Compliance October 19, 2006

Beware the Ides of March

In 44 B.C. a soothsayer advised Julius Caesar to "Beware the Ides of March." It's an admonition that can still apply to 401(k) plan administration today when it comes the to Actual Deferral Percentage Test (ADP).
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In 44 B.C. a soothsayer advised Julius Caesar to “Beware the Ides of March.” It’s an admonition that can still apply to 401(k) plan administration today when it comes the to Actual Deferral Percentage Test (ADP).

What is the ADP test?

Simply stated, 401(k) plans must pass this test in order to retain their qualified status. The test itself is designed to ensure that highly compensated employees (HCEs) aren’t contributing to the plan at a disproportionate rate compared with that of the non-highly compensated employees (NHCEs). If a retirement program doesn’t pass that test — the Ides of March (March 15) — is a critical date in remedying that situation.

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How does the ADP test work?

You first start by determining what the ADP of both the HCE and NHCE groups is by dividing the individual elective deferral contributions divided by the employee’s compensation, and then averaging that result in each of the two groups. You then compare the HCE ADP with the NHCE ADP (after awhile the acronyms will roll off your tongue).

In order to pass, the ADP of the eligible HCEs cannot exceed 125% of the ADP of the eligible NHCEs, OR the ADP of the eligible HCEs cannot exceed two percentage point of the ADP of the eligible NHCEs, and the ADP of the eligible HCEs cannot exceed two times the ADP of the eligible NHCEs (with luck, the plan’s accountant or recordkeeper will be the one performing the test, though it’s not quite as complicated as it sounds).

What if the plan doesn’t pass the ADP test?

There are several ways to remedy a failed ADP test, generally either by reducing the amount of HCE deferrals, or by putting more money into the NHCE accounts. Specific strategies include:

  1. The employer can make special qualified matching contributions (QMACs) or qualified nonelective contributions (QNECs) to the accounts of some or all of the NHCEs.
  2. Excess contributions of HCEs can be recharacterized as after-tax contributions (if the plan allows for these type contributions).
  3. Excess contributions are distributed to HCEs within 2 1/2 months after the end of the plan year (for plans with a December 31 year-end, this is March 15). Rules mandate that beginning after December 31, 1996, excess contribution refunds are to be made first to the HCE deferring the largest dollar amount instead of the HCE with the largest deferral percentage.
  4. The plan can be restructured and retested. For example, the portion of employees who do not meet the statutory minimum age and service requirements, but do meet the plan eligibility requirements, may be tested as a separate group from those employees meeting both plan and statutory eligibility requirements.

Currently, if the excess contributions are not made within the 2 1/2 months after the end of the plan year (March 15 for 12/31 year-ends), the employer is on the hook for a penalty of 10% on the excess contributions. If the test failure isn’t remedied by the end of the next plan year, the plan could be disqualified.

Compliance October 19, 2006

Are You A Fiduciary?

"Fiduciary" is a word that is generally used in the company of ominous terms like "responsibility" or "liability." But is it a word that describes your role, and if so, is that a good thing?
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“Fiduciary” is a word that is generally used in the company of ominous terms like “responsibility” or “liability.” But is it a word that describes your role, and if so, is that a good thing?

Fiduciaries can be held legally accountable for their actions involving an employee benefit plan. It won’t matter if you are ignorant of the law, its requirements, or even the fact that you are a fiduciary. Advisers should realize that there is a fine line between the non-fiduciary activity of selling investment products and the fiduciary function of rendering investment advice — and crossing that line has serious implications for your business, and you personally.

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What Is a Fiduciary?

Any person or entity that has control over the management of an employee benefit plan or its assets is a fiduciary. Also, anyone who offers investment advice regarding plan assets for a fee, or who has the authority or responsibility to do so is considered a fiduciary. Some positions convey an “automatic” responsibility (notably the named fiduciary, trustee or plan administrator), but the law is intentionally broad, and will be applied regardless of official titles. An employee benefit plan must have at least one fiduciary, which is the so-called “named” fiduciary, as well as a plan “administrator” and a trustee.

You can become a fiduciary by playing a controlling role in:

  • Determination of search criteria
  • Making decisions on the investment package
  • Selection of investment options
  • Choosing options for mapping
  • Monitoring of investment options
  • Investment advice to participants

Why Does It Matter To Me?

A fiduciary can be sued for violating, or not performing its duties appropriately. Those penalties can include:

  • The Department of Labor (DoL) may assess a civil penalty of 20% of the amount payable pursuant to a court order or settlement agreement with the DoL for a breach of fiduciary duty (or your knowing participation in a violation).
  • Willful violation of any reporting or disclosure requirement can be subject to a fine of $5,000, imprisonment for one year, or both (in the case of a person other than an individual, the fine can be as much as $100,000).
  • Accepting kickbacks or embezzling funds in connection with an ERISA plan is a federal crime, punishable by a $10,000 fine, five years in prison, or both.

The IRS also has the ability to require that a prohibited transaction be reversed, as well as to impose penalties on individuals that participated in a prohibited transaction. Another plan fiduciary, any plan participant and the Secretary of Labor can bring a lawsuit to establish the liability of an ERISA fiduciary.

As for whose pocket the penalties will “hit,” ERISA notes that in case of a breach of duty, a fiduciary:

  • Shall be personally liable to make good losses to the plan
  • Shall be personally liable to return any profits resulting from the breach
  • May be removed as a fiduciary

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