And that is where retirement plan advisers can really help their plan sponsor clients, says Geno Cufone, senior vice president, retirement administration, at Ascensus in Dresher, Pennsylvania. When it comes to actual deferral percentage (ADP) and actual contribution percentage (ACP) testing, he says, retirement plan advisers really need to be advocates for their plans. “Encourage employers to monitor the [nondiscrimination] testing on an ongoing basis—encourage them to send in complete census information on an ongoing basis so that they have the best opportunity to monitor throughout the year, as opposed to being surprised at the end of the year.”
Small-plan sponsors in particular may not be aware of the nondiscrimination testing requirements, or may not keep their recordkeeper up to date with the plan’s census data. “Especially with start-up plans, plans that have just begun, there does seem to be a surprise element, more often than not,” he comments. Advisers can recommend that sponsors have their recordkeepers test their plans mid-year to see where participants fall. “The more information that they provide … to the recordkeeper, the better prepared we can make them, to ensure that they don’t fail.”
According to a recent survey from Judy Diamond Associates, nearly 60,000 401(k) plans failed the Internal Revenue Service (IRS)’s nondiscrimination testing, and 12% of 401(k) plans issued corrective distributions in 2012.
“Once [plans] fail, they have two options: They can return monies back to the highly compensated employees [HCEs]” via a corrective distribution, Cufone says. “Basically, there’s a calculation that determines how you get the plan to pass by returning money.” That option is by far the more common course of action, he says, taken by 85% to 90% of employers that do fail.
The other possibility is a one-time, nonelective employer contribution to the non-highly compensated employees (NHCEs). However, he warns, “unless you’ve budgeted for it, or if you happened to have a good year, from a financial perspective, it is typically something that employers aren’t prepared to do.”
Next: The factors that determine if a plan is ready for the next round…
Three factors determine whether or not the plan will be prepared for the next round of testing: plan design, employee behavior and continuous monitoring.
“The plan design is by far the best way to get to a point where more employers are passing their nondiscrimination testing, but you have to consider whether or not they have the wherewithal to afford doing some type of employer match,” Cufone says.
According to Cufone, automatic enrollment provides the best opportunity to use plan design to get non-highly compensated employees into the plan, to offset the contributions of the highly compensated employees. If rank-and-file workers are not making sufficient deferrals, though, employee behavior may need to change. One, admittedly unpopular, choice is to ask HCEs to cut down their deferrals. “Ask them to contribute a little bit less if they know that [otherwise] they’re going to be getting a refund,” Cufone suggests
The best thing for the plan and for participants, he says, is to “influence the non-highly compensated employees to contribute more if you see that you’re falling within the range where, potentially, you’re going to fail.” Advisers can help their clients to send out targeted communications to urge participants to increase their deferrals. “We know it’s in their best interest to contribute more to the plan, and you get the added benefit of having a greater opportunity to pass your nondiscrimination testing.”
Advisers may also suggest that the plan adopt a safe harbor employer contribution. “If you can afford to do that, choosing a safe harbor basic employer match will eliminate the need for testing altogether,” Cufone says. “Offering a safe harbor match contribution—which is 100% of the first 3% that employees defer, and then 50% of the next 2% that they defer—eliminates the need for both ADP and ACP testing. And you get the added bonus of not having to do top-heavy testing as well. Another option is to offer a 3% nonelective contribution to all employees in the plan, regardless of whether or not they’re contributing. By doing that, you no longer have to do any of the required testing.”