No Contributions in the First Plan Year

[BeanCounterBlues]

Non-safe harbor 401k plan legally began 10/1/2016 (plan document shows that as the effective date).  Due to issues w/ getting the investments going, no salary deferrals were withheld during 2016 from any paychecks.  No employer contributions planned for 2016.  

Company plans to file a short year first plan year 5500, showing no contributions or assets, for 2016.  Salary deferrals were begun during 2017.

Question:  the Plan was set up for prior year ADP testing.  For ADP testing, is 2016, or 2017 considered the first plan year?  It seems that 2016 would be the "first" year, thus causing the prior year deferral % for 2017 too be zero, which would mean the HCE's could not salary defer.  Remedy would be to recommend amending the plan document for current year testing, to allow the HCE's to contribute.

Any better ideas?  Would prefer that 2017 be the "first" year, but not sure there is an legal basis for doing so under the circumstances.  Thanks for any assistance.

[Tom Poje]

arguably, if there was no possible way for someone to defer the first year, then the 401k 'feature' didn't exist. (despite best intentions) this would be no different than creating a plan in 2016 with profit sharing only and adding a 401k feature in 2017.

[CuseFan]

Respectfully disagree Tom. If under the terms of the plan as legally adopted deferrals could have been made, the issues with failing to have the proper administration in place are irrelevant.

[Mike Preston]

I'm with the Orange man (or woman).

[BG5150]

Keep in mind, once you transition to current year testing, you are stuck with it for at least 5 years.

[austin3515]

Don't you have a operational failure here for not giving participants the opportunity to make 401k contributions?  I certainly think so. I'm assuming the failure was longer than 3 months and as such the QNEC would be 25% of missed deferrals and 100% of the match.

Interesting question is, 25% of what?  Perhaps 25% of the election the ultimately made? Perhaps 25% of 3% (even though EPCRS is clear that it is based on current year activity). But 25% of zero hardly seems appropriate.

[Tom Poje]

Because of the issue with the investment house, it was still impossible for someone to defer. therefore, while every intent to start the thing may have been there, it simply was impossible.

years ago at an ASPPA conference, the question was posed "A safe harbor notice was provided (3% shnec) but the plan was never amended for safe harbor. now what?

the IRS response was there is no 3% due under the terms of the document. you may be on the hook for 3% via the DOL but that is a different issue.

This may be similar, you told people they could defer, but in reality they couldn't. So are you 'on the hook' for making QNECs to make up for missed deferrals, and if so how much? in addition, it was not indicated above what employees were told...e.g. if there would be a delay, etc.

 

[My 2 cents]

I don't practice in the 401(k) area, but wouldn't collecting salary reduction amounts and finding suitable investment vehicles for those amounts essentially be two, independent, functions?  I don't see why not being able to invest the funds with the specific investment house should get in the way of having people sign up for salary reductions (let alone making it impossible for people to defer) and implementing those elections.  Are there no banks in the area that could hold those funds temporarily?

[BG5150]

4 hours ago, austin3515 said:

Don't you have a operational failure here for not giving participants the opportunity to make 401k contributions?  I certainly think so. I'm assuming the failure was longer than 3 months and as such the QNEC would be 25% of missed deferrals and 100% of the match.

Interesting question is, 25% of what?  Perhaps 25% of the election the ultimately made? Perhaps 25% of 3% (even though EPCRS is clear that it is based on current year activity). But 25% of zero hardly seems appropriate.

Failure was <=3 months.  Plan effective date was 10/1

[austin3515]

BG, they said nothing was withheld in 2016 - 10/1/16 to 12/31/16 is 3 months.  Perhaps you inadvertently subtracted 10 from 12?  Or maybe I'm missing something...

[austin3515]

OK maybe I see what you're saying - less than or EQUAL to, but the OP did not specifiy when in 2017 they began, and I'm assuming it was sometime after 1/1.  I suppose if from the first pay-date in October through the first pay-date that deductions began was less than 3 months you could make the case for it.

[BeanCounterBlues]

Thank you all for your thoughtful replies, I greatly appreciate.  

A few more facts and comments.  

Company had bad experience w/ local bank (taking months of time to process conduit IRA rollovers out, to deposit to this new plan, poor communication, etc).  Company not interested in using a bank to temporarily park funds.  I know that doesn't change the law.

Company very excited to start new 401k plan Oct 1.   Every intention to get the investments going, and get the employees enrolled.  Very close knit group of about 10, who had known each other for years.  Two owners, started a contracting business, which thankfully thus far has been very successful despite the short duration of the Company.

Employees well aware that the investments need to be set up, prior to salary deferring (so that there is place to deposit the deferrals).  So it was kind of a "rah rah" beginning, and then it took the Company quite some time to decide on the investment house they wanted to use, get everyone in-house for enrollment meetings, wait for 404a5 notices to be distributed, etc etc.

By the time this all finally came to fruition, it was early December,  They then decided, "since there's only a few payrolls left in the year," let's just wait until January 1 to start the salary deferrals.  I was not made aware of this until late January.  The employees were informed every step of the way, and noone had any issues. 

They could have salary deferred in December, they chose not to (I'm not sure why they made this choice, as there really wasn't any reason to), but they did.

Salary deferrals began w/ the first paycheck of January, everyone's happy, and all is well.  No one is disgruntled about anything.  This is a case of the employer having unreasonable expectations about how quickly everything could come together, amidst running the day-to-day business.

I appreciate the comments about the possibility of QNEC's, but right now I'm trying to figure out if the document needs to be amended to change the testing method to current year.  I appreciate the 5 year comment, I'm unfortunately aware of that.  W/ proper planning, they can be kept informed about the owner's annual ability to defer until the prior year method can be utilized.  Would rather not have the Company incur the expense of the plan document revision if it can be avoided.

Thank you again - if this changes anyone's opinion, I'd be curious to hear, also any additional comments regarding the current year testing are appreciated.

[austin3515]

Quote

Salary deferrals began w/ the first paycheck of January, everyone's happy, and all is well.  No one is disgruntled about anything.

So this would not be relevant, fyi.  When you have a compliance failure you can;t go to your employees and say "are you ok that I didn't follow the terms of the Plan"?  I only mention it because it seems like your suggesting that based on this fact (and based on good communications that there was an ongoing failure to follow the terms of the Plan) there really is no correction required.

My bottom line would be (from a technical perspective) you do have a compliance failure because you HAD a document that said people had a right to defer and you didn't do that.  You excluded them when they were eligible, and EPCRS has a specific correction for precisely what you have.

But to answer your question, your prior year ADP is zero.  The 3% rule is only for the first year of the plan, and this is the second year of the Plan.