Safe Harbor and the Top Heavy free pass

[Guest EPS2]

Plan is a Safe Harbor 401(k) Plan that uses the basic match allocation.

The document provides for the safe harbor basic match to be allocated to HCE and NHCE.

Only the HCE (owners...husband and a wife) contributed deferrals in 2006, 2007 and 2008.

The have about four other rank and file employees, but none of them have deferred.

Everything I've read, says that the plan is a safe harbor plan even if there are no rank and file EEs deferring, as long as the safe harbor contributions are being made to all that defer, and the notice requirements are met in addition to all the other safe harbor requirements.

Now: The plan is terminating in 2009, and the employer cannot afford to put in the safe harbor match for 2008 (it would only go to the owners). The plan was not amended before the 2008 plan year to provide for safe harbor contributions to NHCE only.

What happens now?

Is Top Heavy now an issue because the safe harbor match cannot (won't) be funded?

ADP test must be run?

Neither of these will pass because NHCE have not been deferring for quite some time...

What is the plan had been amended before the plan year to omit the HCEs from receiving a safe harbor match? This means that HCE would defer...just not get a match. NHCE are not deferring, so they don't get a match...is the plan still a safe harbor plan?

I'm thinking that in order for the plan to keep it's safe harbor status, and to have that free pass on Top Heavy, the HCE must be allocated that safe harbor match contribution.

right?

[K2retire]

Perhaps if you point out to the owners that giving themselves the SH match would probably be less expensive than giving all of their staff a top heavy minimum contribution plus they get to keep the contribution, they will reconsider whether or not they can afford to make the required contribution.

Although, I'm not certain that is the correct answer, raising the question might persuade the client to do what they need to do.

[Guest Sieve]

ESP2--

If no NHCEs deferred, I'd first question if the existence of the 401(k) Plan was really known by the NHCEs (notice "distribution" notwithstanding).

Your description of a SH plan is not exactly correct. A SH match contribution is not required to be made to all who defer, just to the NHCEs who defer, while the SH NEC is required to be made to all NHCEs who are eligible to defer (whether or not they actually defer)--except that you cannot cutback on the accrued SH match or accrued SH NEC which the plan may have provided for HCEs (which apparently it did here).

Be that as it may, you are right, but for a different reason. You can't have a SH plan without a SH contribution, which really only needs to be made to NHCEs (although this plan passed along that contribution to HCEs, which it did not need to do). But, you can't eliminate that HCE matching contribution accrual (SH or not) after the fact, for the same reason you can't cutback any other accrued alloction/benefit--IRC Secton 411(d)(6). As a result, TH is not an issue because you have a SH plan-- but because you MUST fund the promised SH contribution for HCEs (i.e., the accrued benefit) for 2008.

Had the SH match been eliminated in mid-year ONLY for HNCEs, then you would still have a SH plan (because only NHCEs have to receive the SH contribution), but you'd be required to fund the 3% to the HCEs while the match was in place since that document-specified matching contribution had been accrued. Could have eliminated SH contribution for HCEs prior to 2008, and plan would still have been SH--but, hindsight is 20/20!

I think K2 has it right, except that these 2 HCEs probably have higher combined comp than the 4 NHCEs, so the argument may not work. But, sas K2 points out, the $$ would be theirs, and not the NHCEs, which is the good news. The HCE contribution for 2008 does not have to be made until due date for filing federal income tax return, so there still may be time to come up with the $$.

[Kevin C]

Had the SH match been eliminated in mid-year ONLY for HNCEs, then you would still have a SH plan (because only NHCEs have to receive the SH contribution) ...

I know this part did not directly relate to the original post, but I have to disagree. 1.401(k)-3(e)(1) prohibits amendments to the safe harbor provisions during the plan year. Also, the rules for suspension or reduction of SH match during the year require that the plan be amended to require that the plan satisfy the ADP test for the entire year using the current year testing method {1.401(k)-3(g)(1)(iv)}. Between the two, I don't see how you could eliminate a SH match mid-year for the HCE's and remain SH.

ESP2,

Unfortunately, the plan sponsor is in a difficult situation. The terms of the plan required the SH match contribution and they cannot amend to retroactively reduce a required contribution that a participant has already earned the right to receive. If they don't make the contribution, they have a qualification issue for not following the terms of the plan.

[Guest Sieve]

Kevin --

A SH plan is one that provides either a SH NEC or a SH match "on behaf of each eligible NHCE" (Treas. Reg. Sections 1.401(k)-3(b) & ©(1), emphasis added.) A SH match is not defined as including a match for HCEs. Therefore, if a SH plan extends the match to HCEs as part of the SH match, I would argue that it is NOT a SH match to the extent that the match goes to HCEs, so the tack-on additional match provided to HCEs therefore can be stopped in mid-year despite the -3(g) rules.

