Creative Solutions for HCEs

[ldr]

Let me clarify this a bit.  They don't plan for the 12 HCEs to be involved in the qualified 401(k) plan at all.  That's because it will have at least 600 employees in it and they don't want to give anything at all to them.  The qualified 401(k) plan will be deferral only, more or less a convenience for the NHCE employees but not a "benefit" in the sense of any employer contributions being made for them.

So for those 12 HCEs, what we are looking at is a "mirror image" plan.  It's not an excess plan on top of normal 401(k) participation; it's a plan to serve the HCEs instead of a normal 401(k) plan, in which the employer can and will make a matching contribution.

We are still studying, calling people, and asking questions.  We are a lot more amenable to the whole idea than we were a week ago.

Thank you all for your comments and observations.  We learn a lot about what to go study further just from your commentary!

 

[FPGuy]

Re corporate creditor risk:

- Leveraged companies that violate loan covenants, even if they are otherwise not in default ("non-performing performing loans") may not be permitted by their creditor(s) to pay out deferred comp;

- As someone famously said, bankruptcies happen slowly then all at once. Who saw Lehman Brother's bankruptcy coming?

However, in my experience, even before 409(A) limited creditor risk strategies, the fly in the ointment re NQDC plans was their symmetrical tax consequences: employer didn't get a deduction until employee had concomitant income recognition.

 

 

 

[loserson]

28 minutes ago, ldr said:

Let me clarify this a bit.  They don't plan for the 12 HCEs to be involved in the qualified 401(k) plan at all.  That's because it will have at least 600 employees in it and they don't want to give anything at all to them.  The qualified 401(k) plan will be deferral only, more or less a convenience for the NHCE employees but not a "benefit" in the sense of any employer contributions being made for them.

So for those 12 HCEs, what we are looking at is a "mirror image" plan.  It's not an excess plan on top of normal 401(k) participation; it's a plan to serve the HCEs instead of a normal 401(k) plan, in which the employer can and will make a matching contribution.

We are still studying, calling people, and asking questions.  We are a lot more amenable to the whole idea than we were a week ago.

Thank you all for your comments and observations.  We learn a lot about what to go study further just from your commentary!

Ahh, this helps explain the issue.  That means it's not really a concern that they will fail testing in the 401(k) plan but it is a concern that they are concentrating risk in the rabbi trust and they are forgoing lots of tax advantages.

I think it makes a lot more sense to suck it up and just do a 401(k).  More employees understand it, the tax consequences are generally better, the administration and vendor selection is easier, and as you pointed out originally the bankruptcy risk is segregated from past plan contributions.

Sticking all the HCEs into a top hat plan means they will not see tax-free accumulation all the way to retirement, unless they keep their NQDC at the company the whole time.  So instead of HCEs getting $19k deferrals limit and $56k annual additions, they have the $6k IRA limit.  For the catch up folks, that's $12k IRA limit, but still nowhere near $25k and $62k limits.

I think you need to have a really generous plan to counteract how much costlier this is to the HCEs to cut them off from the 401(k).  I think that it might be costlier than just making a 401(k) plan that passes testing, but maybe their workforce mix of HCE to rank-and-file is lopsided enough that they can get by with a not-too-generous top hat NQDC and a threadbare 401(k).

If the employer goes through with it, remind their payroll not to report the HCEs as being covered by a retirement plan at work.  That'd be Box 13 on the W-2.  Not checking that box helps the HCEs deduct their IRA contributions.

[ldr]

@loserson:  Thanks for your observations.  They will not do what WE consider to be a "normal" 401(k) plan (in our world that's a Safe Harbor plan).  The employer will not provide a Safe Harbor match or a Safe Harbor Non-Elective contribution.  Period.  They plan to put in a deferral only 401(k) plan for the NHCEs and to do something else entirely for the HCEs.  We are pretty sure that other TPAs are talking to them about NQ plans and have gotten them interested in the idea.

There is no point in enrolling 12 HCE employees into a traditional, non-Safe Harbor 401(k) plan subject to the ADP test because so few NHCE employees are going to participate that the HCE employees would end up having to take all or most of their deferrals back out of the plan, causing a lot of distress.  They will never reach the $19,000 limit you refer to because even if they put it in, they will just have to take most of it right back out when the ADP test fails.  Remember, we are talking about 600 participants in a plan without a match, and most of those 600 employees are really lowly paid.  They have no incentive to participate.  Why would the employer even bother to set up such a plan?  My guess is that he wants to be able to say he offers a 401(k) plan when hiring people.  Okay, that's not a lie - he will be offering a 401(k) plan.  Just a plan without any employer contributions!

The more we read about the NQ plans, the more we like the concept.  It just depends on the company itself and the employees involved.  Do they trust this employer?  Do they believe the company will be in business 5, 10, 20 years from now?  Do they want to stay and find out?  Will they put up with not being able to roll the eventual distribution to an IRA?  Will the employer and the 12 HCEs be willing to endure whatever disadvantages come with a NQ plan?  We don't know.  We have to find out.

