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 Red Bank Pension Services 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 us for further information.
©2019 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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