Many retirement administrators cringe when they hear the terms ADP (Actual Deferral Percentage) or ACP (Actual Contribution Percentage) discrimination testing. Common reactions from plan administrators on testing include, “Oh, no! I have to gather all that census data for the record keeper?”, “Will the test pass this year?”, and, “I don’t want to tell so-and-so that (s)he is getting a refund from the plan!”
IRS testing requirements are frustrating and confusing, and if a test fails, it can take countless hours to remedy. To help you avoid failing a test, here are a few suggestions that you may be able to put into place:
Pre-test- Work with your record keeper to take a snapshot of the test in the middle of the year. This will allow you to implement changes mid-year based on projected results to avoid having to deal with the repercussions of failing a test at year-end.
Use the Prior Year Testing Method- To guarantee how much highly compensated employees can defer, the IRS allows plan sponsors to base ADP and ACP tests on the prior year’s non-highly compensated employee’s deferral rate. For example, if the non-highly compensated employees deferred 4% in 2013, then the highly compensated employees could defer up to 6% in 2014.
Double check the Highly Compensated Employee classification- As a plan administrator, you will want to make sure that highly compensated employees are correctly identified. Even one misclassification could mean the difference between a passing and failing test. As a reminder, in 2014, a highly compensated employee is anyone who made in excess of $115,000 in the prior year, and anyone who is 5% or greater owner and his/her spouse, children, and parents.
Make sure you understand who fits into the “highly compensated employee” category.Apply the otherwise excludable rule- The IRS allows plan sponsors to remove any employee from the test who has not worked one year and 1,000 hours and is not 21 years old. Most of the time, newly hired employees do not defer a high percentage, which drags down the non-highly compensated average.
Safe Harbor Plan Design- Another option is to amend the plan to become a safe harbor plan, meaning the plan is exempt from ADP and ACP discrimination testing. Although safe harbor plans are exempt from testing, there are some cons you’ll want to consider before implementing the change.
For more information on safe harbor plans and ADP/ACP testing in general, we’ve created this reference guide for you to download.
PCI’s archived blog entries are dated, the rules and statutes referenced may have changed. The analysis or guidance within these blog entries may have become stale, dated, or no longer accurate. PCI will not update or change these entries to reflect the latest analysis or development.
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