If a safe harbor 401(k) plan permits an employee to enter the plan immediately for elective deferrals, but requires one-year of service before eligibility for a safe harbor contribution, may the safe harbor contribution computation period be based on the compensation from a participant's safe-harbor contribution entry date, rather than on the participant's full year of compensation?
Rev. 04/29/04, E-mail Alert 2004-9

Yes, the participant's safe-harbor contribution may be based on the compensation earned while an eligible participant instead of using a full year's compensation. However, for this to occur the plan document must limit the compensation computation period to compensation earned while an eligible participant.

To illustrate, if a participant is hired April 28, 2009 with immediate eligibility for elective deferrals, but the plan required one-year of service for the safe-harbor contribution and has a quarterly entry date for the safe-harbor contribution. The employee would satisfy the one-year of service on April 27, 2010. The next entry date would be July 1, 2010. If the plan had compensation computation period of compensation while a participant, the safe-harbor contribution would be based on compensation for the period from July 1, 2010 to December 31, 2010.

CAVEAT: Although the above plan design is allowed under the regulations, it will not be exempt from the top-heavy rules. We addressed this issue in the attached link. While not previously stated, Revenue Ruling 2004-12 makes it clear that a plan does not satisfy the top-heavy exemption if it has different a longer eligibility requirement for the safe harbor contribution than for elective deferrals.

Bill Grossman, QPA