New Safe Harbor 401(k)

[Dougsbpc]

A small employer has a calendar year. They have never had a plan and want to adopt a safe harbor 401(k) plan for 2009.

1. It is our understanding that if the plan is actually adopted 7/15/2009 as a new plan, safe harbor notices can be provided just before that date.

2. Must the effective date be 7/15/2009 or can it be 1/1/2009 with safe harbor provisions effective 7/15/2009? In this case SH NEC's would be based on salary for the entire year.

3. If the plan is adopted 7/15/2009, must comp limit and 415 limit be pro-rated for the short year?

Thanks a million!

[Guest Sieve]

Here's my take on your questions:

1. Perhaps. The SH notice rule for an initial short plan year is no different from the normal SH notice requirements--i.e., the notice must be "provided within a reasonable period before the beginning of the plan year . . . based on all of the relevant facts and circumstances". (Treas. Reg. Section 1.401(k)-3(d)(3)(i).) The 30 to 90-day rule is simply--excuse me for using the phrase--a safe harbor for timing purposes. (Treas. Reg. Section 1.401(k)-3(d)(3)(ii).)

2. Effective date must be 7/15/2009. A safe harbor plan must be "adopted before the first day of the plan year and remain in effect for an entire 12-month plan year". (Treas. Reg. Section 1.401(k)-1(e)(1).) The exception permitting an initial SH period of less than 12 months (Treas. Reg. Section 1.401(k)-1(e)(2)) applies only if the initial plan year is a short plan year, and does not change the requirement that the SH plan must be adopted before the beginning of the plan year, so the initial plan year cannot begin before the date of the plan's adoption (as can a PSP). Therefore, if you do not use an off-calendar 12-month plan year beginning on the SH plan's effective date, then you must have an initial short plan year. So, you cannot use compensation prior to the commencement of the plan year.

(Note that the compensation definition used for SH purposes is the IRC Section 414(s) definition of compensation (Treas. Reg. Section 1.401(k)-3(b)(2)), and can be compensation for "the plan year or the calendar year ending within the plan year" (Treas. Reg. Section 1.401(k)-6). It therefore seems that you can use calendar year comp for the short initial plan year. But, IRC Section 401(a)(17)(A) limits compensation for all purposes (Treas. Reg. Section 401(a)(17)-1(a)(1)), and requires that compensation for periods of less than 12 months be pro-rated (Treas. Reg. Section 1.401(a)(17)-1(b)(3)(iii)).)

3. Pro-ration is required. Because, in your scenario, the initial SH plan year must be a short plan year (unless it is a full 12-month off-calendar plan year beginning on date of adoption), then: (A) the annual compensation limit is pro-rated (Treas. Reg. Section 401(a)(17)-1(b)(3)(iii)), and (B) compensation for purposes of IRC Section 415 is pro-rated because it follows the rules of IRC Section 401(a)(17) (Treas. Reg. Section 1.415©-2(f)), and © the IRC Section 415 limitation is prorated because the limitation year will change from a short limitation year to a full 12-month limitation year (Treas. Reg. Section 1.415(j)-1(d)(2)).

At least that's the way I see it.

[Kevin C]

Sieve,

I disagree with you on 2. 1.401(k)-3(e)(2) allows the mid-year addition of a SH CODA to an existing profit sharing plan. While the 401(k) portion of the plan can't have a retroactive effective date, what stops you from having the profit sharing portion be effective 1/1?

I think you will also get disagreement on part of your 3. The 415 limit is prorated for a short limitation year. But, the limitation year is not necessarily the same as the plan year. Our EGTRRA VS documents have this note in the section defining limitation year: [Note: If the Plan has a short Plan Year for the first year of establishment, the Limitation Year is deemed to be the 12-month period ending on the last day of the short Plan Year.]

[J Simmons]

If you adopted the plan, making the profit sharing portion retro effective to 1/1/2009 (a la Kevin C) and the safe harbor k portion prospective 7/15/2009 and the k safe harbor is the 3% of pay NEC, would that SH NEC 3% apply to pay earned 7/15-12/31/2009 or all of 2009?

[Kevin C]

John,

It could be written into the document either way.

[J Simmons]

Thanks, Kevin.

