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www.verisightgroup.com
401(k) Boot Camp – Part 2Getting Money Into the Plan
November 12, 2014
Presenter:
Nancy J. Manary, Director
Benefits Consulting
Verisight, Inc.
www.verisightgroup.com
401(k) Boot Camp – Part 2
• Part 1 – Getting People Into the Plan
– Eligibility rules and enrollment procedures
• Part 2 – Getting Money Into the Plan
– Contribution rules and ADP/ACP tests
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401(k) Boot Camp - Overview
Key Objectives for Attendees
• Understand your plan’s actual provisions
• Apply plan rules correctly to avoid common operational errors
• Increase your comfort level with respect to in-house plan responsibilities
• Improve the accuracy of your explanations of plan provisions to employees
• Make your plan run smoothly and effectively
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Reminder from Part 1
• Know the provisions of your plan
• Follow the provisions of your plan
• Treat all participants in a non-discriminatory manner
• Keep good records
• Call your TPA or plan consultant for assistance
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Definitions
• Plan Sponsor
– the employer in the case of an employee benefit plan established or maintained
by a single employer,
– the employee organization in the case of a plan established or maintained by an
employee organization, or
– in the case of a plan established or maintained by two or more employers or
jointly by one or more employers and one or more employee organizations, the
association, committee, joint board of trustees, or other similar group of
representatives of the parties who establish or maintain the plan.
• Plan Administrator
– person specifically so designated by the terms of the instrument under which the
plan is operated;
– in the absence of a designation in the case of a plan maintained by a single
employer, the employer.
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Definitions
• Third Party Administrator (TPA)
– Organization that is hired by the plan sponsor (typically the employer) to run
many day-to-day aspects of a retirement plan.
– Examples of responsibilities
• amending and restating plan documents;
• preparing employer and employee benefit statements;
• assisting in processing all types of distributions from the plan;
• preparing loan paperwork for plan participant;
• testing the plan each year to gauge its compliance with all IRS non-
discrimination requirements as well as plan and participant contribution
limits;
• allocation of employer contributions and forfeitures; calculating participant
vested percentages; and, preparing annual returns and reports required by
IRS, DOL or other government agencies.
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Definitions
• Recordkeeper
– Custodian of plan assets or the plan’s investment platform.
– Examples of responsibilities
• value investments;
• provide participants with statements on their accounts;
• process distribution checks
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Contribution Rules - Overview
• Check the plan to determine which types of contributions are permitted
• Possible contribution types include
– Employee salary deferrals (Pre-tax and Roth)
– Employer matching (regular, safe harbor or both)
– Employer non-matching (regular, safe harbor or both)
• Plan may have different age & service requirements and/or entry dates for different
types of contributions.
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Two types of deferrals – Traditional and Roth
• Traditional 401(k) salary deferrals
– Deferrals not subject to income tax at the time of deferral
– Deferrals taxed when distributed from the plan
– Investment income on traditional deferrals taxed when distributed from plan
• Roth 401(k) salary deferrals
– Deferrals subject to income tax at the time of deferral
– Deferrals not taxed when distributed from the plan
– Investment income on Roth deferrals can be completely income tax free if taken
as a “qualified distribution”
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Two types of deferrals – Traditional and Roth
• Roth deferrals do not increase the dollar limit on allowable salary deferral
– Dollar limit on deferrals applies to Roth deferrals, traditional deferrals, or a
combination of both
• Roth deferrals do not increase the limit on salary deferrals available to highly
compensated employees
– Non-discrimination testing applies to Roth deferrals as well as traditional
deferrals made by HCEs
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Roth conversions
• Small Business Jobs Act of 2010 adds a conversion option for 401(k) Plans
– The Plan must allow Roth Deferrals
– Only Participants eligible for an in-service distribution allowed by the Plan can
make a conversion
– Plan amendment is required to add this option
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Maximum salary deferral as a % of pay
• Internal Revenue Code (IRC) allows deferrals up to 100% of pay
– Some plan documents limit deferrals to a lower % of pay
• Can avoid issues with prioritization of deductions such as garnishments etc.
