HCE/Key Employee Only Plan

[Guest Brian Anderson]

Hello,

I have a plan effective 01/01/2011 with two key employees(each owning 50%) that started the company in 2006. They both are eligible to participate but have hired several new employees in 2011. They use prior year testing for ADP with the first year using the 3% rule. The first year of 2011 passes given its an HCE only plan. Given there are no NHCE's in 2011 what ADP percetage would be used to determine 2012 since some of the new hires would become eligible in 2012(the plan's service is 1 year, 1000 hours semi-annual entry)? If anyone could help I would really appreciate it.

Thank you,

-Brian

[chc93]

We had a similar question for a discretionary match that was discontinued for a couple of years. Since this wasn't the first plan year, and the plan was on prior year testing, in the first year that the employer match was reinstituted, the HCE's were limited to $0 match, since the prior year NHCE ACP was zero.

I would imagine it would be the same for deferrals. If the plan is on prior year testing, and 2012 is not the first plan year, the prior year NHCE's ADP is zero, and the HCE's will be limited to zero. One option would have been to start a 401k safe harbor and switch to current year testing effective 1/1/12. Maybe you can still do this for 1/1/13, if necessary.

[BG5150]

You can switch from prior year testing to current year at any time.

The plan must be amended before plan year end to use current year for '12.

But then you would have to use current year testing for 5 years before being able to switch back to prior year testing.

[Kevin C]

If you are using prior year testing and there were no NHCE's in 2011, the plan automatically passes ADP for 2012. The same rule is in 1.401(m)-2 for ACP.

§1.401(k)-2(a)(1)(ii)HCEs as sole eligible employees.—

If, for the applicable year for determining the ADP of the NHCEs for a plan year, there are no eligible NHCEs (i.e, all of the eligible employees under the cash or deferred arrangement for the applicable year are HCEs), the arrangement is deemed to satisfy the ADP test for the plan year.

Having a discretionary match available to NHCE's in the prior year, but not contributing a match is a different situation. In that case, your prior year NHCE ACP would be 0%. That is one reason why prior year testing doesn't work well with discretionary matches.

[chc93]

If you are using prior year testing and there were no NHCE's in 2011, the plan automatically passes ADP for 2012. The same rule is in 1.401(m)-2 for ACP.

§1.401(k)-2(a)(1)(ii)HCEs as sole eligible employees.—

If, for the applicable year for determining the ADP of the NHCEs for a plan year, there are no eligible NHCEs (i.e, all of the eligible employees under the cash or deferred arrangement for the applicable year are HCEs), the arrangement is deemed to satisfy the ADP test for the plan year.

Having a discretionary match available to NHCE's in the prior year, but not contributing a match is a different situation. In that case, your prior year NHCE ACP would be 0%. That is one reason why prior year testing doesn't work well with discretionary matches.

Good point... I missed that. Thanks...