Tag Archive for: ACP

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“I’m confused about the deadlines for correcting 401(k) plan excesses. Can you give me quick tutorial?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Minnesota is representative of a common inquiry regarding 401(k) plan nondiscrimination testing.

Highlights of Discussion

I’ll try my best to summarize, generally, but be sure to seek out tax and/or legal advice for actual plan situations. One of the characteristics that sets 401(k) plans apart from other defined contribution plans are the unique contribution limits that apply to employee salary deferrals and matching contributions, namely the actual deferral percentage (ADP) limit, the actual contribution percentage (ACP) limit, and the IRC Sec. 402(g) annual deferral limit.

I’ll cover the three following excesses in this space:

  1. ADP failures—where the highly compensated employees (HCEs) defer too much in relation to the nonHCEs and create “excess contributions” [IRC Sec. 401(k)(8)(b)]
  2. ACP failures—where matching and/or after-tax contributions are too high for HCEs in relation to those for nonHCEs and create “excess aggregate contributions” [IRC Sec. 401(m)(6)(B)]
  3. 402(g) failures—where plan participants, either HCEs or nonHCEs, defer above the annual limit and create “excess deferrals” [IRC Sec. 402(g)(3)]
401(k) Excess Correction Deadlines
Type of 401(k) Excess Time of Correction Consequences of Failing to Timely Correct
Excess Contributions (ADP test failure where HCEs defer too much compared to nonHCEs)

 

Or

 

Excess Aggregate Contributions (ACP test failure where HCEs’ matching and or after-tax contributions are too high compared to nonHCEs’)

 

Within 2½ months after plan year end (March 15th for a calendar year plan)

Issue corrective distributions to affected HCEs

 

 

 

Excess and earnings taxed in the year distributed

 

 

After 2 ½ months after plan year end

 

Two Corrective Options:

1. Issue corrective distributions to HCEs

or

2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure

·     Excess and earnings taxed in the year distributed

·     Employer subject to a 10% penalty tax

After the end of the plan year following the year of the excess

 

·   Employer subject to a 10% penalty tax

·   Potential for plan disqualification

·   Correct through Employee Plans Compliance Resolution System (EPCRS)

 

If “eligible automatic contribution arrangement” Excess Contribution or Excess Aggregate Contribution

 

6 months following the end of the plan year (June 30 for calendar year plan)

 

Issue corrective distributions to affected HCEs

 

Excess and earnings taxed in the year distributed
After 6 months following the end of the plan year

 

Two Corrective Options:

 

1. Issue corrective distributions to HCEs or

2. Make a Qualified Nonelective Contribution/Qualified Matching Contribution to correct the failure

·   Excess and earnings taxed in the year distributed

 

·   Employer subject to additional 10% penalty tax

 

After the end of the plan year following the year of excess (December 31 for calendar year plan)

 

·      Employer subject to additional 10% penalty tax

·      Potential for plan disqualification

·      Correct through EPCRS

 

Excess Deferrals (402(g) failure, Pre-Tax and Designated Roth) On or before April 15th of year after deferral

Issue corrective distributions of excess deferrals, plus their earnings

·      Excess deferral taxed as income in the year deferred.

·      Earnings on excess taxed in the year distributed.

After April 15 of year following excess

 

·   Excess deferral taxed in the year deferred.

·   Both the excess deferral and earnings taxed in the year removed.

·   If excess deferrals result from deferrals to one or more plans maintained by the same employer, possible loss of qualified plan status

 

Amounts in excess of any one of these limits could have serious consequences for the employer, the participant and/or the plan as a whole. Plan penalties are costly to plan sponsors and every effort should be made to avoid them. But worse than paying the IRS an extra penalty fee is the potential loss of qualified status for the 401(k) plan. If the IRS disqualifies a plan, the plan sponsor loses the tax-saving benefits of the plan, and the assets become immediately taxable to the participants. Therefore, such excesses must be avoided and timely corrected when failures occur.

Conclusion

Treasury regulations contain clear steps and deadlines by which plan sponsors must correct 401(k) excesses. If done so timely, the plan sponsor can avoid additional penalties and potential plan disqualification. Corrections made after the specified deadlines must follow the terms of the IRS’s EPCRS.