• Participant must leave enough money in a paycheck to cover his/her FICA taxes for
that pay period, so 100% deferral is not actually possible
• Maximum $ limit usually overrides maximum % of pay limit
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Maximum salary deferral as a dollar amount
• Basic $ limit set by IRC (adjusted annually for cost of living)
– $18,000 in 2015
• Additional catch-up amount if age 50 or older
– $6,000 in 2015
• Dollar limit on deferrals applies on a calendar year basis, even if the plan year is not
the calendar year
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Maximum salary deferral as a dollar amount
• $ limit on an individual is cumulative for deferrals made to all 401(k)-type plans that
year on combined basis:
– 401(k), 403(b), SAR-SEP, SIMPLE-IRA, or SIMPLE-401(k)
• Roth deferrals are not subject to a separate $ limit, but are included in the $ limit with
all pre-tax deferrals
• $18,000/$24,000 (2015) limit applies to salary deferrals only
– Matching and/or profit sharing contributions do not apply toward the $ limit
available for salary deferrals
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Salary deferral contribution limits
• Additional limits may apply to deferrals by highly compensated employees (HCEs)
due to non-discrimination testing (ADP test)
• HCEs may not be able to contribute maximum $ amount
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Age 50 catch-up deferral contributions increase $ limit if:
• Participant is at least age 50 by 12/31 of that year, and
– Participant’s deferrals are exceeding some other limit
• Basic dollar limit ($18,000)
• $ limit from a failed ADP test on HCEs’ deferrals
• IRC Sec. 415 dollar limit on employee deferrals and employer contributions
combined ($53,000 in 2015)
• % of pay limit (if one is stated in plan document)
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Audience Question
• John, age 50, worked for Tax-Exempt Organization A for the first four months of 2015.
• He deferred $5,500 into Org A’s 403(b) plan during that time.
• John then went to work for Corporation B, which sponsors a 401(k) plan.
• John wants to save as much as possible for his retirement this year.
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Audience Question
Since John (age 50) had already contributed $5,500 to Org A’s 403(b) plan, what is the
maximum amount he can contribute to Company B’s 401(k) plan this year(2015)?
a) $12,500
b) $18,000
c) $18,500
d) $24,000
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Employer’s responsibility for enforcing the $ limit
• Is the employer responsible for limiting an employee’s salary deferrals to the
maximum $ amount?
• Yes – but only for deferrals made from its own payroll
– Not expected to have knowledge of deferrals made by one of its employee to
another employer’s plan in the same calendar year
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Employer’s responsibility for enforcing the $ limit
• An employee is responsible for requesting a refund of excess deferrals if he/she
exceeds the maximum $ limit through multiple employers’ plans
– Deadline for request of refunds – March 1st following end of year in which
excess deferrals were made by the employee
– Deadline for employer to refund excess – April 15th following end of year in
which excess deferrals were made by employee
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Employer’s responsibility for enforcing the $ limit
• The employee can choose which plan to treat as holding the excess deferrals
– Last money in does not have to be the source of the refund
– Matching contributions attributable to refunded deferral amounts in excess of the
annual dollar limit are often forfeited to avoid discrimination issues.
• Check your plan document and discuss with your TPA
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Compensation from which deferrals are withheld
• Deferrals can only be made from “plan compensation”
• Some plans exclude certain types of compensation
– Bonuses
– Commissions
– Overtime
• Check your plan’s definition of “plan compensation”
• You cannot allow employees to make deferrals out of any compensation that is
excluded under the plan.
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Compensation from which deferrals are withheld
• Note: Most plans define “plan compensation” as the employee’s gross pay for the
year, without excluding any items such as bonuses, overtime, commissions, etc.
• Why? Excluding of any part of compensation may be discriminatory in practice, if the
exclusion affects non-highly compensated employees (NHCEs) more than it affects
highly compensated employees (HCEs).
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Compensation from which deferrals are withheld
Flip side of this issue:
• Employer cannot prevent an employee from making deferrals from any part of their
“plan compensation”
– If “plan compensation” includes overtime, you must withhold salary deferrals from
overtime pay
– If “plan compensation” includes commissions you must withhold salary deferrals
from commissions
• Even if commissions are paid in a separate check outside of the regular
payroll cycle
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Compensation from which deferrals are withheld
• If “plan compensation” includes bonuses, you must follow the employee’s salary
deferral instructions and withhold deferrals from bonuses
– Unless the employee gives separate deferral instructions for his/her bonus
– Separate deferral instructions allow employee to defer a different amount (or
nothing) out of a bonus than from regular pay
– Allowing separate deferral instructions from bonuses may be administratively
difficult for the payroll department
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Audience Question
Michelle, age 40, made a 10% of pay salary deferral election for 2015. Her base salary is
$160,000. She will be receiving a $50,000 bonus in a separate check on 12/31/2015.