One contributor to this thread suggested a match so rich that greed overcomes caution and entices the 12 HCEs to overlook their reticence.  Who knows?  That might be a great idea.

So all this is to say that no, sorry, one 401(k) plan for all is not a solution because the employer has no intention of making contributions for anyone except the HCE group.

[loserson]

NQ plans are great and I am certainly not trying to talk you out of them.

If you tell the HCEs that they will get thousands or tens of thousands of dollars a year, I doubt most of them will be paying attention to the bankruptcy risk.  They will be watching the dollars.

I think the employer may need to pay an especially generous NQDC benefit to compensate for the worse tax consequences and the lack of 401(k).  If the executives can move to competitors that offer 401(k)s in addition to exec comp, then they need to be more generous to keep up.  But maybe this is a low-paying industry (if they can go years with no plan at all and now expect employees will be happy with zero match, then it's probably low-paying) and maybe competitor compensation is equivalently paltry.  In which case, maybe even a modest top hat plan is fine.

 

[BG5150]

Don't forget the k Plan will be subject to an annual; audit and the attendant costs.

[ldr]

Thanks, BG5150.  I actually hadn't thought about that yet but I am sure the primary person working on this case probably has.  :)

[Mike Preston]

Once a decision has been made to further investigate a top hat plan make sure that 100% of the HCE's fit the IRS eligibility. 

[jpod]

I think Mike Preston meant "DOL top hat eligibility," but he'll let us know if I am wrong.

[Mike Preston]

2 hours ago, jpod said:

I think Mike Preston meant "DOL top hat eligibility," but he'll let us know if I am wrong.

You are not wrong.

[ldr]

Well now that you mention this.......we are a little bit uncertain as to who is eligible.  We've been told that it's not as simple as identifying the HCEs and calling it a day.  Some rather vague phrases like "top management" and  "decision makers" have been tossed around but we don't know whether there is a hard and fast definition of which employees belong in those categories.  Is "top management" only the corporate officers and/or the shareholder employees?  "Decision makers" could be a broader group than "top management", possibly.  If anyone can provide a link to the law that governs this, we would be most appreciative.  Or do we let the ERISA attorney who ultimately drafts the plan make that determination?

[XTitan]

Determining the top hat group is not so easy.  ERISA defines as "a select group of management or highly compensated employees", but the reference to "highly compensated employees" doesn't (necessarily) mean anyone making over 414(q).  DoL hasn't provided a lot of guidance, and court cases generally refer to qualitative and quantitative analyses. 

For example, in Bakri v. Venture Mfg. Co., 473 F.3d 677 (6th Cir.2007), the Sixth Circuit listed the qualitative and quantitative factors to consider when determining whether a plan qualified as a top-hat plan under ERISA section 201(2): (1) the percentage of the total workforce invited to join the plan (quantitative), (2) the nature of their employment duties (qualitative), (3) the compensation disparity between top hat plan members and non-members (qualitative), and (4) the actual language of the plan agreement (qualitative).

So, you can't really say that the top 10%-15% in compensation with a title of Director and above will automatically be a top hat group, but that might be a good starting place for the ERISA attorney. 

[ldr]

Thanks, XTitan, I appreciate your comments.  We will see what happens next!

[loserson]

On 7/2/2019 at 5:23 PM, ldr said:

Well now that you mention this.......we are a little bit uncertain as to who is eligible.  We've been told that it's not as simple as identifying the HCEs and calling it a day.  Some rather vague phrases like "top management" and  "decision makers" have been tossed around but we don't know whether there is a hard and fast definition of which employees belong in those categories.  Is "top management" only the corporate officers and/or the shareholder employees?  "Decision makers" could be a broader group than "top management", possibly.  If anyone can provide a link to the law that governs this, we would be most appreciative.  Or do we let the ERISA attorney who ultimately drafts the plan make that determination?

If we are talking about 12 out of 1800 employees in the company/group (0.67%), and they are the top 12 in terms of pay, and all HCEs, and they are all managers, and they are all company officers, then I would not really worry if this is a good top hat group.

If those things are mostly true, like maybe they are not all officers, then it's probably still fine.

It helps if it's a clearly defined group and clearly designed to stay select and small.  If it's tied to job title or the employer has a narrow pay-grade class for top managers and executives, then that helps.  The feds have pay grades like GS-15 and FS1 and so forth, and they have a Senior Executive Service above the regular pay grades.  If this company has a similar (though certainly less formal!) pay grade system, and the NQDC plan is only for the executive pay grade, that really helps show it's a small, select group.

I might feel less sanguine if they exclusively define it as HCEs, with no other requirements for job title or job duties, officer or manager duties, pay grade, etc.

The main concern, both as drafted and as enforced, is to not let the top hat exception apply to too many people in a company or group and thereby let the exception swallow ERISA.  If the group is very small and the employees are highly paid (sotto voce: and sophisticated), then DOL is unlikely to blink.  Though the absence of 401(k) coverage is an unusual twist and I have not thought through how it might alter the DOL view here.