HCEs traditional 401(k) vs nonqualified plan

Hello. We have a nonqualified deferred compensation plan for our HCEs. I’m a bit confused as to how we determine eligibility as I feel that it somewhat conflicts with eligibility for our regular 401(k) plan that HCEs are not eligible for. Our qualified 401(k) plan excludes HCEs based on the IRS’ definition of an HCE (not a 5% owner and did not earn greater than 150k in 2023 (for the 2024 plan year)). Our adoption agreement clearly states that HCEs are excluded from the plan. 

My question- How does this work for new VPs or executives that we hire in 2024? Are they eligible for the regular 401(k) plan since they do not meet the HCE definition yet? Or are they eligible for the nonqualified plan? The eligibility for the nonqual plan is for ‘a select group of management or HCE as defined by the employer.’ Our 401(k) administrator is telling me that these new hire VPs and execs should be eligible for the regular 401(k) and should be given the opportunity to elect since they do not yet meet the definition of an HCE. I do agree with this statement since the only employees excluded from the regular 401(k) plan are HCEs in our plan document. We did not elect the top paid group election for our non discrimination testing either.

So where I’m confused is that our administrator for the nonqualified plan on the other hand is telling me that new hires who come in and are in the top 20% of employees current compensation would be eligible for the nonqual plan. But he also says that eligibility is ultimately determined by the company. I understand that these VPs may be eligible in their first year, but may no longer be the following year if we are basing it off of their income in the previous year or ownership and they are determined to be an HCE.

I don’t want to be out of compliance in regards to our regular 401(k) and want to make sure we are offering the plan to non-excluded team members even if they are VPs and above. So based on the info I provided, would they be eligible for the traditional 401(k) plan (until it is determined they are an HCE) or the non-qual plan? I’m getting two different responses, from both administrators so any input would be appreciated!

You and 401(k) provider are correct that new hires with lookback year pay below the HCE threshold are NHCEs initially and, if other eligibility criteria are met, if any, they should be eligible to enter that plan and defer until the first plan year in which they become HCE.

Unless eligibility for the NQDC plan specifically excludes any employee eligible for the 401(k) plan, it is determined independent of that plan. Also, the determination of "highly compensated" for the NQDC is different and independent (I'll use HC). HC for that purpose is someone considered highly paid in the context of the employer, and someone could be HCE for 401(k) but not HC for NQDC, or vice versa but that is less likely. There is the 20% top-paid group election that can be made for 401(k) HCE. For NQ, there is no formal 20% rule but there has been IRS opinion (I think) that to be predominantly for the benefit of HCs a NQDC cannot cover more than 20% of employees. 

Your NQDC provider is correct in saying the employer must determine who is or is not in the top-hat group (select management and HC). If you use generic definitions, be sure that any management or compensation thresholds are not too low/too broad.

In summary, new executives could be eligible for both the 401(k) and NQDC for their first (partial) year or two of employment.

I hope this was helpful.

I didn’t see what the service requirement and entry dates are for the 401(k). Sorry if I missed it. But if it’s 1 year and dual entry, odds are pretty good you’ll know their HCE status by then. 

Thank you both! Service requirement is 90 days and entry day is the first of the month after service requirement is met.

You'll likely have some future HCEs entering the plan then.

Hi @Bill Presson. Thank you. Yes, that is also what I was told by our NQDC rep also. He did say that it doesn’t happen often, but employees can sometimes be eligible for the 401(k) one year and no longer be eligible the following year and vice versa based on compensation preceding the new plan year.

About the other plan:

Consider that an unfunded deferred compensation plan “for a select group of management or highly compensated employees” might provide that the employer decides whether an employee is eligible or selected, and chooses this in its business discretion.

Whether someone is a select-group employee is highly fact-sensitive, varying with many possibly relevant facts and circumstances. Yet, the risks of guessing wrong can be severe.

Further, a plan’s sponsor might seek its lawyer’s advice about which forum would decide a claim that involves a question about whether the plan was sufficiently limited to “a select group of management or highly compensated employees[.]”

@CuseFan Thank you! This was very helpful. 

Thank you @Peter Gulia. I do plan to discuss with legal as well.

If you want to avoid newly hired executives entering the 401(k) their first year (then being excluded the next), you might also look at excluding from the 401(k) plan any other employee whose annualized compensation during their first year of employment is reasonably anticipated to exceed the HCE threshold for that year.

I think this works as long as you pass coverage testing.

You could admit them to the nonqualified plan immediately (assuming, as others note, they are part of a top-hat group).  

Thanks @EBECatty! This is a great idea if we can exclude them and what I propose we do.