The plan’s definition of compensation has no exclusions. How much, if anything, must be
withheld from Michelle’s bonus?
a) $2,000
b) $5,000
c) $8,000
d) $-0-, We do not withhold salary deferrals on bonuses.
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Deadline for depositing employee withholdings
• As soon a salary deferrals (and/or loan payments) are withheld from an employee’s
paycheck, that money is classified by the DOL as a plan asset
• IRC and ERISA prohibit the employer from having use of plan assets
– Keeping deferrals in the employer’s checking account longer than necessary is
seen by DOL as borrowing money from the 401(k) plan.
• Use of plan assets by the employer is a prohibited transaction subject to penalty
taxes and other corrective measures
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Deadline for depositing employee withholdings
• DOL regulations require employers to deposit salary deferrals (and loan payments)
into a plan account as soon as administratively possible after the date the
amounts were withheld from pay.
• Failure to make the deposits as soon as administratively possible will subject the
employer to penalty taxes for late deposits and make-whole contributions to
participants for “lost earnings”.
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Deadline for depositing employee withholdings
• How soon is “as soon as administratively possible after the date the amounts were
withheld from pay”?
– It depends on each employer’s facts and circumstances.
– Since payroll taxes have to be deposited within a few days of payroll, DOL
assumes employers should be able to deposit 401(k) deferrals within a similarly
short time period
– Safe harbor period for small plans is 7 business days after it is withheld from
payroll
• DOL audits plans on this point and aggressively enforces the “as soon as
administratively possible” timing rule.
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Deadline for depositing employee withholdings
• Can you deposit deferrals up to 15 business days after the end of the month during
which deferrals were withheld?
• DOL regulations state that the latest date for depositing these contributions is 15
business days after the end of the month only if it was administratively impossible for
the employer to make the deposits sooner.
– There are very few reasons the DOL will accept to justify taking more than a
week--for small plans, possibly less for large plans--, to deposit deferrals into the
plan.
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Deadline for depositing employee withholdings
• Are there similar deadlines for depositing employer contributions?
• No – The deadline for depositing matching and/or profit sharing contributions into the
plan is the due date of the employer’s tax return for that year, including extensions
(as much as 8 ½ months after the end of the year).
– Exception: Safe harbor matching contributions that are calculated on a pay
period basis must be deposited at least quarterly.
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Deadline for depositing employee withholdings
• Timing of deposit of employer contributions must be non-discriminatory.
• Do not deposit employer contributions earlier for some participants than for others.
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Matching contribution basic rules
• Not all 401(k) plans have a matching contribution
– Salary deferral only plans
– Plans with salary deferrals and non-matching (profit sharing) contributions
• Eligibility rules for the match may differ from eligibility rules for salary deferrals
– Different minimum age and/or minimum service requirements
– Different excluded categories of employees
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Matching contribution basic rules
• Types of match formulas
– Fixed formula stated in plan document
– Discretionary formula determined by the employer annually
– Both
• There may be allocation conditions applicable to the match
– Still employed on last day of plan year
– At least 1,000 hours of service during the year
• Check the plan document for all details about your plan’s matching provisions (if any)
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Many match formulas have two components:
• Matching rate (25% match, 50% match, 100% match, etc.)
