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Terminating Plan and 401(k) Safe Harbor Reliance


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I have a client who is a partnership of corporations.  One of the owners of one of the corporations participates in the plan, the owners do not. The partnership lost a contract and as such all of his employees with the exception of the owners of the corporations are being terminated (it is a condition of their employment when the contract is lost they are terminated).  If it matters most of the participants are HCEs but only 1 is an owner. They wants to terminate the plan but rely on a 3% SHNEC for to pass 401(k) testing.   All of the employees have been notified and they will be let go on a certain date (say June 30.. I am not sure when but it will be well before the end of the year) with the exception of the owners who are employed by their respective corporations.  The partnership will continue for some time (well past the end of the year if not several years) as they are still being paid for work they have already done.  Can they terminate the plan before the end of the year but after all  of the employees have been terminated with the exception of the owners and still rely on the 3% SHNEC?

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i don't think that would fall under the exception unless you can argue the employer is operating at an economic loss but if all all the employees are terminated they will have no more compensation so the  3% SHNEC is unlikely to change much except for the owners assuming there is no HCE carve out of the SHNEC in the document so why not just run through 12/31 and terminate with full 12 months?

they could fund the employees 3% NEC now after the final payroll and start paying out terminated employees if that's what they are concerned about.

If they are trying to save a few bucks on a final 2025 plan year an filing that seems a big gamble if the IRS challenges the SH status for 2024.

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HCEs are not eligible for the safe harbor contribution.  That is where I am stuck on this.  The owner is past normal retirement age and wants to roll everything out to an IRA after he has done his deferrals. He has also expressed concern that he may hire some back this year so there is the real rub.

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It really sounds like this does not qualify for a mid-year exception on terminating a SH plan. If he still wants to proceed, I'd suggest you refer him to an ERISA attorney for an opinion.

If he's past NRA can't he just take an in-service distribution to his IRA?

It sounds like he's trying to save a few bucks with the mid-year termination. You can always tell him you're happy to run a 401(k) test through date of termination and let him know the anticipated refunds.

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@Lou S. has laid out what likely is the best path forward - terminate the plan effective 12/31/2024.  Very likely there will be some assets still in the plan after that date which will require a 2025 5500 filing, but that should be easier than juggling all of the other issues that would come up with a mid-year termination.

Make sure to dig into the details when navigating this situation. For example, here are some random thoughts:

  • The client is a partnership of corporations, and the other owners do not participate in the plan.  Do the other corporations have employees?  You need to confirm that there are no (and never have been any) coverage issues.
  • Is the plan top heavy?  If yes, letting the plan run to 12/31 may provide a pass on making a top heavy minimum, and keep in mind that the top heavy contribution is subject to a last day rule.  If everyone is terminated by 12/31, that should not be an issue.
  • Why Is part of there a concern about hiring some people back? Is the owner thinking he doesn't want to give the rehires the SHNEC?  If the rehires are HCEs, their status as HCEs will not change during this plan year.
  • If there are rehires, will the plan continue possibly into next year?  If so, then it is possible many of the rehires will not be HCEs next year if they are out of work for a significant part of this year.

It sounds as if the owner is overthinking every detail, including wanting definitive answers to situations based on not-yet-known facts.  Keeping it simple likely will be the best approach, and in the end, least expensive one.

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One last thought.  If he is the only active participant on 12/31/24, he rolls the last of his assets out just before 12/31/24 and all other participants have a zero balance as of last day of the plan year (112/31/24) can anyone think of a reason not to have a 12/31/24 termination date?  I am not anticipating this as they have former employees with sizeable sums of money who have chosen not to (or have at least been too lackadaisical) to distribute.

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I see no problem making 12/31/24 the date of termination. If you get all contributions funded and everyone paid out before then great 2024 is your final year. If you have some distributions that carry into next year you just have a final 5500 requirement because the plan is terminated and no additional contributions will be made for 2025 (other than any 2024 receivables that might be deposited in 2025).

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