Plans must be tested each year to ensure that they are compliant with the laws governing retirement plans. To understand the testing performed for your plan, it may be helpful to review some of the terms that are commonly used. First, let’s examine how your plan’s noteworthy individuals are identified.
Highly Compensated Employees (HCE): There are two factors that determine which employees are HCEs for a plan year:
- Ownership: An employee who owns more than 5% of the company in a plan year, or the year preceding it, is an HCE. A spouse, child, parent, or grandparent who participates in the plan will likewise be considered an HCE due to family attribution rules.
- Compensation: An employee is considered an HCE in a plan year based on their earnings the preceding year. An employee is an HCE for 2023 if they earned at least $135,000 in 2022; for 2024, the employee must have earned at least $150,000 in 2023. Plan document provisions may further limit this definition to the top 20% of earners.
Key Employees: There are three factors that determine which employees are considered key employees:
- Ownership: An employee who owns more than 5% of the company in a plan year, or the year preceding it, is a key employee. A spouse, child, parent, or grandparent who participates in the plan will likewise be considered a key employee.
- Owner compensation: An employee who owns more than 1% of the company and earned more than $150,000 in the prior plan year is a key employee.
- Officer compensation: An officer of the company is considered key in a plan year based on their earnings the preceding year. In 2023, the officer must have earned at least $200,000 in 2022; for 2024, the officer must have earned at least $215,000 in 2023.
Now that these individuals have been categorized, let’s explore some of tests that might be performed on your plan:
Deferral testing: The average deferral percentage for all highly compensated employees (HCE) is compared to the average deferral percentage for all non-highly compensated employees (NHCE) to ensure the gap between the two groups is not too wide. If this test fails, there are several methods to correct the test, including refunding deferrals and earnings for HCEs or making contributions for the NHCEs. This test is known as the Actual Deferral Percentage (ADP) test. Safe harbor 401(k) plans are designed to pass the ADP test.
Match testing: This form of testing is similar to deferral testing but compares employer match instead of deferrals. This is known as the Actual Contribution Percentage (ACP) test. Safe harbor 401(k) plans are also designed to pass the ACP test.
Maximum deferral testing: An employee’s deferrals cannot exceed a yearly maximum; this limit was $22,500 for 2023 and will be $23,000 for 2024. An additional $7,500 catch-up contribution can be deferred in 2023 and 2024 by participants who are at least 50 years old. If a participant has deferred more than the limit, a corrective distribution of the excess deferrals and earnings must be processed by April 15th. This limit is known as the 402(g) limit.
Maximum individual contribution testing: Similar to maximum deferral testing, the combined amount of a participant’s employee and employer contributions cannot exceed a yearly maximum. This combined limit is the lesser of $66,000 for 2023, $69,000 for 2024, or the participant’s total compensation. Catch-up deferral contributions are not included in this limit. This limit is known as the annual additions limit or 415 limit and is an important factor when calculating a maximum company contribution.
Maximum employer contribution: The employer’s tax deduction cannot exceed 25% of compensation for plan participants. This is known as the 404 limit and is also an important factor in the calculation of a maximum company contribution.
Top-heavy testing: A plan is considered top-heavy if 60% or more of the plan assets belong to key employees. A minimum contribution may be required if the plan is top-heavy. Many safe harbor plans are designed to satisfy top-heavy testing.
When calculating a contribution for a participant or the plan, these are some of the parameters that determine the permitted amount. Understanding this terminology may provide clarity to the contribution options provided for a plan year.
Does My Plan Need an Audit?
The main determining factor in whether your plan needs an audit performed by an independent qualified public accountant is the participant count. An audit will be required if the beginning of year participant count is more than 100. For the plan year that began in 2023, there is a change to how the participants are counted. Prior to this, the count included active participants—regardless of whether or not they had an account balance—as well as terminated participants who had an account balance. Now, participants without an account balance are no longer included in the count. This is exciting news because it means that some plans who required an audit for 2022 may no longer require an audit for 2023.
