ERISA holds retirement plan fiduciaries to the highest legal standards. To help meet these legal requirements, we can provide plan sponsors with the independent, objective consulting and guidance necessary to effectively meet and manage ERISA standards. Proper selection and ongoing monitoring of investment alternatives within the plan is a critical aspect of the fiduciary process. Our independent and objective analysis provides plan sponsors with the specific detailed information necessary to make informed decisions on behalf of the plan and help fulfill its fiduciary obligation.
IRS Testing Requirements for 401(k) Plans:
What are ADP/ACP Tests?
The ADP (Actual Deferral Percentage) and ACP (Actual Contribution Percentage) tests compare the average of salary deferral and employer match percentages for highly compensated employees (HCE) to the average of salary deferral and employer match percentages for non-highly compensated employees (NHCE).
HCE's include anyone who owns more than 5% of the company, the spouse, children, parents and grandparents of a 5% owner, or anyone who received more than $100,000 (indexed) in gross compensation from the employer in the previous year. There is no minimum income required for a 5% owner or family member to be classified as an HCE. For example, they could earn only $1,000 and still be classified as an HCE.
To perform the ADP test, a salary deferral percentage is calculated for every eligible employee. The numerator is the amount of salary deferred by the employee. The denominator is the employee's pay before salary deferral. The employees are then grouped into HCE's and NHCE's. The percentages are added together and an average is calculated. Eligible participants who did not contribute to the plan are included as zeros.
The example below shows a calculation for an NHCE group. The ACP test is calculated in the same manner, except the numerator is the dollar amount of matching contributions to the employee's account.
The ADP is 6.23%
Once the averages have been calculated, the HCE average is compared to the NHCE average. As a general rule, the HCE average cannot exceed the NHCE average by more than 2%. There are more restrictive rules if the NHCE average is less than 2%.
If the tests are not satisfied, a correction must be made. There are two ways to correct a failed ADP or ACP test. The employer can make a contribution to the plan to raise the NHCE average so that the test passes or return a part of the HCE's contribution to lower the HCE average so that the test passes. The best method to use depends on the individual circumstances of each plan. The Plan Administrator is responsible for deciding which method is to be used to correct the test.
What is the top-heavy test?
Each plan year, it must be determined whether your plan is "top-heavy." A plan is top-heavy if, as of the determination date, the total account value of key employees exceeds 60% of the total account value of all employees in the plan. A key employee is:
For existing plans, the determination date is the last day of the plan year immediately preceding the plan year being tested (i.e. for a calendar year plan, December 31, 2007 is the determination date for the 2008 plan year).
For new plans, the determination date is last day of the current plan year (i.e. December 31, 2008 is the determination date for a calendar year 2008 plan year). This means that for new plans, you may not know your plan will be top-heavy until after the plan year is completed.
When a plan is determined to be top-heavy, a minimum mandatory contribution by the employer is required on behalf of all non-key employees who are still employed as of the last day of the plan year. As a general rule, the required mandatory contribution is 3% of salary for all non-key employees.
What are minimum coverage tests?
Sometimes an employer wishes to exclude certain groups of employees from their qualified retirement plan. They may wish to exclude a certain class of employees, like all hourly employees or all salaried employees. In other instances, the employer may consist of a controlled group of companies and they may wish to include employees from Companies A and C but not Company B.
The minimum coverage tests that determine whether an employer can exclude certain groups of employees are many and varied. To determine if a group can be excluded requires a great deal of information including complete and accurate ownership information and census data.
As a sponsor of your plan, it is your responsibility to provide complete and accurate information, both at the inception of your plan and on an ongoing basis. If there are any changes in your company's structure such as acquisition of a new affiliate, sale of an affiliate, ownership changes, etc., you must notify us immediately so the plan can be tested appropriately.
A plan which does not pass the required minimum coverage tests may be required to make contributions on the behalf of previously excluded employees in order to satisfy the minimum participation requirements.
What is a control group?
A control group of companies may exist when there is overlapping ownership in two or more companies. There are two kinds of control groups: a parent-subsidiary control group and a brother-sister control group.
A parent-subsidiary control group exists when one company owns 80% or more of a subsidiary. A brother-sister control group exists when 5 or fewer individuals own 80% or more of two or more companies. In certain cases, ownership by a spouse, parent, child or grandchild may be combined to determine whether a control group exists.
Companies that are members of a controlled group may be tested separately if they pass minimum coverage tests. If they do not pass minimum coverage tests, controlled groups must be tested together. If a company fails to offer plan benefits to part of a control group and does not pass the required tests, they must pay mandatory contributions for the employees who were excluded from the benefits of the plan.
What are affiliated service groups and affiliated management groups?
In certain instances, companies that do not have interlocking ownership must be aggregated for testing purposes. Affiliated service groups and affiliated management groups are organizations related through specific service or management functions. If your company regularly performs services or management functions primarily for a small number of other companies, you may have an affiliated service group or affiliated management group.
If a company fails to offer plan benefits to part of an affiliated service group or affiliated management group and does not pass the required minimum coverage tests, they must pay mandatory contributions for the employees who were excluded from the benefits of the plan.
What employees must be covered?
As a general rule all non-union employees who have reached age 21 and completed a Year of Service must be included in the plan. You may choose less restrictive eligibility requirements when you adopt your plan.
Can we exclude part time employees?
Per IRS guidelines, the maximum hours requirement for qualified retirement plans is 1000 hours per year. If a part time employee works less than 1000 hours in a year they may be excluded but if they work more than 1000 hours, they must be included in your plan.
What are the tax-deductible limits for 401(k) plans?
Recent tax legislation allows employers to deduct up to 25% of eligible compensation as an employer contribution to their 401(k) plan. The total employer contribution includes both matching and profit sharing amounts.