Safe Harbor 401(k) and Modified Compensation Definition

[buckaroo]

I have a plan where the definition of compensation excludes bonus and overtime. The plan is a Safe Harbor Plan with the 3% non-elective. The client has put in the 3% SHNEC on the based compensation during the year. The year has ended and the 414(s) compensation ratio test is run and it is failing. I am unsure of how this is resolved. I thought that the client would simply make the 3% SHNEC on a defition of comp that satisfies 414(s) (perhaps 415). My colleague states that the SHNEC cannot be corrected in this way and that the plan fails to be a safe harbor plan, still owes the 3% SHNEC on the base pay, and is subject to ADp/ACP testing. Comments?

Additionally, I would think it should be different if the SH was satisfied by the SH match, but I do not think that it is ACTUALLY different. Under this scenario, I think it would definately fail to be a SH plan b/c the participants did not have the opportunity to make the deferrals on the poriton of the compensation excluded from the definition. More comments?

[ERISAnut]

First, you should re-verify the language in your document. Many attorneys have included a little known feature on their adoption agreements that state that if the plan is a safe harbor 401(k), the exclusions from compensation will apply only to the HCEs.

After doing the reverification of the language, then you should test the plan using a compensation that satisfies 414(s) since you have failed to meet the safe harbor 401(k) requirements for the year.

This type of thing should never happen in a safe harbor plan. Totally undermines the purpose of safe harbor when you do not use a safe harbor definition of compensation (as one of the objectives is to avoid the test).

As for the compensation participants are eligible to defer on, the only requirement is that it must be reasonable. Base Pay has been ruled reasonable (even if it turns out to be discriminatory) by the IRS. However, this is only for determining comp that may be used for deferrals. The safe harbor employer contribution must be provided on 414(s), which is a different standard than 'reasonable'.

[buckaroo]

Thanks for the quick reply. To summarize, it appears that you agree with my colleague that if the modified comp def fails to satisfy 414(s), then the plan is not SH for that year and must be tested using a def that satisfies 414(s). Agree?

[ERISAnut]

Yes. Agreed.

[buckaroo]

Thanks again. I appreciate the feedback.

[Kevin C]

If you want a cite for why you can't change the compensation definition used in the safe harbor contribution, look at 1.401(k)-3(e)(1):

(1) General rule. --Except as provided in this paragraph (e) or in paragraph (f) of this section, a plan will fail to satisfy the requirements of section 401(k)(12) and this section unless plan provisions that satisfy the rules of this section are adopted before the first day of the plan year and remain in effect for an entire 12-month plan year. In addition, except as provided in paragraph (g) of this section, a plan which includes provisions that satisfy the rules of this section will not satisfy the requirements of § 1.401(k)-1(b) if it is amended to change such provisions for that plan year. Moreover, if, as described under paragraph (h)(4) of this section, safe harbor matching or nonelective contributions will be made to another plan for a plan year, provisions under that other plan specifying that the safe harbor contributions will be made and providing that the contributions will be QNECs or QMACs must also be adopted before the first day of that plan year.

If I remember correctly, you will have to amend to provide for ADP/ACP testing for the entire year and you are stuck with current year testing.

[ERISAnut]

If I remember correctly, you will have to amend to provide for ADP/ACP testing for the entire year and you are stuck with current year testing.

You are correct, except that you do not have to amend. Also, the current year testing method is already in place, where the document states it to be the method used in the event the plan fails to satisfy the safe harbor. That's the way it works on the prototype plans.

[John Feldt ERPA CPC QPA]

Good answers. Obviously, it is very important to understand these nuances before embarking upon the design of the plan. If a consultant (or sales person) brings in a safe harbor 401(k) design that excludes something like bonuses, commissions, or overtime, they may not completely realize the possibility of the failure and its impact. Before the document is drafted, a discussion should occur regarding the possibility of a future failure of the 414(s) test.

Plus, if the plan is also cross-tested and needa the 5% for gateway, then those exclusions cannot be used for determining that 5% gateway anyway. Way.