nondiscrimination testing - dallas, tx - home … no. 3 components of nondiscrimination testing...
TRANSCRIPT
Slide No. 2
Ensure plan does not discriminate in
favor of highly compensated employees
(“HCEs”) as to eligibility or benefits (i.e.,
same benefits must be provided to non-
HCEs (“NHCEs”))
Required as a condition of tax
qualification
Purpose of Nondiscrimination Testing
Slide No. 3
Components of Nondiscrimination Testing
(“NDT”)
Common NDT Gotchas
Safe Harbor Plan Designs
Prior Year v. Current Year Testing
Leased Employee Coverage Issues
Prototype v. Individually Designed Plans
ROAD MAP
Slide No. 4
Code and regulations
• Apply to all qualified plans
• Different tests for different purposes
Terms of the plan document
• Employer specific
• Must comply with regulations
Participant contribution data
Components of NDT
Slide No. 5
Basic Tests Name Code
Section Description Applies To Failure
Rate
Coverage 410(b) Ensures plan provides benefits to a sufficient percentage of employees
Plan Rare
Contributions 401(a)(4) Applies to defined benefit and defined contribution plans (other than elective deferrals and match) to ensure contributions don’t discriminate in favor of HCEs
Plan Rare
Actual Deferral Percentage (“ADP”)
401(k) Ensure HCE elective deferral percent does not exceed Non-HCE deferral percent by more than specific amount (generally 2%)
Plan Common
Actual Contribution Percentage (“ACP”)
401(m) Ensure HCE after-tax and matching contribution percent does not exceed Non-HCE after-tax and matching contribution percent by more than specific amount (generally 2%)
Plan Common
Deferrals 402(g) Ensure participant deferrals do not exceed a stated limit
Participant Rare
Slide No. 6
Additional Tests
Name Code Section
Description Applies To Failure Rate
Annual Additions
415 Ensures contributions to a defined contribution plan don’t exceed the lesser of 100% of compensation or a specific dollar amount
Participant Rare
Annual Benefits
415 Ensures benefits paid from a defined benefit plan do not exceed a specific dollar amount
Participant Rare
Minimum Participation
401(a)(26) Requires defined benefit plan to cover a minimum number of participants
Plan Common
Top Heavy 416 Ensure benefits provided to key employees do not exceed 60% of contributions and benefits provided to non-key employees
Plan Rare for large plans; common for small
Benefits, Rights and Features
401(a)(4) Ensure specific rights and features, such as contribution levels, do not discriminate in favor of HCEs
Plan Not Uncommon
Slide No. 7
Compensation
Frozen Benefits
Benefits, Rights or Features
Tiered Contribution Formulas
Common NDT Gotchas
Slide No. 8
Uses Elements
Compensation
Slide No. 9
Contributions and Benefits
Determine HCEs
ADP/ACP Testing
Amounts Testing
415
Compensation Uses
Slide No. 10
Specific definitions of compensation
apply for determining HCEs and NDT
Generally, sponsor has discretion in
determining compensation for
contribution purpose
Multiple definitions of compensation
may be used, but increase complexity
of administering the plan
Compensation Uses
Slide No. 11
W-2 Gross
415 414(s)
404
Compensation Elements
Slide No. 12
Ability to track desired definition of
compensation (e.g., W-2 versus
something else)
Cost – benefit of having multiple
definitions of compensation
Imputed income items
Things to Consider
Slide No. 13
Plan definitions of compensation may not
be implemented correctly
• Payroll may not communicate with benefits
• Pay codes may not clearly fall within or outside
plan definitions
• Administrative burdens of tracking varying
definitions lead to errors
Complicated vocabulary makes effective
communication with providers difficult
Failure to implement 401(a)(17) limit
Common Pitfalls
Slide No. 14
Employer contribution allocations are
incorrect
• Correction is time consuming and expensive
(e.g., VCP, audit penalties, additional funding)
• Employee relations issues which can impact
future participation and testing
Incorrect compensation is used for testing
• Different required definitions may not be
followed
• Compensation elements within definition are
incorrect
• Requires retesting and could lead to penalties
Impact
Slide No. 15
Limit number of compensation definitions
in plan document if possible
Always track “gross” compensation, it’s
needed for testing
Review ACP test for match $ or % above
the plan limits
Review annual HCE determination and
compare it to last year
Periodically review pay codes and
compare with plan definitions of
compensation
Administrative Tips
Slide No. 16
A frozen benefit situation occurs when the
benefits or contributions under the plan
are frozen (i.e., closed to new entrants)
• Plan must continue to satisfy 410(b) (and
401(a)(26) if a defined benefit plan) and
applicable amounts NDT (e.g., ACP/ADP or
general test)
• A plan that benefits no HCEs will automatically
satisfy NDT
Frozen Benefits
Slide No. 17
Sometimes plans freeze participants’
rights to certain benefit, rights or features
(“BRFs”) (e.g., a lump sum form of
distribution, death benefits, right to direct
investments, etc.)