My agreement on the necessity to make the match is because it has accrued to the HCEs and therefore cannot be cut back.

But, to borrow from another poster, WDIK . . .

[Kevin C]

Sieve,

I wouldn't want to argue that the match going to the HCE's is not part of the safe harbor. If it is not part of the SH, you can kiss your top heavy exemption goodbye.

I will argue that when you include the HCE's in the SH contribution, it is still a SH contribution. Look at 1.401(k)-3©(7), Example 1:

Example 1. (i) Beginning January 1, 2006, Employer A maintains Plan L covering employees in Divisions D and E, each of which includes HCEs and NHCEs. Plan L contains a cash or deferred arrangement and provides qualified matching contributions equal to 100% of each eligible employee's elective contributions up to 3% of compensation and 50% of the next 2% of compensation. For purposes of the matching contribution formula, safe harbor compensation is defined as all compensation within the meaning of section 415©(3) (a definition that satisfies section 414(s)). Also, each employee is permitted to make elective contributions from all safe harbor compensation within the meaning of section 415©(3) and may change a cash or deferred election at any time. Plan L limits the amount of an employee's elective contributions for purposes of section 402(g) and section 415, and, in the case of a hardship distribution, suspends an employee's ability to make elective contributions for 6 months in accordance with §1.401(k)-1(d)(3)(iv)(E). All contributions under Plan L are nonforfeitable and are subject to the withdrawal restrictions of section 401(k)(2)(B). Plan L provides for no other contributions and Employer A maintains no other plans. Plan L is maintained on a calendar-year basis, and all contributions for a plan year are made within 12 months after the end of the plan year.

(ii) Based on these facts, matching contributions under Plan L are safe harbor matching contributions because they are qualified matching contributions equal to the basic matching formula. Accordingly, Plan L satisfies the safe harbor contribution requirement of this paragraph ©.

[Guest Sieve]

Kevin --

I agree that it is still a SH contribution if HCEs get the match. What I take from the example you quote is that giving the HCEs a SH match is not fatal to the SH match and does not change its SH clothing.

But, based on your persistence, I figured maybe I should analyze a bit more carefully, follow through on my logic (oxymoron?) and complete the loop to determine the consequences of my approach (which go to the heart of the OP). If there's a gap in that analysis, then I'm wrong. So, bear with me while I analyze this aloud and please let me know where I've slipped up . . .

If the HCE portion of the SH match could be eliminated in mid-year and treated as a non-SH match, as I suggest, then it presumably would become just a plain vanilla match. If so, then there's still an ACP free pass on this additional match because the NHCEs received an ADP SH match and the other limitations of the ACP SH provisions--at Treas. Reg. Section 1.401(m)-3(d)--are met. According to IRC Section 416(g)(4)(H), the TH exemption applies to a plan which consists solely of deferrals that pass ADP SH and matching contributions that pass ACP SH (such as under 401(m)(11)). I think this non-SH match to the HCEs meets those requirements and would not disqualify the matching contribution from meeting (m)(11).

Am I missing something? I've been know before to ignore the pole in front of me until it hits me square between the eyes! Or is this just another case of "agree to disagree"?

[Kevin C]

Sieve, I'll try.

1.401(m)-3(a) ACP test safe harbor. --Matching contributions under a plan satisfy the ACP safe harbor provisions of section 401(m)(11) for a plan year if the plan satisfies the safe harbor contribution requirement of paragraphs (b) or © of this section for the plan year, the limitations on matching contributions of paragraph (d) of this section, the notice requirement of paragraph (e) of this section, the plan year requirements of paragraph (f) of this section, and the additional rules of paragraphs (g), (h) and (j) of this section, as applicable. Pursuant to section 401(k)(12)(E)(ii), the safe harbor contribution requirement of paragraphs (b) and © of this section must be satisfied without regard to section 401(l). The contributions made under paragraphs (b) and © of this section are referred to as safe harbor nonelective contributions and safe harbor matching contributions, respectively.

1.401(m)-3(f)(1) General rule. --Except as provided in this paragraph (f) or in paragraph (g) of this section, a plan will fail to satisfy the requirements of section 401(m)(11) and this section unless plan provisions that satisfy the rules of this section are adopted before the first day of that plan year and remain in effect for an entire 12-month plan year. In addition, except as provided in paragraph (h) of this section, a plan which includes provisions that satisfy the rules of this section will not satisfy the requirements of §1.401(m)-1(b) if it is amended to change such provisions for that plan year. Moreover, if, as described in paragraph (j)(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.