For plans that hover around the 100-participant mark, there is a rule in place to help stabilize the audit requirements from year to year. The 80-120 rule states that if the participant account is from 80 to 120 participants, the plan may retain the same audit status as the previous year. In practical terms, this means that an audit is not required until the participant count reaches 121. However, once an audit is required, it continues to be required until the participant count drops to 99 or less.
In addition to participant count, the type of assets held in the plan may cause the plan to require an audit, even if the participant count is under 100. Small plans are required to have an audit unless the plan fulfills the requirements of one of these exemption waivers:
- At least 95% of the plan’s assets are qualifying plan assets. This criterion is satisfied by most small plans. Qualifying plan assets include qualifying employer securities, participant loans, shares issued by a regulated financial institution, registered mutual funds, investments and annuities issued by an insurance company, and certain assets in an individual account of a participant or beneficiary.
- Less than 95% of the plan’s assets are qualifying, but a fidelity bond is in effect. This fidelity bond must cover 100% of the non-qualifying assets, or provide coverage based on standard ERISA bonding rules, based on whichever value is greater.
Since a large plan audit count is now based solely on individuals with an account balance, paying out your terminated participants could help to lower your participant count. It may be time to review your cash out limit, plan assets, and the account balances of terminated participants in order to minimize the need for an accountant’s audit in the future.
401(k) deferrals: Don’t exceed the limit!
Excess deferrals occur when a 401(k) participant defers a greater amount than the annual IRS limit permits. The annual deferral limit was $22,500 for 2023 and $23,000 for 2024. For participants 50 years old and older, an additional $7,500 can be deferred.
When this limit is exceeded, excess deferrals and earnings need to be removed from the plan and returned to the participant. Employer matching on this excess likewise must be forfeited if it was calculated and funded during the year. Distribution of these excess funds must occur by April 15th.
Even with payroll software that limits the deferrals, there are several situations in which excess deferrals might occur:
- A participant who begins working for you may have made deferrals to a previous employer’s plan during the same calendar year. After meeting any eligibility and entry requirements, they then make deferrals into your plan. Combined, these deferrals may exceed the annual limit, which is individual rather than per-plan. This error is often discovered during the preparation of the participant’s tax return, and correction requests are typically received in the first few months of the year.
- When you make a change to your payroll providers or payroll software, deferral limits may be exceeded if year-to-date deferral information is not transferred correctly.
- If a participant’s date of birth was input incorrectly into your payroll software, the participant may be inadvertently permitted to make a catch-up contribution, even though they haven’t reached age 50.
You may be asked to perform any necessary corrections regardless of whether or not the error occurred on your watch. The best way to prevent excess deferrals is to be sure that all deferrals are tracked in your payroll and that dates of birth are correct for all participants making catch-up contributions. Most payroll software has a field to input deferrals made outside of that software; if you hire a new employee, ask for their year-to-date deferrals, and ensure that this information is given to your payroll provider or entered into your software. If you make a payroll change during the year, check the year-to-date deferrals and ensure that they are correct for each employee.
Reminder: Long-Term, Part-Time Employee Rules Effective January 1, 2024
As part of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), part-time employees who worked at least 500 hours each year in 2021, 2022, and 2023 qualify as Long-Term, Part-Time (LTPT) employees. LTPT employees were eligible to make elective deferrals on January 1, 2024.
What happens if you missed enrolling one of these employees?
- Mistakes happen. When it comes to a missed deferral opportunity, the key is to correct the failure as soon as possible. This may include withholding the proper deferrals going forward, making an employer contribution to the plan, and providing the participant with a written notice regarding the failure. If you feel as though you missed offering an employee the opportunity to defer, please contact us immediately to remedy the situation rather than waiting until the end of the plan year.
What effect does this rule have on Solo 401(k) (One-Participant) Plans?
- If a plan covers a business owner (or owner and spouse) but employees have not met plan eligibility requirements in the past, the new Long-Term, Part-Time (LTPT) rules will have an impact. As the company owner is no longer the only participant, the plan will now be subject to ERISA.
