It is common and popular practice to have multiple layers of matching formulas in a safe harbor matching plan. Typically the intention is to create an ADP/ACP safe harbor but have additional layers of matching that may be subject to vesting and/or be discretionary instead of fixed. Many documents set up two types of matching contributions - one as 'safe harbor' and the other as 'non-safe harbor'. Because of the pitfalls described below, ftwilliam.com documents do not set out separate 'safe harbor' and non-safe harbor' matching contribution sections. Instead, we provide flexibility within the single matching contribution section to specify exceptions and special rules.
The benefits of providing a safe harbor matching contribution (e.g., exemption from ADP testing) will be lost if other matching contributions within the plan do not satisfy the regulations under Treas. Reg. 1.401(k)-3 (ADP safe harbor) and 1.401(m)-3 (ACP safe harbor), often referred to as the safe harbor regulations. Unfortunately, a commonly overlooked aspect of safe harbor plan design is that the requirements for non-safe harbor and safe harbor matching contributions are intertwined, making it critical for practitioners to use great caution when drafting a safe harbor 401(k) plan document. The use of multiple matching contribution sections in a document creates a substantial risk that plan drafters will overlook the requirements and interrelationship between the rules governing safe harbor matching contributions and non-safe harbor matching contribution types, thereby increasing the potential that a plan will fail to comply with the safe harbor rules and be subject to nondiscrimination testing.
Below we will describe the rules in the ADP and ACP safe harbor regulations that may lead to inadvertant violations of the safe harbor requirements in safe harbor plans with multiple matching contribution sections.
ADP Safe Harbor Pitfalls
Treas. Reg. 1.401(k)-3(c)(4) (the ADP Safe Harbor rule) provides as follows regarding a plan that satisfies the ADP safe harbor with safe harbor matching contributions:
(4) Limitation on HCE matching contributions.-
The safe harbor matching contribution requirement of this paragraph (c) is not satisfied if the ratio of matching contributions made on account of an HCE's elective contributions under the cash or deferred arrangement for a plan year to those elective contributions is greater than the ratio of matching contributions to elective contributions that would apply with respect to any eligible NHCE with elective contributions at the same percentage of safe harbor compensation.
It is of utmost importance to note that the "ratio of matching contributions" mentioned in the regulation above does not differentiate between safe harbor matching contributions and any other matching contribution type. Therefore, if a plan is designed to use a safe harbor match to satisfy ADP testing, and it also provides for a discretionary (and/or additional fixed) match, then in order to maintain the benefit of the safe harbor match, no HCE can receive a rate of match at any level of deferral that is greater than the rate of match received by any NHCE at the same level of deferral. Unfortunately, this rule can be easily broken simply by including some very common restrictions on the discretionary and/or fixed match portion of the plan. Plans that require participants to meet a last day requirement or hours of service requirement in order to receive the discretionary match put the plan's safe harbor status into jeopardy.
For example, assume that a 401(k) plan includes a safe harbor match as well as an additional discretionary match. This plan requires participants to meet a last day requirement in order to receive the discretionary match. Charles is an NHCE who makes elective deferrals into the plan each year, including in 2012. Charles terminates employment in October 2012, and therefore is not eligible to receive a discretionary matching contribution for 2012. Janet, an HCE, also makes elective deferrals to the plan each year, including in 2012. Janet remains employed with the company for all of 2012 and receives both a safe harbor match and the discretionary match. Janet will receive a higher ratio of matching contributions since she receives the discretionary match and Charles does not. The plan is therefore in violation of the rules discussed above, preventing the plan from benefitting from the safe harbor rules and requiring it to satisfy ADP testing, even though the safe harbor match must still be made and be 100% vested.
ACP Safe Harbor Pitfalls
The ADP safe harbor rules are not alone in setting forth limitations that can affect non-safe harbor matching contributions. Similarly, Treas. Reg. 1.401(m)-3(d) under the ACP Safe Harbor, provides very specific limitations that apply to any ACP safe harbor plan - whether the plan is using a safe harbor matching contribution or nonelective contribution to satisfy the safe harbor. Just to reiterate some of the additional requirements, we copied all of Treas. Reg. 1.401(m)-3(d) below, which you will find in the notes section of our adoption agreements, but it is paragraph (4) at the bottom that we want most to bring to your attention:
(d) Limitation on contributions
(1) General rule.-
A plan that provides for matching contributions meets the requirements of this section only if it satisfies the limitations on contributions set forth in this paragraph (d).
(2) Matching rate must not increase.-
A plan that provides for matching contributions meets the requirements of this paragraph (d) only if the ratio of matching contributions on behalf of an employee under the plan for a plan year to the employee's elective deferrals and employee contributions, does not increase as the amount of an employee's elective deferrals and employee contributions increases.
(3) Limit on matching contributions.-
A plan that provides for matching contributions satisfies the requirements of this section only if-
(i) Matching contributions are not made with respect to elective deferrals or employee contributions that exceed 6% of the employee's safe harbor compensation (within the meaning of § 1.401(k)-3(b)(2)); and
(ii) Matching contributions that are discretionary do not exceed 4% of the employee's safe harbor compensation.
(4) Limitation on rate of match.-
A plan meets the requirements of this section only if the ratio of matching contributions on behalf of an HCE to that HCE's elective deferrals or employee contributions (or the sum of elective deferrals and employee contributions) for that plan year is no greater than the ratio of matching contributions to elective deferrals or employee contributions (or the sum of elective deferrals and employee contributions) that would apply with respect to any NHCE for whom the elective deferrals or employee contributions (or the sum of elective deferrals and employee contributions) are the same percentage of safe harbor compensation. An employee is taken into account for purposes of this paragraph (d)(4) if the employee is an eligible employee under the cash or deferred arrangement with respect to which the contributions required by paragraph (b) or (c) of this section are being made for a plan year. A plan will not fail to satisfy this paragraph (d)(4) merely because the plan provides that matching contributions will be made separately with respect to each payroll period (or with respect to all payroll periods ending with or within each month or quarter of a plan year) taken into account under the plan for the plan year, provided that matching contributions with respect to any elective deferrals or employee contributions made during a plan year quarter are contributed to the plan by the last day of the immediately following plan year quarter.
Again, the plan must ensure that the rate of match at each level a participant defers is no greater for any HCE than it is for any NHCE. In order for the plan to comply with this requirement, and thereby maintain the plan's safe harbor feature and avoid ACP testing, the plan cannot allow for any service or last day requirement on a discretionary (and/or additional fixed) matching contribution (even if the plan is using a 3% nonelective contribution to satisfy the safe harbor rules). To allow such an arrangement in your document is setting the plan up to fail nondiscrimination.
In light of the restrictions noted above, we chose to keep all of the matching provisions in one section of our document in order to ensure that our customers' plans do not become inadvertently taken out of safe harbor status; we certainly do not want any plan to fail in operation because of an oversight of the rules explained in this article.
We hope you will attend Christian Hofstadter's free webinar on September 26, 2012 for more details on how our document can be designed to be compliant with the 401(k) safe harbor rules.
If you have any questions please feel free to contact us at firstname.lastname@example.org or call 800.596.0714.