Annual Compliance Testing for 401(k) Plans

A number tests must be performed each year to demonstrate that 401(k) plans do not discriminate in favor of highly compensated employees and that contributions do not exceed certain limitations. Some of the most common tests include:

• ADP/ACP Tests
• Annual Deferral Limit
• Annual Additions Limit
• Coverage Test
• Top Heavy Determination

Highly Compensated and Key Employees

For purposes of these tests, it is important to understand two basic definitions. Highly compensated employees are employees who (1) own more than 5% of the company*, or (2) earned compensation in excess of a certain dollar amount in the prior year ($120,000 for 2018). Some plans limit the number of employees considered to be highly compensated by making a “top paid group” election. Whether this is beneficial for a given plan depends on a number of factors including the demographics of the workforce.

Key employees are employees who at any time during the plan year (1) owned more than 5% of the company*, (2) owned more than 1% of the company* and had compensation in excess of $150,000, or (3) were officers of the company with compensation greater than a certain dollar amount ($175,000 for 2018).

*Stock attribution rules apply when determining ownership. This means direct relatives of the owner(s) are generally considered to “own” the same percentage for purposes of determining highly compensated and key employee status.

ADP/ACP Tests

The ADP/ACP tests are performed to demonstrate that the plan does not discriminate in favor of highly compensated employees with respect to 401(k)/Roth deferrals and employer matching contributions. If the plan fails one or both of these tests, corrective actions must be taken which often includes issuing corrective distributions.

Note: Plans that provide for safe harbor matching or safe harbor nonelective contributions are generally deemed to satisfy both tests.

Annual Deferral Limit

The annual deferral limit ($18,500 for 2018 plus $6,000 for participants age 50 or older) is a limit placed on the amount a participant may contribute through pre-tax deferrals and/or Roth contributions. This combined limit is always measured on a calendar year basis and applies to the individual. As a result, the participant has the responsibility of informing the plan administrator if they made excess deferrals and participated in an unrelated employer’s plan.

The excess amount, along with related earnings, must be distributed no later than April 15th of the following year. If this deadline is not met the participant will be taxed on the excess amount in both the year of the deferral and the year of distribution.

Annual Additions Limit

Participants are also subject to an overall contribution limit known as the “415 limit” (the lesser of 100% of gross compensation or $55,000 for 2018). This limit generally includes all contributions made to the plan for a particular plan year; however, it does not include rollover contributions or catch-up contributions. If the limit is exceeded, corrective actions must be taken which normally involves issuing corrective distributions or forfeiting the excess amounts, adjusted for related earnings.

Coverage Test

The coverage test is performed to demonstrate that the plan meets the minimum coverage standards required by law. This test must be run separately for each contribution type or component of the plan (e.g. 401(k), match, and profit sharing).

In general, the test is satisfied if the plan covers at least 70% of all of the employees who have met the minimum statutory age and service requirements (i.e. age 21 and 1 year of service). In the event of a failure, the employer typically must make an additional contribution to the plan on behalf of non-highly compensated employees.

Top Heavy Determination

In general, a 401(k) plan is considered to be top heavy when more than 60% of plan assets are attributable to key employees as of the last day of the prior plan year. Top heavy plans are subject certain minimum contribution and vesting requirements.

Other Required Tests

This has been a broad overview of the general testing requirements for 401(k) plans and is not meant to be comprehensive. Other tests may be required depending upon a particular plan’s design and its features. For example, plans that exclude certain types of compensation, such as commissions, or allocate profit sharing contributions to different groups of participants are subject to additional testing requirements.
To learn more about the testing requirements for your specific plan, please contact us.

Important 401(k) Testing Deadlines to Remember!

In general, 401(k) plans must be tested annually to demonstrate that they do not discriminate in favor of highly compensated employees, or provide benefits that exceed certain statutory or regulatory limits. If a plan “fails” any of the required tests, the plan sponsor must take corrective actions, and there are established deadlines for correcting certain failures. The following is a brief summary of these deadlines:

Note: Deadlines are based on a calendar year.

