Originally published on BenefitsPro.com on January 9, 2019
BY: BRAD KNOWLES
Managing Director, Argent/Heritage Retirement Plan Advisors
With 2018 now over, company retirement plan sponsors should start the new year fresh and revisit nondiscrimination testing to ensure contributions are within federal limits and the program is designed to maximize employee participation.
January is the perfect time for company benefits executives to reexamine their retirement plans now that they’ve finished year-end tasks for other essential programs, such as health insurance open enrollment (and filing all the necessary paperwork required by federal and state regulators).
One of the best places to start is by taking a deep dive into nondiscrimination testing to see if your plan is in compliance with federal regulations.
The IRS requires companies perform annual nondiscrimination testing on their qualified retirement plans – for example, a 401(k) and some 403(b) plans – to ensure highly compensated employees (HCEs) do not receive preferential treatment over non-highly compensated employees (NHCEs).
Use nondiscrimination testing
In general, there are two primary nondiscrimination tests: actual deferral percentage (ADP) and actual contribution percentage (ACP).
Actual deferral percentage (ADP): This test compares pre-tax and Roth contribution percentages for HCEs to the average salary deferral percentage for NHCEs. Employers pass if the ADP for eligible HCEs doesn’t exceed the greater of the following:
- • 125 percent of the ADP for the group of NHCEs,
- • Or the lesser of:
- ◦ 200 percent of the ADP for the group of NHCEs, or
- ◦ The ADP for the NHCEs plus 2 percent.
Actual contribution percentage (ACP): This test examines employee after-tax and employer matching contributions and compares the percentages for HCEs versus NHCEs. Employers pass if the ACP for the eligible HCEs doesn’t exceed the greater of the following:
- • 125 percent of the ACP for the group of NHCEs,
- • Or the lesser of:
- ◦ 200 percent of the ACP for the group of NHCEs, or
- ◦ The ACP for the NHCEs plus 2 percent.
If a company’s plan fails the ADP or ACP test, plan sponsors have two and a half months after the end of the plan year to return excess contributions to HCE employees to avoid a 10 percent penalty.
Distributions of excess contributions can be done any time during the plan year. Failure to make corrections could result in the plan losing its tax-exempt status.
Adopt non-qualified deferred compensation
The rule of thumb is employees should save 12 to 15 percent of their salary for retirement. Unfortunately, due to lower participation and contributions from NHCEs, most HCEs are prevented from meeting that saving rate.
One way to avoid non-compliance is adopting a non-qualified deferred compensation for HCEs, while also encouraging NHCEs – through webinars, company meetings and related activities – to maximize their contributions.
Monitoring contributions to make sure a retirement plan remains in compliance can be daunting. To keep your program in compliance with the IRS and help your employees save for retirement, consider these three strategies:
1.Review last year’s nondiscrimination testing
Plan sponsors should examine last year’s ADP/ACP test results and compare it to the current HCE contribution percentage. This will help plan sponsors determine which NHCEs are able to increase their contributions before year-end. It will also show if any HCEs over-contributed to the plan and how much should be refunded. It will also serve as a helpful benchmark for determining contributions for HCEs.
2. Set up automatic enrollment
Automatic enrollment is one of the most effective ways employers can increase plan participation. Once the employee onboarding process is set up, automatic enrollment is easy to manage and results in increased participation. One study showed auto enrollment plans resulted in participation rates of more than 90 percent compared with only 50 percent for plans that require employees to opt in.
3. Consider a Safe Harbor plan
Per IRS regulations, a Safe Harbor plan requires a mandatory contribution by the employer into the retirement account for every eligible employee.
In return for treating all employees equally, employers can automatically pass ADP/ACP testing.
To qualify, employers have two options:
- Contribute a minimum of 3 percent of every employee’s salary (regardless of participation in the plan) or
- Provide a minimum contribution of 100 percent match of the first 3 percent of employee contributions and 50 percent of the next 2 percent.
Poring through retirement plan contribution data isn’t the most exciting way to start the new year. But if you follow these three tips, you’ll be in a better position to pass nondiscrimination testing, help employees save more for retirement and start 2019 on a positive note.