A safe harbor plan eliminates the need for non discrimination testing altogether. A series of nondiscrimination tests were devised to measure whether a plans design or operation lends to favoring the hces over the nonhighly compensated employees. Meanwhile, the available remedies arent ideal because they either prevent hces from maximizing deferrals or are too costly or both. Fortunately, plan sponsors can avoid testing entirely by adopting one of the following safe harbor contribution formulas. Every year, the irs requires all 401k plans except safeharbor plans, as described below to take a discrimination test. Nov 24, 2019 find out why catchup contributions are not included in the adp testing and how the irs uses non discrimination tests to level the playing field. The plan document must state that the actual deferral percentage adp test of code section 401k 3 will be satisfied and must actually satisfy the test in operation.
A safe harbor plan eliminates the need for nondiscrimination testing altogether. Every year, the employee retirement income security act requires employers to undergo 401k discrimination testing to ensure plans are not discriminating against lowerincome employees. Thats what the two major 401k nondiscrimination tests try to assess. Highly compensated employee rules aim to make 401ks fair. To address any risk early, its highly advisable to conduct plan. Jan 16, 2017 you have likely received a number of notices related to year end nondiscrimination testing. The issue from november 8, 2017 provides an overview of the various requirements, and the one from january 2, 2018 discusses dependent care assistance plan requirements.
Coverage and nondiscrimination answer book is the first reference guide that. If key employee balances exceed 60 % of the entire plan balance at the end of the plan year, the employer is required to make a 3% contribution to the non key employees to be non discriminatory. First, he says, there are rules to ensure there is broad coverage of employees. Nondiscrimination testing is required for qualified retirement plans to ensure that benefits under the plan do not discriminate in favor of officers, owners, shareholders, employees in authority of other employees or any other employee classified as a highly compensated employees hces. For nondiscrimination testing, the irs under tax code section 415.
In order to qualify for taxfavored status, a benefit plan must not discriminate in favor of highly compensated employees hces and key employees with respect to eligibility, contributions, or benefits. When a plan uses prior year, rather than current year, to prepare the discrimination testing. The tax code governing 401k plans was written to prevent qualified retirement plans from overly favoring highly compensated employees. A clause found in qualified retirement plans stating that all employees of a company must be eligible for the same benefits, regardless of position within the company. Deadlines to correct for failed adp and acp testing. This snapshot discusses plan testing methods that are permissible pursuant to cca 2016150. The form 5500 series is part of erisa compliance for 401 k. For some of the tests, employees are divided between nonhighly compensated employees nhces and highly compensated employees hces. Passing annual nondiscrimination tests is a crucial part of a 401 k plans administration. Are catchup contributions included in actual deferral. In general each plan must stand on its own for nondiscrimination testing. A word of warning, how to apply the nondiscrimination requirements is not always clear.
Section 105b of the internal revenue code generally excludes from gross income amounts paid through employersponsored health coverage. The simple answer is yes, if the plan sponsor decides to take advantage of some plan design features that will allow a plan to automatically satisfy some of the required testing rules, which eliminate future refunds due to failed testing. If each plan cannot pass 410b coverage testing separately, then the plans will be treated as component parts of the same plan, and must pass the other nondiscrimination tests adp,acp, 401a4. For example, if you are a highly compensated employee, you need to understand how the nondiscrimination test works. For plantesting purposes, the code treats two or more employers as a single employer if there is enough common ownership or a combination of joint ownership and common activity. Dec 01, 2014 with acronyms like adp, acp, nhces, and hces, the technicality of 401 k plan nondiscrimination testing may seem overwhelming. The purpose of these calculations is to determine compliance to the irs nondiscrimination rules for erisa eligibility based on ratios of highlycompensated employee benefit amounts to nonhighlycompensated employee benefit. The following questions will help you get to know the types of tests performed and what to expect. The federal government issues nondiscrimination tests to evaluate the.
