Safe Harbor 401(k) Plan Design Issue
Rev. 07/01/10; E-mail Alert 2010-10

In teaching the safe harbor 401(k) plan rules — for a plan using the safe harbor nonelective contribution (NEC), a point that is always stressed is that in order for the plan to be safe harbored from the ADP, all eligible non-highly compensated employees who work at least an hour during the year must receive the safe harbor NEC. Thus, if the plan is using the guaranteed 3% NEC safe harbor contribution, it must be provided to all eligible nonhighly compensated employees (NHCEs), even those who were eligible to defer but never deferred. Further, it must be provided to those NHCEs who left before attaining 500 or 1,000 hours or the last day of the year, because there are no allocation requirements permitted on the safe harbor contribution.

Although this is clearly how the regulation is written, the plan document is another issue. Specifically, in order to provide the safe harbor contribution only to the NHCEs, the plan document must be written that way. A plan may want to provide the safe harbor contribution to all eligible employees and that is fine also. Plan provisions govern who is to receive an allocation. But note that if the document does not exclude highly compensated employees (HCEs) from receiving the safe harbor NEC, the HCEs must also be provided the safe harbor NEC.

If the plan sponsor wishes to provide the safe harbor NEC to only the NHCEs, the plan document must be drafted with a provision that excludes the HCEs from receiving a safe harbor contribution. Generally, this is accomplished by excluding HCEs from the safe harbor source under the plan's eligibility section before the beginning of the plan year for which they are to be excluded.  They may not be excluded from the current plan year once it has started.

Example 1
A plan is taken over by a new vendor, in reviewing the allocations and the plan document it is discovered that the safe harbor NEC has been provided to only the NHCEs since 2009 when the plan began. However, the document does not exclude HCEs from the safe harbor contribution. A corrective contribution must be made to provide the safe harbor contribution, plus earnings, to the HCEs since the plan opened. The plan may be amended towards the end of 2010 to exclude HCEs from the safe harbor contribution effective with the new plan year starting January 1, 2011.

Example 2
Plan is amended in October 2009 to add a safe harbor 401(k) basic matching payroll-based formula provision for the plan year beginning on January 1, 2010. In June of 2010, on a plan administrator audit of the plan, it is discovered that the safe harbor matching contribution is not being provided to the HCEs. The plan administrator checks the plan document and finds that the HCEs were not excluded from receiving the safe harbor contribution. Therefore, the employer must provide the safe harbor match to the HCEs for the 2010 plan year. The employer may amend the plan towards the end of 2010 for the 2011 plan year, so that effective January 1, 2011, the HCEs will be excluded from the safe match match contribution for 2011.

For more information or to register for our eSeminar: Safe Harbor 401k)s: Design and Correction, click here.