This would then suggest that in adopting a new plan that will have a 401k safe harbor feature, an employer could reduce its k safe harbor 3%-of-pay SH NEC by not making the 401k feature applicable until the beginning of the 10th month of that first plan year--provided it is written to limit the SH NEC to just amounts earned after the 401k feature becomes applicable. Then the SH NEC only applies to compensation earned in the 10th, 11th, and 12th months of that year, but you could have your HCEs max'ing out during those three months their 402g limits and after-age-50 catch-ups.

[Dougsbpc]

Thanks everyone for your input.

As Kevin mentioned, our VS document also contains the same limitation year language. Also, the document allows for a delayed effective date for safe harbor provisions.

[Guest Sieve]

Kevin --

As I said in my item 2, I agree that a straight PS plan adopted in mid-July, 2009 can be effective as of 1/1/2009. But the regs on SH adoption confuse me (as do some others).

As you point out, the regs differentiate between a brand new SH plan and an amendment to an ongoing PSP which is adding SH provisions: "a newly established" SH plan must have an initial "plan year [that] is at least 3 months long", while a SH amendment to an ongoing PSP must be "effective no later than 3 months prior to the end of the plan year". In the latter case, there obviously already is a plan year of 12 months for the PSP being amended to add SH provisions.

So, if the PSP portion of a new SH plan uses a full plan year, then, in one single document, it seems to me that you have a new SH plan "adopted before the first day of the plan year" (which, in the case of a mid-yr. adoption, probably is a short plan year), and, at the same time, that SH plan is part of a PSP with a plan year that actually starts before the document was adopted. How does that happen? 2 different plan years in the same document?

Anyhow, my thought was that you can't include compensation earned before the start of a plan's first year, even if the limitation year stretches to a date prior to the beginning of that first plan year. Therefore, I thought, compensation prior to the adoption of a new SH plan (i.e., prior to the first short plan year) cannot be included for SHNEC purposes. Apparently, that's not correct (and Tripodi would agree with the statement that my reasoning is incorrect).

And why is it that you cannot extend the limitation year beyond the tail end of a mid-year terminating PSP, but you can extend the limitation year earlier than the commencement of the first plan year?

But the real question is why all the King's men couldn't put Humpty Dumpty back together again . . .

[Kevin C]

Sieve, when you are adding a SH CODA to an existing PS plan, you get an exemption from the requirement that the SH be adopted before the beginning of the plan year. Look at the last sentence of 1.401(k)-3(e)(2).

As for the really important question, they didn't try very hard because they didn't like him. Why else would they call him "Humpty Dumpty"?

[Guest Sieve]

Kevin --

Yes, amending an existing PSP relieves the SH CODA from the requirement that it must be adopted before the beginning of the plan year. But, the OP did not deal with an existing PSP--it dealt with a new plan ("They have never had a plan and want to adopt a safe harbor 401(k) plan for 2009"), and my response was crafted with that in mind.

So, I still don't understand how a brand new SH plan, adopted before the beginning of the plan year (in this case, a short plan year) as is required by the regs governing the SH portion, nevertheless can also contain a PS portion that does not also use the short plan year. Nor do I yet understand why the initial limitation year can be longer, on the front end, than the initial plan year is, permitting compensation earned before the start of the short plan year to be considered for SHNEC purposes.

Important question #2: What conceivable help to the King's men, as they tried to put Humpty Dumpty together, could the King's horses provide, anyway?

[J Simmons]

Larry, could this ER adopt a straight PSP now, effective retro to 1/1/2009, and then on 9/26/2009 amend to add a 401k feature--safe harbored at that--to the plan effective 10/1/2009? By 9/26/2009, the PSP would be an existing PSP. (Question seeks input aside from step-transaction doctrine possibly applying.)

[Guest Sieve]

Don't know why I didn't think of that--but, yes, adopting a PS now, effective 1/1/2009, then amending to add a SH feature effective on or before 10/1/2009, will accomplish, I think, what the OP wants: using full plan year compensation for calculating the SHNEC.