And as you can see in the examples above, correcting a failure can have unwelcome consequences for employees or require making employer contributions you may not have budgeted for. In january 2016, the office of chief counsel issued chief counsel advice cca 2016150 that deals with the treatment of otherwise excludable employees for coverage and adp testing. Increasingly, unions have been negotiating in collective bargaining for participation in multiemployer 401k plans. This process looks at the difference between the contributions of highlycompensated employees and nonhighly. A clause found in qualified retirement plans stating that all employees of a company must be eligible for the same benefits. Even though nondiscrimination testing is likely performed by a plans recordkeeper or thirdparty administrator, plan sponsors need to understand the basics of the tests, including the types of contributions that are tested, the methods used and the consequences of failing. Final thoughts on 401k limits for highly compensated employees. These tests are mandated by the employee retirement income security act erisa, which is a set of laws and regulations that govern almost. Jun 24, 2015 nondiscrimination testing is required for qualified retirement plans to ensure that benefits under the plan do not discriminate in favor of officers, owners, shareholders, employees in authority of other employees or any other employee classified as a highly compensated employees hces. A highly compensated employee who receives a noadditional cost service, a qualified employee discount or a meal provided at an employeroperated eating facility for employees shall not be permitted to exclude such benefit from his or her income unless the benefit is available on substantially the same terms to. These nondiscrimination tests for 401k plans are called the actual deferral percentage adp and actual contribution percentage acp tests. If youre an employee of a large organization, your employer has probably figured out how to avoid the hce problem.
Nondiscrimination testing introduction topics covered adp and acp mechanics other nondiscrimination tests 410b coverage benefits, rights and features controlled groups plan aggregation and disaggregation correction of testing failures safe harbor rules. Acing nondiscrimination testing 3 strategies to help your. Basic nondiscrimination testing rules both defined benefit db plans and defined contribution dc plans must satisfy nondiscrimination rules. What nondiscrimination testing rules apply to controlled. If a plan fails the adp test, it essentially has two options to come into compliance. Identify and differentiate the two tests ratio percentage test and average benefit test that are used to demonstrate that a plan satisfies coverage requirements. If each plan passes 410b coverage testing, then the other nondiscrimination tests adp,acp,401a4 can apply to each plan separately. The 401k provider for small and mediumsized businesses you get an affordable, fullservice 401k plan for your employees in just a few minutes. Treatment of otherwise excludable employees for coverage and. The employee retirement income security act erisa requires several tests each year to prove 401k plans do not discriminate in favor of employees with higher incomes.
Guide to nondiscrimination testing for code section 403b. The coverage rules above indicate whether a 401k plan is open fairly to all employees. The adp test counts elective deferrals both pretax and roth deferrals, but not catchup contributions of the hces and nhces. Code section 403b plans are subject to various nondiscrimination rules which are set forth in the code. Identify the impact that excluding certain employees has on coverage testing. Nondiscrimination testing overview dwc the 401k experts. Identify who is considered benefiting under irc 410b coverage testing. For example, if you are a highly compensated employee, you need to understand how the non discrimination test works. You have likely received a number of notices related to year end nondiscrimination testing. Explanation of compliance testing empower institutional. Additionally, the law has changed to allow an employer not to perform an adp test if it makes a safe harbor contribution to the plan on behalf of employees. If you are investing in an employer 401k, you need to understand how all of the rules work, as they can affect you. Overview of cafeteria plan nondiscrimination testing.
Hces and 401k nondiscrimination rules american society of. On a ten thousand dollar las vegas 401k account, there is 1. Sponsors of multiemployer 401k plans must be aware of the special rules that apply when conducting the nondiscrimination tests, which srz partner ronald e. Jan, 2016 nondiscrimination testing introduction topics covered adp and acp mechanics other nondiscrimination tests 410b coverage benefits, rights and features controlled groups plan aggregation and disaggregation correction of testing failures safe harbor rules. Companies can find themselves in regulatory hot water if their 401k plan fails required annual nondiscrimination compliance tests, designed to make sure a plan does not benefit highly paid. It is ideal that you complete all necessary steps outlined by the due date the 401k provider stated, but. This exclusion may not apply to benefits provided to highly compensated individuals hcis under a selfinsured plan if the plan discriminates in favor of these individuals in terms of benefits or eligibility as defined in section 105h.
As the nhces save more for retirement, the rules allow hces to defer more. Why does nondiscrimination testing exist for 401ks. Minimum coverage test nondiscrimination testing dwc. Sep 15, 2011 the discrimination testing passes if the average 401k contributions of hces is the lesser of 2 times or 2% more of the average 401k contributions of nhces. This testing is usually performed by a thirdparty administrator, but employers should still understand the basics of how this testing works. Special coverage and nondiscrimination testing rules for. Treatment of otherwise excludable employees for coverage. Hces and 401k nondiscrimination rules american society. Here are the basics of the nondiscrimination test and how it is used. If your plan regularly passes testing, thats great news. To guide you through the 2016 plan year nondiscrimination test for your retirement plan, below is a general overview of the process. A plan is topheavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees is more than 60% of.
