“Otherwise Excludable Employees”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.  

A recent call with a financial advisor from California is representative of a common inquiry related to 401(k) plan testing. “Who are otherwise excludable employees and why are they important?”

Highlights of the Discussion

The term “otherwise excludable employees” refers to a group of employees who are participants in a qualified retirement plan, but who could otherwise be excluded because the plan’s eligibility requirements are more liberal than the maximum age and service requirements of Internal Revenue Code Section (IRC §) 410(a)(1)(A) (i.e., age 21 and one year of service).  

https://www.irs.gov/retirement-plans/treatment-of-otherwise-excludable-employees-for-coverage-and-adp-testing

The importance of otherwise excludable employees comes into play for certain plan compliance tests. A plan will use special testing rules for otherwise excludable employees when it cannot otherwise satisfy the coverage requirements in Treasury Regulation (Treas. Reg.) https://www.govinfo.gov/content/pkg/CFR-2011-title26-vol5/pdf/CFR-2011-title26-vol5-sec1-410b-1.pdf

 IRC Section 410 and/or the ADP test in IRC Section 401(k) taking into account all of the participants in the plan. 

EXAMPLE:  Doin’ Great, Inc., has an extended tax filing deadline of October 15, 2021, for its 2020 tax year. The owners of Doin’ Great decide in early 2021 they would like to set up a 401(k)/profit sharing plan for the business for 2020. They have until October 15, 2021, to execute plan documents to set up the plan, effective for 2020. While Doin’ Great would be able to make a profit sharing contribution on behalf of participants for 2020, participants can only make pre-tax employee salary deferrals and designated Roth contributions prospectively—meaning after they execute valid salary deferral elections for compensation yet to be received in 2021.  

Conclusion

Thanks to the SECURE ACT, for 2020 and later tax years, a business has more time—until its tax filing deadline, plus extensions for a particular tax year—to set up a plan.