Coverage Fail-Safe for Excluded Interns

Start-up 401(k) plan for small employer (no more than 5 regular employees, not including interns) intends to have eligibility criteria for all contribution sources attainment of age 18 and completion of 6 months of service, elapsed time, with quarterly entry dates.  The sponsor wants to exclude interns, but there is a concern that the exclusion may result in a coverage failure, given the number of interns and their potential duration of service.

To avoid a coverage failure, can the plan provide for an exclusion of interns subject to a fail-safe that allows an intern to enter the plan effective the first day of the quarter coincident with or next following the intern's attainment of age 21 and completion of 12 months and 1,000 hours of service? 

If you have different eligibility requirements for different classes of employees you encounter a BRF problem.  Getting fancy with eligibility won't resolve your issue.  It will add another layer of headache.  

When running 410(b), Otherwise Excludable Employees - those who have not met IRS statutory eligibility requirements - can be tested separately.  Excluding interns as a class should therefore not pose a problem.

. . . unless the 5 regular employees do not meet statutory eligibility requirements either.    

Let's assume the 5 regular employees do not meet statutory eligibility requirements, because the question of interns would otherwise not likely be an issue.

As part of the initial plan design, in the event of a 410(b) failure, the document should provide the plan sponsor the option of: 

• a boilerplate failsafe (which could be sweeping, and thus less optimal), or
• the option to retroactively amend the plan (-11(g) amendment) for the year of failure.  

As a default, we always choose the latter as our correction method.

In choosing to retroactively amend the plan to correct a coverage failure, you can limit the number of individuals you bring in to meet coverage requirements.  Start with your regular employees, and work your way toward a passing test for the year.  

While it may add an annual cost to plan administration (corrective amendment preparation), it allows the plan sponsor to cherry pick who they choose to bring in, and even how they pass coverage.  Bearing in mind you can also pass coverage with ABPT, this may salvage the year in question as well.

This is a broad overview, and I may be missing something.  Generally speaking though, testing Otherwise Excludables separately in a situation like yours resolves the problem without having to jump through hoops.

The question that Plan Doc is asking is not necessarily a 410(b) issue, although it is related. Rather, the issue is whether the eligibility classification (exclusion) for interns passes muster under 410(a). The argument being that the exclusion of interns could be seen as an indirect exclusion based on hours worked, which violates 410(a).  I believe that the failsafe language you are referring to does work according to the IRS. 

Furthermore, I don't see how different eligibility criteria presents a BRF problem under 401(a)(4). If there is a "problem" with different eligibility criteria (assuming the criteria passes 410(a), then it will be "caught" under 410(b), not 401(a)(4) BRF. 

Make sure you know the terms of the failsafe election.  Some elections are written so that the failsafe requires the plan to automatically extend coverage until the Ratio Test is passed.  This can be expensive and this type of failsafe would preclude the use of the Average Benefits Test which often is far less expensive.  If you are using a pre-approved document, check the language in the basic plan document.  Some pre-approved document providers include effectively include an escape clause that preserves the right to use ABT, and other providers do not.

How long has the company been in existence long enough for LTPT employees to become eligible? The LTPT rules are on the horizon could be applicable as early as next year for this plan.  Apparently, for LTPT employees the only classifications that can be used to exclude the employees from participating in the 401(k) part of the plan are union employees and non-resident aliens.  Interns would have to be allowed to participate in the 401(k) part of the plan if they have met the LTPT eligibility service and plan's age requirements.  You will need to make sure any match or non-elective employer contributions retain the exclusion of interns.

Our world changed on December 29, 2022.

Thank you, Towanda, Former Esq. and Paul I, this is great information!