Advanced ADP/ACP Testing – From the Top to the Bottom

1. Advanced ADP/ACP Testing – From the Top to the Bottom Presented by: Robert M. Kaplan, CPC, QPA, CFP, APA Vice President, National Training Consultant ING ASPPA 2009 Annual Conference Sessions 18 and 37 2009 ASPPA Annual Conference

2. Disclaimer The general information in the presentation is not intended to be nor should it be treated as tax, legal, or accounting advice. Additional issues could exist that would affect tax treatment of a specific transaction and, therefore, taxpayers should seek advice from an independent tax advisor based on their particular circumstances before acting on any information presented. This information is not intended to be nor can it be used by any taxpayer for the purpose of avoiding tax penalties

3. Agenda • Getting Started • Defining Your HCE/NHCE Groups • Current Year/Prior Year Issue • Testing Options • Correcting a Failed Test • Questions

4. Getting Started • Do you have all employees • Controlled group members • Leased employees/Independent contractors identified • Did you pass coverage • If not – need to fix prior to ADP/ACP tests

5. Getting Started • Disaggregated Testing • Eligibility less than 1 year • §401(k)(3)(F) lets you test all HCEs (regardless of hire date) along with NHCEs who have completed the statutory requirements (age 21 and 1 year of service) • Entry Date = 365 days??

6. Getting Started • Disaggregated Testing • Eligibility less than 1 year • §410(b)(4) allows you to separate all employees with less than the statutory eligibility from those who have completed statutory • Must use for all plan purposes • Statute references “plan’s entry date • Hot potato that IRS hasn’t absolutely resolved

7. Getting Started • Excess deferrals - §402(g) • HCEs – include amounts in testing, even if corrected • NHCES – exclude amounts from testing • Gap period income no longer included with correction • Roth – which dollars go back first • Document decides or employee decides • Do not include amounts over $16,500 for catch-up eligible participants • Or §415 or plan limit violations

8. Getting Started • Do you have the correct compensation? • Remember new post-severance rules • If an employee has zero compensation • Self Employed • Participant who did not work during year • No official guidance, but IRS has said informally to include (ASPPA does not agree)

9. HCE – Top 20% Election • Document election • Must be consistent for all plans of same employer • If there are a lot of employees over the dollar limit ($110,000 for 2009) may limit to only the top 20%

10. Example – Assume 20 Employees • EEPrior $HCETop 20% • 1 $230,000 Y Y • 2 $230,000 Y Y • 3 $175,000 Y Y • 4 $150,000 Y Y • 5 $130,000 Y N • 6 $125,000 Y N • 7-20 <$60,000 N N

11. HCE Determination • Stock Attribution (rules under §318) • Do you have % of ownership and family relationship? • Often missed during takeovers

12. Current Year/Prior Year • Check Plan Document • Prior Year is default (under regs) • Prior Year – changes in group ignored except: • Amendment in Plan • Consolidation, merger spin-off • Change in permissive aggregation • Change in employee group of more than 10% - calculate the weighted average

13. Current Year/Prior Year • Mix and match ADP/ACP • ADP = Prior • ACP = Current • Effective when Discretionary Match is used • Okay for most plans • But not in GUST prototypes (this will change when you use EGTRRA prototypes)

14. Current Year/Prior Year • Mix and Match ADP/ACP • Cannot use: • QMACs in ADP • Recharacterization • Shifting

15. Current Year/Prior Year • Switching from Prior to Current • Allowed with no restrictions • Timing = this is a discretionary amendment so it must be done by the end of the year being tested

16. Current Year/Prior Year • Switching testing method from Current Year to Prior Year • Allowed with restrictions • Entire life of plan on Current (if less than 5 years) • 5 consecutive years of Current (includes short plan years and safe harbor years) • Merger of two or more plans and change is during the §410(b)(6)(C) transition period • Discretionary amendment – by PYE

17. Current Year/Prior Year • Prior Year use of QNECs • Must be made by end of current year • Example: • Testing 2008 Plan year (calendar year plan) • Prior year 2007 used for NHCEs • QNEC must be made by 12/31/08 • Problem = we don’t know we need a QNEC until 2009!!!!

18. Current Year/Prior Year • Prior year testing in initial plan year? • Assume 3%

19. Correcting a Failed Test • Flat $, Flat %, or Targeted QNEC • QMAC • Shifting • Recharacterization • Reclassified as Catch-up • Refunds • Can use a combination of methods

20. Correcting a Failed Test • QNECs or QMACs • If you want to use a QNEC or QMAC of more than 5% in ADP or ACP test, you must: • Give it to all eligible participants • Give it to at least 50% of eligible participants, and • The contribution for any of those receiving the corrective contribution may not be more than double that of any other participant

21. Correcting a Failed Test • Shifting • If you pass ADP by a lot and fail ACP – you can shift amounts not needed in ADP to ACP • Testing gimmick only – you do not actually move funds • You must pass ADP both before and after shift • You cannot shift ACP to ADP (unless ACP amounts subject to same withdrawal restrictions as 401(k) deferrals)

22. Correcting a Failed Test Example of Shifting Before After ADP ACP ADP ACP HCE 5.40% 1.85% 4.40% 2.85% NHCE 3.90% .85% 2.90% 1.85% • ADP passes before and after • Shift of 1% helps ACP pass

23. Correcting a Failed Test • Recharacterization • Failed ADP amounts are changed to be voluntary after-tax $ • Must be a plan document provision • Must then run ACP test including these amounts • Does anyone do this???

24. Correcting a Failed Test • Reclassifying as Catch-up • If catch-up eligible participant has room; this is automatic. Does not have an option of refund Note: This is done at point in process when check would be written to participants – not before!!!

25. Correcting a Failed Test • Refunds • If participant has both pre-tax and Roth in year? • What does document state? • Some give participants the choice; most define which is returned first

26. Correcting a Failed Test • Gap Period Income • 2008 PY = No Longer needs to be returned • WRERA also eliminated gap for 402(g) failures

27. Correcting a Failed Test • Taxation of distributions • 2008 PY: All distributions and earnings taxable in year distributed (not contributed)

28. Correcting a Failed Test • Timing for Eligible Automatic Contribution Arrangements (EACAs) • 6 months after Plan Year end • Must be EACA that covers all employees

29. Correcting a Failed Test • Tests not corrected by 12 months after the end of Plan Year are disqualified • Hello EPCRS

30. Miscellaneous • Post-Severance Compensation • If terminated in December and paid (unused vacation) in February – do you test February deferrals in that year or in the prior year (when services were rendered) • No guidance

31. Miscellaneous • Permissive 90 day withdrawals (EACA) • Do not include in testing • May want to hold up testing until the 90 day period has completely expired • For those who start deferring very late in the year

32. Testing Plans with Safe Harbor Match • Matching contributions in excess of either ADP or ACP safe harbors must be tested • Matches with conditions • Discretionary in excess of 4% • Last day, 1000 hours • Applied to match on deferrals greater than 6% of pay

33. Safe Harbor Matches • What to Test?? • Include all matching contributions • Only those not considered safe harbor

34. Safe Harbor Eliminated or Reduced • What to Test?? • Entire year • Per Proposed Regs – remember to pro-rate salary • ASPPA challenged this at 9/23 hearing

35. Had enough for one day? • Thank you for your attendance and participation • Questions??