Picking and Choosing Among NHCEs If All HCEs are Excluded

[Guest jhall]

I am hoping this is a relatively simple question. If you have a 401(k) plan that excludes all HCEs from participating, are there any coverage or nondiscrimination issues in also carving out large groups of NHCEs from participating in the Plan? (NHCE carve out would be based on reasonable business criteria--say exclusion of NHCEs at particular geographic location or particular job classification).

It would seem to me that the exclusion of the HCEs basically does away with coverage and ADP testing issues such that the plan sponsor would have wide flexibility in picking and choosing among NHCEs to receive benefits--even if that meant that a majority of NHCEs would not get benefits.

I am not sure that it is relevant to general question but issue arises in situation involving employer acquiring a large number of NHCEs in Puerto Rico (75+% of overall workforce). Puerto Rico employees have 1165 plan in place. Employer would like to continue with separate 1165 plan rather than attempt dual qualified 401(k) plan for both US and Puerto Rico employees. If the Puerto Rican employees are excluded from US 401(k) Plan, there is no way plan can satisfy coverage requirements. Employer, however, would be willing to also carve out the handful of HCEs working for company and take care of them in some other fashion rather than including them in 401(k) Plan. End result would be a US 401(k) Plan covering just US NHCEs (about 25% of total workforce) and separate 1165 Plan covering Puerto Rican employees (about 75% of total workforce) with handful of HCEs excluded altogether.

Any reason the exclusion of the large Puerto Rican group of NHCEs from the US Plan would cause a problem if the Plan excludes all HCEs? Would the answer change at all if the Puerto Rican employees had no 1165 plan and thus had no retirement benefits at all? (I wouldn't think that would make a difference with respect to the US plan.)

Anybody have an alternative suggestion for addressing. Excluding the HCEs from the plan is apparently not all that big of a deal for the company and I think would prefer that than starting down dual plan route with its apparent many compliance burdens.

[Guest jhall]

Maybe if I rephrase my question / example:

Suppose company has small facility in New York with 100 NHCEs and 3 HCEs acquires a larger facility in New Jersey with 400 NHCEs and 2 HCEs. The facility in New York has previously provided a 401(k) Plan with small comany match. The New Jersey employees have never had a 401(k) Plan. NHCEs at both facilities are otherwise generally similarly situated. Due to cost, adminstrative hassle, etc., the company prefers not to add the new NJ employees to the 401(k) Plan. If the company excludes all HCEs from participating in the Plan, will the exclusion of "all individuals employed at the company's NJ facility" from the 401(k) plan create any testing issues or concerns? Thanks.

[Jim Chad]

I know nothing about Puerto Rico, so I did not answer before. But now I can.

You are correct. If there are no HCE's in the Plan, You cannot fail Coverage or Nondiscrimination testing.

[david rigby]

... but you cannot exclude NHCEs based on criteria that would fail other tests, such as "exclude all males".

[Guest jhall]

... but you cannot exclude NHCEs based on criteria that would fail other tests, such as "exclude all males".

Thanks to all. David Rigby raises an excellent point that i had given some thought. I am bothered a bit more with the scenario involving exclusion of all employees at a Puerto Rico facility than in the example involving a New Jersey facility due to the arguably indirect exclusion / discrimination of employees on basis of ethnicity or national origin (assuming that all or nearly all of the workers at the Puerto Rico facility are likely Puerto Ricans). Overall however I've started to convinced myself that this really shouldn't be a concern in this situation. In my defense I would argue that the exclusion is aimed directly at exclusion along specif geographic boundaries rather than demographics of the employees. If you can do that with NY / NJ, excluding a PR facility shouldn't be all that different. In addition, it is my understanding that all Puerto Ricans are classified as U.S. citizens, just subject to some different tax rules in certain cases. Thus, although the employees at the PR facility may not be as similarly situated to U.S. employees as in the NY / NJ scenario, they are all still US citizens in a broader sense.

Finally, my ultimate defese would be that the exclusion is really the result of the varying tax laws and unique treatment of PR employees under the PR tax code. If the government has reason to be upset or offended by any of that they should change the laws. I know I do not appreciate all the historical reasons and significance to having a separate PR tax code but this seems to me to be an areas where the laws simply create unnecessary and illogical differences in treatment of PR employees versus others for pension plan purposes. I also think that PR employees are the ones that suffer the most from this as I have seen other employers simply carve out the PR employees from plans altogether when the demographics permit it rather than trying to deal with the tax different rules, separate plans, etc. If not for the unique PR laws, those employees would generally be permitted to participate in the company's plans just like all other employees. However, the unique PR tax laws cause employers to have to stop and adjust changes which, as a result, can easily result in exclusion of PR employees altogether.