Safe Harbor Plan with Different Definition of Compensation

[NYHeel]

Someone is asking if a traditional match safe harbor plan can have different definitions of compensation for employee deferrals and employer match. Specifically, they want to know if the definition of compensation for employee deferrals can include bonus but exclude bonus for match eligible compensation. In addition, the plan pays match on a payroll period basis and does not provide a true-up.

I'm leaning strongly towards no on this but haven't found anything that specifically excludes this design. I'm worried that the match for an NHCE could be lower than the match for an HCE when compared to deferral eligible compensation. The only way I could see this as allowable is if you only look at match eligible compensation when determining match percentage and you completely ignore deferral compensation. But administratively this would be difficult with a payroll period match and no true-up.  There would need to be some kind of mid year true-up after the bonus was paid to make sure those deferrals were taken into account for purposes of match.

Any thoughts on this?

[MWeddell]

I'll assume that the matching contributions are safe harbor matching contributions, i.e. that there isn't an unmentioned 3% safe harbor nonelective contribution fulfilling the safe harbor rules.

This doesn't work.  A HCE might have a better ratio of safe harbor match to elective deferrals than an NHCE electing the same percentage of pay to be contributed as elective deferrals.  That would violate Treas. Reg. 1.401(k)-3(c)(4).

Welcome to the message boards!

[NYHeel]

 

On 7/30/2020 at 1:21 PM, MWeddell said:

I'll assume that the matching contributions are safe harbor matching contributions, i.e. that there isn't an unmentioned 3% safe harbor nonelective contribution fulfilling the safe harbor rules.

This doesn't work.  A HCE might have a better ratio of safe harbor match to elective deferrals than an NHCE electing the same percentage of pay to be contributed as elective deferrals.  That would violate Treas. Reg. 1.401(k)-3(c)(4).

Welcome to the message boards!

Yes, it's a safe harbor match and yes, I'm in agreement that this design doesn't work. My only thought was that the percentage of pay deferral election could possibly be viewed against the match eligible pay only and thus the higher ratio of match to deferrals is due to the lower percentage of pay deferral election, when viewed against match eligible pay. But clearly this argument is a stretch.

[MWeddell]

NYHeel:

The argument is NOT a stretch.  It just plain doesn't work.

I provided the regulatory cite so you can decide if you agree with me.  That particular restriction looks at the ratio of match to elective deferrals for HCEs and compares it to the ratio of match to elective deferrals for any NHCE with elective deferrals at the same percentage of safe harbor compensation.  I don't see any way to construe the restriction to have anything to do with match-eligible compensation.

[AKconsult]

What Treas. Reg. 1.401(k)-3(c)(4) is getting at  is that the rate of match for the HCEs cannot be greater than the rate of match for the nonHCEs.  I think it would be permissible to exclude bonuses from the match calculation to the extent that the 414(s) compensation test can be passed (which may be problematic).

In a situation where employees are allowed to defer on a bonus payment but the matching contribution is NOT being calculated on the bonus payment, the only way that the Regulation will be satisfied is if the match for all participants is determined by first determining the employee's deferral % for purposes of the matching formula by excluding the bonus (even though the employee deferred on the bonus).  For example:  if an employee is paid $60,000 plus a $10,000 bonus, and he elects to defer 3% to the plan, his deferral would be $2,100 (3% of $70,000).  However, to determine his match, you would have to assume his deferral % is 3.5% ($2,100/$60,000).  If the plan uses a basic safe harbor match, he would receive a match of $1,950.   As long as all the match calculations are done this way, you haven't violated the Regulation.  Again, the compensation test would have to pass, though. 

[MWeddell]

I disagree with AKconsult's second paragraph for reasons previously explained.

[Kevin C]

As mentioned, the safe harbor compensation definition used to determine the safe harbor match must satisfy 414(s).  1.401(k)-3(b)(2).  You will have to test each year to see if the compensation definition excluding bonuses satisfies 414(s). If it doesn't, a correction is needed.  Our VS document automatically changes the safe harbor compensation definition to gross comp if the definition used doesn't satisfy 414(s).

The safe harbor regulations address the compensation definition used for deferrals in

Quote

1.401(k)-3(c)(6)(iv) Restrictions on types of compensation that may be deferred. A plan may limit the types of compensation that may be deferred by an eligible employee under a plan, provided that each eligible NHCE is permitted to make elective contributions under a definition of compensation that would be a reasonable definition of compensation within the meaning of §1.414(s)-1(d)(2). Thus, the definition of compensation from which elective contributions may be made is not required to satisfy the nondiscrimination requirement of §1.414(s)-1(d)(3).

So, it is possible to have the compensation definition for deferrals be different than the safe harbor compensation definition used to determine the safe harbor match.  There are other requirements for restrictions on the amount NHCEs can defer in the other parts of 1.401(k)-3(c)(6).

The cited restriction on HCE match in 1.401(k)-3(c)(4) compares the possible rates of match (match / deferrals) for HCEs and NHCEs who defer the same percentage of safe harbor compensation.  Unless you have a really unusual safe harbor match formula, the safe harbor match should be determined using the amount of the participant's deferrals and his/her safe harbor compensation.  With a typical safe harbor match formula that applies to everyone, I'm not seeing how you could have different rates of match for participants who defer the same percentage of safe harbor compensation.

