Question: I work for a company that doesn't have a 401(k) plan. I have been trying to convince my employer to start one, and my employer's accountant said we couldn't. He says that all employees must sign on or the ones that do not will limit the amount all others can contribute. As it stands, our company has 13 employees. Six make $80,000 a year or more, and the other seven only make $18,000 or less and don't want to contribute. The employer won't offer a matching contribution. Are we all limited by those who don't want to contribute?

TB: This limitation that the accountant is talking about is what is known as the discrimination test. This was a provision Congress added to the 401(k) plan to ensure that this benefit is offered equally to all employees. The contribution limits for the highly paid, or highly compensated employees (HCE) in IRS lingo, are dependent upon the contributions made by the lower-paid employees. This creates an incentive for the highly paid employees to encourage the lower-paid employees to contribute, and as much as they can. While this may seem to be a self-serving argument for the top-paid folks, the upshot is that the lower-paid employees get a real benefit.

Given the situation you've described, there is a way that your employer could make this work.

The compensation limit for HCEs is now $85,000 a year rather than $80,000. If you start a 401(k) plan this year, employees who earned over $85,000 last year will potentially be included in the HCE group. I say potentially because there is another alternative. When there are a relatively high number of employees earning over $85,000, the employer may elect to include only those who are among the 20 percent of the highest paid in the HCE group. In your situation, this would include only two employees. The others who earn more than $85,000 may be included in the nonHCE group so long as they aren't 5 percent owners.

You may be asking at this point, what will all this accomplish? This is the reasoning to use with your accountant to justify a plan.

Eligible employees who aren't among the top 20 percent (in terms of compensation) may contribute up to 25 percent of pay subject to the $10,500 individual annual contribution limit. Contributions for the employees who are in the top 20 percent group will be limited to the average percentage of pay that the other employees contribute, plus an additional two percentage points. For example, assume the contribution average for the other eligible employees is 3 percent. The employees who are in the top 20 percent group may contribute 5 percent. Assume these individuals earn $130,000; they will be able to contribute $6,500, which is a lot better than the $2,000 they can contribute to an IRA. The fact that half or more of the eligible employees choose not to contribute only impacts the two employees who are highly compensated.

It doesn't make sense not to have a plan just because these two employees may not be able to contribute as much as they would like. Please get back to me if you would like further assistance.

Question: Last year, my employer elected to contribute 3 percent of salary for all employees to the 401(k) plan so that the company would qualify for the safe harbor plan provision (no discrimination test). However, they set it up stating their contribution for the entire year would go in at the end of the year. The year ended weeks ago and their contribution still has not been put into our 401(k). Each time I ask when their contribution will be made, I get vague responses that they can't figure it out until our W-2s for 2000 are issued. Is this way of doing things legal?

TB: The deadline for employer contributions to the plan is the day the corporate tax return is filed for the applicable year. Let's assume in your situation that the corporate tax year is the calendar year. The deadline for filing the tax return is March 15 unless an extension is granted. If it is, that could push the tax-filing deadline all the way to Sept. 15. This means your employer will have to make the contribution by March 15, unless a filing extension is obtained, in which case the employer will have until the extended tax-filing date to make the contribution.

The W-2s must be issued by Jan. 31. That date is long gone at this point. What your employer is doing is legally OK, but your employer should tell you when this contribution will be made.

Question: I was chief operating officer for a company that failed and had naývely signed up to be trustee for our 401(k) plan, not fully understanding that my role as trustee would survive our bankruptcy filing.

I have been working to close out the plan by getting all employees to request distributions or rollovers. I hope to close everything out and file my IRS 5500 Forms for 2000 and 2001 and then be done with this headache. If some of the employees do not complete their forms, at what point can I just complete the form for them, send them a distribution check, and give them information about doing a rollover? Also, what if I can't track down employees because they've moved?

TB: At least you are hanging in there to do what is needed to get the plan terminated. In many instances, closing a plan when a company goes out of business is delayed because those involved don't hang around to get the job done. My recommendations to expedite this process are as follows:

1. Send those who have not responded written notice that their money will be automatically distributed, less the taxes that must be withheld, if they do not respond. You can force them to take a distribution since you are terminating the plan.
2. To find lost employees, contact the Social Security Administration to see if they can help. Another possibility is to let all former employees know which ones you can't locate and/or to place a small ad in a paper in the area where the employee lived.
3. If you are unable to find all participants, I would still file the Form 5500 (the plan annual report) for 2001 marked as final return. The company is responsible for filing the Form 5500 not the trustees. Any penalties for filing deficiencies are also the company's responsibility.

Question: I'm in a safe harbor 401(k) plan where the employer matches dollar-for-dollar on the first 3 percent of compensation and $0.50 on the dollar for the next 3 percent. But, the employer doesn't actually fund the match until the next plan year. Is there anything that precludes the employer from cashing out account balances under $5,000 before the match is made?

For example, if an employee left the company in 2001 with an account balance of $4,800, could the employer still cash him out in 2001 even though the employer is obligated to contribute the 2001 matching contribution of $500 to his account in 2002?

TB: The employer contribution earned by terminated employees must still be made regardless of when the contribution is made. Settlement of the accounts for terminated employees will depend upon the terms of the plan document. Generally, no distributions are made until all contributions have been made.

Technically, the contribution that has not been deposited is an asset of the plan as of Dec. 31 as an accrued contribution. In my opinion, each employee's vested share of this contribution should be included when determining whether the benefit payable exceeds the $5,000 threshold.

Ted Benna, creator of the first 401(k) retirement savings plan, will answer your most intriguing questions every Tuesday. With over 30 years of experience as an employee benefits consultant, Ted is a nationally recognized expert on benefits issues. He has authored two books, Helping Employees Achieve Retirement Income Security and Escaping the Coming Retirement Crisis, and is President of the 401(k) Association. Ted is a frequent speaker at meetings of 401(k) plan sponsors and participants. His articles and comments have appeared in numerous publications, including The New York Times and The Wall Street Journal.

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The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

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