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  Safe-Harbor Options

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

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

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

ADP & ACP Tests ADP for NHCEs Max ADP for HCEs Rule Used 12Times 2 24Plus Times Times Times 1.25

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

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

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

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

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

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

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%

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

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

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

Automatic Enrollment

 State wage withholding laws preempted  Automatic Contribution Arrangement (ACA)  Eligible Automatic Contribution Arrangement (EACA)  Qualified Automatic Contribution Arrangement (QACA)

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

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

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

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

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

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

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

Dealing for 401k Testing Failures