Plan Compliance Packages
Posted on April 11, 2023 by Legacy Retirement Solutions
With the ever increasing need for complete disclosure; managing and maintaining all of the documents, forms, testing results, tax filings, etc. has become a daunting and exhaustive task. In addition, the regulatory agencies charged with auditing and investigating retirement plans continue to raise their expectations with respect to the formal policies and procedures implemented and maintained by retirement Plan Sponsors in order to facilitate the compliant operation of their plan.
Legacy is here to help your Company satisfy these requirements and expectations by offering 3 different levels of Plan Year Compliance reporting for the Defined Contribution plans from our Standard and our Plus, right up to our Premium. Each Plan Year report is designed to help your Company maintain a “single source” organized and streamlined record of a prior Plan Year’s operation. We also have a compliance package for our Defined Benefit/Cash Balance Plans. Below is a listing of each Plan Year Compliance package offered along with a list of included reports and pricing. Please contact us for more information.
1. Summary of Test
2. Eligibility Status
3. 410(b) Test
4. Deductibility Test
5. Annual Additions
6. ADP/ACP Test
7. ADP/ACP Corrections
8. HCE & Key
9. Top Heavy Report
$250 – Flash Drive
$350 – Hardcopy Binder
1. Standard Package
2. Basic Plan Document
3. Adoption Agreement
4. Summary Plan
5. SAS-70 Recordkeeper
6. Form 5500
7. Summary Annual
8. 5500 Reconciliation
9. Safe Harbor Notice
$400 – Flash Drive
$500 – Hardcopy Binder
1. Plus Package
2. Auditor Report
3. Administrative Report
4. Trust Report
5. Loan Summary Report
6. Investment Policy
7. 404(a)(5) Notice*
8. Auto Enrollment Notice*
9. QDIA Notice*
$500 – Flash Drive
$600 – Hardcopy Binder
|Defined Benefit Package
2. Summary of Plan Provisions
3. Form 5500 with all applicable schedules
5. Plan Document
6. Adoption Agreement
9. Participant Statements
10. Trust Rpt/Brokerage Account statements
11. AFTAP – Adjusted Funding Target Attainment Percentage
12. AFN – Annual Funding Notice
13. PBGC Filing, if applicable
$500 – Flash Drive
$600 – Hardcopy Binder
*If applicable and subject to third-party provision of such documents, if necessary
The tax code governing 401(k) plans was written to prevent qualified retirement plans from overly favoring highly compensated employees (HCEs). A series of non-discrimination tests were devised to measure whether a plan’s design or operation tends to favoring the HCEs over the nonhighly compensated employees (NHCEs). In our last installment we discussed how the Average Deferral Percentage (ADP) test is calculated. In this article we dive into the different methods of correcting for an ADP test failure
Correcting ADP Failures: Refunds to HCEs
There are generally two ways to correct a failed ADP/ACP test. The most-popular correction method is to refund “excess” deferrals to HCEs. The refund calculation is a two-step process. First, the total refund amount is determined by calculating the total percentage points that must be refunded to satisfy the ADP test.
The next step calculates the dollars which would be refunded if the excess percentages were refunded first to the HCE with the highest deferral percentage until either the total excess percentages are refunded or until the resulting deferral percentage of that HCE equals that of the HCE with the next-highest deferral percentage. If the test is still not satisfied, both HCEs are reduced together until the test is satisfied, and so forth.
The final step determines how much each HCE is to be refunded. This is calculated by first allocating the total refund to the HCE with the highest deferral, in terms of dollars, until the total refund is applied or until the deferral of such HCE is reduced to that of the HCE with the next highest deferral, and so forth.
The amount refunded is considered a taxable distribution from the plan, and is reported as taxable income to the participant in the year it is distributed from the plan. The corrective distribution is required to be completed by March 15th of the year following the year the excess contribution occurred. If completed after March 15th of the following plan year, it is still considered to be taxable income in the year paid, however in addition, the Internal Revenue Code imposes a 10% excise tax on the employer.
Correcting ADP Failures: QNECs
While a refund is the most-popular method of correcting an ADP failure, it is not always the most beneficial. The primary reason is that the HCEs, often the owners of the company or its most-valuable employees, lose-out on the tax deferral aspects of contributions to a 401(k) plan. An alternate method of satisfying the test is for the employer to make a Qualified Non-elective Contribution (“QNEC”). A QNEC is an employer contribution that is fully-vested when made and subject to the same distribution limitations otherwise applicable to section 401(k) contributions. A QNEC counts as a deferral in the ADP test. Thus, a QNEC can be used to correct a failed ADP test. A pro-rata QNEC would be allocated among NHCEs on the basis of compensation.
