Very high paid HCE, terminates, under 3 years and 401(a)(17) limit

Company has a traditional DB plan (X% x Years of Participation x 3-year Average Annual Comp) and hires "Guy" 9-1-2017. Wages paid for 4 months in 2017 are $195,000. Paid $500,000 in 2018. After 8 months in 2019, Guy terminates. 2019 wages were $300,000. Vesting is 2-20, so Guy is 20% vested.

Comp before entry is not excluded and comp in the year of termination is not excluded. Document says if Guy has less than the 3 years of compensation, the average annual compensation will be the average of "whole and partial years (whole months) of compensation."

I think that means we sum the compensation and divide by Guy's 24 months. That produces a higher average for short service employees, but after limiting each year by 401(a)(17) comp limit, the result here is essentially ($195,000 + $275,000 + $280,000) / 24 = $31,250. Well, $31,250 is an annual compensation of $375,000, which exceeds the 2019 comp limit.

What is Guy's Average Compensation? The plan has has no prior employee with this fact pattern.

1. We limit Guy to the comp limit in the year of termination ($280,000 annual or $23,333.33 monthly average)

2. We prorate the comp limit for each year for periods of employment (4/12 x $270,000 + $275,000 + 8/12 x $280,000) / 24 = $22,986.11 

I read treasury regulation section 1.401(a)(17)-1(b)(3)(iii)(A) and (B), "if compensation for a period less than 12 months is used for a plan year, then the otherwise applicable annual compensation limit is reduced in the same proportion as the reduction in the 12-month period" and "a plan is not treated as using compensation for less than 12 months for a plan year merely because the plan formula provides that the allocation or accrual for each employee is based on compensation for the portion of the plan year during which the employee is a participant in the plan."

Based on that, I think #2 above is incorrect as a "plan year" is defined in the document, not by the participant's service. Would #1 be your choice? If so, someone with over 36 months at the comp limit each year who terminates in 2019 would have a lower average compensation, since the 2017 and 2018 limits drag down the average: $270,000 + $275,000 + $280,000) / 36 = $22,916.66 or $275,000 annual. The plan document lacks the detail I'd like to see to clarify this.

Any comments are welcome.

Does plan say three years, three plan (or limitation) years or 36 months?

If three years, then I'd be inclined to say $190k +$275k +$280k divided by 3 for average annual compensation.

If you are averaging the 24 months I think that's fine if your document has some sort of proration for years where the participant works less than 12 months.

That said no matter which method you wind up using I don't think the 3 year comp can exceed the 3 year $275,000 annual limit ((2017 + 2018 + 2019) / 3)

I think we’ll just apply a reasonable interpretation, since it does appear to require months to be used for averaging.

Thanks for the responses.