Retroactive Amending to Deny HCE Safe Harbor Contributions: When, If, and How
By Pa Nhia Lor, QKA
Employers with qualified retirement plans cannot disproportionately favor highly compensated employees (HCEs). This basic principle may lead to a misconception that no issues would result from implementing changes that negatively affect only HCEs. Although the Internal Revenue Code contains discrimination rules that differentiate between treatment of HCEs and non-HCEs, there are also prohibitions that apply to all participants, without regard to their HCE/non-HCE status. One principle and regulatory provision in particular deals with the right to retain benefits already accrued. This anti-cutback provision applies to all employees who are entitled to receive benefits, not just non-HCEs. This principle is sometimes forgotten when a plan has to resolve conflicts involving operational failures in the benefits it has provided, and the anti-cutback rules under Internal Revenue Code Section (IRC. Sec.) 411(d)(6) .
The Issue
A 401(k) safe harbor plan was established in 2018. The plan documents required safe harbor contributions to be made to all eligible employees. In 2019, the plan sponsor decided that HCEs would be excluded from the safe harbor contribution, but failed to amend the plan document to reflect its intent. The plan sponsor has only allocated safe harbor contributions to non-HCEs since 2019.
What is the Failure?
The plan sponsor has failed to follow the terms of the plan document, which results in an operational failure. The current plan document states that all employees who satisfy the eligibility requirements will receive safe harbor contributions. Although HCEs can be excluded from safe harbor contributions, the plan document must specify this exclusion. Because the plan document doesn’t exclude HCEs and a timely amendment was not executed, the company is required to fund the safe harbor contributions for the HCEs as it would for any other eligible participant.
What is the Correction Method?
Under The IRS’ Employee Plans Compliance Resolution System, as governed by Revenue Procedure
2021-30, the affected participants need to be made whole. The plan sponsor must provide the safe harbor contributions to all affected HCEs and adjust their late contributions for missed earnings.
Can a Retroactive Amendment be Done Under the Self Correction Program?
This failure cannot be self-corrected with a retroactive amendment. Such a self-correction would violate the anti-cutback rules under IRC Sec. 411(d)(6). The anti-cutback rules protect a participant’s accrued benefits, early retirement benefits, retirement type subsidies, and other forms of optional benefit offered under qualified retirement plans. Retroactive amendments are available under the Self Correction Program only if they enhance a benefit, right, or feature.
Can the Plan Sponsor Apply Nondiscrimination Testing in Lieu of Safe Harbor Status?
No. Failure to make a required contribution as defined by the plan document is an operational failure, therefore the safe harbor contributions need to be made, adjusted for earnings, and the plan sponsor cannot fall back on ADP/ACP testing or the general nondiscrimination tests under IRC Sec. 401(a)(4).
Are There Any Other Alternatives?
A retroactive amendment to exclude HCEs from the safe harbor contribution would decrease benefits, and therefore would require submission to the IRS for approval under the Voluntary Correction Program (VCP). There is a submission fee associated with filing under VCP. This fee is nonrefundable—even if the IRS does not approve the request. Furthermore, receiving IRS approval requires convincing proof that the plan sponsor’s intent and the employees’ expectations aligned with the manner in which the plan was operated—that is, excluding the HCEs from receiving safe harbor contributions; verbal communications between the employer and employees will not suffice. The IRS will consider such things as employee handbooks, plan summaries, notices, and other written documentation as evidence of intent.
Conclusion
The plan document is the operational guide for administering the plan. If the plan sponsor’s intent is not properly reflected in the plan document, it is incumbent upon the plan sponsor to make it so through a timely-executed amendment.