• March 15th – Deadline for issuing corrective distributions to correct ADP/ACP testing failures for non-safe harbor 401(k) plans.

In general, corrective distributions must be issued within 2 ½ months following the close of the plan year to avoid a 10% excise tax imposed on the excess amounts. Plan sponsors of 401(k) plans that include an “eligible automatic contribution arrangement” have up to 6 months to issue corrective distributions without incurring the excise tax.

In either situation, correct distributions must be issued no later than the last day of the plan year following the plan year in which the testing failure occurred to protect the qualified status of the plan.

• April 15th – Due date for issuing corrective distributions for excess deferrals (i.e. participant deferrals made in excess of 402(g) limit – $18,500 for 2018). If the excess amount, plus related earnings, is not distributed by this date, the participant is in effect taxed on the excess amount twice, both in the year the excess occurred and the year of the distribution. (Note: This deadline is the same, regardless of plan year).

• June 30th – Extended due date for issuing corrective distributions for ADP/ACP testing failures under “eligible automatic contribution arrangement” 401(k) plans; the 10% excise tax applies to distributions made after this date.
• October 15th – Deadline for adopting a retroactive plan amendment to correct a coverage or nondiscrimination testing failure (if applicable). The amendment must be adopted no later than 9 ½ months following the close of the plan year in which
the failure occurred, as provided for under the applicable regulations.

• December 31st – Final deadline for issuing corrective distributions for ADP/ACP testing failures for the prior year (or for making a QNEC/QMAC to correct the failure).

The deadlines 401(k) plan sponsors must observe are numerous and complex; the deadlines listed above are not meant to be comprehensive, but rather, represent critical dates related to the correction of specific plan testing failures.

Please contact us to learn more about how these rules impact your plan and participants!

Plan Compensation – Not So Simple!

At face value, it seems like “compensation” would be one of the simplest issues to deal with in a retirement plan, but it is actually one of the most complex. Understanding what compensation is “plan eligible” is one of the biggest headaches for plan sponsors and an area in which plan sponsors often make mistakes.

If you think about all the different forms of compensation you pay your employees (e.g. bonuses, commissions, fringe benefits, paid sick time, vacation time, automobile allowance, severance pay, group term life in excess of $50,000, etc.), it becomes clear why this is such a complex issue!

What is “plan eligible” compensation?

Plan eligible compensation must be defined under the terms of the plan, and the terms of the plan must be followed. There are 3 basic definitions of compensation that are commonly used:

  • W-2 Compensation
  • Income subject to federal income tax withholding
  • “415” Compensation (basically, an all-encompassing definition)

Note: Other definitions of compensation may be used, but they are generally subject to additional testing requirements.

Why does plan compensation matter?

It matters for several reasons, but primarily because all contributions must be based on the plan’s definition of compensation.

What is this important to me as a plan sponsor?

At the end of the day, a plan must be operated in accordance with the terms of the plan to protect its qualified status, so it is very important to understand what compensation is plan eligible.

Common sense often drives employers to make decisions about whether to apply an employee’s 401(k)/Roth election to certain compensation items, but common sense doesn’t rule in this situation.

For example, one of the most common mistakes made by plan sponsors is to not withhold employee deferrals from bonuses, rather than allowing employees to make this election.

Bonuses are plan compensation, unless specifically excluded under the terms of the plan. Unless the plan allows employees to make a specific election with respect to bonuses, the deferral election must be applied to this compensation.

So, what happens if an employer makes a decision not to withhold from bonuses? Generally, the correction is for the employer to make a corrective contribution on behalf of the affected participants for the “missed deferral” along with any related matching contributions, adjusted for earnings. A mistake that is costly for the employer and totally preventable!

Can a plan exclude bonuses or commissions from its definition of compensation?

It depends; unless the plan uses one of the “common” definitions, certain testing must be done each plan year to ensure the plan’s definition of compensation doesn’t discriminate in favor of the plan’s highly compensated employees. Excluding bonuses or commissions from eligible compensation requires this additional testing, so whether it is viable in a given situation depends on a number of factors.

What about fringe benefits; must they be included?

