The HCE Who Wants to Defer More Than the Match Allows
A manufacturing company with 140 employees has a traditional 401(k) with a 50% match on the first 6% of pay. The plan is top-heavy and has failed ADP testing two years running. The owner (an HCE, 100% owner, age 55, compensation $310,000) wants to defer the maximum in the coming year and is frustrated that the plan keeps refunding his deferrals. He asks whether the company can simply 'turn off' the match for rank-and-file employees to improve the test, or alternatively add a safe harbor nonelective so he can defer freely. The CFO worries that dropping the match will hurt participation and that a safe harbor nonelective is 'too expensive.' You have last year's data: the average deferral rate for NHCEs was 4.1%, and 38 of 140 employees deferred nothing.
1. Explain why the owner's deferrals are being refunded and evaluate the two options he proposes.
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The refunds are an ADP test failure, not a match problem. With NHCE average deferral at 4.1% and 38 non-deferrers dragging the average down, the HCE permitted average is constrained. Under the ADP test, the HCE group's average deferral rate must stay within the permitted spread above the NHCE average. At roughly 4.1% NHCE average, the HCE ceiling is close to 6.1% (the 2-percentage-point/2x band). The owner deferring near the dollar limit on $310,000 produces a deferral rate far above that ceiling - hence refunds.
Evaluating the options:
- Turning off the match does nothing for ADP. Matching contributions are tested under ACP, not ADP. Removing the match may reduce ACP exposure but will not fix the deferral test and will likely worsen NHCE participation, pushing the NHCE average lower and shrinking the HCE ceiling further. Bad idea.
- Safe harbor nonelective is the real fix. A 3% nonelective safe harbor removes the plan from ADP/ACP testing entirely (if structured correctly), letting the owner defer the full limit and receive the employer contribution up to 415(c). The 'expense' is 3% of pay for all eligible employees, but it is deductible and replaces unpredictable refunds plus the existing 50%-of-6% match cost for many employees. Run the numbers: 3% nonelective vs. current match cost and the value of removing testing risk.
2. The CFO asks whether the company could instead adopt a safe harbor match. Compare a basic safe harbor match to the nonelective for this employer.
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A basic safe harbor match (100% on the first 3% plus 50% on the next 2%, i.e., up to 4% of pay) also exempts the plan from ADP/ACP testing and is generally cheaper for an employer with low participation because employees who don't defer get nothing.
Key trade-offs for this employer:
- Cost profile. With 38 of 140 employees deferring nothing, a match-based safe harbor costs less than a 3% nonelective on total payroll, because non-deferrers receive no employer money. However, the employer must also satisfy top-heavy minimums separately under a safe harbor match (top-heavy exemption generally applies to the nonelective, not the match), which can add cost.
- Participation incentive. A match rewards deferral and may pull the 38 non-deferrers in - good for the plan's health but adds cost.
- Owner outcome. Either safe harbor design removes ADP testing, so the owner can defer the full limit.
Recommendation logic: if the goal is lowest guaranteed cost and the plan is top-heavy, the 3% nonelective is often cleaner because it satisfies top-heavy minimums and testing in one stroke. If participation is the priority and the workforce skews toward non-deferrers, the safe harbor match may cost less in practice. Present both with projected dollar costs using the actual payroll and deferral distribution.