The Controller Who Wants to Be Excluded
Meridian Fabrication sponsors a single-employer 401(k) plan with a calendar plan year and a 1,000-hour/age-21 eligibility requirement. The plan's coverage test has always passed because the employer uses the ratio percentage test. The controller, Dana, is a highly compensated employee (compensation above the prior-year threshold, more than 5% owner). She has asked to be excluded from the plan so she can contribute to her own IRA instead. The plan document has no exclusion for a class of employees that would cover only Dana. The plan year is mid-year, and Dana has already deferred $9,000. The TPA suggests simply coding her as ineligible going forward and refunding nothing. The plan's document permits mid-year amendments only if they do not reduce benefits accrued to date. The employer wants to know whether the TPA's approach is workable and what testing consequences follow.
1. Can the employer amend the plan mid-year to exclude Dana from future participation, and what is the effect on her existing deferrals?
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A mid-year amendment that excludes a specific individual is generally not permissible because it would create a disguised individual exclusion and could violate the definitely determinable / nondiscrimination rules. Even if the document allowed it, the amendment cannot cut back benefits already accrued. Dana's existing elective deferrals remain in the plan; they are 100% vested and cannot be forfeited or refunded merely because she is later excluded. The correct answer is that the TPA's coding approach is not a valid fix. If the employer truly wants her out, the amendment would have to be prospective and satisfy coverage and nondiscrimination testing for the year of change. The safer path is to leave her eligible and let her stop deferring (she can elect 0% going forward), which does not require an amendment at all.
2. If Dana is excluded mid-year, how would the coverage test change, and what data would you need before deciding?
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Coverage under §410(b) is tested on the last day of the plan year using the plan's eligibility rules. Removing a single HCE from the benefiting group shrinks the numerator of the ratio percentage for the HCE group but does not change the NHCE group. You would need the count of total employees, the count of benefiting employees, and the HCE/NHCE split as of the last day. If the plan previously passed only narrowly, losing one HCE could actually improve the ratio for the HCE group (fewer HCEs benefiting) while leaving NHCE coverage unchanged, but the more important risk is that a mid-year exclusion of one person may be treated as an impermissible amendment. You also need to confirm whether Dana is a key employee for top-heavy purposes and whether her exclusion affects the 410(b) average benefit test if the plan ever falls off the ratio percentage test. Do not code anything until the document amendment question is resolved.