• Cap on salary deferrals to which the match applies
– Match may apply only to salary deferrals of up to X% of pay
– Match may apply only to salary deferrals of up to $Y
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Matching contribution basic rules
• Examples of match formula with two components:
– 50% match, applicable to salary deferrals of up to 6% of pay
– 25% match, applicable to salary deferrals of up to $2,000
• Describe your match formula carefully when discussing it
– Avoid misleading employees about the match they can receive
– Avoid confusing the people who calculate the match
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Audience Question
HR rep tells employees “We match 50% up to 3% of pay”. What is the plan’s match
formula?
a) 50% match, applicable to salary deferrals of up to 3% of pay (maximum match
amount = 1.5% of pay)
b) 50% match, applicable to salary deferrals of up to 6% of pay (maximum match
amount = 3.0% of pay)
c) You cannot tell from this verbal description
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Compensation used to calculate match
• Match amount must be calculated on “plan compensation”
• Cannot exclude certain types of pay [bonuses, commissions, overtime, etc.] when
calculating match amount
– Unless that type of pay is excluded from “plan compensation”
• Check your plan’s definition of “plan compensation”
– May be different for match purposes than for deferral purposes
– May exclude compensation earned prior to entry date in first year of eligibility
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Compensation used to calculate match
• Match formula applies only to compensation up to the maximum that can be taken
into consideration under a 401(k) plan
• Capped compensation = $265,000 in 2015
• Compensation in excess of the cap must be ignored when applying the match
formula
• Definition of Compensation for Safe Harbor Match must be safe harbor definition
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Compensation used to calculate match
• Example: Employee A defers $15,000 out of his/her $300,000 salary. The plan has a
dollar for dollar match, which applies to salary deferrals of up to 5% of pay.
– $300,000 x 5% = $15,000
– $265,000 x 5% = $13,250
• A’s matching contribution is $13,250, not $15,000
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Catch-up deferrals and match calculations
• Catch-up salary deferrals are eligible for the match unless:
• Catch-up amounts exceed the % of pay or $ cap on salary deferrals to which the
match applies, or
• Plan document specifically excludes catch-up deferrals from the match calculation
– Note: A safe harbor 401(k) plan is not allowed to exclude catch-up deferrals from
the match calculation
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Calculating matching contributions
• Methods used to calculate the matching contribution:
– Pay-period method (cap on salary deferrals applied each pay period)
– Annualized method (cap on salary deferrals applied on an annual basis)
– Pay-period method with a “true-up” at year end to annualize the calculation
Caution: “Prefunding” match contribution to participants’ accounts by payroll period
when match contribution eligibility requires “last day of employment” and/or “1,000
Hours of Service”.
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Calculating matching contributions
• Check your plan document to see which match calculation method is specified
• If the plan has a discretionary match, the match calculation method may also be
discretionary and not stated in the plan document
– You must calculate the match using a consistent method for all participants.
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Summary
• Inform employees of the match calculation method
– Different match calculation methods can result in very different dollar amounts,
depending on how an employee’s deferrals are spread throughout the year
• Follow the match calculation method specified in the plan
– Or follow the method communicated to participants, if one is not stated in the
plan document
• Treat all participants the same when calculating the match
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Audience Question
Arnold prefers to defer out of his bonus instead of deferring by regular payroll deduction
all year. Arnold receives $90,000 in salary plus a $10,000 bonus in a separate check, for
a total of $100,000 in pay this year.
Arnold’s 401(k) plan has a 50% match, which applies to salary deferrals up to 4% of pay.
The match is calculated on a pay-period basis. Bonuses are included in the definition of
plan compensation.
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Audience Question
Arnold defers $4,000 out of his $10,000 bonus check. How much will Arnold receive as a match this year?
a) $2,000
b) $200
c) Cannot determine from the facts provided
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NON-DISCRIMINATION TESTING ON SALARY DEFERRALS
BY HIGHLY COMPENSATED EMPLOYEES
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Non-discrimination testing on HCEs
• Non-discrimination testing applies to salary deferrals made by highly compensated
employees (HCEs)
– The average % of pay deferred by HCEs is limited, based on the average % of
pay deferred by non-HCEs
• Similar non-discrimination testing applies to matching contributions made for HCEs
(not covered in this webcast due to time constraints)
– The average % of pay received as a match by HCEs is limited, based on the
average % of pay received as a match by non-HCEs
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Who is classified as an HCE?