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Definition of Compensation When Safe Harbor Match Eliminated Mid Year

“The company is a safe harbor 401(k) match plan and they pay the match in a lump sum after the plan year.  The company amended the plan to remove the safe harbor matching contribution mid-year. What definition of compensation should the plan use to determine the amount of match to make—full year or partial year?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Ohio is representative of a common inquiry related to the definition of compensation.

Highlights of the Discussion

The IRS has provided guidance in treasury regulations  as follows.

“A plan that is amended during the plan year to reduce or suspend safe harbor contributions (whether nonelective contributions or matching contributions) must pro rate the otherwise applicable compensation limit under section 401(a)(17) in accordance with the requirements of § 1.401(a)(17)–1(b)(3)(iii)(A).”

Consequently, when a safe harbor 401(k) reduces or suspends the matching contribution mid-year via amendment, the plan would use prorated compensation to determine the amount of match to make for the shortened period of time the match is given.

However, because the plan is no longer a safe harbor plan, it must be amended to provide that the actual deferral percentage (ADP) test and actual contribution percentage (ACP) tests will be satisfied for the entire plan year in which the reduction or suspension occurs using the current year testing method described in §1.401(k)–2(a)(2)(ii).  Therefore, the plan would be required to use full year compensation to run the ADP and ACP tests [see Treas. Reg. Sections 1.401(k)-3(g)(1)(iv) ].

Conclusion

Using the correct definition of compensation for plan purposes is one of the top compliance concerns of the IRS. This hurdle is confounded even further when plans realize more than one definition of compensation may apply depending on the circumstance.

 

 

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401(k) After-Tax Contributions May Be Testy–But Worth It

“What are the limitations, if any, on making after-tax contributions to a 401(k) plan?” Read more

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After-Tax Contribution Limits in 401(k) Plans

“What are the considerations for a 401(k) plan participant who wants to “max out” his/her after-tax contributions in the plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Ohio is representative of a common inquiry related to after-tax contributions in 401(k) plans.

Highlights of Discussion

  • There are several considerations for making after-tax contributions to a 401(k) plan, including whether the plan allows for after-tax contributions and, if so, what limits apply.
  • In order for a participant to make after-tax contributions to his or her 401(k) plan, the plan document must specifically allow for this type of contribution. For example, using our “Plan Snapshot” library of employer plan documents, RLC was able to confirm that the 401(k) plan in question does permit after-tax contributions.
  • Additional considerations when making after-tax contributions include any plan specified contribution limits; the actual contribution percentage (ACP) test; and the IRC Sec. 415 annual additions test.
  • Despite having a plan imposed contribution limit of 50 percent of annual compensation according to the plan document, the advisor determined his client could maximize his pre-tax contributions and still make a large after-tax contribution as well.
  • After-tax contributions are subject to the ACP test—a special 401(k) test that compares the rate of matching and after-tax contributions made by those in upper management (i.e., highly compensated employees) to the rate made by rank-and-file employees (i.e., nonhighly compensated employees) to ensure the contributions are considered nondiscriminatory. Even safe harbor 401(k) plans are required to apply the ACP test to the after-tax contributions if any are made. If the plan fails the ACP test, a typical corrective method is a refund of after-tax contributions to upper management employees.
  • In addition, each plan participant has an annual total plan contribution limit of 100 percent of compensation up to $54,000 for 2017 and $55,000 for 2018, plus an additional $6,000 for catch-up contributions, under IRC Sec. 415 (a.k.a., the annual additions limit). All contributions for a participant to a 401(k) (e.g., salary deferrals, profit sharing, matching, designated Roth and after-tax) are included in a participant’s annual additions. If a participant exceeds his annual additions limit, a typical corrective method is a refund of contributions.
  • In general, a 401(k) plan participant can convert his after-tax account balance to a Roth IRA while working as long as 1) the plan allows for in-service distributions; 2) the after-tax contributions and their earnings have been segregated from the other contribution types in a separate account; and 3) the participant follows the standard conversion rules (IRS Notices 87-13, 2008-30 and 2014-54).

Conclusion

Roughly one-third of 401(k) plans today offer participants the ability to make after-tax contributions.[1]  While this may be viewed as a benefit from many perspectives, there are several important considerations of which plan participants must be aware.

[1] Plan Sponsor Council of America, 59th Annual Survey; and Retirement Learning Center Plan Document Database, 2018

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