Most practitioners and other advisors to 401(k) and 403(b) plans. Nuanced ADP/ACP Safe Harbor Plan Design

VOLUME 40, NUMBER 3 JOURNAL of PENSION PLANNING & COMPLIANCE Editor-in-Chief: Bruce J. McNeil, Esq. FALL 2014 JPPC Nuanced ADP/ACP Safe Harbor Plan Design DANIEL SCHWALLIE Daniel Schwallie, JD, PhD is an attorney with Aon Hewitt s Retirement-Legal Consulting & Compliance practice. His areas of consulting include the design and administration of qualified pension and profit-sharing plans, 403(b) and 401(k) plans, and 457(b) nonqualified deferred compensation plans. He has published articles on plan compliance and is the primary author of the Cash Balance Plan Answer Book, 2nd ed. (New York: Wolters Kluwer, 2012). Most practitioners and other advisors to 401(k) and 403(b) plans are well aware of the contribution, vesting, and enrollment requirements of the two basic safe harbor designs. However, there are many fine points to the actual deferral percentage (ADP) and actual contribution percentage (ACP) safe harbor rules, which entail nuanced aspects of safe harbor plan design and require attention to be compliant with all the safe harbor rules. 1

2 / JOURNAL OF PENSION PLANNING & COMPLIANCE TWO BASIC ADP/ACP SAFE HARBORS There are two basic ADP/ACP safe harbor designs, although each of the two can have certain variations. The first, effective in 1999, was introduced by the Small Business Job Protection Act of 1996 and is sometimes known as the traditional safe harbor. 2 The second, effective in 2008, was introduced by the Pension Protection Act of 2006, requiring automatic enrollment in deferrals (with the ability to opt out ) and automatic escalation of deferral rates, and is sometimes known as the qualified automatic contribution arrangement or QACA safe harbor. 3 It should be noted at the outset that ADP testing is not required for 403(b) plans. Elective deferrals to a 403(b) plan are instead subject to a separate universal availability requirement. 4 Nevertheless, ACP testing does apply to matching contributions to nongovernmental 403(b) plans, and the ACP safe harbor offers relief from this ACP testing. Accordingly, this discussion is relevant to nongovernmental 403(b) plans that provide matching contributions. Many of the requirements of the ADP safe harbors apply, even if a plan, whether 403(b) or 401(k), intends only to satisfy the ACP safe harbor requirements. 5 Both the traditional and QACA safe harbors require advance notice be provided to newly eligible employees and annually to all eligible employees, which must describe the safe harbor design and a participant s rights and obligations. 6 Certain contingent notices and notices of reduction or suspension of the safe harbor design also may be required for some plans in addition to timely plan amendments to reduce or suspend the safe harbor design. 7 Failure to timely provide the proper required notices may affect the safe harbor status of the plan. The basic design requirements for each of the two ADP/ACP safe harbors are described and compared in the table below. Note that, for purposes of the safe harbors, elective deferrals include Roth contributions. 8 Each of the two safe harbor designs requires an employer safe harbor contribution, either in the form of a matching contribution or nonelective (i.e., nonmatching) contribution. 9 The basic safe harbor matching designs described in the table below can be modified to provide for an enhanced matching formula, provided each nonhighly compensated employee (NHCE) receives a matching contribution under the modified safe harbor that is at least equal to the total matching contribution the NHCE would have received at any rate of contributions elected by the NHCE under the basic safe harbor matching design. 10

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 3 Comparison of Traditional and QACA Safe Harbor Basic Designs Basic Design Requirements Traditional Safe Harbor QACA Safe Harbor Safe Harbor Matching Contribution Safe Harbor Nonelective Contribution Each plan year match 100% of first 3% of safe harbor compensation deferred by each eligible nonhighly compensated employee, plus 50% of next 2% of safe harbor compensation deferred by the nonhighly compensated employee Each plan year match 100% of first 1% of safe harbor compensation deferred by each eligible nonhighly compensated employee, plus 50% of next 5% of safe harbor compensation deferred by the nonhighly compensated employee Or Or Or Vesting of Safe Harbor Employer Contribution Limitations on Matching Contributions Automatic Enrollment Automatic Deferral Escalation Each plan year provide a nonmatching, nonelective contribution of at least 3% of safe harbor compensation to each eligible nonhighly compensated employee Immediate 100% vesting Matching contributions cannot be made with respect to elective deferrals (including Roth contributions) or employee non-roth after tax contributions that exceed 6% of an employee s safe harbor compensation And Discretionary matching contributions cannot exceed 4% of an employee s safe harbor compensation No requirement for automatic enrollment, although permitted No requirement for automatic deferral escalation Each plan year provide a nonmatching, nonelective contribution of at least 3% of safe harbor compensation to each eligible nonhighly compensated employee 100% vesting after two years of service Matching contributions cannot be made with respect to elective deferrals (including Roth contributions) or employee non-roth after tax contributions that exceed 6% of an employee s safe harbor compensation And Discretionary matching contributions cannot exceed 4% of an employee s safe harbor compensation Each employee eligible to participate is treated as electing to participate at the qualified percentage (described below) unless the employee affirmatively elects (or elected) a deferral level or not to participate Automatic deferral must be at least the following qualified percentages of compensation, applied uniformly, but not more than 10% of compensation: 3% during first plan year in which the employee begins elective deferrals to the plan; 11 (Continued)

