Partial year Safe Harbor plan: compensation definition

[AndrewZ]

There's a theoretical new plan, effective 1/1/08 (for profit sharing allocations), adopted 9/30/08 with Safe Harbor match effective 10/1/08. The match is to be calculated annually (not per-payroll).

Can you calculate the SH match based on compensation from 1/1/08, or is it restricted to 10/1/08? It seems clear to me that compensation for purposes of calculating the SH match would be restricted to 10/1/08-12/31/08, but others disagree with me.

It doesn't seem to be explicitly addressed in the regs, other than the requirement that the SH is effective only after the plan is adopted, and I believe that includes the entire SH contribution formula.

Without it being explicitly addressed, I think it may be aggressive to use 12-month compensation, as it would be discriminatory for for NHCEs to have to defer 16% of their last 3 months' compensation to get the full match, while it's easier for the HCEs to afford to so. Conversely, however, if this were a Safe Harbor nonelective contribution, the NHCEs would only benefit more from SH being determined on 12 months' compensation, so I don't think the IRS would take issue with that.

The plan document doesn't specifically address this either, but we are able to custom-define compensation periods to meet our objectives.

Finally, what about a self-employed HCE in this situation, or any other with partial-year eligibility? My understanding is that the total compensation is deemed to be earned on 12/31/08, but that also seems discriminatory. Do any of you pro-rate self-employment compensation in this case?

Thanks.

[K2retire]

Unless there is some other definition of comp somewhere, I think you have to use 12 month comp for the match. Our clients do it all the time.

[AndrewZ]

Unless there is some other definition of comp somewhere, I think you have to use 12 month comp for the match. Our clients do it all the time.

Thanks, but if the Safe Harbor provisions are not allowed to be effective prior to 10/1 under IRS regs, how could the SH match be calculated based on compensation prior to 10/1? And wouldn't the IRS consider the full SH match not effectively available to NHCEs if they can't afford to contribute 16% of salary to receive the full match?

I realize that, during an audit, the IRS may not identify this issue or be too concerned, (unless perhaps the NHCEs clearly aren't benefiting), but I'm looking for some justification to allow making the SH formula effective prior to the SH provisions.

[Tom Poje]

stopping short of running some test numbers to see what would happen. I'd lean toward saying you would use comp from date of entry, otherwise I think the 'rate of match' gets gummed up, which would blow the safe harbor match out of the water. In a situation like that, I would (assuming its possible) have the document be very specific how to handle.

well no, since you get to use 3% for prior year testing, I would probably use that and then go safe harbor in the follwoing year. you are only talking about a 3 month initial plan year.

[AndrewZ]

stopping short of running some test numbers to see what would happen. I'd lean toward saying you would use comp from date of entry, otherwise I think the 'rate of match' gets gummed up, which would blow the safe harbor match out of the water. In a situation like that, I would (assuming its possible) have the document be very specific how to handle.

well no, since you get to use 3% for prior year testing, I would probably use that and then go safe harbor in the follwoing year. you are only talking about a 3 month initial plan year.

Tom, by "entry date," do you mean the 10/1 effective date of the safe harbor provisions (which is effectively the entry date for 401(k)/SH)?

And do you mean the rate of match would be gummed up because participants may terminate prior to 10/1 and so would effectively receive 0% match, or may effectively receive a lower rate due to not being able to defer 16%?

The 3% prior-year ADP probably isn't our best solution, as we're usually dealing with small top-heavy plans where the owners make over the comp limit and want the full $15.5K.

[Tom Poje]

I'd go out on a limb an think the IRS may argue the following:

since you could only defer from 10/1 on, even though you matched on a full year of comp, you figure the rate of match based only on comp from 10/1 since that is the period your deferrals started.

who knows how they think.

At the ASPPA conference one questioned asked in regards to safe harbor plans, was whether a plan could change a discretionary match during the year. (e.g. the match was 50% up to 3% deferred per payroll, now they wanted 100% up to 3% per payroll) and the IRS agents said no, because of the rate of match issue. while your case isn't really the same, in some ways the aspects are somewhat similar.

perhaps the issue (at least if a match was involved) would focus on the following:

you can limit what comp someone can defer on (e.g. exclude bonuses) as long as someone can still receive the full 4% [basic] match. in this case, comp is limited to 1/4 of the year, so the NHCE would have to defer 16% [as you indciated] to receive the full match.