NONDISCRIMINATION TESTING - Dallas, TX - …

1 Presents TRAPS FOR THE UNWARY Felicia A. Finston NONDISCRIMINATION TESTING Slide No. 2 Ensure plan does not discriminate in favor of highly compensated employees ( HCEs ) as to eligibility or benefits ( , 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)

2 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.

3 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 ( , 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.

4 14 Employer contribution allocations are incorrect Correction is time consuming and expensive ( , 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 ( , closed to new entrants) Plan must continue to satisfy 410(b) (and 401(a)(26) if a defined benefit plan) and applicable amounts NDT ( , ACP/ADP or general test) A plan that benefits no HCEs will automatically satisfy NDT Frozen Benefits Slide No.

5 17 Sometimes plans freeze participants rights to certain benefit, rights or features ( BRFs ) ( , a lump sum form of distribution, death benefits, right to direct investments, etc.) Benefit must be currently available ( , satisfy section 410(b)) Benefit must be effectively available ( ,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 ( , ACP test) BRF TESTING Failures can only be corrected by expanding tier to NHCEs Tiered Contribution Formulas Slide No.

6 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.

7 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.

8 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.

9 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.

10 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 Treasury Regulations, we advise you that any 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. Questions??