4 / JOURNAL OF PENSION PLANNING & COMPLIANCE Basic Design Requirements Traditional Safe Harbor QACA Safe Harbor 4% during the second plan year of the employee s contribution of deferrals into the plan; 5% during third plan year of the employee s contribution of deferrals into the plan; and 6% during the fourth (and any subsequent) plan year of the employee s contribution of deferrals into the plan. ADDITIONAL LIMITATIONS ON SAFE HARBOR CONTRIBUTIONS Safe harbor contributions, whether based on one of the two basic formulas described in the table or an enhanced matching formula, 12 must satisfy the following requirements. Rate of Matching Contribution for HCEs Cannot Exceed Rate for NHCEs If safe harbor matching contributions are used to satisfy either the ADP or ACP safe harbor, the ratio of matching contributions to elective contributions (including Roth contributions) of a highly compensated employee (HCE) for a plan year cannot exceed the ratio of matching contributions to elective contributions (including Roth contributions) for any NHCE for the plan year. 13 The result of this requirement is that an employer cannot have two different safe harbor formulas covering different employee groups in the same safe harbor plan, even if each safe harbor formula considered alone would meet all safe harbor requirements. 14 Note that the ADP and ACP safe harbor matching contribution requirements will not fail to be satisfied merely because safe harbor matching contributions are made with respect to the sum of an employee s elective contributions (including Roth contributions) and (non-roth) after-tax contributions on the same terms as with respect to elective contributions alone. Nor will the ADP and ACP safe harbor matching contribution requirements fail to be satisfied merely because safe harbor matching contributions are made on both an employee s elective contributions (including Roth contributions) and (non-roth) after-tax contributions, if safe harbor matching contributions with respect to the employee s elective contributions are not affected by the amount of the employee s (non-roth) after-tax contributions. 15

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 5 Example A company establishing a safe harbor plan for its two divisions could not create a design under which the first division has a basic traditional safe harbor (100 percent match on the first 3 percent of compensation deferred and 50 percent match on the next 2 percent deferred) and the second division has an enhanced safe harbor (100 percent match on the first 5 percent of compensation deferred) in the same plan, because an eligible HCE in the second division can receive a higher ratio of matching contributions to elective contributions than an eligible NHCE in the first division. Rate of Matching Contribution Cannot Increase as Elective Deferrals Increase If safe harbor matching contributions are used to satisfy either the ADP or ACP the safe harbor, the ratio of matching contributions to elective deferrals (including Roth contributions) of any employee for a plan year cannot increase as the amount of the employee s elective deferrals (including Roth contributions) increases. 16 Example A safe harbor plan cannot provide a 50 percent match on the first 3 percent of pay deferred and a 150 percent match on the next 2 percent of pay deferred. ACP Safe Harbor Requires That Matching Rate Not Increase as Contributions Increase To satisfy the ACP safe harbor, regardless of whether safe harbor matching contributions or safe harbor nonelective contributions are used to satisfy the safe harbor, the ratio of matching contributions to elective deferrals (including Roth contributions) and (non-roth) aftertax contributions of any employee for a plan year cannot increase as the amount of the employee s elective deferrals (including Roth contributions) and (non-roth) after-tax contributions increases. 17 Unlike the immediately prior limitation on both the ADP and ACP safe harbor, this ACP safe harbor limitation applies to both elective deferrals and after-tax contributions combined. ACP Safe Harbor Requires That Match Not Exceed 6 Percent of Safe Harbor Compensation To satisfy the ACP safe harbor, regardless of whether safe harbor matching contributions or safe harbor nonelective contributions are used to satisfy the safe harbor, matching contributions cannot be made with respect to elective deferrals (including Roth contributions) or