I read “this section” to mean “1.401(m)-3”. The SH match is described in 1.401(m)-3©. The other limitations on matching contributions, including the restrictions on the match received by HCE’s, are listed in 1.401(m)-3(d). I think that makes the SH match received by the HCE’s part of the provisions that satisfy the rules of 1.401(m)-3. -3(f)(1) above says you can not amend those provisions during the plan year.

416(g)(4)(H) CASH OR DEFERRED ARRANGEMENTS USING ALTERNATIVE METHODS OF MEETING NONDISCRIMINATION REQUIREMENTS. --The term "top-heavy plan" shall not include a plan which consists solely of --

416(g)(4)(H)(i) a cash or deferred arrangement which meets the requirements of section 401(k)(12) or 401(k)(13), and

416(g)(4)(H)(ii) matching contributions with respect to which the requirements of section 401(m)(11) or 401(m)(12) are met.

We are not talking about 401(m)(12) here, so to be TH exempt, the match would have to satisfy 401(m)(11). That means the match has to satisfy 1.401(m)-3. If you are amending the match mid-year, then that match does not satisfy 1.401(m)-3 because it does not satisfy -3(f)(1).

[Guest Sieve]

Kevin --

I agree with your analysis -- except one point. You say that the HCE allocation of the SH match is part of the "plan provisions that satisfy the rules of this section" (from (m)-3(f)(1) that you quote). It certainly is a plan provision, but I don't think it is a plan provision satisfying the (m)-3 regs--I think the HCE allocation is superfluous when it comes to satisfying the SH rules.

I can live with it either way. In this case, of course, the OP related to 2008, and that's done & gone anyhow.

[Kevin C]

The HCE match allocation is not required to satisfy 1.401(m)-3. But, if there is an HCE match allocation, it must satisfy the requirements of 1.401(m)-3, specifically -3(d), if you want the plan to satisfy the ACP safe harbor.

1.401(m)-3(a) starts off with "Matching contributions under a plan satisfy the ACP safe harbor provisions of section 401(m)(11) for a plan year if ...". Notice it does not say matching contributions for NHCE's...

When you are looking at the top heavy exemption, you are saying the HCE match satisfies the ACP SH rules of 1.401(m)-3. But, when you look at the requirements for the ACP safe harbor, you don't want it to be subject to the ACP SH rules. I think you have to be consistent.

[Guest Sieve]

OK, I can go another round or 2 if you want . . .

Remember that a plan can pass ACP without a SH match. All a plan needs is to pass ADP SH (with either a SH NEC or SH match), and then meet certain other requirements (including regs. (m)-3(d)), and you have a SH plan which also passes ACP. The SH match is for ADP purposes only. Nothing in the statute or regs requries that a SH plan which passes ACP must have a SH match--it could have a SH NEC.

Of course, a SH match does, in fact, pass ACP because it does not violate the requirements of a SH plan to pass ACP. But a plan without any SH match whatsoever--i.e., with a SH NEC and a normal, garden-variety match--can still also meet ACP SH.

So, reg 1.401(m)-3(a) starts off with "Matching contributions under a plan satisfy the ACP safe harbor provisions of section 401(m)(11) for a plan year if ..." without mentioning HCE or NHCE because the matching contributions that qualify for ACP SH do NOT have to be a SH match as described for ADP SH--they can be plain vanilla matches, of any kind and flavor, which happen to meet (m)-3(d) and which are also attached to a SH plan which passes ADP safe harbor (which is the first requirement of a number of requirements to pass ACP testing).

I don't think there's an inconsistency. I'm not saying that the matching contribution for the HCEs is part of a SH match, because it is not a SH match. I'm saying that the varying matches--for NHCE & HCE--meet the requirements for an ACP free pass, and that the ADP pass (required for an ACP SH plan) comes from the SH match to NHCEs and does not come from any HCE match whatsoever.

[Kevin C]

How they could have designed the plan is immaterial. What matters is how the code and regulations apply to the plan provisions they have.

My position is that if you want the plan to be ADP and ACP safe harbor, then the HCE match provisions must satisfy the applicable rules of 1.401(k)-3 and 1.401(m)-3. That makes the HCE match part of the "provisions that satisfy the rules of this section", meaning 1.401(k)-3 and 1.401(m)-3. Part of those rules are the mid-year amendment restrictions in 1.401(k)-3(e) and 1.401(m)-3(f).

One one hand you are saying these HCE match provisions satisfy the rules of 1.401(m)-3, but then you claim they can be SH without following the rules of that section, namely -3(f). I disagree. I would also point out that 1.401(k)-3 has rules regarding the HCE match, too.