The IRS requires companiesto perform annual nondiscrimination testing on their qualifiedretirement plans to ensure highly compensated employees do notreceive preferential treatment over non-highly compensatedemployees. (Photo: Shutterstock)

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With 2018 now over, company retirement plan sponsors shouldstart the new year fresh and revisit nondiscrimination testing toensure contributions are within federal limits and the program isdesigned to maximize employee participation.

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January is the perfect time for company benefits executives toreexamine their retirement plans now that they've finished year-endtasks for other essential programs, such as health insurance openenrollment (and filing all the necessary paperwork required byfederal and state regulators).

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One of the best places to start is by taking a deep dive intonondiscrimination testing to see if your plan is in compliance withfederal regulations.

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The IRS requires companies to perform annual nondiscriminationtesting on their qualified retirement plans – for example, a 401(k)and some 403(b) plans – to ensure highly compensated employees(HCEs) do not receive preferential treatment over non-highlycompensated employees (NHCEs).

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Use nondiscrimination testing

In general, there are two primary nondiscrimination tests:actual deferral percentage and actual contribution percentage.

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Actual deferral percentage (ADP): This test compares pre-tax and Roth contribution percentages forHCEs to the average salary deferral percentage for NHCEs. Employerspass if the ADP for eligible HCEs doesn't exceed the greater of thefollowing:

  • 125 percent of the ADP for the group of NHCEs,
  • Or the lesser of the following:|
    • 200 percent of the ADP for the group of NHCEs, or
    • The ADP for the NHCEs plus 2 percent.

 Actual contribution percentage(ACP):  This test examines employee after-tax andemployer matching contributions and compares the percentages forHCEs versus NHCEs. Employers pass if the ACP for the eligible HCEsdoesn't exceed the greater of the following:

  • 125 percent of the ACP for the group of NHCEs,
  • Or the lesser of the following:|
    • 200 percent of the ACP for the group of NHCEs, or
    • The ACP for the NHCEs plus 2 percent.

If a company's plan fails the ADP or ACP test, plan sponsorshave two and a half months after the end of the plan year to returnexcess contributions to HCE employees to avoid a 10 percentpenalty.

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Distributions of excess contributions can be done any timeduring the plan year. Failure to make corrections could result inthe plan losing its tax-exempt status.

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Adopt non-qualified deferred compensation

The rule of thumb is employees should save 12 to 15 percent oftheir salary for retirement. Unfortunately, due to lowerparticipation and contributions from NHCEs, most HCEs are preventedfrom meeting that saving rate.

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One way to avoid non-compliance is adopting a non-qualifieddeferred compensation for HCEs, while also encouraging NHCEs –through webinars, company meetings and related activities – tomaximize their contributions.

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Monitor contributions

Monitoring contributions to make sure a retirement plan remainsin compliance can be daunting. To keep your program in compliancewith the IRS and help your employees save for retirement, considerthese three strategies:

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1. Review last year's nondiscriminationtesting.

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Plan sponsors should examine last year's ADP/ACP test resultsand compare it to the current HCE contribution percentage. Thiswill help plan sponsors determine which NHCEs are able to increasetheir contributions before year-end.

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It will also show if any HCEs over-contributed to the plan andhow much should be refunded. It will also serve as a helpfulbenchmark for determining contributions for HCEs.

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2. Set up automatic enrollment.

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Automatic enrollment is one of the most effective ways employerscan increase plan participation. Once the employee onboardingprocess is set up, automatic enrollment is easy to manage andresults in increased participation.

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One study showed auto-enrollment plans resulted in participationrates of more than 90 percent compared with only 50 percent forplans that require employees to opt in.

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3. Consider a safe harbor plan.

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Per IRS regulations, a safe harbor plan requires a mandatorycontribution by the employer into the retirement account for everyeligible employee.

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In return for treating all employees equally, employers canautomatically pass ADP/ACP testing.

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To qualify, employers have two options:

  1. Contribute a minimum of 3 percent of every employee's salary(regardless of participation in the plan) or
  2. Provide a minimum contribution of 100 percent match of thefirst 3 percent of employee contributions and 50 percent of thenext 2 percent.

Poring through retirement plan contribution data isn't the mostexciting way to start the new year. But if you follow these threetips, you'll be in a better position to pass nondiscriminationtesting, help employees save more for retirement, and start 2019 ona positive note.

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Brad Knowles is managing director for HeritageRetirement Plan Advisors, a Registered Investment Advisor withthe SEC that specializes in providing fiduciary and investmentadvisory services to employer sponsored qualified and non-qualifiedretirement plans. Brad began his financial services career in 2001and founded his own retirement plan advisory firm, RBK Capital, in2014. Brad joined joined Heritage in 2016 and is one of around 50advisors nationally who have earned the Certified BehavioralFinance Analysts (CBFA) designation. Brad earned his Master ofBusiness Administration and Bachelor of Science degrees from theUniversity of Oklahoma.

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