6 / JOURNAL OF PENSION PLANNING & COMPLIANCE (non-roth) after-tax contributions of any employee for a plan year that exceed 6 percent of the employee s safe harbor compensation. 18 Safe harbor compensation is described further in the section Additional Rules for Safe Harbor Plans below. Examples Although an enhanced traditional safe harbor plan could provide a 100 percent match on the first 3 percent of safe harbor compensation deferred and a 50 percent match on the next 3 percent deferred to satisfy both the ADP and ACP safe harbor, the plan could not provide a 100 percent match on the first 3 percent of safe harbor compensation deferred and a 50 percent match on the next 4 percent deferred and still satisfy the ACP safe harbor. Similarly, an enhanced traditional safe harbor plan could not provide a 100 percent match on the first 7 percent of safe harbor compensation deferred and satisfy the ACP safe harbor. ACP Safe Harbor Requires That Discretionary Match Not Exceed 4 Percent of Safe Harbor Compensation If a plan provides discretionary matching contributions, in order to satisfy the ACP safe harbor, regardless of whether safe harbor matching contributions or safe harbor nonelective contributions are used to satisfy the safe harbor, the discretionary matching contributions cannot exceed 4 percent of an employee s safe harbor compensation. 19 Example If the only matching contributions under an ACP safe harbor plan are discretionary matching contributions, as is sometimes the case, then matching contributions under the plan would need to be limited to 4 percent rather than 6 percent of an employee s safe harbor compensation and the plan would have to use nonelective contributions to satisfy the ACP safe harbor. On the other hand, as described later in the section Some Flexibility in Safe Harbor Design, it may be possible to layer discretionary matching contributions on top of safe harbor matching contributions. ADDITIONAL RULES FOR SAFE HARBOR PLANS A number of additional requirements apply to safe harbor plans that either are set forth explicitly in the applicable regulations or result from explicit requirements. The additional rules listed below are not meant to be exhaustive.

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 7 Safe Harbor Contributions Must Be Based on Safe Harbor Compensation A safe harbor plan must use safe harbor compensation to determine safe harbor contributions, whether safe harbor matching contributions or safe harbor nonelective contributions. 20 For purposes of the ADP and ACP safe harbors, safe harbor compensation means compensation as defined in Internal Revenue Code (Code) Section 414(s) and Treasury Regulation Section 1.414(s)-1, except that it may not exclude all compensation in excess of a specified dollar amount. 21 A discussion of what constitutes 414(s) compensation is beyond the scope of this article. 22 Note that the safe harbor regulations permit a different definition of compensation to be used to determine elective deferrals than to determine safe harbor matching contributions. In particular, the regulations provide that: A plan may limit the types of compensation that may be deferred by an eligible employee under a plan, provided that each eligible NHCE is permitted to make elective contributions under a definition of compensation that would be a reasonable definition of compensation within the meaning of 1.414(s)-1(d)(2). Thus, the definition of compensation from which elective contributions may be made is not required to satisfy the nondiscrimination requirement of 1.414(s)-1(d)(3). 23 While it is, therefore, possible for a plan to use a different definition of compensation to determine elective deferrals than safe harbor matching contributions, one should be heedful of how deferrals and safe harbor matching contributions are calculated and the potential issues this could create. Example Suppose a traditional safe harbor plan as described in the table (i.e., without enhanced safe harbor matching contributions) uses gross pay to determine elective deferrals (i.e., a Code Section 415 definition of compensation), which would satisfy a reasonable definition of compensation within the meaning of Treasury Regulation Section 1.414(s)-1(d)(2), and uses base pay to determine the safe harbor matching contributions (assuming such base pay satisfies the requirements of Treasury Regulation Section 1.414(s)-1, including the nondiscrimination requirement of 1.414(s)-1(d)(3)). Suppose further that a participant has base pay of $50,000 and gross pay of $60,000 and the participant defers 5 percent