Human interest provides retirement savings plans to over 2,000 companies and ongoing support to more than 60,000 employees get started. Nondiscrimination testing requires that employees of a certain status highly compensated employees and key employees stay within a specific contribution rate, as determined by the contribution rate of nonhighly compensated employees. What is nondiscrimination testing for retirement plans. Get a jump on your 2016 401k nondiscrimination testing. The discrimination testing passes if the average 401k contributions of hces is the lesser of 2 times or 2% more of the average 401k contributions of nhces. These are referred to in this guide as nondiscrimination tests. Still, just under 40 percent of plans polled by the plan sponsor council of america reported refunding or restricting hce contributions in order to pass the test. Top heavy rules for traditional 401k plans a plan is topheavy when, as of the last day of the prior plan year, the total value of the plan accounts of key employees is more than 60% of the total value of the plan assets. The average deferral percentage adp of all hces, as a group, can be no more than 2 percentage points greater or 125 % of, whichever is more than the nhces, as a group.
Even though nondiscrimination testing is likely performed by a plans recordkeeper or thirdparty administrator tpa, plan sponsors need to understand the basics of the tests, including the types of contributions. Nondiscrimination testing is a series of calculations performed on demographical employee data provided by the employer. This process is designed to ensure that upper level executives in a company are not the only ones that are contributing to a company 401k plan. Form 5500 is intended to assure that employee benefit plans are operated correctly and the rights of participants are protected. Human interest provides retirement savings plans to over 2,000 companies and ongoing support to more than 60,000 employees. The minimum coverage test is one of several nondiscrimination tests a plan must satisfy in order to remain compliant with irs rules. It can have a return of excess done to the hces to bring their adp to a lower, passing, level.
Performing the adp and acp tests each year can be an administrative burden. Safe harbor 401k plans and qualified automatic contribution arrangements qaca and their effect on nondiscrimination testing. Apr 02, 2020 on a ten thousand dollar las vegas 401k account, there is 1. As irs rules and regulations often change year to year, it is important to. Mar 12, 2020 why does non discrimination testing exist for 401ks.
This process looks at the difference between the contributions. What are the nondiscrimination requirements for code section 403b plans. The employee retirement income security act, or erisa, requires a number of tests on an annual basis to ensure that your companys 401k plan isnt discriminatory by favoring those who make more money. An hce is any employee who meets either an ownership test or a compensation test. But the older safe harbor rules, as presented below, remain available as. Learn important facts about the series of numerical nondiscrimination tests plans.
A guide to common qualified plan requirements internal. Coverage and nondiscrimination answer book, fourth edition. These rules are described in code 414b, c, and m, which are directly incorporated into the cafeteria plan rules. Even though the plan may be open to lowerpaid employees, does not mean that they will take advantage of it. When you hear the words nondiscrimination tests your first thoughts might be your 401k plan, but there are nondiscrimination rules that apply to health and welfare plans. If your plan regularly passes testing, thats great. Find out why catchup contributions are not included in the adp testing and how the irs uses nondiscrimination tests to level the playing field. New comparability testing is an irs approved method for testing nonelective profit sharing contributions made to a defined contribution retirement plan or a defined contribution plan used in concert with a defined benefit i. However, if you are not so fortunate or your plan is on the cusp. March 15 th is a magical deadline for calendar year plans in the 401k testing world. The dollar limit is effective january 1 and is applied in the calendar year in which the plan year begins.
In fact, there are books that are hundreds of pages in length that still dont cover. The topheavy test looks at how much key employees contribute to the plan compared to everyone else. With acronyms like adp, acp, nhces, and hces, the technicality of 401 k plan nondiscrimination testing may seem overwhelming. When a plan uses prior year, rather than current year, to prepare the discrimination testing, the passing rate for hces is known early in the year. If you are the employer, this is a situation youll need to monitor closely. Use our solo 401k contribution calculator to see what you can contribute to a solo 401k and sepira. This process looks at the difference between the contributions of highlycompensated employees and non highly. However, special rules require certain employee groups to be disaggregated for testing and tested separately. An employee is an hce based on ownership if he or she owns more than 5% of the company sponsoring the plan or any related company at any time during the current plan or previous year. Here are the basics of the non discrimination test and how it is used. Dec 01, 2014 even though nondiscrimination testing is likely performed by a plans recordkeeper or thirdparty administrator, plan sponsors need to understand the basics of the tests, including the types of contributions that are tested, the methods used and the consequences of failing. The 401k industry is a complex mixture of rules and regulations that are.
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