Employees Opted Out

[Guest mikeboard]

A small business - 3 key employees (owners) and nine full-time non-key employees - wants to set up a 401(k). They were originally planning on a Safe Harbor 401(k) because the owners didn't want to be on the hook for large matches. When presenting the plan to the employees, every single one of the non-key employees decided to opt out / not participate in any retirement plan. Because of that, the owners now want to sock away as much as possible.

Question: If all non-key employees opt out of a 401(k) and the three key employees max out their contributions, would it be top heavy? Does the top heavy test apply to "total employees", "eligible employees", "total participants", or one of those three but with "whom have not opted out of the plan" added to the definition?

Thanks!

[ak2ary]

ok I'll bite

WHY would all the nonkeys opt out of the plan?

BTW opting out and electing to defer zero are two different things

[Guest mikeboard]

The business is run by three highly paid owners, and the eight employees are very low compensated "assistants" (for the most part). For whatever reason, the employees decided not to get involved in the plan. Maybe they can't afford to defer anything; maybe the owners sold them a bill of goods to save on matching. I honestly can't say.

I was thinking that a Top-Hat plan might be appropriate, but I was curious as to how the Top Heavy rule applied to this situation. If the owners are safe from being top heavy with no other participants, they would prefer the 401(k).

[rcline46]

Put in a Matching Safe Harbor plan - start with say 100 to 4. If no employees decide to defer (they cannot be permitted to 'opt out', only to not defer), up it to 200% to 6% to get owners to max. When employees start deferring enough, reduce the match.

[ak2ary]

I agree with rcline

Do not let them opt out IRS will see it for the sham it is

[BG5150]

Eligible employees become participants on their entry dates. A TH contribution goes to eligible participants employed on the last day of the plan year. So if these people did not irrevocably waive participation (ie, decided to defer zero) then a TH contribution would have to be made.

Although, it would seem fishy that all the people would opt out totally rather than just not deferring if they had even a halfway decent education session.

[Kevin C]

If all the nonkeys really opted out of the plan, I think you would have a coverage problem. I don't see opting out listed as a class of excludable employees under 410(b).

Has the plan already been adopted? If the nonkeys have already made their elections, I would expect the plan to have already been adopted.

[austin3515]

"Put in a Matching Safe Harbor plan - start with say 100 to 4. If no employees decide to defer (they cannot be permitted to 'opt out', only to not defer), up it to 200% to 6% to get owners to max. When employees start deferring enough, reduce the match. "

Of course, a discretionary match cannot exceed 4% of pay. In order to do this 200% of 6% the match would need to be written into the document, which would eliminate the benefit of hindsight.

[John Feldt ERPA CPC QPA]

Thus, a suggestion should appear now to have both a fixed match and a discretionary match. Limit the discretionary match to deferrals not exceeding 6% of pay and limit the discretionary match overall to 4% of pay (but have no allocation conditions). Then back into the fixed match formula based on the compensation of the HCE, limiting the fixed match to be based on deferrals that are not over 6% of pay, but the overall fixed match is not limited like the discretionary match (also no allocation conditions). You can apply a vesting schedule on the fixed an discretionary match (the SH match is already 100% vested).

This means those deferring zero will get zero employer dollars with no top heavy contribution required either (as long as you took care of the plan language for the forfeitures properly too).

[Kevin C]

If the plan has already been adopted, it's too late to change any safe harbor provisions for this plan year. The match changes would have to wait until next year.

[Kimberly S]

Question: If all non-key employees opt out of a 401(k) and the three key employees max out their contributions, would it be top heavy? Does the top heavy test apply to "total employees", "eligible employees", "total participants", or one of those three but with "whom have not opted out of the plan" added to the definition?

Thanks!

Back to the above question: yes, if the only people with money in the plan are key employees, the plan is definitely top heavy. However, if the only contributions in a given year are salary deferrals and the safe harbor contribution (ie no discretionary match or profit sharing) then they get a pass on the top heavy minimum contribution.

[austin3515]

if the only people with money in the plan are key employees, the plan is definitely top heavy. However, if the only contributions in a given year are salary deferrals and the safe harbor contribution (ie no discretionary match or profit sharing) then they get a pass on the top heavy minimum contribution.

Small (but very important modification/expansion) is that the TH exemption is still maintained with discretionary and fixed matches above and beyond the basic SH match provided they satisfy the ACP safe harbors described by JFKBC (as he/she also pointed out).

This infamous idea is referred to as the "triple stacked match" and is really quite cool IF no one defers. The problem with it is that sometimes employees change their minds and before you know it you could have a BIG MATCH if your not paying attention (i.e., if discovered early enough they can all be discontinued mid-year)!

[Kevin C]

Small (but very important modification/expansion) is that the TH exemption is still maintained with discretionary and fixed matches above and beyond the basic SH match provided they satisfy the ACP safe harbors described by JFKBC (as he/she also pointed out).

The IRS DC Q&A session at the 2006 ASPPA annual conference had a similar question. In the second part of Q 14, they add a discretionary matching contribution that satisfies the ACP SH limitations to an example that was top-heavy exempt. My notes say the IRS representative said it was not top-heavy exempt. The updated session handout available on the ASPPA website says "Plan is top heavy (?) maybe. Further discussion on the issue is needed someday." I will point out that the IRS representative in this session had some controversial opinions that made for a very lively session.

Austin, have you seen anything on this more recent than October 2006?

[austin3515]

My answer was based on my reading of the EOB:

Part 2 of the top-heavy exemption in the EOB states:

to the extent there are matching contributions made to the plan, all of the matching contributions satisfy the ACP safe harbor prescribed by IRC §401(m)(11)...

Since all of these contributions satisfy the ACP safe harbor, at least according to Sal, TH exemption would be in tact.