburn and cheap. Keeps massive amounts of cash on hand "just in case". Evidentally, "just in case" doesn't mean to make profit sharing contributions in slower years.

Demographics do not allow him to offset should he not be allowed to contribute. Which is why we encouraged him to go safe harbor; figuring the 3% SHNEC would be perfect scenario for him. He's focused on what he hasn't been able to do over the last few years and not what he "can do". As I said...stubborn. He also has difficulty getting by the vesting of the SH contribution.

[Guest 401der]

Your client is the poster child for why these rules are in place to begin with. He wants to own the business, get the corporate tax deduction, maximize his personal tax-deferred contributions, all without his employees getting a fair shake. His best bet for a plan design that would allow him to maximize his deferrals without raising his costs is the safe harbor, and your unenviable challenge is to convince him that he can either short the tax man or short his employees, but he can't do both.

[jquazza]

If you aggregate the plans for coverage, you must aggregate for nondiscrimination (ADP/ACP.) The other thing is even if you pass coverage independently (say 2nd plan covers staff as well,) and you run separate ADP for each plan, but you have an HCE in both plans, you have to combine his/her deferrals from both plans on each test.