|Cash vs 401k

Client currently funds 7% Profit Sharing to all participants.  This is cross tested plan.

They also allocate the 3% to all participants. 

For the upcoming plan year, the HCEs will not receive the 7% - testing will not be an issue.  However, the client wants to know if they can allow the HCE to decide if they will take the 7% as cash or defer into the plan.   The 7% would be paid as wages in the current plan year and deferred to the 401(k).

If the employee has already deferred for the 2023 plan year, the 7% would push him over the deferral limit, so he would be capped at the 402(g) limit.

I thought the IRS had some guidance when you allow the employee in this case to take the cash or defer.  I am trying to figure out if the client is opening themselves up to an issue down the road.

This is literally the definition of a 401(k) arrangement. Can you elaborate on what you are concerned about? Maybe provide some specific examples with numbers?

When you said "They also allocate the 3% to all participants" does this mean a safe harbor non-elective contribution? If so there is no ADP test, so there is nothing stopping HCEs from contributing up to the annual limit.

Short answer - the client is opening themselves up to an issue as soon as they adopt this design.

Just curious - you refer to "the HCE" which leads me to believe there is only 1 HCE.  Does this also happen to be the owner of this business?

You comment that "if the employee has already deferred", so can we assume that the plan already is a 401(k) plan?

You note the "they also allocate the 3% to all participants" which is addition to the "7% profit sharing to all participants".  Is the 3% a Safe Harbor Nonelective Employer Contribution?  And, is the 7% a discretionary profit sharing contribution allocated pro-rata on compensation to all participants who meet the allocation conditions?

You note the plan is cross-tested.  Is there a reason the plan is cross-tested?

The answers to all of these questions will help describe the plan's situation.

Fundamentally, giving employees the right to make a cash-or-deferred election on the 7% contribution makes this a 401(k) election as you seem to acknowledge.  Giving only the HCE that right makes it discriminatory.

I agree that this is the basic definition of a 401(k) arrangement, and that it is confusing - either the employer is trying to do something that doesn't make sense or it isn't being described properly.

I disagree that it is discriminatory though. For the HCE(s?) it devolves to a 7% cash bonus that may be deferred if desired and if limits aren't exceeded.

In order to treat the HCE's an amount as a cash bonus, it would have to be included in the plan's definition of compensation and already eligible for a deferral.  The HCE would still get the 7% profit sharing on top of that unless the HCE was excluded from the allocation of that particular contribution source.

It will be interesting to get a clearer picture of how this plan is set up.

As long as it's a 401(k) plan that allows participants to change their election with sufficient frequency to allow it, then sure. I have a small client who pays out bonus in December and sends out a reminder e-mail that they employees can make an election to defer as much of their bonus up to the 402(g) limit allowed if they would like to defer taxes on it.

That bonus is part of the W-2 so I do remind the client that they will giving the 3% Safe Harbor and and required gateway on top of the bonus since it is part of the Plan's compensation definition.

19 hours ago, Lou S. said:

As long as it's a 401(k) plan that allows participants to change their election with sufficient frequency to allow it, then sure. I have a small client who pays out bonus in December and sends out a reminder e-mail that they employees can make an election to defer as much of their bonus up to the 402(g) limit allowed if they would like to defer taxes on it.

That bonus is part of the W-2 so I do remind the client that they will giving the 3% Safe Harbor and and required gateway on top of the bonus since it is part of the Plan's compensation definition.

 

Lou, Op's situation is a little different from this. Your client is paying cash unless the participant chooses to defer. The OP's client is making a PS contribution unless the participant chooses cash. Still can be done and I've had a handful of plans that did the latter over the years, but it's not very common.

1 hour ago, Bill Presson said:

Your client is paying cash unless the participant chooses to defer. The OP's client is making a PS contribution unless the participant chooses cash.

Is there really a difference? I'm not sure what the paperwork looks like on the latter. If that is somehow do-able then Paul's statement about it being discriminatory is indeed a concern. The OP's fact pattern is contradictory (below)...will NOT receive but then wants to know if they can allow it..so we are all speculating.

On 8/16/2023 at 9:02 AM, 52626 said:

For the upcoming plan year, the HCEs will not receive the 7% - testing will not be an issue.  However, the client wants to know if they can allow the HCE to decide if they will take the 7% as cash or defer into the plan.

I'll throw this in.  First, generally you may pay employees current taxable compensation of whatever amount, subject to wage and hour law and contracts you may have with them.  Second.  Prior to the enactment of sec. 401(k) we gave all our participants a 10% (3% mandatory and 7% discretionary) qualified profit-sharing plan contribution each year.  The first year 401(k) became effective (and for some years thereafter), we amended the plan to allow employees to take 30% of the profit-sharing contribution in cash, or some fraction thereof, or let it stay in the plan as a 401(k) deferral.  Cash-or-deferred arrangement option (1).  Cash-or-deferred arrangement option (2) was for the employee to reduce pay to put even more in the plan as a 401(k) deferral (the more common approach to 401(k) today).  All subject to applicable testing, $ limits, blah, blah, but not cross-tested ever.  This was all completely legal and still would be.  Eventually we discontinued option (1), so that the entire 10% profit-sharing contribution had to stay in the plan (always 100% vested).  We did this because too many NHCEs and some HCEs (prior versions) were taking the 30% cash, which presented testing problems and because we thought the employees were better off, in any case, with the deferral (being somewhat paternalistic in the matter).

As to your situation number 52626, I'll admit that I don't understand the question enough to try to give you my thoughts.