Annual additions

[imchipbrown]

I have a client with Safe Harbor 401(k) and Age Weighted Profit-Sharing. One of the employees is currently deferring 20% of pay and getting a 3% non discretionary match.

Their plan document and the prototype I use both seem to say the same thing:

If the Employer Contribution would put ANY participant over the maximum permissible amount, the contribution must be scaled back.

Does this sound right? Sounds like the tail wagging the dog.

(The Plan doesn't have a maximum deferral percentage hard coded into it.)

[Kathy]

Unfortunately, the tax-deferred contribution bucket is only so big and if the deferrals and the employer contributions going into it are greater than the overall annual additions limitations allow, something has to spill out into taxable income land. Obviously the best solution is to cut back on the deferrals before the end of the year so nothing has to spill out and the bucket is neatly filled with employer money and then just enough deferrals to level it off. However, if this isn't possible, check your plan document. Some plans allow 415 excesses to treated as 401(k) contributions first and then employer contributions (1.415(6)(B)(6) allows 401(k) contributions in excess of the 415 limits to be returned to the employee.) However, if the document says that employer contributions can not be made in excess of the 415 limits, then yes, the employee loses out on employer dollars in order to have the tax deferral on the salary reduction. Some plans do allow the administrator to cut any one back at any time in order to avoid a test failure of any type. If your document provides for this, cut the participant off - even if he does complain - it's easy to explain that your making room in the bucket for more employer money.

[imchipbrown]

I agree that limiting the deferral is the easiest/best solution. However, the employer is in no position, at least currently, to determine whether it will make any discretionary contribution.

It's hard to tell the participant he has to stop, no wait, start, no stop.