401(k) Safe Harbor Match fails 414(s)

[bcmom]

I have a 401(k) Safe Harbor Match Plan that excludes Bonuses. It fails 414(s) for 2016. The Plan is a McKay Hochman non-standardized prototype using Basic Document #03. The plan allows for exclusion of bonuses as long as compensation is tested under 414(s), but I can't find where it addresses what to do if 414(s) fails. If anyone know where fail safe language is to permit full comp, can you point it out for me? If there is none, can I amend the plan or is it just no longer a Safe Harbor Plan? I know the topic has been addressed before, but there seems to be no definitive answer.  

[Mike Preston]

Haven't you answered your own question?  Doesn't the document effectively read: "Use comp without bonuses if 414(s) is satisfied, otherwise use comp with bonuses"?

[Tom Poje]

you can't amend the plan so that it is no longer safe harbor.

however, I think there are some areas that haven't been addressed. for example, suppose the person makes 10,000 (including 1000 in bonus)

he defers 3%.

so his deferral is 270. his match is 270 which is 100% of deferrals. but since you failed 414s you have to use total comp for the match. The comp used for deferral could be considered 'reasonable' so it is only the comp for match that fails.

so now you have a deferral rate of 3% based on plan definition of comp, and a match rate of 2.7% based on total comp. this would seem to me to fail the rate of match requirement. so then do you have to provide a QNEC for missed opportunity to defer on that bonus comp as well?

[Kevin C]

Whether the document has failsafe language or you have to do an -11(g) corrective amendment to change the SH compensation definition, the safe harbor contribution will have to be recalculated using the new compensation definition if they want to remain a qualified plan.  I would expect most documents to have some sort of failsafe provision. If not, a corrective amendment will be needed.  

We use ASC and their documents revert to gross comp if the SH compensation definition used fails 414(s).

[bcmom]

I know I wanted the document to include bonuses upon failure of 414(s), but that doesn't make it correct. So, I'm glad you agree that I should include bonuses. 

 Each post I read on time this topic came up with another "what about this" question and without a clear answer. Good question and I think your question helped me with the answer. The deferral rate exceeds 5% for all but 1 person (there's always 1). This is a Basic Match and that 1 person deferred 5% w/o bonus and 4.48% with the bonus. So the SH Match on the 4.48% rate using the comp with bonus will give the ptp an additional SH Match of $90, but if I calculate the SH match on the 5% rate using the comp with bonus, the SH Match gives the ptp an additional $240 in match. I think you're correct in that the ptp gets a QNEC of $150 ($240 - $90) because the definition of Comp under the SH section says that the comp used must permit the ptp to defer at a rate that allow them to get the maximum Match. So, since the ptp deferred at 5% w/o bonus, they clearly intended to defer at the rate to get the maximum match, so she need to get a QNEC of $150.

[bcmom]

Thanks Kevin. That also helps supports this since McKay Hochman documents transitioned to ASC.

[Kevin C]

While I think you could probably include a QNEC for missed deferrals because someone might have deferred more if the SH Match compensation definition would have been different at the beginning of the year, I don't think you have to do so.  The failsafe provision or corrective amendment should only be changing the compensation definition for the safe harbor match, not the compensation definition for deferrals.  If the plan did not allow deferrals from bonuses, there is no missed deferral opportunity.  As I mentioned before, the safe harbor match will need to be recalculated using the new compensation definition.

 

If you amend the compensation definition for deferrals retroactively to include bonuses, then I can see that you have retroactively created a missed deferral opportunity. But, why would anyone want to do that?

[Tom Poje]

my problem with not providing an additional deferral, in the example I gave

the ee deferred 270 and received 270 in match.

plan fails comp test.

so now I use total comp. ee can't receive more match otherwise the match is greater than the deferral. so net effect, you still get the free ride on the adp/acp test

you get the free ride on top heavy (assuming no other contributions) and yet you failed the comp test, so the company has gotten by without providing that extra match. I don't know, I don't think that is the intent on how the thing should work

[John Feldt ERPA CPC QPA]

You have to follow the terms of the plan. If the plan spells out what compensation must be used for determining the safe harbor allocation and that definition includes a specific modification to be done if 414(s) fails, then you have your answer.

Otherwise, a retroactive amendment will be needed, but...