No, provided the plan’s definition excludes all of the following (even if includible in gross income): reimbursements or other expense allowances, fringe benefits (cash and noncash), moving expenses, deferred compensation, and welfare benefits.

Can we exclude other compensation items from the plan’s definition of compensation?

It depends on your specific company, how you compensate your employees, the demographics or your workforce and the general provisions of your plan. It is certainly acceptable to design your plan in such a way that certain compensation items are excluded provided the plan can meet the necessary nondiscrimination testing requirements and you can properly administer its provisions.

The Bottom Line

A plan’s definition of compensation is one of the most complex issues impacting retirement plans. It is important your plan is designed properly to meet your specific needs and that you, as a plan sponsor, understand your plan’s definition of compensation so that you can keep your plan in compliance and avoid costly mistakes!

We possess the necessary expertise to help you navigate through these issues and want to help you optimize your plan’s design so that it works well for you and your employees! Please contact us to learn more.

Subject: The Importance of Cybersecurity for Retirement Plans

Subject: The Importance of Cybersecurity for Retirement Plans

Cybersecurity should never be an afterthought, but sometimes it is not taken seriously enough. With the ever-increasing risk of cyber-attacks, it is imperative that every company and every employee take threats extremely serious.  PWC’s 2018 Global State of Information Security survey found that cyber attacks have been growing quickly and will continue to increase. With the prevalence of attacks it is imperative that companies ensure they have Cybersecurity processes in place.

Cybersecurity processes are put in place to protect both the individual user and companies as a whole from hackers, cyber criminals, and hacktivists, among others. Not only does a lack of cybersecurity in an organization affect the individual whose personable identifiable information (PII) may have been compromised; the average cost of a data breach to an organization is $6.5 million.

The law governing cybersecurity is developing and is currently a patchwork of state and federal regulations. There is no comprehensive federal law governing cybersecurity.  However, there are many established state and federal laws that govern the financial industry’s use of financial information, as well as laws regarding personable identifiable information, giving TPA’s ample inspiration for best practices to implement and stay ahead of data breaches. TPA’s should ensure protections such as:

  • Technology tools and measures to prevent and detect attacks and data breaches.
  • Detailed processes and procedures to follow when sharing benefits plan and personable identifiable information.
  • Proper authentication processes to ensure everyone accessing information is verified.

With the growing risk of cyber-attacks, we at EJReynolds take client privacy very seriously. In our efforts to protect the financial information provided by our clients and entrusted to our employees, EJReynolds, Inc. offers a Cybersecurity Commitment to give you the comfort and peace of mind when working with us.

Our Cybersecurity Commitment stems from the core principles of trust, integrity and ethics: We collect only client information that is pertinent to the services provided by our team. Thus, we have implemented security standards and processes including physical, electronic and procedural safeguards to ensure that access to client information is limited only to select employees who may need it to do their jobs.

  • Secure file sharing links put in place to provide a safe & secure way to share sensitive information online.
  • Advanced Firewall Security system protects computer networks from being attacked online by hackers, worms, viruses, etc.
  • Use of Advanced Threat Protection (ATP), an industry leading threat protection network used internally to protect from malicious attacks.
  • Two-factor authentication, 2FA, requires the user to have two out of three types of credentials before being able to access an account.

If you have any questions about our services and/or how we protect your information please feel free to contact us.

New Rules for Hardship Distributions in 401(k) Plans

Hardship Distribution Rules Relaxed

The Bipartisan Budget Act of 2018 liberalized the rules applicable for hardship distributions in 401(k) plans. These changes impact the “safe harbor” hardship distribution rules (the ones most commonly used in plans) and will generally become effective for plan years beginning after December 31, 2018.

To assist plan sponsors with implementing these changes, the IRS issued proposed regulations in November 2018, and it is anticipated those regulations will be finalized in early 2019.

What is changing?

In general, the new rules make it easier for participants to qualify for hardship distributions, expand the sources available for such distributions, and remove the 6-month deferral suspension period following a hardship distribution. They also make it easier on plan sponsors by simplifying the substantiation process.

What qualifies for a hardship distribution under the new rules?

