exclusion of NHCE as a class

I just wanted to share a WTF moment that I think many of you can understand. Mostly rhetorical - but feel free to chime in, especially if you think my indignation is unfounded. 

This week in reviewing an existing 401(k) plan document there was a written in class exclusion for Non-Highly Compensated Employees. In the Other line option in the adoption agreement. I could not believe a service provider, and and large national one at that, would let a sponsor include it. But it is a lower cost one, so I really shouldn't be surprised. It is a small plan, likely owner only, but still. 

A few weeks earlier I saw a similar exclusion in a defined benefit plan for a small employer. Though that class exclusion did not use the term Non-Highly Compensated Employee. It was something like 'everyone except two of the owners, Jack Smith and Jill Smith are excluded'  that employer definitely had plenty of employees that are NHCE that have plenty of service and cause the testing to fail. And no, there did not seem to be any other plan with this one combined for testing and benefits. 

Setting up a plan that on its face fails non-discrimination before any benefit accruals or contributions are even considered is terrible! Even if those exclusions are ultimately considered void, there were document providers, service providers, financial advisors, and probably a TPA or recordkeeper involved in setting those plans up! They never should be there in the first place! 

Two in such a short time, from two different places, I just felt like was worth sharing. Maybe these exclusions are written in more than I realize and I've just been fortunate enough to not see them up until now. 

I'll play devil's advocate to be feisty and get you riled up. Apologies in advance.

Excluding NHCEs from a 401(k) plan might be advisable where they do not work 1000 hours ever for YOS eligibility but the plan wants eligibility determined on elapsed time. Of course, as soon as one NHCE becomes non-excludable you have a coverage failure.

We see NHCEs excluded from small employer DB/CB plans many times when aggregated with DC to satisfy coverage and nondiscrimination AND the DB/CB covers enough HCEs to satisfy minimum participation.

BUT I agree with your WTF, and would grill the drafters of these plans as to HTF they satisfy coverage, nondiscrimination and for the DB minimum participation.

Maybe there is a second plan that ONLY covers NHCE with identical BRF?

There are many possibilities—including those CuseFan and Gadgetfreak allude to, and many more—about how provisions of the kinds you describe could be what a plan’s sponsor thoughtfully intends.

But even if you see the provisions might be, or even likely or certainly are, tax-disqualifying, here’s another outlook.

For a service provider that lacks discretion to administer the plan and denies that it provides tax and other legal advice, there can be legitimate business reasons to accept a client’s or customer’s document (or instruction for making a document), even one the service provider believes to be contrary to the plan sponsor’s proper interests.

While a service provider might politely ask its client or customer whether it has fully thought about its document or instruction, there is a range in which too much questioning suggests the service provider, despite its denials and disclaimers, really provides tax or other legal advice.

For many service providers, that might cross a line into the unlawful practice of law, which is a crime in almost every State of the United States. Even if one worries not at all about a criminal prosecution, a nonlawyer that provides legal advice is liable for its inaccurate or incomplete advice if it did not meet a competent lawyer’s standard of care. Often worse, someone seeking to pin a fiduciary’s breach on a service provider might use facts about too much involvement to assert that the service provider exercised discretion about the plan’s administration and so was a fiduciary, which had duties not to enable, participate in, conceal, or fail to make prudent efforts to remedy, another fiduciary’s breach.

In my experience, the more established the recordkeeper or other service provider is, the tighter and harsher are the constraints about what a worker must not say. As just one example, a recordkeeper might have told its employees not to refuse an adoption agreement unless it is obvious on the face of the document alone that the user’s choice or use of a fill-in line is contrary to the adoption agreement’s instructions.

And consider this: If other service providers did not mention an issue, is that an opportunity to show or remind your new client why it needs justanotheradmin’s services?

I would check whether this plan is aggregated with another for the NHCEs, and if not I would inquire whether someone has thought through the 410(b) issue.