8 / JOURNAL OF PENSION PLANNING & COMPLIANCE of gross pay as elective deferrals, which would be $3,000. The traditional safe harbor plan would provide a 100 percent match on the elective deferrals of the first 3 percent of base pay deferred (i.e., a 100 percent match on $1,500) and a 50 percent match on the next 2 percent of base pay deferred (i.e., a 50 percent match on $1,000) for a total match of $2,000. If, despite the plan language, the plan administrator used gross pay to determine both elective deferrals and the safe harbor matching contribution, the calculated matching contributions would exceed the safe harbor matching contributions and the safe harbor requirements would not be satisfied. Such noncompliant result can be illustrated by assuming gross pay and base pay are the same. If the participant s base pay and gross pay were both $60,000, the match would have totaled $2,400 (a 100 percent match on the elective deferrals of the first 3 percent of $60,000 deferred, a 100 percent match on $1,800, plus a 50 percent match on the next 2 percent of $60,000 deferred, a 50 percent match on $1,200). 24 Periodic Safe Harbor Matching Contributions Must Be Contributed at Least Quarterly If safe harbor matching contributions are used to satisfy either the ADP or ACP safe harbor and are made separately with respect to each payroll period (or with respect to all payroll periods ending with or within each month or quarter of the plan year) taken into account under the plan for the plan year, the safe harbor matching contributions with respect to any elective contributions (including Roth contributions) made during a plan year quarter must be contributed to the plan by the last day of the immediately following plan year quarter. 25 Safe Harbor Contributions Are Not Eligible for Hardship Distribution Safe harbor contributions are not eligible for hardship withdrawal. This is because safe harbor contributions must satisfy the distribution restrictions of Code Section 401(k)(2)(B). Hardship distributions under Code Section 401(k)(2)(B)(i)(IV) and the corresponding regulations are limited to contributions pursuant to a cash or deferred election to a 401(k) plan or pursuant to a salary reduction agreement to a 403(b) plan. Safe harbor contributions are not elective contributions to a 401(k) or 403(b) plan and so are not eligible for hardship withdrawal. 26 Last Day or Hours Requirement Is Not Permitted Every NHCE eligible to make elective contributions must receive the safe harbor contribution under the plan to satisfy the safe harbor. 27 A requirement to be employed on the last day of the plan year to receive a safe harbor contribution is not permitted with respect to any eligible

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 9 NHCE. 28 Similarly, an hour s or other service requirement cannot be a condition for an eligible NHCE to receive the safe harbor contribution, except as may be permitted by the permissive disaggregation described in the subsection, Safe Harbor May Be Limited Only to Employees Satisfying Minimum Age and Service below. True Up of Safe Harbor Contributions May Be Required Unless every eligible NHCE has received the full safe harbor contribution under the plan by the end of the plan year (or by the end of the following plan year quarter for a safe harbor plan that makes safe harbor matching contributions on a payroll-by-payroll period basis), a true up of safe harbor contributions will need to be made that ensures each eligible NHCE receives the full safe harbor contribution under the plan for the plan year (or plan year quarter). 29 If an eligible NHCE separates midyear (or midquarter) without receiving the individual s full safe harbor contribution under the plan for the plan year (or for the plan year quarter for a safe harbor plan that makes safe harbor matching contributions on a payroll-by-payroll period basis), a true up of safe harbor contributions will need to be made to ensure the eligible NHCE receives the full safe harbor contribution under the plan for the plan year (or plan year quarter). Although not required to maintain safe harbor status, most plans true up safe harbor matching contributions for HCEs as well as for NHCEs. No Exception from Safe Harbor Matching Contributions for Age-50 Catch-Up Contributions If a plan permits age-50 catch-up contributions and the plan satisfies the ADP safe harbor requirements with safe harbor matching contributions, the safe harbor matching contributions must be applied to the age-50 catch-up contributions to the extent the safe harbor matching contributions would otherwise apply to elective deferrals under the plan. The preamble to the 401(k) regulations issued in 2004 states that there is no exception with respect to those catch-up contributions. 30 Example A participant contributes elective deferrals up to the maximum dollar amount ($17,500 for 2014) before receiving the plan s maximum match as limited by the compensation limit ($260,000 for 2014). The participant also contributes the maximum catch-up contribution ($5,500 for 2014). If the plan matches elective deferrals dollar for dollar up to 8 percent of compensation, the compensation limit would cap matching contributions at $20,800 (8 percent of $260,000) and $3,300

