Salary Reduction for 401k SH Match

Hello - I have a client with an enhanced safe-harbor match 401k plan ($1 for $1 up to 6%.)   When negotiating salary contracts for new employees, the client wanted to tell some employees (none are excluded) that their negotiated salary will be reduced by the 6% safe-harbor match as well as the 6% deferral if they sign up for the plan.  I told them they can not do that, and as there's not rhyme or reason to the employees that the plan sponsor wants this to affect, it can't really be fixed by excluding a class or some other document provision.  The client asked me where these rules are written and to provide in writing.  I can't seem to find anything that specifically says a plan sponsor can't reduce an employee's pay in order to receive an employer contribution.  (Obviously the salary is reduced by employee deferrals.)  Any help with written guidance would be appreciated.

17 minutes ago, TN CPA said:

When negotiating salary contracts for new employees, the client wanted to tell some employees (none are excluded) that their negotiated salary will be reduced by the 6% safe-harbor match as well as the 6% deferral if they sign up for the plan. 

First, the 6% deferral is part of their salary and a piece that they have control over on a payroll period basis. So if the total negotiated compensation is $100,000 (forgetting about the match for now), the $6,000 deferral does not reduce compensation for other contributions and benefits, it only reduces taxable compensation.

Employer contributions are not considered compensation so there can be no employee election, otherwise you have a cash or deferred arrangement (i.e., more 401(k) deferrals). However, as part of initial negotiation and setting starting compensation, I see no reason an employer could not assume the employee will defer 6% and get a 6% match. Say starting pay would be $106,000, and match of $6,000 is assumed in the total rewards package such that compensation is started at $100,000 - and that should be locked in, if they decide to not defer (or to stop) they don't get that match in their pay.

I think a dig into the 401(k) regulations and definitions of what is a salary deferral and what is a matching contribution will clear that up. A match being an employer contribution contingent upon the employee making a salary deferral. Your client wants to also make it contingent upon/resulting in a reduction in pay.

You ARE allowed to tell employees that they have the option to reduce their salary by a certain amount and have it made as a plan contribution instead. This is called a "cash or deferred election" (CODA) and the rules governing it are found in section 401(k), including 402(g) limits, ADP testing, etc. etc. And 401(k) contributions are actually considered to be employer contributions; see 1.401(k)-1(a)(4)(ii) of the regs.

What your sponsor would be doing would be considered a "deemed CODA." Essentially they would disqualify the plan unless they subjected the amounts to ADP testing and all the other rules that apply to 401(k) arrangements.

I agree with both CuseFan and CB Zeller, although they seem to reach different conclusions. Per CB Zeller, if the deal is that the employee can defer and get the match, or not defer and get the amount of the match as additional cash compensation, you have a nonqualified CODA. If, per CuseFan, you just assume that they will all defer and get the match, and so get them all to take a voluntary pay cut as compared with what they had agreed to (assuming nonunion employees, of course), and they pay cut applies even if they don't defer and get the match, then you'd be OK. The key is whether my not pressing the deferral button is in effect pressing the cash bonus button.

Take a look at ERISA section 510.  I think that would apply here.

My supposition is that this gets done during the compensation/total rewards package negotiation pre-employment when the contract is hammered out, an initial one-time event before employment actually begins, and not subject to change (i.e., can't get cash for what match would have been) if person decides not to defer. I don't disagree with CBZ (or Luke) as we're talking apples and oranges.