Profit Sharing for Terminated Unvested Participant

Ran across a situation where in order to avoid a 410(b) failure, must make a profit sharing contribution for a terminated participant who is 0% vested.  The plan is top heavy and has never made a profit sharing situation before.  The required contribution is over the $5k involuntary cash-out threshold.  What are the options for how should the plan handle this circumstance?    Hope that the balance falls below $5k so they can force the participant out?  Wait until the plan someday terminates and the funds become 100% vested?  Any ideas are much appreciated. Thanks.

The force out threshold is based on the vested balance. Check your plan document for "deemed cash out" or similar language. What it usually says is that when a participant terminates with a $0 vested account balance they are deemed to have received a distribution of their vested account, and the unvested amount is immediately forfeited.

From a practical standpoint, this means the sponsor would contribute the amount to the participant's account and then immediately forfeit it.

Note that if the correction was done with a retroactive amendment, a.k.a. an -11(g) amendment, then this goes out the window. The -11(g) rules require that the benefits granted by the amendment "have substance" which means an allocation to a 0% vested terminated participant does not count. You have to grant them some vesting, not necessarily 100%, in order for it to count. After applying the vesting, if their vested balance is less than the applicable limit then they can be forced out.

You didn't specify the nature of the coverage failure. If this is a correction of a coverage failure on profit sharing, maybe there were non-key HCEs who received the top heavy minimum, then this is fine, but $5k as a 3% contribution for an NHCE seems like a lot.

However if this is a correction of a 401(k) coverage failure which you are correcting with a QNEC then disregard what I said, since a QNEC must be 100% vested. In that case you have a participant with a vested balance over the involuntary distribution threshold, just like anyone else. They can not be required to take a distribution until age 72 (or plan termination).

As always, more facts are better.

C.B., thank you for the response.  The situation in question is for the calendar 2020 plan year, but we're addressing profit sharing early.  This is a small family business that had a windfall in 2020 when they sold off a segment of the business.  Its a standard safe harbor match plan, top heavy since inception, but had never made a profit sharing contribution before.  The 2 participants in question were terminated mid-year, and would be receiving roughly a 24% profit sharing contribution.  The HCE group consists of 2 partners and their wives.  The only NHCE's include only the 2 participants that both terminated mid-year.  The plan has a last day requirement.  The failure is on the non-elective portion of the Ratio Percentage Test.  Let me know if there is more info you might need, I appreciate the help!

Does the document have 'fail safe' coverage?  If not, have you tried running the average benefits test?

25 minutes ago, 401kSteve said:

C.B., thank you for the response.  The situation in question is for the calendar 2020 plan year, but we're addressing profit sharing early.  This is a small family business that had a windfall in 2020 when they sold off a segment of the business.  Its a standard safe harbor match plan, top heavy since inception, but had never made a profit sharing contribution before.  The 2 participants in question were terminated mid-year, and would be receiving roughly a 24% profit sharing contribution.  The HCE group consists of 2 partners and their wives.  The only NHCE's include only the 2 participants that both terminated mid-year.  The plan has a last day requirement.  The failure is on the non-elective portion of the Ratio Percentage Test.  Let me know if there is more info you might need, I appreciate the help!

You might have a partial plan termination under these circumstances. If so it would require the terminated employees to become 100% vested.

1 hour ago, C. B. Zeller said:

You might have a partial plan termination under these circumstances. If so it would require the terminated employees to become 100% vested.

Very important point.

I'm guessing that this the allocation formula is either pro-rata or integrated w/SS if you're having to give 24% to pass the 410(b) ratio test.  Are the terms younger than the owners?  Have you looked at a new comp allocation to reduce that contribution?  It's not too late if the plan has a last day requirement.