Qualified plans must perform annual testing to be sure that the plan doesn’t unfairly discriminate in favor of "highly compensated employees" (HCEs) or exceed the contribution limits set forth by the IRS. Depending on your plan provisions, it isn’t just one calculation, but a series of tests that show that your plan is not discriminatory. If your plan is audited, the auditor is looking for proof of this compliance.
Since most retirement plans operate on a calendar year basis, testing season is now! If a testing failure occurs, correcting the failure by March 15th can save the plan sponsor excise taxes and additional filings. Getting year-end data in early, including complete census information, is paramount. Though Alliance Pension does all the heavy lifting to ensure your plan passes the appropriate testing, all plan sponsors should understand the basics of testing so that they can confirm all tests and any appropriate corrections are completed each year. The following are some helpful definitions to get you through the basics of compliance testing.
Is an HCE the same as a Key Employee?
An HCE and a Key employee are two separate definitions used to test different aspects of a retirement plan. Who qualifies as an HCE is determined on an annual basis. An employee is an HCE if:
- they own more than 5% of the company (including family attribution rules), or
- they received compensation exceeding a threshold set by the IRS in the prior plan year ($120,000 in 2017 for the 2018 plan year HCE determination).
An employee is a “Key” employee if they meet any of the following criteria:
- They own more than 5% of the company (including family attribution rules).
- They own more than 1% of the company (including family attribution rules) and have an annual compensation greater than $150,000.
- They are an officer of the company and have compensation of at least $175,000.
What do the different compliance tests mean?
- Annual Non-Discrimination Testing (ADP/ACP) – If your plan is a 401(k) plan, the ADP and ACP tests are a comparison between the average rates of deferral and matching contributions of HCEs to non-HCEs. Regulations generally allow for a 2% disparity between the two groups. If your plan has opted for a safe harbor election in any given year, it automatically satisfies the ADP and ACP testing.
- Annual Deferral Limit – Regulations restrict the amount that an individual can defer into a retirement plan in any calendar year. For 2018, an individual could have deferred a maximum of $18,500 and for those who attain or are over age 50 by December 31, 2018, an additional $6,000 can be contributed. Any amounts in excess of the limits must be returned with the appropriate allocation of investment gains by April 15, 2019.
- Minimum Coverage - Minimum coverage testing determines if the plan benefitted the required percentage of non-HCEs. This test is applied, not to the plan as a whole, but to each type of contribution; 401(k) contributions, matching, and employer profit sharing. Generally, each contribution type must meet 70% of the total number of non-HCEs that are not otherwise excludable. Examples of excludable employees are those governed under collective bargaining or non-resident aliens.
- Top-Heavy Testing - A plan is considered top-heavy if more than 60% of the benefits belong to "key employees." An annual test must be performed to determine if the key employees have more than 60% of the benefits or assets in the plan after certain allowable adjustments. If it is determined that the plan is top heavy, it must meet the top-heavy minimum contribution and vesting requirements.
- Annual Additions – Like most other aspects of retirement plans, the IRS sets the limit of how much can be contributed to any individual’s account for a plan year. Contributions would include amounts from all sources such as 401(k), matching, and employer profit sharing, but also includes any amounts allocated as forfeitures. For 2018, the limit is $55,000 for those under age 50 and $61,000 for those eligible for catch-up contributions.
- Allowable Deduction Limit – Regulations restrict an employer’s ability to contribute more than 25% of the sum of all participants’ compensation to a retirement plan. This restriction only pertains to employer contributions. Employee contributions are disregarded.
- General Non-Discrimination Testing – This testing only applies to plans that allocated contributions on a formula which weights contributions in favor of certain employees. These types of plans are commonly referred to as “cross-tested” or “new comparability plans.” If a plan uses a “uniform allocation formula,” this testing may not apply.
Plan sponsors should be aware that sometimes other companies or plans must be aggregated to satisfy the tests listed above. If you have any questions about the tests, be sure to contact Alliance Pension for further information.
Upcoming Compliance Deadlines for Calendar-Year Plans (12/31)
||Form 1099-R – The Form 1099-R is due for any distributions that that occurred during the 2018 calendar year. Note: Participant Loans that are in default may be considered “deemed” distributions and are reportable on Form 1099-R.
||ADP/ACP Corrective Testing - This is the deadline for distributing contributions and earnings to participants as corrective measures to ADP and ACP testing for calendar year plans.
||Employer Contributions - Profit Sharing and matching contributions must be deposited for 2018 amounts that will be deducted on the employer’s tax return (unless employer returns are on extension).
||Required Minimum Distributions - Regulations require that a participant must receive a required minimum distribution (RMD) by April 1st of the year following the year in which the participant attains age 70 ½. Distributions may be delayed until actual retirement unless the participant is a 5% or more owner.
||Excess Deferral Amounts - If a participant makes salary deferral contributions in excess of the IRS-issued limits in any calendar year, the plan must return the excess amount plus earnings to the participant by April 15 of the year following the year in which the excess occurred. The limits for 2018 were $18,500, or $24,500 for those age 50 and over if the plan allowed for catch-up contributions.
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