• Any employee owning more than 5% of the business in the current year or prior year,
regardless of compensation
• Family members of > 5% owners, regardless of compensation [Family members =
owner-employee’s lineal ascendants, descendants, and spouse]
• Non-owner employees with compensation about a specified level in the prior year
[regardless of compensation in current year]
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Compensation threshold for determining non-owner HCEs
• Dollar threshold for 2015 HCEs:
– Earned more than $120,000 in 2015
• The non-owner HCE group can be limited to the top 20% of employees when ranked
by pay, using prior year data
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Non-discrimination testing on HCEs
• In-house staff handling the 401(k) plan can generally determine who is an HCE at the
beginning of a plan year
– HCE status is based on prior year’s compensation for non-owners
• HCE status is based on prior year or current year ownership status
– Therefore, newly hired owners or family members of owners are immediately
classified as HCEs in the year hired
– Current non-owner employee who becomes an owner during the year will
immediately become an HCE
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Why do you need to know who is an HCE for the current plan
year?
• So you can tell HCEs that their salary deferral contributions may be limited [based on
the average level of salary deferral participation by non-HCEs]
• So you can gather information about the amounts each HCE would like to defer this
year
– to see if their desired deferral levels are likely to pass or fail non-discrimination
testing
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Non-discrimination testing on salary deferrals
• Non-discrimination testing applies to salary deferral contributions made by HCEs
– Unless the plan is a Safe Harbor 401(k) plan
• The average % of pay that can be deferred by HCEs is determined by the average %
of pay deferred by non-HCEs
• Low levels of deferral participation by non-HCEs will result in low limits on the
amounts HCEs can defer
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Two testing methods available for limits on deferrals by HCEs
• Prior year testing
– Compare the average deferral % (ADP) of non-HCEs in the prior plan year to
the ADP of HCEs in the current plan year
• Current year testing
– Compare the average deferral % (ADP) of non-HCEs in the current plan year to
the ADP of HCEs in the current plan year
• HCE deferral percentages always based upon current year.
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Non-discrimination testing on salary deferrals
• Check the plan document so you know whether your plan uses prior year or current
year testing
• Prior year or current year ADP testing does not change which non-owners are
classified as HCEs in the current year.
– Determining which non-owners are HCEs is always based on employees’ prior
year compensation.
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How is the limit on salary deferrals by HCEs calculated?
•Calculate the average deferral % (ADP) of the non-HCE group (current year or prior
year, depending on plan provisions)
•Calculate the average deferral % (ADP) of the HCE group for the current year
•Compare the ADP of the HCE group to the ADP of the non-HCE group.
•If the HCE group average is too much higher than the non-HCE average, the plan failed
the ADP test on salary deferrals
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Non-discrimination testing methods
Example:
Compensation Sal.Deferral Deferral %
HCE 1 $200,000 $12,000 6.0%
HCE 2 $50,000 $5,000 10.0%
8.0% HCE avg.
NHCE 3 $75,000 $7,500 10.0%
NHCE 4 $50,000 $2,500 5.0%
NHCE 5 $35,000 -0- 0.0%
5.0% NHCE avg.
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Compare ADP of HCEs to ADP of non-HCEs
• Test I: ADP of HCEs cannot exceed ADP of non-HCEs multiplied by 1.25
– 5.0% (non-HCE avg) x 1.25 = 6.25% max for HCE avg.
• Test II: ADP of HCEs cannot exceed the lesser of (a) ADP of non-HCEs multiplied by
2.0 or (b) ADP of non-HCEs plus 2.0%
– (a) 5.0% x 2 = 10.0%, or (b) 5.0% + 2.0% = 7.0%
Lesser result must be used
• In this example, the HCE average of 8.00% fails both Test I and Test II
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Correcting failed test on salary deferrals
• Option A:
Refund excess salary deferral amounts to HCEs
• Option B:
Make an extra fully vested employer contribution for non-HCEs only (QNEC –
qualified non-elective employer contribution)
• Most employers use Option A unless the cost of a QNEC under Option B is a very low
dollar amount.
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Correcting failed test on salary deferrals
• Which HCEs make the ADP test fail?
– HCEs with the largest % of pay salary deferrals
• Which HCEs have to get refunds to correct a failed ADP test?
– HCEs with the largest dollar amount deferred
– Lower paid HCEs may be unaware that their large deferral amounts will make
the plan fail non-discrimination testing. They might not even be among the HCEs
who have to get a refund of excess deferrals due to a failed ADP test.
