Irrevocable Election between Plans

[Guest AEA]

I have an employer that is considering allowing employees to make a one-time, irrevocable election between participating in a 401(k) and defined benefit plan versus a 401(k) plan only with a much more generous match.

I know that an employee can elect not to participate in a plan and that it must be voluntary and irrevocable (unless it is a 401(k)), but what will this do to the testing situation? Do all of the employees get counted for every plan for coverage and nondiscrimination?

[Guest]

irreveocable means just what it says. even in a 401(k).

you can elect not to defer, but that is different, as you would still be eligible for a profit sharing contribution.

1.401k-1(g)(2)(ii) such employee is not an eligible employee

therefore he does not show up in the ADP test - he is excludable.

however, since he can not defer he will end up being treated as 'includable and not benefiting' once he has met eligibility requirements.

of course, if such person is an HCE it will only help testing. if NHCE, then you could fail coverage, but if push comes to shove, and you are close to passing, you could probably argue the facts and circumstances end of things of why you failed.

[actuarysmith]

I'm not following the logic of the last response. (Maybe it's just Monday morning and I haven't had sufficient caffiene intake).

Our firm has always held the opinion that if an "otherwise eligible" employee (HCE or NHCE) signs an irrevocable election not to participate - they were still included in all relevant tests (ADP/ACP/410(B), etc.)

This means that if you have a large number of these folks, you may not pass coverage.

One additional question that just occurred to me is - do you include their compensation for 404 deduction purposes?

[Guest]

when was the irrevocable election signed?

choosing to defer zero is different than the irrevocable election.

Ignore the fact the plan is a 401k.

pretend it is a straight forward profit sharing.

an ee signs an irrevocable election. he can never ever ever ever be in any plan again. the IRS logic is as follows, if he changes his mind then you have a CODA if you let him into the plan. but you don't since you have a profit sharing only. that is why the election is irrevocable.

my understanding it is no different in a 401(k). an irrevocable election still means irrevocable (despite the fact the plan is actually a CODA) and as the reg site says, such an ee is treated as 'excluded' from the plan.

see also ERISA Outline Book - such an employee is not treated as an eligible and is excluded from the ADP test.

if excluded, then of course, such individual's comp is not included in 15% deduction limit.

again, maybe you are confusing the irrevocable election with choosing to defer 0. the terms are different, though some clients will tell you that such and such a person chose not to participate, when they really mean they chose not to defer. (you get to count the comp of ees choosing not to defer)

[actuarysmith]

I agree - irrevocable means for ever and ever with regard to THAT plan only. Not another plan the employer may set up.

I am not confusing deferring 0% with irrevocable- in the former the employee is actually a participant, in the latter, he/she is not a participant.

I did some checking, and it appears that you can exclude employees who sign an IRENTP from ADP/ACP/404, etc.

However, the plan must still pass the 410(B) 70% test based upon statutory exlcusions only. Therefore, these folks would be counted in the total number of statutory employees who were eligible. This is only likely to be a problem with a fairly small employer.

[Guest]

relook at 1.401(k)-1(g)(4)(ii)

"...employee does in fact elect, not to be eligible to make a cash or deferred election under the plan or any other plan maintained by the employer (including plans not yet established) for the duration of the employee's employment with the employer."

nasty, ain't it.

you are correct, they get counted in the 410(B). if my plan failed ratio % test of 410(B) because such an employee was an nhce, and failed safe harbor but passed unsafe harbor under the classification test I would argue facts and circumstances test and conclude plan passes.

By the way, I originally 'learned' (incorrectly) many years ago such ees are excluded from 410(B) and it has taken me awhile to unlearn this!

[actuarysmith]

Thanks for the clarification and additional input. Do you think that it is possible to have an irrevocable election that applies only to a particular plan? Or do you understand the regs to state that such an election would apply to ALLS PLANS sponsored by the employer?

I have always advised clients that the only way to get out of the election is to terminate the plan for which the election was valid for, and set up another new plan (Of course, if it is a 401(k) you have to be careful regarding the issue of not setting up a replacement plan within 12 months).

[Guest]

I don't know. I find it hard to go against what the reg says. If plan was a 401k, never top heavy, and no ps contributions you might argue the ee didn't waive out, but simply deferred 0.

another point would be to make sure document even allows ee to elect out. I wouldn't think a standardized document would allow it (since they are written to automatically pass 410(B)), which raises an even more interesting question. if you allowed someone to waive out previously on another plan, does that mean you cant have a standardized document. ouch. my head is begining to hurt. i don't even want to think about it. i dont know what to tell you at that point.

[Bob R]

I've always taken the position that the regulation is generally a "safe harbor" provision. In other words, the regulations state that you won't be deemed to have a CODA if the election is irrevocable, made at the time you are first eligible, and applies to all plans of the employer (existing and plans established in the future). But, it doesn't state that I automatically have a CODA if I have an election that doesn't satisfy the regulation. Rather, I think it's a facts and circumstances test to determine whether an individual is receiving compensation for electing out the plan.

For partners, you must use the safe harbor because electing not to participate autmatically increases earned income. But, for a corporation, electing out doesn't automatically increase compensation.

Having said that, if I were an IRS agent and I saw someone using an election that doesn't meet the "safe harbor," I'd hunt pretty hard for the smoking gun. Generally people, especially NHCEs, don't turn away a free contribution from an employer. But, there are legitimate reasons for electing out. For example, I've heard of situations where the only allocation is a small amount of forfeitures for a particular year. If the amount is allocated to an individual's account, the individual is an active participant and might be precluded from making a deductible contribution to an IRA.

The bottom line is you have to be extremely careful in using elections not to participate. Plus, if NHCEs elect out, you will have the 410(B) coverage issues to deal with. If the election satisfies the safe harbor, then, as Tom pointed out, the employer would never be able to use a standardized prototype adoption agreement.