• Benefit must be currently available (i.e., satisfy
section 410(b))
• Benefit must be effectively available (i.e.,under
facts and circumstances available to not just
HCEs)
• Determined as of freeze date
Frozen Benefits, Rights and Features
Slide No. 18
When BRF is only available to active
employees whose benefits are frozen the
following tests must be met:
• The BRF must satisfy the current and effective
availability tests with respect to the frozen
participants
• There must not have been any change in the
availability of the BRF, or
• Any change in the availability of the BRF is
made in a nondiscriminatory manner
Frozen BRFs Limited to Frozen Benefits
Slide No. 19
Contributions may vary based on age,
years of service or facility
Subject to multiple NDT
• Amounts testing (e.g., ACP test)
• BRF testing
• Failures can only be corrected by expanding
tier to NHCEs
Tiered Contribution Formulas
Slide No. 20
Run preliminary test before the year to avoid
surprises
Utilize transition period in a merger and
acquisition to determine going forward game plan
Consider how population will evolve over time
Consider plan designs to simplify administration
Administrative Tips
Slide No. 21
Formulaic method of satisfying ADP
and ACP test
Three types
• 3% nonelective
• Non-automatic enrollment safe
harbor match
• Automatic enrollment safe harbor
match
Safe Harbor Plans
Slide No. 22
Must adopt before 12 month plan year
unless exception applies
Notice requirements
Limited ability to amend plan mid year
Limited ability to suspend contributions
mid year
Safe Harbor Requirements
Slide No. 23
Incorrect compensation
used
Eligibility provisions misapplied
Discretionary match provisions
gone wrong
Component plan testing failures
Notice requirements
Safe Harbor Plan Pitfalls
Slide No. 24
Remember the safe harbor ≠ a testing
exemption
Beware of discretionary match - not
allowed with automatic enrollment safe
harbor
For safe harbor match, check that every
participant who deferred got one
Review definition of compensation
Give timely notice and spring plan if
necessary
Administrative Tips
Slide No. 25
Method of ACP and ADP testing
Must be specified in document
Limits plan aggregation
Specific rules on changing methods
Prior Year vs. Current Year Testing
Slide No. 26
What Is it
• Method where last years NHCE ADP testing is used for current year
Why is it used
• Belief it helped HCEs determine how much they could defer each year
Problem
• Test results aren’t available soon enough for planning
• Error in one year cascades to others
Prior Year Testing Method
Slide No. 27
Limited ability to use QNECs or QMACs to
satisfy testing because they have to be
allocated before end of the plan year being
tested
If different methods are used for ADP and
ACP then
• Can’t recharacterize elective deferrals as after-
tax contributions,
• can’t use elective deferrals under ACP and
• QMACs can’t be taken into account under ADP
Potential Gotchas
Slide No. 28
Ensure plan specifies testing method
being used
If prior year is specified, ask why and if
a reason cannot be articulated consider
amending plan
Administrative Tips
Slide No. 29
Individual who provides services to the
employer pursuant to an agreement on
a substantially full-time basis for at least
one year under the primary direction
and control of the employer
Not required to cover, but count in
410(b) testing
Code’s limited safe harbor for leasing
company that maintains a money
purchase plan rarely applies
Leased Employee Issues
Slide No. 30
Plan terms don’t exclude leased
employees
Leased employees not considered in
NDT
Hours worked as leased employee
count for eligibility and vesting
Transfer from employee to leased
employee isn’t a separation from
service
Common Pitfalls
Slide No. 31
Be sure plan terms exclude leased
employees from participation
Be sure you track leased employee
hours for eligibility and vesting
Be sure you consider leased employees
in NDT
Benefits provided to leased employees
may be counted under your NDT
Administrative Tips
Slide No. 32
Consists of adoption agreement and
base plan document
Employer selects design options in
adoption agreement
Prototype sponsor obtains opinion letter
from the Internal Revenue Service
employer can rely on
Prototype sponsor responsible for
document updates
Prototype Plans
Slide No. 33
Custom amendments may negate
prototype status
Plan will incur cost and inconvenience
of needing to obtain determination letter
Future amendments will need to be
managed by plan sponsor
Ancillary documents will need to be
managed by plan sponsor
Prototype Plan Amendment Pitfalls
Slide No. 34
Run all amendments by prototype
sponsor to ensure desired change can
be accommodated
If amendment will impact prototype
status, consider need and timing
Administrative Tips
Slide No. 35
Prototype plan will outline certain NDT
provisions
HCE determination
ADP/ACP testing
Top Heavy
Prototype plan will specify compensation
that may be used for contribution
purposes
Prototype NDT Pitfalls
Slide No. 36
Make sure you review NDT provisions
of prototype plan before you adopt it to
ensure you can capture and administer
relevant compensation definitions
If you change prototype plans make
sure provisions of the new document
are the same or you are aware and
want differences
Administrative Tips
Slide No. 37
The information presented in this presentation is of a general nature and should not be
considered as legal or tax advice.
You are encouraged to seek direct counsel on legal matters. To ensure compliance with
requirements imposed by U.S. Treasury Regulations, we advise you that any U.S. tax
advice contained in this communication was not intended or written to be used, and cannot
be used, for the purpose of avoiding penalties under the Internal Revenue Code.
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