Can a 401(k) feature be added b/4 year end?

[Guest Dash02]

I received a call from a colleague. She has a client that maintains a calendar year profit sharing plan. Can the client add a 401(k) feature to the existing P/S plan before the close of 2006 (effective 1/1/2006?)?

The thought is to use the assumed 3% deferral rate for NHC's for the 1st year (2006). I'm told that such an assumed rate would enable the business owner to defer $16,000 for 2006. Any problems?

It seems that the amendment adding the 401k feature would need to be made effective as of 1/1/2006 so that the owner's comp for the entire year is considered. Any problems?

Since the deferrals actually made by the NHCE's in 2006 will likely be zero, the utilization of prior year testing will preclude the owner from making any deferrals for 2007. To avoid this result, could the plan elect (prior to 1/1/2007) to switch to current year testing for 2007? I realize that such a switch, if permissible, would bind the plan to current year testing for future years unless IRS approval is obtained.

Any thoughts, comments, concerns would be appreciated.

Thanks.

[Leopurrd]

I'm not sure if this would be allowed, since the majority of your NHCE's wouldn't have a chance to defer (as you stated in your post). Seems that you would be adding the 401(k) just so your HCE's could max out, since you'd have less than 2 days to amend, receive salary deferral agreements, etc. It sounds discriminatory......I'm curious as to what other posters say about this.

I'd go with an amendment to add the 401(k) as of 1/1/07 and start there.

[JanetM]

I agree with you Leopurrd. Since the NHC wouldn't have ability to defer it would be discriminatory. Just amend to add the CODA 1/01/07.

[Guest Dash02]

Thank you both for your thoughts.

I've since had the opportunity to research the matter further and thought I'd share my findings.

The arrangement appears to successfully navigate and take advantage of the first year rule and the ability to make a one-time switch to the current year testing method. In other words, I found nothing in these provisions which preclude their use in the situation posed.

However, I believe the arrangement runs afoul of sec. 1.401(k)-1(e)(2)(ii), which requires that a caxsh or deferred arrangement provide an employee with an effective opportunity to make (or change) a cash or deferred election at least once during each plan year.

[Bird]

As long as there's a payroll for everyone to take advantage of the 401(k) feature after the plan is adopted I don't see a problem with it.