CODA situation ?

I am getting a little mixed up when I try to think this through so could use some help

I have a client who is currently contributing for their field employees $4 per hour into the 401k  plan.  This is tested under 401(a)(4) testing by the recordkeeper.  it is not Prevailing Wage, just profit sharing.

The client wants to change the arrangement so that employees will have the option of either continuing to receive a $4 per hour contribution into the plan OR getting a $3 per hour pay raise.

What are the implications of this?  Since employees will have a choice, has the employer effectively given a pay raise to all of them of either $4 per hour or $3 per hour, depending on what they elect?  I would think that previously the employer was taking a tax deduction for the employer contribution, but under this new arrangement employees who elect to receive the $4 per hour contributed to the plan are really just contributing their own pay, so this is no longer an employer deduction?  And the employer will now need to pay applicable payroll taxes, etc on these raises?  

Also this seems really confusing in the case of an  employee who is currently already contributing to the 401k plan as a % of their pay, and now they elect to continue to receive the $4 per hour into the plan.  Doesn't that conflict with their deferral election?  

thanks!

A few thoughts off the cuff, probably not exhaustive and definitely not fully formed:

• Does this convert $3/hour for everyone (whether they choose the $4 to the plan or $3 in cash) into a CODA? It's essentially giving everyone a $3/hour raise, with some subset of people electing to defer it into the plan (as an elective deferral subject to 402(g) limits, etc.) and some taking it in cash. 
• If so, does that make the additional $1/hour going into the plan (for those who elect it) a match? If someone chooses to defer $3/hour into the plan, the employer makes an additional $1/hour contribution, which cannot be a PS contribution without violating the contingent benefit rule (i.e., you cannot offer $1 in profit sharing only for participants who contribute $3 in deferrals). Not sure how you would draft the match formula ("a $1 match on every $3 deferred, but only if you choose the option offered by the employer and capped based on the participant's hours of service during the year"?) or who would be designated as the employees eligible for the match. 
• Presumably most people who choose the plan contributions will skew toward HCEs, which could affect ADP and ACP and match coverage if the extra $1 is treated as a match.
• The employer will still get a deduction, either for contributions to the plan or compensation paid via payroll, but employer-side FICA would surely increase as a result of people choosing cash over employer contributions.  

6 minutes ago, EBECatty said:

• Does this convert $3/hour for everyone (whether they choose the $4 to the plan or $3 in cash) into a CODA? It's essentially giving everyone a $3/hour raise, with some subset of people electing to defer it into the plan (as an elective deferral subject to 402(g) limits, etc.) and some taking it in cash. 

... and take note of the FICA implications.

I think EBECatty is spot-on. The $3/hour is definitely a CODA and the additional $1/hour, if applicable could only be a match. That does create a design problem in coordinating with any other deferrals or match (and potential coverage and/or BRF issue if you now have different matching formulae or match/no match deferrals). Unless, maybe if the employer would require everyone to make a one-time irrevocable election, and new participants to do the same upon eligibility, does that keep the $4/hour into the plan out of the deferral and match buckets? I don't know but that might be worth exploring with legal counsel. Regardless, I don't think this is supported in any pre-approved document, would need to be individually designed or through a pre-approved plan modification requiring d-letter submission - but get some ERISA legal counsel input before doing any of that.

I would also put on your consulting hat and dig deeper into why the client wants to do this. There may be better ways to accomplish the objective. If it's because many/most employees do not appreciate the profit sharing, then scrapping the $4/hour PS for the $3/hour pay  raise across the board might be the simplest way to go. 

Breaking this down (and agreeing with previous comments and observations),

The company sponsor a 401(k) plan for all employees.

All of the field employees get a $4/hour non-elective employer profit sharing contribution to the plan.  The profit sharing plan is tested for nondiscrimination (since non-field employees do not get $4/hour NEC and the amount of contribution for field employees varies based on hours worked).  The nondiscrimination test supposedly passes.

The company wishes to offer to the field employees the option to continue receiving the $4/hour NEC or receive $3 in direct compensation.  This clearly is considered a cash or deferred arrangement (CODA) going back to the 1950s when Kodak offered employees the right to take their profit sharing amount in cash or have it contributed to the plan.  In this case, put another way, a field employee can choose to receive $3/hour in direct compensation, or get a $3/hour amount deferred into the 401(k) plan and get a $1/hour match contribution.  There is not enough information to know how this deferral and match interacts with the provisions of the existing 401(k) plan.  The 401(k) plan's eligibility to make elective deferrals, any existing match, match allocation eligibility requirements, vesting and other similar BRFs would need to be reviewed.  The 401(k) plan also would need to consider what happens should a field employee reach the 402(g) annual deferral limit during the plan year.  There would be no opportunity to deposit the $3/hour deferral into the plan without violating 401(a)(30) limits.

A guess as to the motivation for considering this idea is that enough field employees want cash-in-hand now, even at the cost of $1/hour off the top and paying payroll and income taxes.  The company likely is looking at its portion of payroll taxes plus any impact this may have on other company-provided benefits.

As a possible compromise, the company could consider keeping the current $4/hour NEC and making in-service withdrawals as readily available as permissible.  For example, these amounts could be withdrawn from the plan once they have been in the plan for at least 2 years.  The amounts also could be available if the participant, for example, has at least 60 months of participation, or attained Normal or Early Retirement, or is disabled, or has a safe-harbor or non-safe-harbor hardship.  This avoids all of the payroll tax issues, doesn't complicate the 401(k) plan design, apparently already passed nondiscrimination testing, does not involve a match, and cannot trigger 401(a)(30) limits.  Once an employee is qualified for in-service withdrawals under any one of these rules, the employee would have access to the funds.

Generally, we don't advocate very liberal in-service withdrawal rules and would recommend limiting the number of withdrawals per year, but if the recordkeeper is geared up for plan accounting for new features like emergency savings, qualified disaster, qualified adoption and all of the other available in-service forms of payments, this approach should be relatively to implement.

Someone put on his consulting hat - nice response!