Quote

1.401(k)-3(c)(4) Limitation on HCE matching contributions. The safe harbor matching contribution requirement of this paragraph (c) is not satisfied if the ratio of matching contributions made on account of an HCE's elective contributions under the cash or deferred arrangement for a plan year to those elective contributions is greater than the ratio of matching contributions to elective contributions that would apply with respect to any eligible NHCE with elective contributions at the same percentage of safe harbor compensation.

 

[MWeddell]

Suppose that (consistent with the original post) the definition of compensation for elective deferrals includes both base pay and bonus but that the definition of compensation for matching contributions is base pay only, excluding bonuses.  Suppose that the plan purports to be a 401(k) safe harbor plan using an enhanced safe harbor match of 100% on the first 4% of pay.  Here is an example illustrating why this plan design violates the restriction Treasury Regulation Section 1.401(k)-3(c)(4), as quoted above.  Hence, this plan will not be a 401(k) safe harbor plan but instead the plan has a disqualification issue.

Quote

                             HCE       NHCE
Base            $130,000  $120,000
Bonus                     $0     $10,000
Comp            $130,000 $130,000
Election                   4%            4%
Deferrals          $5,200     $5,200
Match               $5,200     $4,800
Match/Deferrals  100.00%   92.31%

 

[MWeddell]

11 hours ago, Kevin C said:

With a typical safe harbor match formula that applies to everyone, I'm not seeing how you could have different rates of match for participants who defer the same percentage of safe harbor compensation.

 

In the example shown in my prior post, the ratio of match to elective deferrals for an HCE contributing 4% of pay is greater than the ratio of match to elective deferrals for an NHCE contributing 4% of pay.

[Kevin C]

The limitation in 1.401(k)-3(c)(4) compares HCEs and NHCEs who defer the same percentage of safe harbor compensation. You are comparing two individuals who are deferring the same percentage of the compensation definition used for deferrals.  Those two compensation definitions are not required to be the same.

Assuming that base pay meets the requirements to be safe harbor compensation, in your example, they are not both deferring the same percentage of safe harbor compensation.  The HCE is deferring $5,200 with safe harbor compensation of $130,000, which is 4.0% of safe harbor compensation.  The NHCE is deferring $5,200 with safe harbor compensation of $120,000, which is 4.33% of safe harbor compensation.  If the NHCE in your example deferred $4,800, they would both be deferring the same percentage of safe harbor compensation. The NHCE would receive a $4,800 match and both would be receiving a 100% match. (5,200 / 5,200 = 100% and 4,800 / 4,800 = 100%). 

Of course, if the two in your example are the only two participants, base pay would not satisfy 414(s) and a different compensation definition would have to be used for safe harbor compensation. 

[MWeddell]

At least we have isolated the source of our disagreement clearly enough for others to follow the conversation and decide for themselves, Kevin. 

Using the phrase from the end of Treas. Reg. Section 1.401(k)-3(c)(4), the two individuals that I have compared have "elective contributions at the same percentage of safe harbor compensation."  They both elected to defer 4% of the safe harbor definition of compensation (base + bonus) that is used by the plan to compute elective deferrals.

[Kevin C]

No, they both elected to defer the same percentage of "compensation" under the plan's compensation definition specified for salary deferrals.  Safe harbor compensation is the compensation used to determine the safe harbor match. There are different rules for the compensation definition used for salary deferrals.   In your example, safe harbor compensation excludes bonuses and the compensation definition for salary deferrals includes bonuses.  See the description of the basic SH match in:
 

Quote

 

1.401(k)-3(c)(2) Basic matching formula. Under the basic matching formula, each eligible NHCE receives qualified matching contributions in an amount equal to the sum of—

(i) 100% of the amount of the employee's elective contributions that do not exceed 3% of the employee's safe harbor compensation; and

(ii) 50% of the amount of the employee's elective contributions that exceed 3% of the employee's safe harbor compensation but that do not exceed 5% of the employee's safe harbor compensation.

 

As mentioned before, the safe harbor compensation definition must satisfy 414(s).  The compensation definition used for salary deferrals only has to be a reasonable definition of compensation within the meaning of §1.414(s)-1(d)(2). 

[MWeddell]

I was wrong   Apologies to Kevin C, AKconsult, NYHeel, and anyone else I missed. 

Example 3 in Treas. Reg. Section 1.401(k)-3(c)(7) is what convinced me that I was wrong.  The example isn't quite identical to the original poster's question but close enough.  It deals with a situation where elective deferrals are computed using a different definition of compensation than the definition of compensation that is used to compute the safe harbor matching contributions.  It would have been a cleaner example if it had discussed and dismissed my objection based on the ratio of deferrals to match from 1.401(k)-3(c)(4), but it still seems to indicate that there is not a problem.

[Kevin C]

If this was easy, everyone would be doing it.  Thanks for the reminder to look at the examples. 

[Bill Presson]

This was actually fascinating. Thanks to you both for an excellent discussion.