- The ability for the employee to defer will not necessarily impact your employer contribution and testing, but it will have an impact on the plan’s filing status. This means that filing a Form 5500 or 5500-SF will be necessary, rather than filing a Form 5500-EZ. These forms require additional information to be reported, and are publicly available after filing, whereas Form 5500-EZ is not made public.
- The plan will also need to be covered by a fidelity bond to protect the assets, even if part-time employees make no deferrals.
Keep the new LTPT rule in mind when hiring employees—even if not full-time—as they may have an unexpected impact on your plan. Continue to evaluate the status of your part-time employees as well so that you can be prepared for their eligibility for the plan.
Upcoming Compliance Deadlines for Calendar-Year Plans
© 2024 Benefit Insights, LLC. All Rights Reserved.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.
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Spring will arrive soon, promising new growth and a fresh beginning. It could also be the perfect time to do some spring cleaning for your plan. Let’s look at some areas that you might consider reviewing to ensure your retirement plan is operating efficiently.
Document your processes and procedures to make certain that plan tasks can be handled in case of any absences during an enrollment or pay period. Having a backup in place can prevent errors and delays that could lead to penalties.
Make sure to have a process in place to notify all new enrollments of their eligibility, regardless of whether the plan has automatic enrollment. Depending on the timing for plan entry, including the plan enrollment paperwork with the new hire paperwork could make entry easier for you. Please reach out with any questions regarding when an employee enters the plan.
Deposits of employee deferrals and loan repayments must be submitted to the plan as soon as possible to avoid penalties and corrections. For plans with less than 100 participants, a safe harbor rule allows deposits to be made within seven business days. For larger plans, the expectation is that the money will be deposited more quickly. Depositing these funds on the pay date will avoid the possibility of being late.
Monitoring deferral contribution limits during the calendar year will avoid refunds after year end. Make sure that your payroll is set up to stop deferrals once the limit is reached, including any catch-up contributions for those who have reached age 50.
To keep the plan in compliance, employer contributions must be deposited timely. Due dates are impacted by the type of contributions, required status and tax deductibility. If you have questions on when to deposit your employer contribution or even whether to make an employer contribution, please contact us.
Most plans must be covered by a fidelity bond. The minimum coverage is 10% of plan assets (rounded up to the next $1,000) and the maximum coverage is $500,000. Additional requirements apply to plans with employer securities or non-publicly traded assets. If your fidelity bond is insufficient, now is the time to raise the coverage. Inflation clauses that increase the bond amount as the plan assets increase can ensure that your bond coverage is always adequate. Contact us or your insurance provider if you don’t have a fidelity bond.
Another area to review is communication with participants. Helping your employees understand and trust the plan can increase their contributions. Be sure that your procedures include distributing any plan-related communications—including required participant notices.
Distributions also involve communication, including some of the aforementioned notices. Discussing distribution options with terminated participants, possibly as part of an exit interview, can help to reduce risk of lost participants. We’ll provide instruction on distributions for force-out distributions for small balances, testing corrections and required minimum distributions.
Your plan document is the legal source on how the plan should be administered; operating within its parameters is critical. It’s always worth taking time to review the plan document to ensure that you fully understand and are following its provisions. We’ll cover more details about the plan document later in this newsletter. We’re here to support you in keeping your plan in compliance. Please feel free to reach out with any questions.
Addressing the Challenge of Uncashed Distribution Checks
Uncashed distribution checks present a persistent and often overlooked challenge for retirement plan sponsors. Despite the best efforts of plan administrators, some participants fail to cash their distribution checks, leading to administrative burdens, fiduciary concerns and potential compliance issues. A recent publication by Retirement Management Services (RMS) sheds light on this issue and offers practical guidance for employers seeking to manage and mitigate the risks associated with uncashed checks.
Uncashed checks can arise for various reasons. Participants may have moved without updating their contact information, may not recognize the check as legitimate or may simply forget to deposit it. Regardless of the cause, the responsibility for addressing these uncashed funds ultimately falls on the plan sponsor. This creates a fiduciary obligation to act in the best interest of the participant while ensuring compliance with IRS and Department of Labor (DOL) regulations.
