Compensation for 3% SH Nonelective contribution

[Guest NPS Darren]

I have a plan that is top-heavy. The plan is a Safe Harbor 401(k) Plan with a 3% Safe Harbor Nonelective contribution. The plan document allows for the plan to exclude compensation paid during the determination period for ALL contributions.

My question is this because the plan is top-heavy must I give someone who enters half way through the year the 3% SH contribution on a full year of compensation or can I allocate the 3% SH contribution based on compensation paid from the employee's date of entry to the end of the plan year.

My thought is that if the answer is I allocate the 3% SH contribution based on compensation paid from the employee's date of entry to the end of the plan year I would then need to allocate a special Top Heavy minimum contribution so that the eligible employee does receive a total of 3% in total contributions based on a full year of compensation.

Anybody who might have knowledge to this type of situation please let me know. I am not sure how to handle this situation, honestly I don't like that the document allows the plan to exclude compensation paid during the determination period for ALL contributions.

[Laura Harrington]

Are there any other employer contributions (i.e. profit sharing, match, etc.) for the plan year? Or are the only contributions deferral and safe harbor nonelective?

[Guest Sieve]

Here's what Laura was getting at: If the plan has only safe harbor employer contributions and salary deferrals, then it is not subject to TH requirements (unless there are some other sources--e.g., forfeitures from old $$, or discretionary PS contributions). (IRC Section 416(g)(4)(H). And see the special rule in the last sentence of (H).) Of course, if the SH plan were subject to TH, then the 3% employer nonelective contribution, as you describe it, would come close to meeting SH requirements, anyway.

In general, for a plan subject to TH requirements, TH compensation is full-year compensation, regardless of date of entry into the plan, and the TH contribution must be based on this compensation amount. You should be able to determine that when you look at the TH contribution/allocation provisions in the document.

By the way, what do you mean when you talk about the "determination period"? Is that the period before an individual becomes a plan participant? If so, a plan may not exclude those compensation amounts for purposes of determining a TH allocation (even though it may exclude that portion of compensation for other plan purposes).

[Guest NPS Darren]

Are there any other employer contributions (i.e. profit sharing, match, etc.) for the plan year? Or are the only contributions deferral and safe harbor nonelective?

For this plan year the client will not be making a Profit Sharing contribution but the plan allows for discretionary profit sharing contributions.

I am now under the impression that the way the plan document is done that I would use comp from 07/01/08 to 12/31/08 for Safe Harbor and then I would need to give a top-heavy minimum contribution to come up with the remainder of the required 3% of gross plan year comp. I was able to get our pension software (ASC) to allocate both the pro-rated safe harbor and the top-heavy minimum required to satisfy the 3% TH min requirement.

Do you think that this is correct, or do you feel I need to allocate the 3% SH non-elective on a full year of gross compensation?

[Laura Harrington]

Read IRC 416(g)(4)(H) which contains the requirements for a safe harbor 401(k) plans to be deemed not top heavy even if the top heavy ratio is greater than 60%.

In order to satisfy the exemption the plan must consist solely of deferral, safe harbor contributions and match that satisfies the ACP safe harbor.

If the exemption is met, it does not matter that your safe harbor nonelective was allocated on compensation after date of entry. The plan is deemed not top heavy and no additional contributions must be made to satisfy the top heavy minimum.

When these rules went into effect back in 2002 there was some question as to whether or not a discretionary profit sharing feature in the plan document would prevent a plan from being eligible for the exemption in years that they decided not to put in a profit sharing contribution. Revenue Ruling 2004-13 clarified that a plan with a discretionary profit sharing feature could still meet the exemption in years that no profit sharing was allocated as only the contributions and forfeitures allocated for the plan year have to be considered.

Based on the data you have provided, I think this plan meets the exemption.

[Guest Sieve]

. . . if, as you indicate, there are no forfeiture allocations for the year (from prior discretionary PS contributions).

Of course, we now have a slightly new animal--a QACA, with forfeiture allocations, which still is exempt from TH requirements.

