Discrim. Testing for 3% SHNEC

[Guest Dash02]

Trying to establish new plan effective 1/12006 with 401k effective 2/12006. The plan provides for --

1. 401k defls.

2. discretionary nonelective contributions with a cross-tested allocation scheme (each participant consituting a separate alloc. group).

3. The ability to elect to utilize the 401k safe harbor provisions and to make either 3% SHNECs or SH Matching contributions.

The sponsor has only been in business for a couple years and is not making a lot of money. The owner wants to do something for himself and his EEs, but doesn't want to commit to much expense. The thought was to offer 401k and to provide a contingent notice regarding SHNECs (plan uses current yr testing). If business does well, these SHNECs can be made and the owner and his wife can make $15,000 in defls. It's unlikely that he will be able to afford or pass the general test in order to provide himself with additional (9%) allocations.

It now occurs to me that the ave. benefit prong of the general test (which takes into account 401k defls) may not be met to validate the 3% SHNECs even if these are not provided to the HCE/owner. My question is whether these SHNECs satisfy the designed based safe harbor provisions?

Thanks for the help.

[Tom Poje]

remember, there is no requirement to test on an accrual basis. you can test on an allocation basis.

thus if the only contribution is a SHNEC you would easily pass ratio % test.

this is one of those areas people forget about.

in fact, consider a non cross tested plan that is integrated at 100% TWB and 5.7% in excess.

The regs say you dont have to test it because it is a safe harbor formula.

what would happen if you tested using allocation method and imputing disparity? everyone would have the same e-bar! Thus the fact the regs say you get a free pass is rather moot.

[Guest Dash02]

Thanks Tom.

I hadn't forgotten about testing on an allocations basis. I did forget, however, that pursuant to 1.401(a)(4)-2©(3)(i), if every rate group percentage is over 70%, the general test is passed without having to resort to the two-prong testing that is usually done (i.e., the nondiscrim. classification test and the ave. benefit test). Without having to perform the ave. benefit prong, the 401k defls., which were the source of my concern, never have to be brought into consideration.

When tested on an allocations basis, every rate group percentage is 100% because everyone gets the same 3% SHNEC and, therefore, everone is included in every rate group.

Do I have this right now?

[Tom Poje]

that sounds like a gold star