One-time nonelective contribution for acquired employees

[7806akp]

Company X acquired the assets of Company Y, including certain employees. Company X promised Company Y that it would pay a certain dollar amount to each acquired employee in connection with the sale, and the dollar amount owed to each acquired employee pursuant to this agreement varies by employee. Company X wants to contribute these amounts to its 401(k) plan as a nonelective contribution, only up to the annual additions limit. The employees have no legally binding right to the money and will not be allowed to make an election. The employees are not HCEs for the year in which the contribution would be made because they had no compensation from the employer during the look-back year. Is this type of one-time nonelective contribution to a group of NHCEs allowed? Is there a way to word the allocation formula of such a nonelective contribution so that it will work (concerned about the allocation formula being definite and predetermined in accordance with Reg. sec. 1.401-1)? This seems somewhat analogous to mandatory contribution by the employer of unused vacation pay to a 401(k) plan as a nonelective contribution, which has been approved by the IRS as long as nondiscrimination requirements are satisfied.

[K2retire]

How does the document allocate nonelective contributions?

[7806akp]

How does the document allocate nonelective contributions?

Currently the plan does not provide for nonelective contributions. Company would like to amend plan to allow for one time discretionary nonelective contribution to be allocated according to a schedule which would be attached as addendum and include individual's name and dollar amount to be contributed to plan. The dollar amount would be calculated so as not to exceed annual additions limit.

[austin3515]

Remember an amendment that benefits only NHCE's can still be discriminatory if some of those NHCE's are reasonaby excpeted to be HCE's, and are not simply because they had no comp in the look back year. So, for example, you can't give the former owner of Y $49,000 and the people in the factory $1,000 and call it nondiscriminatory [edit: assuiming the owner will make more than 110K with Y]. There's stuff in the EOB about this that you can look up, or perhpaps someoen can post...

Also, a DC contribuion formula must have a definitely determinable allocation. Sure, there are new comp plans that provide discretion, but totally arbitrary would not cut it.

And finally, if Y's plan does not include a last rule, OR if some people's allocation conditions are waived, you might not be able to amend Y's plan to accomplish what you watn anyway.

[7806akp]

Remember an amendment that benefits only NHCE's can still be discriminatory if some of those NHCE's are reasonaby excpeted to be HCE's, and are not simply because they had no comp in the look back year. So, for example, you can't give the former owner of Y $49,000 and the people in the factory $1,000 and call it nondiscriminatory [edit: assuiming the owner will make more than 110K with Y]. There's stuff in the EOB about this that you can look up, or perhpaps someoen can post...

Also, a DC contribuion formula must have a definitely determinable allocation. Sure, there are new comp plans that provide discretion, but totally arbitrary would not cut it.

And finally, if Y's plan does not include a last rule, OR if some people's allocation conditions are waived, you might not be able to amend Y's plan to accomplish what you watn anyway.

What is the EOB? I would like to look at that. I have not found anywhere that discusses the type of discrimination you mention (where employees are only NHCEs because of the look back year), but that was my initial concern and the reason I posted. Let me clarify that these amounts are not totally arbitrary and are being given to all former employees of Company Y who become employees of Company X (NHCEs and HCEs). The amounts are based on an estimate of the amount of pension benefits each employee would have received from new employer Company X if Company X had implemented a pension plan to cover the employees (based on the terms of the pension plan by which employees were previously covered at Company Y). With respect to the "definitely determinable" allocation, is it not definitely determinable if there is a schedule of the individuals' names and dollar amount to be allocated to each individual? The nonelective contribution would be worded in the plan amendment to be limited to individuals affected by the purchase of Y's assets by X, to be allocated in accordance with the attached schedule.

