Employment Contract requires employees to not participate

A client let it slip today that the employment contract for two of their new employees prohibits them from participating in their safe harbor match 401(k) plan.  At their request, the plan (effective 1/1/16) has immediate eligibility and no excluded employees.   So, both employees are participants.  Both are non-owner doctors hired late enough in 2017 year that they will be NCHEs for both 2017 and 2018. I'm trying to sort though potential problems.  So far, I have:

1.401(k)-3(c)(6)(i) says it's not a safe harbor match if there are restrictions on NHCE deferrals other than those listed.   This doesn't fit any of the allowed restrictions, so I read it as goodbye safe harbor.

I haven't seen the employment contract, but I will be shocked if it contains a one-time irrevocable election under 1.401(k)-1(a)(3)(v).  Besides, the plan does not allow such an election.  So, it appears we either have an operational failure or the employment contract provision is a CODA.

Does anyone see anything I missed? or have any additional comments?

I agree.  This seems like a classic fiduciary breach.  The one thing that the Plan Administrator must do (if nothing else) is enforce each participant's rights under the written terms of the plan.  In this instance, they are impeding the participants' rights.  If they do not want them to participate, then the plan should be written to exclude them.  If they cannot pass non-discrimination by excluding them, then they shouldn't have a plan.

Good Luck!

The client should be advised to bite the bullet and tell these folks - immediately - that they have to be eligible for 2017 and if they become entitled to a match the client will pay it.  The client can then think about 2018 and thereafter and if it works to amend the plan to exclude them you could do that, if it doesn't work then they will need to renegotiate the employment agreements.

A different thought - is it necessarily goodbye safe harbor? The PLAN does not restrict anything. So the operational error must be corrected, (make up deferrals and match as required under the terms of the plan and the self-correction procedure) and then exclude them prospectively as an excluded class, assuming you can pass coverage testing. I'm no lawyer, but I'm assuming the terms of the employment contract can be modified with the agreement of all parties?

Looks like Jpod and I were replying at the same time...

I agree with the above, I don't think it is has to be goodbye safe harbor.  You have an unenforceable clause in the employment agreement and an operational error in the plan that can be corrected.  Going forward, look at a proper exclusion in the plan document if possible.  

They made a mistake in the employment agreement and now they get to pay up for not checking with their plan expert first.

To what extent can there be an excluded class in a safe harbor plan?  Just wondering.

Quote

(6) Permissible restrictions on elective contributions by NHCEs.

(i) General rule. The safe harbor matching contribution requirement of this paragraph (c) is not satisfied if elective contributions by NHCEs are restricted, unless the restrictions are permitted by this paragraph (c)(6).

The reason I think the Safe Harbor is gone is the wording above.  The prohibition does not refer to plan restrictions, just restrictions.  In contrast, the exceptions listed after it refer to things the plan may limit.  After sleeping on it, since the affected employees are otherwise excludable, the loss of safe harbor should only affect that portion of the plan, which only has NHCEs.  They are not top heavy, so the negative impact of losing the SH may be minimal.

I agree that approaching it as an improper exclusion would be best, but need to have a handle on what happens if they don't for the discussion.  

A plan provision excluding a class of employees isn't a problem as long as 410(b) passes and you don't violate some other rule (ie excluding part-time).  In this case, they have enough other NHCEs that they could have excluded these two without any 410(b) problems.  The SH rules say that all eligible NHCEs have to receive the SH, but don't impose any rules on eligibility requirements.    

Inasmuch as they are physicians by 2019 they may be clearly in the HCE zone.

Terms of the employment contract do not alter terms of the plan document.

David Rigby:  I am pretty sure everyone recognizes that.  We are contemplating whether and when the plan can be amended to accommodate the deal which the parties have struck, or at least that's what I am contemplating.   

Kevin - FWIW, I have always understood that to mean (and I hope I haven't understood incorrectly all these years!) that you can't restrict the right(other than as allowed as you cite) for employees who are eligible under the terms of the plan. If, for example, you exclude leased employees from any participation in the plan, are you saying that you cannot have a safe harbor plan? That doesn't seem right to me.

What you can't do, except within specified limitations, is exclude from the safe harbor anyone who is eligible to make deferrals. And a properly excluded class is not eligible for deferrals.

Unfortunately, I don't have time right now to search for citations to support my understanding, or worse yet, to discover I've been wrong...

I read Kevin and Belgarath to be agreeing and saying the same thing in different words.

I read Kevin to be saying that since they are already eligible to participate, you can't exclude them from deferring for fear of losing safe harbor status because of their employment agreement.

I think it's understood that you can exclude class(es) of employee(s) and still have a safe harbor plan.  You just have to pass coverage.

Yes, I agree with Belgarath.  The last paragraph of my last post was in response to My 2 Cents, who asked a question while I was typing.  

These employees are eligible under the terms of the plan and according to the client, their employment agreement says they can not participate in the plan. I see that as a restriction on the amount they can defer, which means the safe harbor match requirement is not satisfied.

I also see giving the choice between plan benefits and compensation as being a problem, since it would fit the definition of a CODA.  

If it is a safe harbor match plan, then the employee's could simply elect not to defer.  It seems like that is what they have agreed to through the employment contract, so it is probably not an issue with them.  They do not defer and they do not receive a match, then there isn't an issue in the years they are NHCE's.

jsample, I disagree.  First of all, why would anyone voluntarily give up the right to receive a safe harbor contribution unless they receive something in return?  An choice between benefits and cash is a CODA, unless it is a one-time irrevocable election as referenced above.  The other problem is that once the contract is signed, the participant can't decide later on to defer unless the employer is willing to revise the employment contract.  It is still a restriction on their deferrals that doesn't meet one of the exceptions listed in the regulations.

That does bring up an interesting question.  What happens if the employee signs the contract and later elects to defer in violation of the employment contract? Would ERISA 510 prohibit the employer from discharging the employee for violating the employment contract?  Any lawyers out there with an opinion? 

Yes I think there would be a lot of potential for a 510 claim.  However, maybe these docs are just honorable people and won't take advantage of their employer's mistake and won't contribute.  As long as it is not the result of any threats by the employer, no problem.   

The more I think about it, the more I gravitate towards @Kevin C's conclusion. 

Here's is where I get a little stuck though.  Without some kind of action on the part of the plan, is the clause in the employment agreement even enforceable? From a plan perspective, they are still allowed to participate.  So is is an unenforceable restriction still a restriction? 

You could easily take Kevin C's point to levels beyond a mere Safe Harbor. I think that beyond the clear fiduciary breach, it's bye bye to the qualified status of the plan. BRF must be currently and effectively available on a nondiscriminatoru basis. You can easily argue that the deferral is not effectively available; despite the written terms of the plan. I guess it becomes an issue of 'what level of wrong' you're trying to substantiate. 

Good Luck!