Last minute 401k

[Santo Gold]

Very small employer wants to look into setting up a 401k for 2005, here in the last week of December!!! There's only about 5 employees (3 of which are HCEs) and the objective is for the owner to take a big bonus and defer some/most/all out of it. Lots of mechanical problems obviously, but lets assume that the plan can be adopted as soon as today, and that investments are chosen and ready to go. If only the HCE chooses to defer, then this won't work (failed ADP test). Could a massive QNEC to NHCEs only solve this problem? Alternatively, let's assume 1 or both of the NHCEs agree to have some of their bonuses deferred and there is room for the HCE(s) to contribute. Would this be acceptable? Would 401(k) comp. have to be limited to earnings paid on or after 12/19/2005? This is pushing the envelope but is their anything inherently wrong here?

Thanks

[Archimage]

Two quick ideas:

1. You are allowed to assume the NHCEs' ADP is 3% in the first year of the plan. This gives the HCEs the ability to defer an average of 5%.

2. You can still use bottom-up QNECs for 2005.

[four01kman]

and you can have the plan effective on January 1, 2005, with deferrals effective December __, 2005. This allows you to use 2005 414(s) pay for the deferrals.

[Santo Gold]

four01kman: I would proceed as you mentioned, but I thought you could not retroactively defer 401k money? If the owner wants to defer $14,000 in 2005, he will need comp of $14,000 or more from 12/__/2005 - 12/31/2005. Given that, is there something else to be gained by making the non-401k components effective 1/1/2005?

[Guest mrjones]

Santo Gold: You're right, 401(k) deferrals can't be made retroactively. However, owners' compensation can't be determined before the end of the year, and is therefore treated as all being received at year-end; a single deferral is made for all of the year's income. Technically, it isn't retroactive.

[GBurns]

That might cover the owner but what about the other employees?

If the plan is "retroactive" but the only deferral for 2005 is for the owner, What would happen?

[Guest mjb]

As long as you are going to make contributions for NHCEs why not establish a SEP which can be adopted up to the date the employer files its 2005 tax return. Participation can be limited to employees who have performed service in 3 of the last 5 yrs and the contribution formula can be intergrated with SS, e.g., 2x deferral % permitted for comp over SS wage base. SEP doesnt have built in admin costs of 401k plan, e.g., adoption of qual plan, 5500 forms, adp testing etc. Employer is not obligated to maintain a SEP for any period of time and could adopt a 401k for 2006.

[R. Butler]

In these situations does anyone ever have concern over whether the ability to make elective deferrals is "effectively" available to the NHCE's?

[TBob]

I have encountered the same situation. The HCE's were only going to defer the "catch-up" amount so as to avoid the testing issue but since things were established too late in December, the NHCE's did not have a chance to make an election to defer. We pushed off the establishment of the 401(k) until 1/1/2006 and just did P/S for 2005 to avoid a possible BRF issue.

[R. Butler]

I have encountered the same situation. The HCE's were only going to defer the "catch-up" amount so as to avoid the testing issue but since things were established too late in December, the NHCE's did not have a chance to make an election to defer. We pushed off the establishment of the 401(k) until 1/1/2006 and just did P/S for 2005 to avoid a possible BRF issue.

Thats how we handle it also. This year we got some pressure from a couple of CPAs who wanted to encourage their clients to adopt the 401(k) the last week of this year. We don't make the decision for the prospective client, but we did hold firm & discouraged them from adotping a 401(k) until 2006. It worked out this year, but there were a few tense conversations with a couple of CPAs.