[austin3515]

From the 2010 ERISA Outline Book, Chapter 9:

4.a. Timing of amendment to apply only in year before the individual becomes an HCE. Suppose the employee is not an HCE for the year that the accelerated eligibility is effective, but becomes an HCE in the following year. For example, suppose an employee is hired in September and the plan year is the calendar year. Also assume the normal eligibility requirements are 1 year of service and attainment of age 21. For the remainder of the year in which the employee is hired, the employee earns $195,000. Further assume that the employee is not a 5% owner for HCE purposes, so the only way this individual will be an HCE is through the compensation test under IRC §414(q). For the plan year in which the employee is hired, the employee is not an HCE because he/she does not have prior year compensation in excess of the compensation limit (i.e., his/her compensation forthe prior year is zero). If the employer amends the plan so that employees hired in September are eligible on October 1 of the same year, so that just this employee is eligible for an allocation for the plan year in which he/she is hired, is that a discriminatory amendment? Technically, nondiscrimination testing should not be a problem because the only employee benefited by this amendment for such year is an NHC. However, this employee will be an HCE for the next plan year because his/her compensation exceeds the IRC §414(q) compensation requirement for the prior plan year (i.e., the $195,000 of compensation in the year in which he/she is hired).

Arguments in favor of prohibited discrimination. Although the Treasury and the IRS have not addressed this issue directly in the regulations or other guidance, it is possible that the amendment will be viewed in the context of the employee’s status in subsequent years. The argument would be that the effect of the amendment was to create an additional year of allocations for an employee who is an HCE in the plan year following the year in which the employee is hired (and probably thereafter), along the lines of a past service issue, resulting in a discriminatory timing issue with respect to the amendment. Additionally, the person who benefited from this amendment, although not an HCE for the year that his/her eligibility is accelerated, will definitely be an HCE in the next plan year since the employee’s compensation for the year in which he/she was hired is already known to be enough to make this person an HCE for that next year (unless there is a possibility that the top paid group limitation under the HCE definition might enable this person to continue his NHC status for 1 or more additional years).

Arguments for a finding of no discrimination. There would be arguments on the other side, too. First, the past service issues discussed in 1. above involve a plan amendment (or the establishment of a plan) that gives credit for prior service for employees who are HCEs with respect to the years for which such prior service is granted. Accelerated eligibility provisions do not result in past service credits. Second, nondiscrimination testing is generally a year-by-year determination, and the fact that the employee becomes an HCE at a later time does not necessarily address the discriminatory effect of an amendment that benefits such person in one or more years that he or she is not an HCE. Guidelines Regarding Rollovers as Business Start-ups, In a different context, the IRS has acknowledged that this may be a difficult argument where the alleged discrimination occurs in a year when an individual does not satisfy the HCE definition. See the Memorandum from Michael Julianelle, Director, Employee Plans, SE:T:EP, IRS Employee Plans Bulletin (Special Edition: November 5, 2008), which relates to Rollovers as Business Startups, and is discussed in Section IV, Part G, of Chapter 7.

Design tips. If the employer wants to accommodate a particular individual, but is uncertain of the discrimination testing implications, the employer might consider opening up the amendment to other employees hired within a specified period who will not become (or are unlikely to become) HCEs in the near future. This might necessitate make the amendment effective for more than one plan year where an employer has low hiring rates. If there is a pattern of these types of amendments, that also would dictate some additional caution with respect to the manner in which the amendment is handled, and a closer examination of the classification and number of employees who benefit from the amendment.

Not a “right or feature.” In Section X of this chapter we discuss the requirement in Treas. Reg. §1.401(a)(4)-4 to provide nondiscriminatory “rights and features” under a plan. IRS representatives at the May 2007 meeting of the Taxation Section of the American Bar Association agreed that “rights and features” do not include plan design elements relating to who is included in, or excluded from, the plan. See Q&A-15 of that session. The discriminatory impact of dual eligibility is picked up by IRC §410(b) testing. Nonetheless, the issues raised above with respect to the timing of the amendment could still trigger a discrimination issue.

[7806akp]

Thank you for sending that language. What are your thoughts about the fact that our amendment is not being timed in order to capture HCEs when they are NHCEs because of the lookback year, but rather, it is timed based on the corporate transaction? Also, do you have any thoughts based on the additional facts I provided in my latest post? Thanks again for your help.

[austin3515]

I think if, like I mentioned in my previous post, the would-be-HCE's are getting a lot more than the rank and file, then I think you could have problem. This problem might be alleviated if you can prove that the allocations provided are not discriminatory on a benefits basis somehow.

But I'm also not certain that providing a schedule in the amendment necessarily works, but you're getting into a very gray area. My advice is don't proceed without the blessing of an ERISA attorney. The only thing I know for sure is that this transaction would be scrutinized if it came up under audit. You could submit the amendment for a determination letter, which might be your only good option...