Can someone help with my understanding of how 1.401(a)(4)-11(g) can apply here and how such an amendment to affect safe harbor allocations for the prior plan year actually complies with the safe harbor regulations? Do the safe harbor rules require there to be a minimum number of months remaining in the plan year when such an amendment is done that increases benefits? Is there an explicit exception for -11(g)?

1.401(a)(4)-11(g)(2) spells out the scope of this type of amendment, stating a corrective amendment may retroactively benefits for coverage (410(b)), nondiscrimination (1.401(a)(4)-1(b)(2)), or a discriminatory timing of amendments. Under a safe harbor plan, the safe harbor allocation amounts are not subject discrimination testing by the very definition of being safe harbor, so how does -11(g) apply?

Certainly a VCP could be done. Has the IRS indicated that such a correction, with a retroactive amendment as described in the posts above, can be done without VCP?

[Kevin C]

Tom,  Sorry, but I'm not understanding your reasoning.  The rate of match is the match divided by deferrals. Your example has someone deferring 3% of gross-bonus or 2.7% of gross.  Either way, match divided by deferrals is 100% since the formula yields a 100% match regardless of which compensation definition you use.  Obviously, someone who deferred more than 3% of gross-bonus would receive more match using gross comp.

 

John, there have been discussions on -11(g) in previous years and -11(g)(2) does not list the only reasons an -11(g) amendment can be done.  If you look at the preamble to the final regs that added it, they make it clear that you don't need to fail anything to do an -11(g) amendment. The nice thing about -11(g) for SH plans is that the amendment is treated for purposes of 401(a) as having been adopted and in effect as of the first day of the plan year, (1.401(a)(4)-11(g)(1)) so there should not be any problems with the safe harbor rules. If you look at 1.401(a)(4)-1(b)(2)(ii)(B), it requires 401(k) plans to satisfy 401(k)(3).

 

 

[austin3515]

Another wrinkle: Let's say the plan is a pay-period match, and bonus is run as a separate payroll.  Now what??  Amendign to include bonus does nothing for a pay-period match in this scenario because no 401k is withheld (i.e., because bonuses were excluded for everything).

[Tom Poje]

Kevin, that is point exactly. by dividing by total comp, the NHCE only defers "2.7%" not 3%.

so basically the HCEs get their full match no matter what, but, in some ways you have limited the NHCEs to less than 3% and so the company didn't need to fund a "full" match despite failing the comp test.. you can argue "Then the NHCE needs to defer more" but the crux of the matter (or the wrinkle) is you failed the comp test, but you still get the free ride on everything. or, put another way:

Why the heck did you run a comp test. it makes no difference in this situation. there is no "penalty" or correction, and you are still rewarded with a free ride.

 

[Kevin C]

Austin, in the case you describe, I think you would need to either give them a match on the bonus payroll based on their deferral election rate, or true up the match at the end of the year.  

 

Tom, I don't think the IRS would object if the match correction was calculated assuming the participant's deferral rate had applied to the bonus payrolls.  But, I still don't see a missed deferral opportunity unless they retroactively create one with the corrective amendment.  

Let's try this from a different angle. If a plan does not allow deferrals from bonuses, but the SH match formula applies for the plan year using gross compensation, does it still satisfy the safe harbor rules? I think it does. Using gross compensation as the safe harbor compensation definition would satisfy 414(s).  1.401(k)-3(c)(6)(iv) says the deferral compensation definition must be reasonable under 1.414(s)-1(d)(2), but does not have to satisfy 414(s).  I'm looking at the corrective amendment as retroactively changing the plan to be like this.

[K2retire]

3 hours ago, Tom Poje said:

Kevin, that is point exactly. by dividing by total comp, the NHCE only defers "2.7%" not 3%.

so basically the HCEs get their full match no matter what, but, in some ways you have limited the NHCEs to less than 3% and so the company didn't need to fund a "full" match despite failing the comp test.. you can argue "Then the NHCE needs to defer more" but the crux of the matter (or the wrinkle) is you failed the comp test, but you still get the free ride on everything. or, put another way:

Why the heck did you run a comp test. it makes no difference in this situation. there is no "penalty" or correction, and you are still rewarded with a free ride.

 

But the person deferring 5 or 6% would be due a correction.

[John Feldt ERPA CPC QPA]

If the plan was SH match, such as 100% of 4% of pay, any NHCEs deferring 4% of base pay would have no additional match if an amendment is done retro to now include bonuses just for purposes of match calculation. Even with the HCEs, any that deferred 4% of base pay would still have the higher matches. I don't see how the -11g amendment to simply include bonuses for the match calculation gets us to "Yeah, we're good, that'll do it."