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Correcting failed test on salary deferrals
Comp. Salary Deferral Deferral %
HCE 1 $245,000 $16,500 6.73%
HCE 2 $110,000 $11,000 10.0%
8.36% Average
ADP of the non-HCE group was 5.5%, so plan failed the ADP test because the ADP of HCEs exceeded 7.5% of pay. Required refund amount = $1,903
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Correcting failed test on salary deferrals
• HCE 1 (deferred $16,500, 6.73% of pay)
• HCE 2 (deferred $11,000, 10.0% of pay)
• Which HCE made the ADP test fail?
– HCE 2 – deferred the largest %
• Which HCE will get the $1,903 refund?
– HCE 1 – deferred the largest $ amount
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Deadline for refunding excess salary deferrals to correct a
failed ADP test
• 2 ½ months after end of plan year in which excess contributions occurred, to avoid a
10% penalty tax on employer for late refunds
• 3/15/2015 for plan year ending 12/31/2014
• By end of plan year following year in which excess contributions occurred, to avoid
plan disqualification
• 12/31/2015 for plan year ending 12/31/2014
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Tax treatment of refunded salary deferrals to HCEs
• Taxable to employee for the calendar year in which it is refunded
– If refunded to HCE within 2 ½ months following end of plan year (March 15 for
calendar year end plan).
• Refunded amount not subject to 10% penalty tax on distributions prior to 59 ½
• Refunded amount not eligible for rollover to an IRA
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Common error #1
• Late deposit of salary deferral and/or loan payments into the plan.
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Required corrections for error #1:
• Make employees whole through employer contribution for lost earnings
– Lost earnings
• Calculator available on DOL website
(www.dol.gov/ebsa/calculator/main.html)
– Caution – use Calculator when submitting under the DOL’s Voluntary
Fiduciary Correction Program.
• Calculation based on the greater of: Plan’s investment rate of return, or the
IRS Underpayment Rate (currently at 3%)
– Employer pays excise tax for the prohibited transaction due to use of plan assets
(borrowing from the plan)
• Excise tax is 15% of amount employer would have paid in loan interest on
the amount “borrowed” from the plan
• Excise tax reported on IRS Form 5330
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Best practices to avoid error #1
• Make sure all in-house staff understand the financial consequences to the company if
deferrals are not deposited ASAP after every pay period.
• Give salary deferral deposits the same importance and timeliness as the deposit of
payroll tax withholdings.
• Have a back-up person available if the primary person who handles this task is on
vacation, out sick, or is being replaced due to a job change.
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Common error #2
• Not following the match calculation method specified in the plan document
• Typical errors of this type include:
– Calculating match on an annualized basis when plan document specifies pay-
period match calculation
– Calculating match on a pay-period basis without a year-end true-up when plan
document specifies an annualized calculation of the match
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Required corrections to error #2
• Recalculate the match using method specified in plan document
• Deposit additional match amounts for participants who did not receive the full amount
of match to which they were entitled
• Remove the excess match amounts from accounts of participants who received too
high a match, and transfer the excess to the forfeiture account.
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Best practices to avoid common error #2
• Train in-house staff to refer to plan document for exact specifications on the way the
match is to be calculated.
• Have the third party administrator check the in-house staff’s calculation of the match.
• Amend the plan document to change the match calculation to an alternate method, if
the alternate method is preferable to the company.
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Common error #3
• Not applying the same match calculation method to all participants.
• Typical error – Calculating the match on a pay-period basis (as specified in the plan)
for most participants, but doing an annualized match calculation for those who
capped at the $18,000 limit (2015)
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Required correction for error #3
• Recalculate the match for those participants capping at $18,000 (2015 limit) in
deferrals using the method specified in the plan and transfer the excess match
amount from their accounts to the forfeiture account.
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Best practices to prevent error #3
• Communicate clearly to all employees the method used to calculate the match, so
they can plan the timing of their salary deferrals accordingly.
• Train in-house staff to follow the plan’s provisions uniformly for all plan participants.
• Consider amending the plan document to use a different method of calculating the
match, if that would better fit the company’s objectives.
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Summary
• Understand your plan’s actual provisions for contributions: deferrals and match
– Type of contributions
– Limits on contributions
• Understand your plan’s operational issues for contributions
– Timing of deposits
– Nondiscrimination testing
• Understand common operational errors and how to avoid them
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