Restricted employee window of opportunity

[dmb]

This started out in the "Retirement Plans in General" section, but i think it needs to be in the DB section. It seems there is a window of opportunity for a restricted employee to recieve reduced compensation in the year prior to termination/retirement/distribution to take them out of HCE status so they can receive a lump sum. If a non-owner active participant who has been earning more than the HCE threshold recieves less than the HCE threshold in 2006, they would not be considered an HCE in 2007 and therefore could retire and receive a lump sum distribution in 2007. Is this considered an acceptable loophole? I don't think the intent was for the 110% test to be circumvented. I'm not sure if this is something that needs to be discussed when a restricted employee is thinking about retiring and taking a lump sum. Any thoughts would be appreciated. Thanks.

[Slider]

The regulations (1.401(a)(4)-5(b)) define restricted employees as "any HCE or former HCE". It would seem that as long as the employee was an HCE at any time. the employee does not lose that status.

[AndyH]

Right; otherwise he'd just have to wait 1 year after he terminated.

[dmb]

Thanks for the responses. It was my understanding that a "Highly Compensated Former Employee" for a determination year is a former employee who had a separation in a year prior to the determination year. So if a participant earns, for example, $80,000 in 2006 and therefore is not a HCE (or a foirmer HCE) in 2007. This particpant then terminates/retires in 2007 and can receive a distribution since he/she is not considered a restricted employee. Please advise if i am incorrectly reading the definition of a Highly Compensated Former Employee. Thanks again.

[mwyatt]

Your key reg:

1.401(a)(4)5(b)(3)(ii) Restricted employee defined: For purposes of this paragraph (b), the term restricted employee generally means any HCE or former HCE. However, an HCE or former HCE need not be treated as a restricted employee in the current year if the HCE or former HCE is not one of the 25 (or a larger number chosen by the employer) nonexcludable employees and former employees of the employer with the largest amount of compensation in the current or any prior year. Plan provisions defining or altering this group can be amended at any time without violating section 411(d)(6).

Your only out is potentially if the individual wasn't in the top 25 of all time paid list, not whether they were defined to be a HCE at the time of distribution. Now of course they could get around this, assuming there are 25 employees, by bonussing the heck out of the others so that your individual falls out of the count, but I suspect your client won't view this as an intelligent idea .

[dmb]

That is the reg i was looking at, but according to the definition of former HCE, this participant would not be considered an HCE or former HCE in the year of separation (2007). The definition of a former HCE is "a Highly Compensated Former Employee" as defined in 1.410(b)-9, which defines it as "a former employee who is a highly compensated former employee within the meaning of section 414(q). 414(q)(6)(A) states that a former employee shall treated as a HCE if such employee was a HCE when such employee separated from service. Again, this participant will not be an HCE in 2007 (year of separation) if they earn $80,000 in 2006.

According to the definitions (at least i read them, and I may be wrong), a former HCE is not someone who was an HCE at any prior point. It is someone who is an HCE in the year of separation.