Introduction January 31st, January 15th January 31st

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1 Introduction Nondiscrimination testing is one of the most critical aspects of plan administration. Maintaining a tax-qualified plan provides significant tax advantages to both the plan sponsor and the plan participants. Failure to comply with the nondiscrimination testing requirements may jeopardize the tax-qualified status of the plan. The Compliance testing service offered by Prudential can help your plan comply with nondiscrimination tests that the government has established. If you have elected our compliance testing services, this booklet will assist you with general guidelines and help you understand how a successful submission of plan data will result in the efficient and accurate completion of your tests. If your plan's nondiscrimination tests are not administered within the time frames specified by federal regulations, the employer may be subject to penalties, excise taxes and potential plan disqualification. Please refer to the information below when submitting accurate data in the specified format to Prudential. If testing data is accurate and is submitted by January 31st, Prudential will process any ADP/ACP corrective distributions (adjusted for earnings or losses) by the 2 ½ month deadline. If you want Prudential to complete a contribution or forfeiture allocation that is intended to be funded during the first quarter of the plan year, your data and questionnaire must be provided by January 15th. If testing data is not accurate and/or is not submitted in the correct format, you will be required to resubmit the data. In addition, if you resubmit the data after January 31st, Prudential may not be able to remove excess contributions by the 2 ½ month deadline. To ensure timely completion of your Nondiscrimination Tests, please ensure your data submission includes the following: Completed Compliance Testing Questionnaire, and Accurate testing data in the format described in the Data Specifications section of this booklet. To ensure timely results, please the data submission and completed questionnaire via PruSecure to compliance.testing.reporting@prudential.com. The questionnaire can also be faxed to (877) Please note: The information you provide directly affects the results of your tests. Prudential has no responsibility for consequences resulting from incorrect data. In addition, the data provided for compliance testing purposes does not automatically update Prudential s recordkeeping system. Any recordkeeping updates must be submitted via normal business process. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

2 Table of Contents What s New... 4 Reminders... 4 Compliance Testing Timeline... 7 Compliance Testing Questionnaire... 8 Data Specifications Compensation Glossary Qualified plans under section 401(a) [including section 401(k) plans]: Section 415 (Annual Additions Limitation) for Qualified Plans under Section 403(b) Compliance Testing Definitions Actual Deferral Percentage Actual Contribution Percentage Catch-Up Contribution % Owner Highly Compensated Employee (HCE) Key Employee Non-Highly Compensated Employee (NHCE) Minimum Coverage Test (IRC Section 410(b)) Elective Deferral Limit (IRC Section 402(g)) Annual Additions Limit (IRC Section 415(c)) Compensation Nondiscrimination Test (IRC Section 414(s)) ADP/ACP Test (IRC Section 401(k) & Section 401(m)) Top Heavy Test (IRC Section 416) General Nondiscrimination Tests (IRC Section 401(a)(4)) Question and Answers Employee Classifications October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

3 Compensation Safe Harbor and EACA Plan Designs Contributions ADP/ACP & Minimum Coverage Testing Top Heavy Testing Related Employers Mid Year Compliance Testing October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

4 What s New Plan Sponsor Testing Checklist Provides a helpful checklist to assist in ensuring complete and accurate data is provided. Please refer to the Plan Sponsor Testing Checklist page for important information. Reminders Data must be submitted in good order and in the required standard data format If revised testing is requested because of incorrect data submission, additional fees will be assessed. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

5 Plan Sponsor Testing Checklist Plan Sponsor is responsible for performing the below steps: 1. Submission of a completed Compliance Testing Questionnaire Note: Any items left unanswered upon submission will be assumed to be No/Not Applicable. 2. Submission of complete and accurate data for testing purposes Population: Confirm the entire testing population was provided. This is generally all employees who perform at least one hour of service within the plan year. Certain employees are excludable from testing and do not need to be included, such as excluded union, excluded non-resident aliens and employees who did not meet minimum age & service do not need to be provided. However, you would need to identify Highly Compensated Employees (HCE) who were not previously provided. Compensation: Confirm compensation provided is correct per the definition elected in the plan document. HCE/415 compensation must be provided (one of the following definitions must be used per your document: W2, 3401(a), 415, 415 Simplified). If eligible compensation is not provided under Pretax, Match, Other, or Post-Tax Compensation columns as needed, HCE/415 compensation will be used to identify plan limit overages. Contributions: Confirm contributions tie back to your payroll records for the plan year. Employer contributions applicable to the plan year should be included, even if not yet funded. Review for employees who terminated prior to the start of the year, but have compensation or contributions reported for the plan year being tested. In general, severance pay would not be included in testing compensation and those employees should be removed from the data file. *Employees remaining in the file will be assumed to have trailing pay (aka last pay check) and will be included in testing, as needed. Indicators: All indicators (ex: Officer) and additional information (ex: Ownership) were included on the data file. Confirm there are no missing or invalid dates, indicators, compensation or contribution amounts. If the plan uses hours for eligibility for allocation purposes, confirm hours were provided for all employees. If hours are not provided we will assume 1000 hours for the plan year. Confirm data is in the standard data file format. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

