Top-paid group election and HCFE - is the following correct:

[John A]

Employer has 21 active employees as of 1/1/98. 7 of these employees are HCE for 1998 and 14 are NHCEs. One of the 7 HCEs, who is age 40, has a compensation history of $150,000 in 1995, 1996 and 1997, and $74,000 in 1998 and 1999. The other 6 HCEs have comp. over $100,000 in 1998. The 14 NHCEs have comp. under $80,000 in 1998. The employer decides to use the top-paid group election for 1999. There are no new employees and no terminations of employment.

Is the following correct:

The HCE in 1998 with $74,000 comp. in 1998 has a deemed separation year in 1998 and so is an HCFE for 1999.

Number of ees considered for top-paid group = 20.

The number in the top-paid group will be 4 (20% of 20).

There are 5 HCEs for 1999: the 4 employees with the highest compensation in 1998, plus the 1998 HCE with $74,000 comp. in 1998 (due to being an HCFE).

Is the above correct?

[IRC401]

1. You stated that the #7 HCE had $74,000 of compensation in 1999. Therefore, it doesn't appear that he was a former employee.

2. Check the regulations. I believe that a plan amendment (covering all plans in the controlled group) must be made to use the "20% election". Was a timely amendment made?

3. You didn't discuss 5% owners. Should we assume that they (don't forget relatives) are all in the $100,000+ group?

4. Determining who is an HCE is a very important matter for 401(k0 plans. Perhaps you should consult with someone who has all of the facts in front of him.

[Guest]

I agree with the above. the individual in question is simply an NHCE. since he did not terminate he is not a former HCE.

21 employees (you would also have to include employees who may be ineligible but have worked 6 months, and averaged sufficient hours, etc).

21 * 20% = 4.2 you are permitted to round up or down, but your rounding convention should be consistent from year to year.

my understanding of the regs, since we are in a transistion state, you could 'switch' to top paid group as long as when you amend for SBJPA your document indicates what testing methods you used in 97,98,99,,,etc

to indicate if you were using prior year vs current year, etc. I think top paid group option was also included in this - mainly cuz how could you amend your plan at this point in the game since the IRS hasn't given its official sanction for new regs amendments.

[John A]

IRC401 and Tom,

Please read the following example from IRS Reg. 1.414(q)-1T Q&A 5:

Example (1). Assume that in 1990 A is a highly compensated employee of X by reason of having earned more than $75,000 during the 1989 look-back year. In 1987, 1988 and 1989, A's years of greatest compensation received from X, A received $76,000, $80,000 and $79,000 respectively. In February of 1990, A received $30,000 in compensation. Because A's compensation during the 1990 determination year is less than 50% of A's average annual compensation from X during A's high three prior determination years, A is deemed to have a separation year during the 1990 determination year pursuant to the provisions of paragraph (a) of this A-5. Since A is a highly compensated employee for X in 1990, A's deemed separation year, A will be treated as a highly compensated former employee after A actually separates from service with the employer unless A experiences a deemed resumption of employment within the meaning of paragraph (B) of this A-5.

Based on this example, it still appears to me that the #7 HCE in my question would be a Highly Compensated Former Employee (HCFE), NOT an NHCE. After reading the example, would you agree?

IRC401, regarding your other points:

2. I'll check the regulations again, but my understanding is that a plan can choose to use the top-paid group election as long as the plan is amended to conform to actual practice by the end of the remedial amendment period.

3. My apologies for not including ownership info. For purposes of the question, assume that the top-paid HCE is a 100% owner who is not related to any of the other employees.

4. I agree that determining HCEs is a very important matter - it is important for all plans, not just 401(k) plans. That is why I am trying to be sure I understand the rules pertaining to Highly Compensated Former Employees (HCFEs) and when those rules affect the determination of HCEs.

Tom and IRC401, would your above responses now change?

[Guest]

Since A is a highly compensated employee for X in 1990, A's deemed separation year, A will be treated as a highly compensated former employee AFTER A actually separates from service with the employer unless A experiences a deemed resumption of employment within the meaning of paragraph

(good try!)

I put emphasis on word in the reg you cited.

Former HCE works slightly different than former key where the person is still working.

I was never sure why the term 'former' hce was important, the only reference or best example I can find is in the ERISA OUTLINE BOOK

"The HCE tests described above apply to ACTIVE employees. For certain qualifcation rules, it is necessary to determine who are highly compensated FORMER employees. for example, if new benefits are accrued in a defined benefit plan for former employees (e.g. an amendment to provide a cost of living adjustment) the coverage and non discrimination requirements must be satisifed with respect to those benefits."

[John A]

Tom,

Thanks for setting this straight.

I did not read the reg carefully enough because I had first read the following example from Q 1:19 in the 2000 Pension Distribution Answer Book: Example I-14. Irene is an HCE of Rene's Cookie Creations, Inc. During each of the years 1992, 1993, and 1994, she earned $150,000. In 1995, she decided to cut back her hours to spend more time with her grandchildren and only earned $40,000. Since her compensation during the determination year (1995) is less than 50 percent of the average annual compensation earned in her three consecutive highest paid years ($150,000), Irene has a deemed separation year in 1995. Irene is treated as a HCFE in 1995 and future years, unless she experiences a deemed or actual resumption of employment.

It seems clear upon rereading the reg noting your emphasis, that the Pension Distribution Answer Book example is incorrect - Irene would be an HCE in 1995 and would only be an HCFE after actual termination of employment.

Do you agree that the Pension Distribution Answer Book example is wrong?

Even with the ERISA Outline Book example you cited, it seems to me at this point that the HCFE designation is never important. I do not understand why the designation was created.

Thanks again for pointing out what I missed in the reg.

[Guest]

My 'guess' is that former HCE wouldn't matter in a DC plan since your benefit is your account balance. based on the example I found it looks like it may be important in a DB plan, but only in regards to nondiscrim testing. DBs are not my area. (heck, I still have to research a lot on DC just to make sure, but its people like you that keep me on my toes learning more!Thanks!)