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WHAT IS NONDISCRIMINATION TESTING?

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WHAT IS NONDISCRIMINATION TESTING?. The IRS requires that organizations that sponsor a qualified retirement plan perform annual nondiscrimination testing to ensure that the plan does not discriminate in favor of highly compensated employees (HCEs). WHAT TESTS ARE REQUIRED EACH YEAR?.

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what is nondiscrimination testing
WHAT IS NONDISCRIMINATION TESTING?
  • The IRS requires that organizations that sponsor a qualified retirement plan perform annual nondiscrimination testing to ensure that the plan does not discriminate in favor of highly compensated employees (HCEs).
what tests are required each year
WHAT TESTS ARE REQUIRED EACH YEAR?
  • Actual Deferral Percentage (ADP) Test
  • Actual Contribution Percentage (ACP) Test
  • Deferral Limits Test (402(g))
  • Annual Additions Test (415 Limit)
  • Top Heavy Test (416)
  • Minimum Coverage Testing (once every three years unless the plan demographics substantially change).
who is an eligible employee
WHO IS AN ELIGIBLE EMPLOYEE?
  • Anyone who satisfies the plan’s age and/or service requirement is eligible to participate in the plan.
  • Dual eligibility- Different eligibility for 401(k) and Employer contributions.
  • Excluded Employees – ex. Employees covered under a collective bargaining agreement, non-resident aliens with no U.S. Source income, leased employees, hourly employees, etc.
who is considered an hce
WHO IS CONSIDERED AN HCE?
  • More than 5% owner
  • Family member of a 5% owner (wife, child, parent, and grandchild)
  • Employees who earned more than $110,000 in the prior plan year (for 2010, indexed annually)
compensation limit
COMPENSATION LIMIT
  • Limit determined by the IRS and indexed annually. The maximum compensation limit for 2011 is $245,000.
  • This means that employee deferrals and employer contributions cannot be made on compensation in excess of $245,000.
  • Compensation for purposes of testing is limited to $245,000.
actual deferral percentage adp test
ACTUAL DEFERRAL PERCENTAGE (ADP) TEST
  • Test includes pre-tax and Roth contributions for eligible employees.
  • Tests all eligible employees, whether or not they elect to participate in the Plan.
  • Determines who are HCEs and calculates the average of their ADP (deferrals/salary) and compares it to the average of the ADP of the Non-highly compensated employee (NHCE) group.
  • Verifies that the ADP of the HCEs does not exceed the ADP of the NHCEs by more than an allowable difference determined by the IRS.
  • If the differential is greater than the amount permitted, the test will fail and some contributions to the HCE group will need to be refunded, re-characterized as catch-up, if permitted, or the employer can elect to make a qualified non-elective contribution to NHCEs.
  • Any refunded taxable contributions must be reported as taxable income in year distributed.
actual contribution percentage acp test
ACTUAL CONTRIBUTION PERCENTAGE (ACP) TEST
  • Test includes employer match and after-tax contributions for eligible employees.
  • Tests all eligible employees, whether or not they elect to participate in the Plan.
  • Determines who are HCEs and calculates the average of their ACP (contributions/salary) and compares it to the average of the ACP of the Non-highly compensated employee (NHCE) group.
  • Verifies that the ACP of the HCEs does not exceed the ACP of the NHCEs by more than an allowable difference determined by the IRS.
  • If the differential is greater than the amount permitted, the test will fail and some contributions to the HCE group will need to be refunded or forfeited, depending on their vested percent.
  • Any refunded taxable contributions must be reported as taxable income in year distributed.
top heavy test 416
TOP HEAVY TEST (416)
  • A plan is considered “top heavy” when the account balances of “key” employees account for more than 60% of plan assets.
  • A “key” employee is defined as either:
    • 5% owner
    • 1% owner who earns more than $150,000
    • An officer of the company who earns more than $160,000 (for 2011, indexed annually)
    • A family member of a 5% owner (spouse, child, parent, or a grandchild)
  • The test is performed on an annual plan year basis using balances as of the “determination date”. The determination date is the last day of the prior plan year. The December 31, 2010 test would use balances as of December 31, 2009.
  • If your plan is top heavy, you may be required to make a contribution for each non-key employee. The minimum contribution must be either 3% of each non-key employees compensation or the highest percentage for any key employee, whichever is lower.
deferral limits test 402 g
DEFERRAL LIMITS TEST (402(g))
  • Pre-determined IRS limit on pre-tax and Roth contributions
  • 2011 limit is $16,500 (indexed annually)
  • Additional $5,500 in catch-up contributions permitted for employees over age 50 before the last day of the plan year
  • If participant exceeds this limit, a refund of excess deferrals plus earnings will be required and must be reported as taxable income in the year distributed.
annual additions test 415 limit
ANNUAL ADDITIONS TEST (415 LIMIT)
  • Pre-determined IRS limit on all employee (pre-tax, Roth and after-tax) and employer contributions (match, profit sharing, QNEC, forfeitures) on an aggregate basis (indexed annually).
  • 415 limit for 2011 is 100% of compensation not to exceed $49,000.
  • If a participant exceeds this limit, a refund of excess contributions plus earnings will be required and must be reported as taxable income in the year distributed. Generally, unmatched employee contributions will be refunded before any employer contributions will be forfeited.
safe harbor plan
SAFE HARBOR PLAN
  • Adopting a safe harbor plan allows the employer to avoid, in most cases, ADP, ACP and Top Heavy testing.
  • There are two primary safe harbor employer contributions:
      • Employer Safe Harbor Match
      • Employer Safe Harbor Non-Elective
  • Safe Harbor Match Contribution-100% of compensation up to the first 3% contributed and 50% of the next 2%. (There are variations of this formula which are permitted.)
  • Safe Harbor Non-Elective Contribution - a contribution of at least 3% must be given to all eligible participants.
  • The Safe Harbor contribution must be 100% vested.
  • A Notice must be provided between 30-90 days prior to the first day of the plan year, to all eligible employees.
  • If the plan provides for employer contributions other than employer match, such as a discretionary contribution or after-tax contributions, then an ACP and Top Heavy test must be performed.
pentegra s role
PENTEGRA’S ROLE
  • Our goal is to provide technical guidance and support to clients
    • Perform all non-discrimination testing
    • Deliver testing results and compliance report
    • Identify and solve specific testing problems
    • Improve current practices
    • Establish ongoing measures to keep your plan in compliance
  • Each client has a dedicated Compliance Analyst who will work with you to ensure the plan is in compliance with IRS non-discrimination regulations.
  • Compliance Analyst name and phone number is on the plan sponsor website under “contacts”.
plan sponsor s role
PLAN SPONSOR’S ROLE
  • By understanding how plan design can impact testing, you can take advance planning steps to minimize both the uncertainty and the consequences of the testing process
pentegra s process
PENTEGRA’S PROCESS
  • Census and Participation & Coverage Questionnaire are on the Plan Sponsor Website
  • Client downloads file and saves on their workstation
  • Client completes required information by deadline identified and uploads census file via secure file upload system
  • Client completes and faxes, emails or mails the Participation and Coverage Questionnaire by applicable deadline
  • Pentegra performs compliance analysis and notifies clients of results via a compliance report
  • Test results are loaded to the plan sponsor website
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