How Companies Can Pass the Mandatory Nondiscrimination Testing Process

Federal Employee retirement

The new year is a time for company retirement plan sponsors to look over their nondiscrimination testing procedures to make sure contributions are still within the federal limits and is set up to boost employee participation.

January is the right time for company benefits executives to look over their retirement plans with everything else addressed – health insurance open enrollment, for example. It’s important to begin with the nondiscrimination testing to ensure the plan is following the federal guidelines.  Companies are required by the IRS to do annual non-discrimination testing on qualified retirement plans such as the 401(k) and a 403(b). The goal is to make sure highly-compensated employees are not giving preferential treatment, leaving out the non-highly- compensated employees.

Actual Contribution Percentage and Actual Deferral Percentage Tests

There are two key tests that are used to make this determination:

Actual deferral percentage – This looks at the pre-tax and Roth contribution percentages for HCEs comparing them to the NHCE’s average salary deferral package. If eligible HCEs do not surpass any of the following listed below, they pass.

-125 percent of ADP for NHCE group

-200 percent of ADP for NHCE group or ADP for NHCE group plus another two percent.

Actual contribution percentage – This looks at the employee after-tax and employer matching contribution, comparing the HCE’s percentages to the NHCE’s. They pass if the HCEs is not more than the notations listed below:

-125 percent of ADP for NHCE group

-200 percent of ADP for NHCE group or ADP for NHCE group plus another two percent

Should a company’s plan does not pass, the sponsors have nearly three months after the plan’s year ends to give back the extra contributions to the HCE or pay a 10 percent penalty. The money can be given back at any point in the year. And, failure to implement corrections could lead to the plan not being tax-exempt.

Use a Non-Qualified Deferred Compensation

Employees need to save anywhere from 12 to 15 percent of their salary for their retirement. However, since many NHCEs are not participating and contributing, the majority of HCEs are unable to do this.

How does a company address this?

Companies can implement a non-qualified deferred compensation plan for their HCEs, and encourage NHCEs to contribute more, using company meetings, webinars, and other similar activities.

Companies Need to Keep an Eye on Contributions

It can be difficult to keep an eye on contributions of a retirement plan to ensure it stands compliant. However, to ensure this happens, there are three things you can do – to help yourself and your employees save for retirement.

Analyze the Nondiscrimination Testing From The Year Before

Plan sponsors need to look over the year before’s ADP/ACP test results, getting a good look at the present HCE contribution percentage. This will let sponsors know if NHCEs can boost contributions before the end of the year.

It will also help to find out if an HCE paid too much into the plan and how much they need to be refunded. This will give them an idea of how to determine their HCEs’ contributions.

Create an Automatic Enrollment Option

Another way to boost the participation plan is to set up an automatic enrollment option. This is very easy to manage and can increase the level of participation in the sponsor plan. According to one study, auto-enrollment plans have a 90 percent participate rate compared to just 50 percent if opted-in

Create a Safe Harbor Plan

According to the IRS rules, a safe harbor plan demands the employer to contribute toward the retirement account of all their eligible employees. When they do this, the employees will automatically pass the testing. What are the measures that employers must pass to qualify?

-They must contribute at least three percent of all employees’ salaries (no matter how many are participating)

-They must provide a minimum of 100 percent match for the first three percent of an employee’s contribution and 50 percent for the next two percent.

Granted, going through the information isn’t a great way to start the new year, but doing so means you’ll be in good shape to pass the nondiscrimination test, help your employees to save for their retirement and start each year off right.

Federal Employee retirement

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