Special HCE Elective Deferral Eligibility Requirement for Safe Harbor 401(k) Plan

We have a client with a safe harbor 401(k) plan that imposes different elective deferral eligibility requirements for NHCEs and HCEs. NHCEs may begin making elective deferrals on the first day of the month following the first day of employment or re-employment. HCEs must complete 12 months of service before entering the elective deferral portion of the plan. However, in practice, HCEs have entered the plan at the same time as NHCEs (that is, the first day of the month following the first day of employment or re-employment).

On a separate, but possibly related note, all eligible employees must complete 1 year of eligibility service to receive the safe harbor match.

We have not seen a plan eligibility provision like this before, and wonder if this provision was intended to address early participation rules and nondiscrimination testing requirements. Has anyone else seen this provision? If so, in practice have you only applied the HCE eligibility provision to 5% owners (because a new employee cannot be a HCE based on compensation that first year)?

I think they are trying to ensure they have no HCEs in the otherwise excluible group so they don't have to run a 401(k) test and process potential refunds. It may be that the owners kids pop on the payroll that could cause testing issue with the less than a year of service group. And I have not seen that particular provision in practice.

3 hours ago, KMMB said:

However, in practice, HCEs have entered the plan at the same time as NHCEs (that is, the first day of the month following the first day of employment or re-employment).

I've never understood why people write weird provisions in the plan and then ignore them.

19 hours ago, KMMB said:

If so, in practice have you only applied the HCE eligibility provision to 5% owners (because a new employee cannot be a HCE based on compensation that first year)?

Yes, this would only apply to 5% owners, and makes sense because (like Lou noted) you don't want an owner's child instantly eligible and potentially blowing up your testing. 

This is helpful Lou and CuseFan, but what do you about the following scenario: You hire someone today and for 2021 they are an NHCE (not a 5% owner and no prior year comp) so they enter the plan, but in January 2022 you look back at 2021 comp and see that they are an HCE for 2022. Now you have a HCE in the plan who has not completed 12 months of service. Do they continue participating in the plan for the first 4 months of 2022 as they did before or do they now have to wait until they complete 12 months of service (because they are now an HCE)?

What does the document say?

Eligibility is not a protected benefit but often documents will grandfather those who previously met the eligibility conditions.

Though in practice it might be difficult to suspend his election when it's now determined he became an HCE based on look-back comp. To me this seems like an overly complicated provision designed to create unforseen problems.

Thank you Lou. This is a preapproved volume submitter that does not specifically address grandfathering, or even transfers from eligible to ineligible classes.

20 hours ago, KMMB said:

volume submitter that does not specifically address grandfathering, or even transfers from eligible to ineligible classes.

Surprised - at least on class transfers, although I don't think that's the applicable issue because HCEs are not an ineligible class, they merely have a different eligibility requirement. Most plans (although not required because not protected as Lou stated) say that upon amendment of eligibility those already in the plan continue in the plan regardless, but that doesn't really fit here either.

Without seeing specific language, I would think or otherwise might interpret that the exclusion/waiting period for an HCE specifically applies to an "eligible employee" and does does not mention someone who is already a participant. Most likely, the language with respect to this precise issue is sufficiently vague enough so that the Employer/Plan Administrator can exercise its right and duty to interpret the plan as it deems reasonable provided this is applied on a uniform and nondiscriminatory basis in the future.

That is, figure out what makes the most sense, document the decision and move forward now and forever accordingly.

So is the ER monitoring during the year who will be an HCE on January 1 and stop their deferrals right then?

Otherwise, they might be deferring and they will become retroactively (so to speak) ineligible for deferrals on 1/1 and will have to have those deferrals (plus earnings) refunded to them. (Via EPCRS SCP)