10 / JOURNAL OF PENSION PLANNING & COMPLIANCE of catch-up contributions would need to be matched. 31 The participant would have made elective deferrals totaling $23,000 for 2014, but only $20,800 would be matched at the 100 percent matching rate ($17,500 plus $3,300 of the $5,500 catch-up). Plan Document Not to Include Testing Language in the Alternative If Safe Harbor Is Not Satisfied A safe harbor plan document must specify which safe harbor is used and which safe harbor contributions are used to satisfy the safe harbor requirements, as well as any optional provisions applicable to the selected safe harbor. Thus, it would appear that the plan document cannot provide that ADP or ACP testing will be used in the alternative if the requirements for the ADP or ACP safe harbor are not satisfied. 32 Safe Harbor Contributions Must Be Disregarded for Purposes of Permitted Disparity The safe harbor contribution requirements must be satisfied without regard to Code Section 401(l). In other words, safe harbor contributions cannot be taken into account for purposes of Code Section 401(l). 33 Although safe harbor nonelective contributions may be taken into account for purposes of determining whether a plan satisfies the nondiscrimination requirements of Code Section 401(a)(4), such as the general test, to the extent they are needed to satisfy the safe harbor contribution requirement, safe harbor nonelective contributions may not be taken into account under any plan for purposes of Code Section 401(l), including the imputation of permitted disparity under Treasury Regulation Section 1.401(a)(4)-7. 34 Midyear Change to a Different Safe Harbor Formula Seemingly Not Permitted Although it is possible to suspend or reduce safe harbor contributions under certain circumstances, the regulations require that the ADP and ACP tests must be satisfied for the entire plan year when safe harbor contributions are suspended or reduced. 35 The regulations do not expressly permit suspending or reducing safe harbor contributions to move from one safe harbor design to another midyear. 36 Further, the timing and content requirements for the safe harbor notice would seem to preclude even a change to a more generous alternative safe harbor design midyear. Generally, the notice must be provided within a reasonable period prior to the start of the plan year to which the safe harbor applies and must include, among other details, the safe harbor formula used under the plan. 37

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 11 May Need Second Plan If Not All Employees to Receive Safe Harbor Contributions in a 403(b) Plan To satisfy the ACP safe harbor requirements, the safe harbor contribution must be provided to all NHCEs eligible to make elective deferrals to the 403(b) plan. 38 However, the universal availability requirements of Code Section 403(b) require that all employees be eligible to make elective deferrals under a 403(b) plan with certain limited exceptions. 39 One exception permits employees eligible to make elective deferrals to another 403(b) plan of the employer or a 401(k) plan of the employer to be excluded. Unless the employer intends to provide safe harbor contributions to all employees required to be eligible to make elective deferrals under the universal availability rules, the employer may need to maintain a second plan for those employees to whom the employer does not wish to provide the safe harbor contributions. By allowing those employees to make elective deferrals to the second plan, the exception to universal availability for employees who participate in another plan is satisfied and the employees participating in the second plan can be excluded from receiving the safe harbor contribution. 40 SOME FLEXIBILITY IN SAFE HARBOR DESIGN The safe harbor rules do permit some flexibility in design, beyond providing enhanced contributions, as illustrated by the options described below. Safe Harbor Matching Contributions May Be Included in ACP Test of After-Tax Contributions The ACP safe harbor does not apply to (non-roth) after-tax contributions, which must be ACP tested even under an ACP safe harbor plan. However, safe harbor matching contributions may optionally be included or excluded from the ACP test of the after-tax contributions. 41 Annual Reset to Minimum Automatic Enrollment Deferral Is Possible under QACA Safe Harbor A QACA safe harbor plan specifically can provide that an affirmative election expires and, thereby, require an employee to make a new affirmative election to continue the employee s prior affirmatively elected rate of contribution, without violating safe harbor requirements. In the absence of a second affirmative election, the employee would be enrolled automatically at the plan s default percentage, which must meet the QACA safe harbor minimum percentage requirement ( qualified

12 / JOURNAL OF PENSION PLANNING & COMPLIANCE percentages ) described in the table above. Note, however, that a plan is permitted to treat an employee, who for an entire plan year did not have contributions made pursuant to a default election under the QACA, as if the employee did not have default contributions under the QACA in any prior plan year for purposes of determining the applicable qualified percentage for the employee. 42 Safe Harbor May Be Limited Only to Employees Who Satisfy Minimum Age and Service A plan can be treated as two separate plans under Code Section 410(b)(4)(B), one for the group of employees who have satisfied the minimum age and service requirements of Code Section 410(a)(1)(A) and the other plan for the group of employees who have not. The ADP (or ACP) safe harbor can apply to one of these two separate plans and the ADP (or ACP) test can apply to the other. 43 This ability to treat the group of employees who have not satisfied the minimum age and service requirements of Code Section 410(a)(1)(A) as covered under a separate plan provides a limited exception to the general requirement that every eligible NHCE must receive the safe harbor contribution to satisfy the safe harbor. It is possible to use this permissive disaggregation of otherwise excludable employees to provide the safe harbor contribution only to the group of employees who have satisfied the minimum age and service requirements of Code Section 410(a)(1)(A) and the corresponding regulations. Example Permit all employees covered by a plan to make elective contributions, but provide the safe harbor contribution only to those employees who have satisfied the minimum age and service conditions permitted by Code Section 410(a)(1)(A), including the use of two entry dates, such as January 1 and July 1 for a calendar year plan, when permitted. 44 The group of employees who have not satisfied the minimum age and service requirements of Code Section 410(a)(1)(A) would be subject to ADP and ACP testing, as applicable. 45 Possible to Layer Discretionary Match onto Safe Harbor Matching Contributions Safe harbor contributions must be nondiscretionary, but an ACP safe harbor plan can provide for discretionary matching contributions in addition to required safe harbor contributions. These discretionary contributions can benefit from the protection of the safe harbor and are not subject to ACP testing, provided that:

