Plan Design Risk: Small Number of Participants

Plans with a small number of participants may have an elevated compliance risk.

Small companies without a Safe Harbor plan design and with fewer than ten participants have an increased likelihood of some compliance testing issues and should be particularly mindful of how low employee participation rates can impact compliance testing results. With fewer participants, it is more likely that key employees’ (typically officers and owners) 401(k) contributions will exceed 60% of plan assets, resulting in a Top Heavy testing failure. Further, in a smaller company, one highly compensated employee’s (HCE) decision to defer a large amount or one non-highly compensated employee (NHCE, also referred to as rank and file employees) deciding to unenroll can increase the HCE deferral rate or reduce the NHCE deferral rates beyond the IRS limits. 

One approach to addressing potential risks related to having a small number of participants is for owners to contribute consistently over the year, observing NHCE deferral rates and adjusting their deferrals accordingly.

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