A benefit plan must not discriminate in favor of highly compensated employees (HCEs) and key employees with respect to eligibility, contributions, or benefits. To ensure compliance, all 401(k) plan sponsors should understand the basics of nondiscrimination testing and, considering the complexity of the rules, make sure this critical duty is being done right. Even if a plan sponsor relies on a third-party administrator (TPA) to perform the nondiscrimination testing, the plan sponsor is responsible for the consequences of noncompliance, which could include tax consequences for plan member investments.
Nondiscrimination testing put simply ensures that all 401(k) plan participants contribute fairly without favoring HCEs. Currently for 2019, an HCE is a more-than-5% owner in the current or prior year and/or whose income exceeds $120,000 in 2018. Testing for calendar year 2020, an HCE will be an employee whose income exceeds $125,000 in 2019.
Sounds pretty simple, but the rules and requirements are complex in some situations. Perhaps the first issue to consider is the employer’s structure — does it have multiple divisions, and if so must all the divisions be tested as a single employer? What if the divisions are separate legal entities? For example, employers that meet the common ownership requirements to be considered a “controlled group” are treated as a single employer. Under controlled group rules it can become more difficult for employers to offer tax-favored employee benefits to HCEs, further complicating nondiscrimination testing.
After solving the employer structure issue, plan sponsors must consider:
Various nondiscrimination requirements focus on comparing contributions provided for HCEs and non-HCEs. The key contribution types to compare are elective deferrals (what plan participants contribute), matching contributions (what employers contribute on behalf of plan participants), and profit-sharing contributions:
Seventy percent or greater of the employees benefiting under the plan must be non-HCEs. Testing for this key ratio can involve many variables and exceptions. Elective deferral, matching, and profit-sharing portions of the plan are tested separately. This means, for example, that if all non-HCEs are eligible to make elective deferrals, but not enough non-HCEs are eligible to receive profit-sharing contributions, the profit-sharing portion of the plan will be discriminatory. For purposes of testing elective deferrals and matching contributions, employees are considered to be benefiting if they are eligible to participate — even if they elect not to contribute.
A plan is considered “top heavy” if the total accounts of key employees exceeds 60% of the total accounts of all employees as of the last day of the prior plan year. A "key employee" is an employee who at any time during the prior plan year had met any of the following criteria:
Top heavy 401(k) plan testing is an annual test required for all 401(k) plan sponsors. Top heavy plans that fail testing must be fixed so that all employees benefit from the plan.
In our 2015 MarketPulse trend study, we introduce our first annual WellnessPulse benchmarking study, in which we survey our clients about their wellness programs and share key results. We also cover trends in executive compensation and benefits, health plan design, healthcare reform, social engineering and cyber risks, workers' compensation, and retirement benefits.
Download the PDF: MarketPulse 2015
Retirement planning is very different from planning for other benefits because the end goal is many years – even decades – away. It’s impossible to develop a foolproof plan that will guide a 25 year-old to her retirement 40 years later. But the practice of planning, the financial education obtained and the savings habits created along the journey can steer employees closer to reaching their retirement goals.
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