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 13 The discretionary matching contributions do not exceed 4 percent of an employee s safe harbor compensation; and The total of matching contributions under the plan cannot be made with respect to elective deferrals (and/or non-roth aftertax contributions, if applicable) that exceed 6 percent of the employee s safe harbor compensation. 46 Example A plan has an enhanced safe harbor matching design that provides a 100 percent match on the first 6 percent of safe harbor compensation deferred by an employee and also provides a discretionary match of up to 50 percent on the first 6 percent of safe harbor compensation deferred by an employee. Neither the safe harbor matching contribution nor the discretionary matching contributions are made with respect to elective deferrals that exceed 6 percent of the employee s safe harbor compensation, so the total of matching contributions under the plan are not made with respect to elective deferrals that exceed 6 percent of the employee s safe harbor compensation. Because the discretionary matching contributions of the example cannot exceed 3 percent of the employee s safe harbor compensation, the discretionary matching contributions cannot exceed 4 percent of the employee s safe harbor compensation. Permissive Aggregation of Safe Harbor Plans for Nondiscrimination Testing May Be Possible In some cases, it may be advantageous to permissively aggregate plans for purposes of Code Section 410(b) coverage testing or Code Section 401(a)(4) benefits testing. However, plans using inconsistent ADP testing methods (including an ADP safe harbor) or inconsistent ACP testing methods (including an ACP safe harbor) cannot be permissively aggregated. 47 A plan, including permissively aggregated plans treated as a single plan, must apply a single ADP method, namely, the ADP test, the traditional safe harbor, or the QACA safe harbor. Parallel rules apply for purposes of the ACP testing methods. 48 This suggests that it should be possible to permissively aggregate plans using the same safe harbor (i.e., either the traditional or QACA safe harbor). While not expressly stated in the regulations, it would seem that a uniform safe harbor contribution design would need to be present across the permissively aggregated safe harbor plans to satisfy the safe harbor requirements, likely beyond simply being either a traditional or QACA safe harbor. Possibly, each element that goes into defining the safe harbor would need to be the same between two separate safe

14 / JOURNAL OF PENSION PLANNING & COMPLIANCE harbor plans that are permissively aggregated. One approach might be to examine the two safe harbor plans as one plan and look only to the elements defining the safe harbor to see that they are all identical. In that case, the situations where two or more safe harbor plans could be permissively aggregated seem limited. CONCLUSION ADP and ACP safe harbor designs can be an attractive alternative to ADP and ACP testing for many plans. At first blush, the safe harbor requirements may seem straightforward, but practitioners and other plan advisors should strive to ensure their clients are aware and accepting of the full panoply of safe harbor requirements before choosing to implement a safe harbor design. NOTES 1. A number of the concepts described in this article were previously raised in the article, How Safe Is Your ADP/ACP Safe Harbor? published by the author with A. Steinberg in Benefits Quarterly magazine. The author thanks the International Society of Certified Employee Benefit Specialists for permission to use portions of author s work from that article in developing this one. 2. The traditional safe harbor became effective for years beginning after December 31, 1998; see Small Business Job Protection Act of 1996 1433. Because ADP testing is done on a plan year basis, the effective date has been taken to mean effective for plan years beginning after December 31, 1998. 3. The QACA safe harbor became effective for plan years beginning after December 31, 2007; see Pension Protection Act of 2006 902. 4. See Internal Revenue Code (Code) 404(b)(12) and Treas. Reg. 1.403(b)-5; see also D. Schwallie, Excluding Part-Time Employees under the 403(b) Universal Availability Rules, 39 Journal of Pension Planning & Compliance 31 (Spring 2013). 5. See Code 401(m)(11)(A) and 401(m)(12)(A) and Treas. Reg. 1.401(m)-3(a). 6. See Treas. Reg. 1.401(k)-3(d) and 1.401(m)-3(e). 7. See Treas. Reg. 1.401(k)-3(g) and 1.401(m)-3(h). Note that the regulations regarding reduction or suspension of safe harbor contributions were revised significantly in late 2013, but a discussion of those changes is outside the scope of this article. See 78 Fed. Reg. 68735 (November 15, 2013) and TD 9641. 8. See Code 402A(a) and Treas. Reg. 1.401(k)-1(a)(4), 1.401(k)-6, and 1.401(m)-5. 9. See Treas. Reg. 1.401(k)-3(a)(1) and 1.401(m)-3(a)(1). 10. See Treas. Reg. 1.401(k)-3(c)(3) and 1.401(k)-3(k)(1). 11. The first period to which the qualified percentage applies is actually the period beginning on the date of the employee s first elective deferrals to the plan and ending on the last day of the first plan year beginning after that date, which generally will be longer than one plan year. This

