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Understanding 401(k) Testing Failures: Key Strategies and Compliance Solutions

This presentation summary provides an overview of 401(k) testing failures, focusing on compliance and strategic improvements. It examines the implications for highly compensated employees (HCEs), the ADP and ACP tests, and the impact of top-heavy regulations. Strategies for increasing employee contributions are explored, including Safe Harbor options and automatic enrollment features. Additionally, corrective measures for testing failures are discussed, providing practical insights for employers to ensure compliance and enhance employee retirement contributions.

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Understanding 401(k) Testing Failures: Key Strategies and Compliance Solutions

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Presentation Transcript

  1. Dealing with 401k Testing Failures

  2. DEALING WITH 401(k) TESTING FAILURES

  3. PRESENTATION SUMMARY • Highly Compensated Employees • Actual Deferral Percentage (ADP)/Actual Contribution Percentage (ACP) Tests • Key Employees • Top Heavy Tests • Strategies for Increasing Contributions • Safe-Harbor Options

  4. Highly Compensated Employees (HCE)

  5. Highly Compensated Employees (HCE) • An active employee who owns at least 5% of the company during the plan year or preceding 12 months • An active employee who receives compensation in excess of $115,000 (2014) in the 12 months prior to the plan year

  6. Top Paid Group Election • May be advantageous to a company with a large number of HCEs • Limits the number of HCEs to the highest 20% of employees • Election must be made in the plan document

  7. ADP & ACP Tests

  8. ADP & ACP Tests • Elective and matching contributions satisfy the ADP & ACP test respectively if one of the following tests is met • Contribution by HCEs is not more than 125% of contribution by NHCEs • Contribution by HCEs is not more than 2% greater than NHCEs and the percentage for HCEs is not more than 2x the percentage for NHCEs

  9. ADP & ACP Tests

  10. Correcting ADP/ACP Test Failures • Excess contributions are reclassified • Excess contributions and allocable income are distributed • Employer makes additional contributions to the plan to cause the ADP test to be satisfied

  11. Reclassifying Excess Contributions • HCEs over 50 may re-allocate deferrals up to $5,500 (2014) as Catch-Up contributions • Plan document must permit Catch-Up contributions

  12. Distribution of Excess Contributions • HCEs receive a refund of contributions and income to bring the plan into alignment with ADP/ACP requirements • Must occur within 2 ½ months of the end of the plan year to avoid 10% excise tax • Must occur within 12 months for elective deferrals to remain tax qualified

  13. Testing Year Election • Current Year and Prior Year calculation of NHCE ratios permitted • No IRS approval required for either election but it must be reflected in the plan document • Prior Year calculation provides certainty for HCE contribution limit

  14. Key Employee • An officer earning more than $165,000 in 2013 • A 5% owner • A 1% owner earning more than $150,000

  15. Top Heavy Plan

  16. Top Heavy Plan • A 401k plan becomes top heavy if more than 60% of the plan assets belong to key employees • Generally the calculation is performed as of the last day of the plan year and determines plan status for the following year

  17. Top Heavy Minimum Contributions • Non-key employees must be provided with a minimum contribution • Generally the minimum contribution will be equal to 3% of compensation • Contribution requirement may be lower if the total contribution for all key employees is less than 3%

  18. Top Heavy Strategy • No key employee contributions • Profit sharing contributions may be counted towards top heavy minimum • Matching contributions may be counted toward top heavy minimum

  19. Top Heavy Strategy • Contributions made to satisfy ADP/ACP testing may be counted towards top heavy minimum • Converting plan to Safe Harbor 401(k) can automatically satisfy top heavy rules • Adding a Qualified Automatic Contribution Arrangement can automatically satisfy top heavy rules

  20. Increasing Contributions • Education works – long term commitment required • Matching contributions have a direct impact • Automatic Enrollment

  21. Automatic Enrollment

  22. Automatic Enrollment • State wage withholding laws preempted • Automatic Contribution Arrangement (ACA) • Eligible Automatic Contribution Arrangement (EACA) • Qualified Automatic Contribution Arrangement (QACA)

  23. Automatic Contribution Arrangement • An employee who fails to make an election to contribute to the plan is treated as having elected to do so • Plan determines contribution percentage • Notice required • Participant may elect to stop contributions by may not take distribution of funds already deposited

  24. Eligible Automatic Contribution Arrangement • An employee who fails to make an election to contribute to the plan is treated as having elected to do so • Plan determines contribution percentage • Notice required before plan year • Participant may elect to stop contributions and may take distribution of funds already deposited

  25. Qualified Automatic Contribution Arrangement • Can be the same as EACA unless participants are not permitted to direct the investment of their account • Contributions must start at 3% or higher and must be increased to 6% • Avoids ADP/ACP testing, may satisfy top heavy requirement • Required 3% contribution to all eligible or matching $1 for $1 on the first 1% of pay and $0.50 for $1 on next 5% of pay

  26. Automatic Contribution Increases • Permitted under all automatic contribution arrangements • Required with Qualified Automatic Contribution Arrangements until contribution percentage reaces 6%

  27. Safe Harbor Plans

  28. Safe Harbor Plans • Avoid ADP/ACP testing requirement • HCEs may contribute full 401k dollar amount ($17,500 in 2014) • May satisfy top heavy minimum requirements

  29. Safe Harbor Plans • Required employer contributions • Matching contribution - $1 for $1 on the first 3% of pay and $0.50 for $1 on the next 2% of pay • OR • 3% contribution to all employees who have met the plan’s eligibility requirement

  30. Safe Harbor Plans • Additional requirement • Safe Harbor contributions must be 100% vested • Employees must receive a Safe Harbor notice 30 days before the beginning of the plan year • Plan document must reflect Safe Harbor election

  31. Dealing for 401k Testing Failures

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