But what about this language form the preamble to the new proposed SHNEC elimination/reduction regs: "In addition, a plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether nonelective contributions or matching contributions) must prorate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of §1.401(a)(17)-1(b)(3)(iii)(A)." Does that somehow limit compensation for the OP's SHNEC as a result of the mid-yr. commencement of the SHNEC, or does that proration only apply (if at all) with respect to provisions which terminate in mid-year?

Presumably, 415 limits would not be pro-rated because there is no limitation year change.

[J Simmons]

Hey, Larry,

I think the OP was wanting to know what period of time for compensation would the 3% SH NEC apply to, more than necessarily wanting it one way or the other.

What I've been driving at is that you could set up the PSP first (or, per Kevin, contemporaneously with the k SH) and have profit sharing comp go back to 1/1/2009. But if the effective date of the k SH is 10/1/2009, then if the plan so says, the 3% SH NEC only applies and must only be made for the last 3 months of the year, during which three months the HCEs will all max out the 402g (and if applicable, over-age-50 catch-ups) limits, $16,500 and $5,500.

[Guest Sieve]

Yes, as Kevin indicated in an early post. (Treas. Reg. Section 1.401(k)-3(b)(2).)

[Dougsbpc]

Thanks again for all the input on this.

Our 401(k) VS document allows us to have a delayed effective date for salary deferrals and a delayed effective date for safe harbor NECs. If they adopt this plan now with a retro effective date of January 1, 2009, delayed salary deferrals and SHNEC effective 9/1/2009, we would have a plan that started out as a profit sharing plan and therefore not subject to any short plan year restrictions. If the employer wishes to provide 3% of full year salary, they can provide SHNEC and an additional PS contribution.

[Kevin C]

But what about this language form the preamble to the new proposed SHNEC elimination/reduction regs: "In addition, a plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether nonelective contributions or matching contributions) must prorate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of §1.401(a)(17)-1(b)(3)(iii)(A)." Does that somehow limit compensation for the OP's SHNEC as a result of the mid-yr. commencement of the SHNEC, or does that proration only apply (if at all) with respect to provisions which terminate in mid-year?

Sieve,

If you use compensation for the full 12 month year for the SHNEC, I don't think you have any proration issues. The regulation cited talks about the period for determining compensation. In that case, it would be a 12 month period.

If, however, compensation prior to becoming eligible to defer is excluded in determining the SHNEC, then I think §1.401(a)(17)-1(b)(3)(iii)(B) allows you to not prorate the 401(a)(17) limit.

(B) No proration required for participation for less than a full plan year. --Notwithstanding paragraph (b)(3)(iii)(A) of this section, a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan. In addition, no proration is required merely because an employee is covered under a plan for less than a full plan year, provided that allocations or benefit accruals are otherwise determined using compensation for a period of at least 12 months. Finally, notwithstanding paragraph (b)(3)(iii)(A) of this section, no proration is required merely because the amount of elective contributions (within the meaning of §1.401(k)-6), matching contributions (within the meaning of §1.401(m)-5), or employee contributions (within the meaning of §1.401(m)-5) that is contributed for each pay period during a plan year is determined separately using compensation for that pay period.

[Guest retirement planner]

If the Plan has a short Plan Year for the first year of establishment, the Limitation Year is deemed to be the 12-month period ending on the last day of the short Plan Year.

[Guest Sieve]

retirement -- I think you're right for 415 purposes (contrary to my first post). Of course, the length of the limitation year does not address the issue of compensation being used for allocation purposes.

Kevin --I now can agree with you that full year compensation can be used for a SHNEC allocation even when a SH provision is added/established in mid-year. But I still think that the reg cited in the preamble points to a reg which requires pro-rating the maximum permissible compensation for the employer SH contribution if the SHNEC (or SH match) is terminated mid-year. That's because the reg. cited in the preamble describes neither the rule for using full year comp for allocation purposes (-1(b)(3)(ii)) nor the rule permitting no proration for periods of less than 12 months due to participating for less than 12 months (-1(b)(3)(iii)(B))--rather, the preamble reference is specifically to -1(b)(3)(iii)(A) (which requires proration of the maximum permissible amount of compensation "f compensation for a period of less than 12 months is used for a plan year . . .").

Preambles are sometimes enlightening. I find this particular preamble statement more confusing than enlightening.