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 15 statutory framework accommodates the fact that employees may become eligible for the plan throughout a plan year, either as new hires with immediate eligibility or due to age or service requirements for eligibility. See Code 401(k)(13)(c)(iii)(I). 12. See Code 401(k)(12)(B)(iii) and Treas. Reg. 1.401(k)-3(c)(1) and 1.401(k)-3(k)(1). 13. See Treas. Reg. 1.401(k)-3(c)(4) and 1.401(m)-3(c). The 401(k) ADP safe harbor regulations use the term elective contributions, while the 401(m) ACP safe harbor regulations use the term elective deferrals. Treas. Reg. 1.401(m)-5 defines elective deferrals as defined in Code 402(g)(3), which includes employer contributions made pursuant to a qualified cash or deferred arrangement under Code 401(k)(2) or pursuant to a salary reduction agreement under Code 403(b). Treas. Reg. 1.401(k)-6 defines elective contributions as employer contributions made to a plan pursuant to a cash or deferred election under a cash or deferred arrangement, whether or not the arrangement is a qualified cash or deferred arrangement under Treas. Reg. 1.401(k)-1(a)(4). For purposes of this article, the terms elective deferral and elective contribution shall be used interchangeably, as the article is only concerned with qualified cash or deferred arrangements for purposes of the ADP safe harbor. See also Treas. Reg. 1.402(g)(3)-1, 1.401(k)-3(a)(3), and 1.403(b)-3(a). 14. However, there is an express exception to this general result, discussed later, for employees who have not met the statutory minimum age and service requirements. See Treas. Reg. 1.401(k)- 3(h)(3) and 1.401(m)-1(b)(4)(iv)(A). 15. See Treas. Reg. 1.401(k)-3(c)(5)(i) and 1.401(m)-3(c). 16. See Treas. Reg. 1.401(k)-3(c)(3) and 1.401(m)-3(c). 17. See Treas. Reg. 1.401(m)-3(d)(2). After-tax contributions (i.e., employee contributions) do not include designated Roth contributions. See Treas. Reg. 1.401(m)-1(a)(3). 18. See Treas. Reg. 1.401(m)-3(d)(3)(i). 19. See Treas. Reg. 1.401(m)-3(d)(3)(ii). 20. See Treas. Reg. 1.401(k)-3(b), 1.401(k)-3(c), 1.401(m)-3(b), and 1.401(m)-3(c). 21. See Treas. Reg. 1.401(k)-3(b)(2) and 1.414(s)-1(d)(2)(iii). 22. See, e.g., Appendices G and H of the Cash Balance Plan Answer Book, 2nd ed. (New York: Wolters Kluwer, 2012), D. Schwallie, B. Hogg, E. Keener, and P. Rangecroft. 23. See Treas. Reg. 1.401(k)-3(c)(6)(iv). 24. This example is based on multiple experiences with plans that use a broader compensation definition to determine elective deferrals and a narrower compensation definition to determine employer contributions. It is intended to illustrate generally the potential perils of using a different compensation definition for purposes of determining elective deferrals than determining safe harbor matching contributions. Other situations certainly exist. 25. See Treas. Reg. 1.401(k)-3(c)(5)(ii) and 1.401(m)-3(c). 26. See Code 401(k)(12)(E)(i), 401(k)(13)(D)(iii)(II), 401(k)(2)(B)(i)(IV), and 402(e)(3) and Treas. Reg. 1.401(k)-3(b)(1), 1.401(k)-3(c)(1), and 1.401(k)-1(d)(3)(ii)(A), and the definitions of qualified nonelective contribution and qualified matching contribution in Treas. Reg. 1.401(k)-6. 27. See Treas. Reg. 1.401(k)-3(b)(1) and 1.401(k)-3(c)(1). For this purpose, eligible means an employee who is directly or indirectly eligible to make a cash or deferred election under the plan for all or a portion of the plan year. Certain conditions on eligibility are permitted and

