I had a great question today about Code section 410(b) testing. For those of you that don’t do much testing, Code section 410(b) requires that the average benefit percentage for employees who are not highly compensated employees is at least 70 percent of the average benefit percentage for highly compensated employees. The test is a simple mathmatical calculation which breaks employees down into two groups – highly compensated employees and non-highly compensated employees – and then compares the number of employees in each group who are benefiting under the plan to the total number of employees in that group.
Today’s question was about a 401(k) profit sharing plan which requires an employee participating in the plan to work at least 1,000 hours of service AND be employed on the last day of the plan year in order to receive an allocation of the profit sharing contribution. The administrator wanted to know if they had to include terminated employees in the 410(b) test if the employee had not received an allocation because the employee had worked less than 1,000 hours of service and had been terminated before the last day of the plan year.
To answer this question, one more piece of information is needed – how many hours did the terminated employee work? The reason is that Treasury Regulation section 1.410(b)-6(f) draws a distinction between employees who terminate with 500 or less hours of service and employees who terminate with more than 500 hours of service. In a plan with a last day requirement or a service requirement to receive an allocation, an employee who does not receive an allocation of the employer contribution because they failed to satisfy the minimum period of service or last-day requirement can be treated as excludable for the plan year if they work 500 or less hours of service. If the employee in this situation worked more than 500 hours of service, the employee is not excludable but instead is included as not benefiting.
Treas. Reg. 1.410(b)-6(f)(3) has a really good example if you find this a little confusing. It states:
- “Example (1). An employer has 35 employees who are eligible to participate under a defined contribution plan. The plan provides that an employee will not receive an allocation of contributions for a plan year unless the employee is employed by the employer on the last day of the plan year. Only 30 employees are employed by the employer on the last day of the plan year. Two of the five employees who terminated employment before the last day of the plan year had 500 or fewer hours of service during the plan year, and the remaining three had more than 500 hours of service during the year. Of the five employees who were no longer employed on the last day of the plan year, the two with 500 hours of service or less during the plan year are treated as excludable employees for purposes of section 410(b), and the remaining three who had over 500 hours of service during the plan year are taken into account in testing the plan under section 410(b) but are treated as not benefit under the plan.”
