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Dealing with 401k Testing Failures

Dealing with 401k Testing Failures. DEALING WITH 401(k ). TESTING FAILURES. PRESENTATION SUMMARY. Highly Compensated Employees Actual Deferral Percentage (ADP)/Actual Contribution Percentage (ACP) Tests Key Employees Top Heavy Tests Strategies for Increasing Contributions

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Dealing with 401k Testing Failures

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  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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