16 / JOURNAL OF PENSION PLANNING & COMPLIANCE certain one-time irrevocable elections are not considered to be cash or deferred elections. See Treas. Reg. 1.401(k)-6 for the definition of eligible employee. 28. See Example 4 of Treas. Reg. 1.401(k)-3(c)(7). 29. See Treas. Reg. 1.401(k)-3(d) and 1.401(m)-3(e). 30. See 69 Fed. Reg. 78151 (Dec. 29, 2004). 31. However, to be an ACP safe harbor plan, matching contributions cannot be made with respect to elective deferrals of any employee for a plan year that exceed 6 percent of the employee s safe harbor compensation, so the plan in the example cannot be an ACP safe harbor plan even though it is an ADP safe harbor plan. 32. See Treas. Reg. 1.401(k)-1(e)(7) and 1.401(m)-1(c)(2). See also Treas. Reg. 1.401(k)-3(g) (1)(i)(E) and 1.401(m)-3(h)(1)(i)(E), which require that the plan be amended to provide that the ADP and/or ACP test will be satisfied for the entire plan year in which the reduction or suspension occurs. 33. See Code 401(k)(12)(E)(ii), 401(k)(13)(D)(iv), 401(m)(11)(A)(i), and 401(m)(12)(B). 34. See Treas. Reg. 1.401(k)-3(h)(2). 35. See Treas. Reg. 1.401(k)-3(g) and 1.401(m)-3(h). 36. Note, however, that the revisions to the safe harbor regulations published November 15, 2013 (TD 9641), provide that guidance of general applicability published in the Internal Revenue Bulletin may set forth additional situations in which a safe harbor plan will not fail to satisfy safe harbor requirements for a plan year even if the plan is amended during the plan year to implement a midyear change to those provisions. This will provide the IRS with greater flexibility to develop rules to address special circumstances under which a midyear change to a Section 401(k) safe harbor plan is appropriate, such as an amendment to the plan in connection with a midyear corporate transaction. This flexibility also extends to midyear changes to a safe harbor plan under Section 401(m) of the Code. (78 Fed. Reg. 68737) 37. See Treas. Reg. 1.401(k)-3(c) and 1.401(m)-3(c). 38. See Treas. Reg. 1.401(m)-3(b), which cross-references Treas. Reg. 1.401(k)-3(b), and Treas. Reg. 1.401(m)-3(c), which cross-references Treas. Reg. 1.401(k)-3(c). 39. See Internal Revenue Code (Code) 404(b)(12) and Treas. Reg. 1.403(b)-5; see also D. Schwallie, Excluding Part-Time Employees under the 403(b) Universal Availability Rules, 39 Journal of Pension Planning & Compliance 31 (Spring 2013). 40. The second plan could be another 403(b) plan, a 401(k) plan, or a 457(b) eligible governmental plan, whichever is applicable to the employer and permitted under the circumstances. 41. See Treas. Reg. 1.401(m)-2(a)(5)(iv) and 1.401(m)-3(j)(6). 42. See the preamble to the final Treasury regulations on automatic contribution arrangements, 74 Fed. Reg. 8202-8203 (Feb. 24, 2009). 43. See Treas. Reg. 1.401(k)-3(h)(3), 1.401(k)-1(b)(1), 1.401(k)-1(b)(4)(iv)(A), 1.401(k)-1(b) (4)(vi) Example 2, 1.401(m)-1(b)(1), and 1.401(m)-1(b)(4)(iv)(A). Note that under the cited regulations it also seems possible to apply one safe harbor design to the group of employees who have satisfied the minimum age and service requirements of Code Section 410(a)(1)(A) and another safe harbor design to the group of employees who have not. 44. See Treas. Reg. 1.410(a)-4(b)(1), but see Treas. Reg. 1.410(a)-7(c)(3) in the case of an elapsed time service plan.

NUANCED ADP/ACP SAFE HARBOR PLAN DESIGN / 17 45. For instance, a plan without either matching contributions or after-tax contributions would not be subject to ACP testing, and there is no ADP test requirement for 403(b) plans. 46. See Treas. Reg. 1.401(m)-3(d)(3). 47. See Treas. Reg. 1.401(k)-1(b)(4)(iii) and 1.401(m)-1(b)(4)(iii). Permissive aggregation rules are set forth in Treas. Reg. 1.410(b)-7(d), but are modified by Treas. Reg. 1.401(k)-1(b)(4) (v), 1.401(m)-1(b)(4)(v), and, with respect to 403(b) plans, 1.410(b)-7(f). 48. See Treas. Reg. 1.401(m)-1(b)(4). 2014 Aspen Publishers. All Rights Reserved. Reprinted from JPPC Fall 2014, Volume 40, Number 3, pages 1 to 16, with permission from Aspen Publishers, a Wolters Kluwer business, New York, NY, 1-800-638-8437, www.aspenpublishers.com.