Depending on the facts and circumstances, I would want more assurance than that.

[Kevin C]

Our VS document has a fail-safe provision that says if you elect a safe harbor compensation definition that fails to satisfy 414(s), safe harbor compensation becomes gross compensation for the plan year.  If any of our plans have this problem, we don't need an amendment and the correction is covered by our opinion letter.  The -11(g) amendment I suggested does the same thing as our document's fail-safe.  If you are not comfortable with that, you can always use a more generous correction.

[austin3515]

Which provider?

[John Feldt ERPA CPC QPA]

It's a Vol sub, which has IRS approval, so I guess you are covered. you must follow the plan's terms.

I find it very curious that this surprise, which occurs after year-end (to find that comp discriminates), has no correction required, under the written terms of the plan, for any NHCEs deferring right at the limit of the full safe harbor match rate (based on discriminatory compensation), thus leaving their original allocations as "perfect" even after the 414(s) test fails and the plan's automatic compensation fix language gets applied.

I would assume your document's 414(s) "automatic fix" language applies this automatic new definition of compensation only to the NHCEs? This could be awesome as a plan design for getting extra to mostly just the HCEs. Go ahead and write up wage exclusions that affect NHCEs the most, fail 414(s), which already allowed the HCEs to get higher safe harbor matches anyway, and then just apply an automatic "bait and switch provision" in the document's compensation definition for the NHCEs after it's too late to defer, affecting very few NHCE's SH match, if any! This is especially nice if the IRS has truly bought into this. Am I being serious, or am I just kidding around here, I'm not even sure yet.

[Tom Poje]

k2retire- I am aware of that (an NHCE deferring more would get something extra), but that still leaves you some NHCEs who are, I guess, "out of luck". and despite that, the HCEs get the free ride, again, despite the fact comp test failed. no further penalty. so for example, if all NHCEs deferred 4% they received 4% match. now plan fails comp test. no correction needed because they still received 100% of deferral, despite the fact they couldn't defer 4% of total comp. to me that just smells bad.

[Kevin C]

1 hour ago, austin3515 said:

Which provider?

ASC.  

 

  

[Tom Poje]

I'd take this one step further.

let's say you exclude commissions.

you give a base pay of $1000 and $49,000 in commission.  even if the person defers 10% of pay the maximum make up match using total comp only brings the person up to $100 in match.

but the company gets a top heavy free ride, no adp testing, etc. you can't convince me that is how it is suppose to work.

[Kevin C]

Tom,  if your hypothetical person receiving commissions is an NHCE, amending or automatically reverting to gross comp retroactively for the year would cause the plan to fail to satisfy 1.401(k)-3(c)(6)(iii).  That would need to be corrected by retroactively allowing deferrals from previously excluded compensation. In that case, you would have a missed deferral opportunity as part of the correction.  This is different from your previous scenario because in this one, it would not have been possible for this person to defer enough to receive the maximum match under the revised SH match provisions.  In your previous scenario, they could have deferred enough to get the maximum match even using gross comp, but chose not to.  I agree that they might have deferred more if they had known, but the SH regs have rules for plan imposed limits on deferrals, not rules based on how much each participant decides to defer.   As I've mentioned before, you can always be more generous in your correction, if that is what you want to do.

 

Quote

1.401(k)-3(c)(6)(iii) Restrictions on amount of elective contributions. A plan is permitted to limit the amount of elective contributions that may be made by an eligible employee under a plan, provided that each NHCE who is an eligible employee is permitted (unless the employee is restricted under paragraph (c)(6)(v) of this section) to make elective contributions in an amount that is at least sufficient to receive the maximum amount of matching contributions available under the plan for the plan year, and the employee is permitted to elect any lesser amount of elective contributions. However, a plan may require eligible employees to make cash or deferred elections in whole percentages of compensation or whole dollar amounts.

 

[Tom Poje]

so change the numbers to whatever comp you want (or go back to my example of every NHCE deferring 5%.)

I only used an extreme example to make a point (which obviously doesn't meet the need to 'allow to defer enough to meet the max') that excluding comp leads to possible abuse and ends up 'saving' the company $ that they don't have to put in, a nice end around. I do not think that is the intent of the law, that you can fail a comp test, and there are no ramifications in that situation.

we will simply agree to disagree on that point.