Under the existing rules, hardship distributions may only be made from a participant’s 401(k) and/or Roth account for the following:

  1. Unreimbursed, tax-deductible medical expenses (without regard to the deduction limitation);
  2. Certain costs associated with the purchase of a participant’s principal residence;
  3. Post-secondary educational expenses for a participant, his or her spouse, children or dependents (for the next 12 months);
  4. Funeral expenses for a participant’s spouse, parents, children or dependents;
  5. Expenses necessary to repair damage to a participant’s principal residence incurred as a result of a casualty (tax-deductible loss); and
  6. Amounts necessary to prevent foreclosure or eviction from a participant’s principal residence.

Under the new rules, the conditions under which a participant can obtain a hardship distribution have been expanded to include the following:

  1. Expenses incurred as a result of a natural disaster in a federally-declared disaster area; and
  2. Medical, post-secondary educational, and funeral expenses for a participant’s primary beneficiary.

Additionally, the proposed regulations clarify that if a participant’s principal residence is damaged as a result of a casualty, such as a fire or windstorm, it is not necessary for the participant’s home to be in a federally-declared disaster area. When the income tax law changed, it impacted the hardship distribution rules since the 401(k) regulations (current) require the casualty loss be tax-deductible.

What contribution types are available for hardship distributions?

Under the existing rules, hardship distributions can only be made from a participant’s 401(k) and/or Roth account, excluding any related earnings. In other words, a participant can only withdraw his or her contributions.

Under the new rules, the amount available for hardship distributions will include related earnings. In addition, participants will be able to take hardship distributions from safe harbor account balances as well as QNEC or QMAC account balances, if provided for under the terms of the plan document.

Note: Some plans permit “hardship” distributions from other sources, such as profit sharing or matching account balances. These contribution sources are not “restricted” from taking in-service distributions prior to attainment of age 59 ½ (like 401(k), Roth, safe harbor, QNEC and QMAC account balances), so it is still permissible to allow for hardship distributions from these accounts, if provided for under the terms of the plan document.

How much can a participant receive as a hardship distribution?

The amount cannot exceed the lesser of (1) a participant’s financial need (grossed up for applicable income taxes), or (2) his or her available account balance. This rule has not changed, although the amount available has been expanded to include related earnings and additional contribution sources.

What substantiation is required for hardship distributions?

The proposed regulations provide new standards for determining whether a hardship distribution is deemed necessary to meet a participant’s financial need.

  • The participant must have obtained all other available in-service distributions under any plans maintained by the employer; and
  • The participant must represent that he or she does not have enough liquid assets to satisfy the financial need.

Currently, a participant is generally required to take a loan from the plan (if available) prior to receiving a hardship distribution, and the determination of whether a hardship distribution is deemed necessary to meet an “immediate and heavy” financial need is based on all relevant facts and circumstances.

The new standards remove the plan loan requirement and simplify the process for plan sponsors as they can rely on the participant’s representation, absent actual knowledge to the contrary.

How will the new rules for the 6-month deferral suspension apply?

Under existing rules, plans are required to suspend participant deferrals for a period of 6 months following a hardship distribution. Under the new rules, plans will no longer be permitted to suspend participant deferrals.

The proposed regulations provide flexibility in implementing these changes, though. For 2019, plan sponsors have the option of imposing the 6-month suspension period, or they can permit participants to continue to defer immediately following a hardship distribution.

Additionally, for hardship distributions made during the last 6 months of 2018, plan sponsors can either continue the 6-month suspension period or resume deferrals for all participants effective January 1, 2019.

For hardship distributions made on or after January 1, 2020, however, plans will be prohibited from imposing the 6-month suspension period.

When are these changes effective?

Generally, these changes are effective for plan years beginning after December 31, 2018.  There are special rules, however, that apply for certain purposes such as the 6-month suspension period.

Will these changes require a plan amendment?

Yes, these changes will require a plan amendment. It appears that plan sponsors will be able to implement the new rules prior to amending their plan, though. We are hopeful the IRS will issue additional guidance on this important point in the final regulations.

How can I learn more about these requirements?

Please contact us to learn more about how these rules impact your plan and participants!