A QNEC must be provided for in the plan document. In addition, the allocation formula must be set forth in the document prior to the end of the plan year being tested. Many plans which contain QNECs will contain the “pro-rata” allocation formula set forth above. Keep in mind that the existence of QNEC language in a plan does not obligate the employer to make a QNEC in the event the ADP test is not satisfied. The employer retains the option of distributing amounts to HCEs.
Correcting ADP Failures: Retroactive Safe Harbor Election
With the passage of the SECURE Act employers are permitted to adopt a 3% non-elective contribution safe-harbor retroactive to the first day of the plan year as long as they do so at least 30 days before the end of the plan year (or, if the employer adopts a 4% or more Safe Harbor, it may be adopted by the end of the following plan year). The contribution would be awarded to any employee that was eligible to defer compensation into the plan from their own pay, regardless of whether or not that voluntarily participate.
Safe Harbor non-elective provides for the automatic passage of the ADP Test, ACP Test and Top Heavy testing that the plan would otherwise be subject to, each of which could potentially limit the contributions that owners and highly compensated employees can make or receive from the company for a given year. Since a safe harbor plan will automatically pass these tests that in turn would mean that owners, officers and other HCEs can maximize their contributions each year without concern about possible refunds or additional contribution liabilities for the company.
The tax code governing 401(k) plans was written to prevent qualified retirement plans from overly favoring Highly Compensated Employees (HCEs). A series of non-discrimination tests were devised to measure whether a plan’s design or operation lends to favoring the HCEs over the Non-Highly Compensated Employees (NHCEs). All year end testing begins with the coverage test in accordance with IRS Code section 410(b). Once the coverage test is passed or, if not passed, once steps have been taken to pass coverage, then the average deferral percentage (ADP) test must be performed. The ADP test uses mathematical equations to compare the participation and contribution rates of the HCEs to the NHCEs in order to determine whether the plan is discriminating in favor of the HCEs.
Who is considered a Highly Compensated Employee?
Generally, a highly compensated employee is an employee who is either a more than 5% owner of the business (also known as a 5% owner) in the year of testing or the prior year, or someone who makes more than a specific dollar threshold determined by the IRS and adjusted annually for cost-of-living increases ( for 2022 testing purposes, someone who earns $130,000 or more in 2021). It is possible to further restrict the number of HCEs associated with a particular employer by limiting HCE designation based on a compensation threshold to only the highest paid 20% of employees. This election may be particularly effective for small plans maintained by professional groups such as law firms and physicians. However, this election must be written into the plan document provisions in order to be effective.
The 5% owner rule also requires careful review of the ownership attribution rules for families and trusts. Family attribution rules dictate that the spouse, parent, legal child and grandchild of a more than 5% owner of the company are also considered 5% owners themselves. For example, if John Smith owns 100% of a business that also employs his wife Jane; the family attribution rules dictate that, as hiswife, Jane would also be considered to own 100% of the business. Therefore, both John and Jane would be considered to be HCEs due to either direct or attributed ownership.
How does the ADP Test work mathematically?
To perform the ADP test, first determine every employee who is eligible to make an elective deferral regardless of whether they actually contribute. Then you divide this list into groups: HCEs and NHCEs. Starting with the HCEs, each employee’s Actual Deferral Ratio (ADR) is determined by dividing the employee’s compensation into the amount the employee deferred into the plan. Once each employee’s ADR is determined, the ADRs are averaged to arrive at the HCEs’ ADP.
Below is an example to illustrate this process:
|ADRs Averaged to derivethe HCEs’ ADP|
|Average Deferral %||5.02%|
The same process is followed for the NHCE group.
|ADRs Averaged to derive the NHCEs’ ADP|
|Average Deferral %||3.13%|
Once both the HCE and the NHCE and ADP figures have been determined, they are compared against each other. The HCEs’ ADP may only exceed the NHCEs’ ADP by specific limits. The limits may be summarized as follows:
|ADP TEST LIMITS|
|NHCEs’ ADP||Maximum HCE limit|
|0 to 2%||2 times the NHCE limit|
|2% to 8%||Add 2 to the NHCE limit|
|> 8%||1.25 times the NHCE limit|
Using our example in which the NHCEs’ ADP is 3.13%, the HCEs’ ADP is limited to 3.13% plus 2% for a maximum of 5.13%. This test passes as the HCE average is 5.02%
Timing of the test
In general, the ADP testing should be completed within 2½ months after the end of the plan year. The typical correction for a failing test involves the distribution of excess contributions to the HCEs until the point at which the test is satisfied. In order to avoid an excise tax penalty, the plan sponsor is required to process these refund distributions by no later than 2 ½ months after the plan year end date. If the plan document allows for it, a failing test may also be remedied by the plan sponsor contributing a Qualified Non-Elective Contribution (QNEC) to the NHCEs to raise their average to a passing result or adoption of a Safe Harbor feature.