Beginning a 401(k) plan later in the year can have a few effects:
- Newly established Safe Harbor plans beginning after October 1st are not exempt from required nondiscrimination testing, including ADP/ACP and Top Heavy testing, until the following January 1st.
- If owners and officers who are deemed key employees or HCEs make a maximum contribution in a short year, the risk of falling outside allowable contribution levels (namely the ADP and Top Heavy limits) is increased unless other rank and file employees are, on average, making the same levels of contributions. This is because other employees generally make only a portion of the contributions they would otherwise make over the course of a full year.
- In a short plan year, you have less time to change the course of your contributions if your plan is estimated to be outside of IRS compliance limits. In a longer plan year you might have several months to encourage employees to defer more or dial back your own contributions.
- If a plan is outside Top Heavy limits at the end of the first year, it will be considered Top Heavy in both the first and second years. Often, owners and officers who are key employees will reduce contributions during an initial short plan year to avoid making the plan Top Heavy or having to make employer contributions for the year.