As you may be aware, 401(k) plans must pass a special nondiscrimination test for elective deferrals commonly referred to as the actual deferral percentage ("ADP") test. The SBJPA added an alternative or safe harbor method to comply with the ADP test. The safe harbor requires that a 401(k) plan satisfy both (a) a contribution requirement (either by matching contributions or nonelective contributions) and (b) a notice requirement. In addition, the safe harbor requires that a participant be fully vested in all employer contributions (including matching contributions) used to satisfy the safe harbor. The contribution requirement may be satisfied by, a basic matching contribution method, an enhanced matching contribution method or a nonelective contribution method.
The basic matching contribution method is satisfied if (a) the employer makes a matching contribution on behalf of each non-highly compensated employee ("NHCE") equal to: (i) 100% of the employee's elective contributions up to three percent of compensation and (ii) 50% of the employee's elective contributions from three to five percent of compensation for a total of four percent, and (b) the matching contribution rate for any elective contribution of a highly compensated employee ("HCE") is not greater than that for any NHCE.
The enhanced matching contribution method is satisfied if the plan's matching contribution formula provides that (a) the rate of an employer's matching contribution does not increase as an employee's rate of elective contributions increases and (b) matching contributions made on behalf of each NHCE at any rate of elective contributions will provide an aggregate amount of matching contributions at least equal to the aggregate amount of matching contributions that would have been provided under the basic matching contribution method described above. For example, a plan formula that provides that an employer matches 125% of an employee's elective contributions up to the first three percent of compensation, or 3.75%, and 25% of elective contributions from three to four percent of compensation, or .25%, and provides no match thereafter would satisfy the enhanced matching contribution method because the total in this example equals four percent, the minimum match required by the safe harbor.
In lieu of satisfying either of the matching contribution methods, an employer may satisfy the safe harbor by using the nonelective contribution method. The nonelective contribution method requires an employer to make nonelective contributions on behalf of every NHCE who is an eligible employee under the plan, equal to at least three percent of the employee's compensation regardless of whether the employee makes contributions to the plan.
The notice component of the safe harbor generally requires that participants be given notice of the use of the safe harbor and the formula being implemented to comply with the safe harbor. Notice must be given at least 30 days (but not more than 90 days) before the beginning of a plan year in which the safe harbor is being utilized. The notice must be (a) sufficiently accurate and comprehensive to inform the employee of his or her rights and obligations under the plan and (b) written in a manner calculated to be understood by the average participant. For employers adopting the safe harbor for the 1999 plan year, the notice requirement deadline has been extended to March 1, 1999. Employers adopting the safe harbor for the 1999 plan year may satisfy the notice requirement by making a good faith effort to comply with the standard.
A plan which provides for matching contributions also must pass an additional special nondiscrimination test -the actual contribution percentage ("ACP") test. Under the safe harbor, a plan which satisfies the ADP safe harbor through the basic matching contribution method described above and provides no other matching contributions will satisfy the ACP safe harbor. Further, a plan which satisfies the ADP safe harbor through the enhanced matching contribution method described above, provides matching contributions with respect to elective contributions that do not exceed six percent of the employee's compensation and provides no other matching contributions will also satisfy the ACP safe harbor.
If the plan does not utilize either the basic or enhanced matching contribution approach, then the ACP safe harbor will be satisfied if matching contributions are not made with respect to employee contributions that in the aggregate exceed six percent of the employee's compensation, the rate of matching contributions does not increase as the rate of employee contributions increases, and at any rate of employee contributions, the rate of matching contributions that would apply with respect to any HCE is no greater than the rate of matching contributions that would apply with respect to a NHCE and who has the same rate of employee contributions.
With the issuance of this guidance, the safe harbors rules under Section 401(k) of the Code provide unique structuring opportunities for your plan. The safe harbors eliminate the expense and time involved in annual ADP/ACP testing, and provide that a plan will automatically pass its nondiscrimination tests.