[Guest KVAlbert]

I thought I had this down, if the plan only consisted of deferrals and safe harbor contributions then it was exempt from the top heavy rules. This link from Mckay Hochman seems to contradict my understanding.

http://www.mhco.com/library/articles/2010/ashth_022510.html

In the Alert it says

" * When employees are eligible to make elective deferrals upon hire but are not eligible for the match until after one year of service is completed. This is explained in detail below.

According to the ruling, a safe-harbor 401(k) plan will not be exempt from the top-heavy rules if it permits immediate or short eligibility for an employee to enter the plan for elective deferrals, but imposes a longer service requirement for the employee to enter the plan to receive safe-harbor matching contributions.

In a safe-harbor 401(k) plan that permits employees to defer before meeting the statutory one-year-of-service requirement, but that requires a longer period of service before being eligible for the safe harbor matching contribution, the plan is not eligible for the top-heavy exemption. Why? Because newly-hired nonhighly compensated employees (NHCEs) will not be eligible to receive the same level of contributions as longer-term highly compensated employees (HCEs), and thus, the plan does not satisfy the requirements for the top-heavy exemption. This has a significant impact on the plan. For example, longer-term non-key employees who are eligible to defer but did not contribute any deferrals would now be eligible to receive the top-heavy minimum. Those who deferred 1 or 2 percent might also be eligible to receive the difference up to the 3% (and they would be, if the plan's top-heavy minimum is actually 3%.) Since staggered eligibility is a normal design method, employers should consider this rule when designing their plan's eligibility. "

I have a situation where the employees are allowed to defer but do not have the year of service necessary to receive the safe harbor contribution. Do they need to get a top heavy allocation?

[Guest Sieve]

Yes, McKay Hochman is correct. Your plan design could meet SH requirements for those eligible for the SH match, and could meet ADP requirements for those not eligible for the match, but would not be exempt from the TH requirements because the entire plan is not a SH plan. Here is what Rev Rul 2004-13 says about your plan design:

" . . .

"Section 401(k)(12) provides that a CODA is treated as satisfying the ADP test if the CODA meets certain contribution and notice requirements. To satisfy the ADP test safe harbor contribution requirement, an employer must make either (1) a nonelective contribution equal to at least 3 percent of each eligible nonhighly compensated employee’s compensation (“safe harbor nonelective contribution”) or (2) a matching contribution that satisfies certain minimum amount and rate conditions (“safe harbor matching contribution”). Matching contributions do not satisfy § 401(k)(12) or § 401(m)(11) if the rate of matching contributions for a highly compensated employee at any rate of elective contributions is greater than that for a nonhighly compensated employee who is eligible to make elective contributions. Also, a plan does not meet the requirements of § 401(k)(12) if, under the terms of the plan, a nonhighly compensated employee is eligible to make elective contributions but is not eligible to receive either a safe harbor nonelective contribution or a safe harbor matching contribution. Safe harbor nonelective contributions and safe harbor matching contributions must be nonforfeitable when contributed to the plan and subject to withdrawal restrictions. . . .

"In Situation 4, under the plan, newly hired nonhighly compensated employees who make elective contributions will not be eligible to receive any matching contributions until they have completed 1 year of service. Since this will result in a greater rate of matching contributions for highly compensated employees than for nonhighly compensated employees, the matching contributions do not satisfy the requirements of § 401(k)(12) (or § 401(m)(11)). Further, since all eligible nonhighly compensated employees under the plan do not receive safe harbor nonelective contributions or safe harbor matching contributions, the matching contributions made under the plan do not satisfy the requirements of § 401(k)(12). However, certain plans that provide for early participation may satisfy the requirements of § 401(k)(12) with respect to the portion of the plan that covers employees who have completed the minimum age and service requirements of § 410(a)(1), while satisfying the ADP test of § 401(k)(3)(A)(ii) for the eligible employees who have not completed the minimum age and service requirements. Unless a plan (within the meaning of § 414(l)) meets the requirements of § 416(g)(4)(H), no portion of the plan will satisfy § 416(g)(4)(H). (See Notice 2000–3, 2000–1 C.B. 413, Q&A–10.)"