Sponsors are encouraged to maintain up-to-date contact information for all plan participants and to follow up promptly when checks remain uncashed. This may involve sending reminder letters, making phone calls or using certified mail to confirm receipt. In some cases, plan sponsors may also consider using electronic payment methods to reduce the likelihood of checks going uncashed in the first place.
The IRS and DOL have issued guidance on how to handle these situations, including the use of forfeiture accounts and escheatment to state unclaimed property programs. However, these options come with their own set of rules and potential pitfalls. For example, using a forfeiture account may require the plan document to explicitly allow for such treatment. Escheatment laws, which allow the government to assume control of unclaimed property, vary by state. As such, plan sponsors must carefully evaluate their options and consult with legal or compliance experts as needed.
Another important consideration is the documentation of all the efforts made to contact participants and resolve uncashed checks. Maintaining a clear audit trail can help demonstrate fiduciary prudence and protect the plan sponsor in the event of an audit or legal challenge. It is extremely important to have a written policy in place that outlines the steps to be taken when a check remains uncashed beyond a certain period.
By taking a proactive, well-documented and compliant approach, employers can fulfill their fiduciary duties, reduce administrative burdens and ensure that participants receive the benefits they are entitled to.
Source: Retirement Management Services – “Uncashed Distribution Checks” https://www.consultrms.com/Resources/59/Plan-Sponsor-Tips-and-Help/212/Uncashed-Distribution-Checks
Divorce and the Retirement Plan
When a participant in a qualified retirement plan undergoes a divorce, the participant’s account balance may be an asset that is split with the former spouse. As the plan exists for the exclusive benefit of its participants, a court order is required to transfer the participant’s benefits to the ex-spouse. Once approved by the plan administrator, this court order is called a Qualified Domestic Relations Order (QDRO).
The QDRO is a judgment, decree or order that must be issued by a state authority (usually a court). It can be part of the divorce settlement or it may be a separate document. Because of the serious nature of separating the participant’s account balance, the QDRO is more than just an agreement made by both parties — it must also be signed by a judge.
A QDRO will describe how to divide the participant’s account balance between the participant and the ex-spouse, referred to as the alternate payee. In some cases, a set dollar amount will be allocated; in others, a percentage of the account may be designated. In the latter case, the amount assigned to the alternate payee represents the given percentage of the participant’s total vested account balance as of a specified valuation date. This percentage will apply to all sources — such as deferrals, matching or profit sharing — unless specified by the QDRO. Any interest and investment gains/losses that accrue between this valuation date and the date the funds are separated into an account for the alternate payee are often factored into this final calculation. If the participant has outstanding loans, the QDRO will usually indicate how the loans are handled.
Contributions such as deferrals and employer matching made after the valuation date are credited to the participant’s account. Earnings and losses are applied to the account balances. Once the division is complete, the alternate payee’s portion (either dollars or shares) is transferred to an account in the alternate payee’s name.
If the plan allows, the alternate payee may be paid out in a cash or rollover distribution. Not all plan documents allow the alternate payee to receive a distribution before reaching normal retirement age, so it’s important to follow the terms of the plan. In addition, the QDRO cannot violate the provisions of the plan document by requiring a plan to provide an alternate payee or participant with any type or form of benefit not otherwise provided under the plan.
Although the most common situation for a QDRO is a divorce, it can be issued in other situations, such as to a dependent in the case of child support. If the alternate payee is a minor child or legally incompetent, the order can also require payment to the individual with legal responsibility for the alternate payee. If a participant or their attorney provides you with a copy of a divorce decree that references the plan or a QDRO, please contact us immediately, and we will work with you to ensure it meets the requirements of the plan.
Important note for defined benefit plans: For 2025 plan years, PBGC premiums are due one month earlier than usual, specifically on the 15th day of the ninth month after the beginning of the plan year. For calendar year plans, this means the premium is due on September 15, 2025, instead of the usual October 15. This accelerated deadline is due to a provision in the Bipartisan Budget Act of 2015.
Upcoming Compliance Deadlines for Calendar-Year Plans
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