6 The template of the standard data file format may be found on the Compliance Testing section of the Sponsor Center under Quick Links. See the Data Specifications page for details on good order. 3. Submission of additional data as requested Once the Questionnaire and data is remitted, Prudential may request additional information as it relates to the below questionnaire items: Puerto Rico participants, USERRA contributions, Mergers & Acquisitions, Controlled Groups, QSLOB identification, Missed Deferrals and requested allocations. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

7 Compliance Testing Timeline Plan Year-End Data Submission Deadline* (1 month following plan year-end) ADP/ACP Correctives processed by (2 ½ month deadline) ** (mm/dd) (mm/dd) (mm/dd) 12/31 01/31 03/15 01/31 02/28 04/15 02/28 03/31 05/15 03/31 04/30 06/15 04/30 05/31 07/15 05/31 06/30 08/15 06/30 07/31 09/15 07/31 08/31 10/15 08/31 09/30 11/15 09/30 10/31 12/15 10/31 11/30 01/15 11/30 12/31 02/15 * This is the deadline by which a Plan Sponsor must submit the Compliance Testing Questionnaire and the employee data file to Prudential to have corrections to a failed ADP/ACP test completed within 2 ½ months after the end of the plan year. Any corrective distributions to remedy a failed ADP or ACP test that are processed after the 2 ½ month deadline will result in a 10% excise tax for which the Employer is responsible. However, it is permissible to refund ADP excess contributions or ACP excess aggregate contributions to correct a failed test after the 2 ½ month deadline so long as corrective distributions are made within twelve months after the end of the plan year being tested. Prudential suggests that Plan Sponsors taking corrective action more than twelve months after the end of the plan year refer to the correction guidance in Revenue Procedure (as known as the Employee Plans Compliance Resolution System (EPCRS) guidance). ** If test results with respect to a plan that contains an eligible automatic contribution arrangement (EACA) provision show ADP and/or ACP excess amounts that need to be distributed to HCEs, the deadline for distributing ADP/ACP corrective distributions to avoid the 10% excise tax is 6 months after the close of the plan year rather than 2 ½ months after the end of the plan year. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

8 Compliance Testing Questionnaire Plan Name: _ Plan Number/Sub Plan: _ Plan Year End: _ All questions are required to be answered. If the Questionnaire is returned with unanswered questions, they will be assumed to be No/Not applicable. QUESTION 1. Please indicate the first and last pay check date for the plan year being tested. First Paycheck Date _ Last Paycheck Date _ 1a. If you remitted compensation and census information to Prudential for all employees for each pay period, would you like to use this data for testing? Additional Information For Prudential to provide you with a complete data file, information such as compensation, contributions, dates and hours etc. must have been submitted for all your employees including any non-participating employees and any excluded plan participants. Question & Answer #13 Yes, provide me with data from Prudential for approval. No, data will be submitted separately. 2. Did the company employ individuals who were in any of the following categories? Make sure all Collectively Bargained Union and Officers are identified on your data file. Question & Answer #1 Collectively Bargained Union Yes No Officers Yes No 3. Did the company employ individuals who were excluded from plan participation? Leased Yes No Independent Contractor Yes No Non-Resident Aliens Yes No Other _ Yes No 4. Did you have any participants who returned to your employment from military service and have made employee, or received employer makeup contributions as provided by the Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA)? Yes No Question & Answer #8 Make sure all excluded, as well as Non- Resident Aliens are identified on your data file. If you employed Independent Contractors (see Q&A), make sure you remove them from the data file. Question & Answer #2-4, 6 Question & Answer #7 October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

9 QUESTION 5. Did your company employ individuals that resided in Puerto Rico? Additional Information Question & Answer #5 Yes No 6. Did your company have any employees and/or family members, whether employed by the company or not, who own or owned stock in the corporation in the current or prior plan year? Yes No 6a. Do the employees who own stock have family members employed with the company? (Note: Only indicate yes if family member is a Spouse, Child, Grandparent or Parent.) Make sure all stock ownership and family attribution information is identified on your data file. Question & Answer # 9 and 10 Question & Answer #11 Yes No 7. Has there been a merger, acquisition or spin-off within the plan year being tested? Yes No 8. If your plan document allows, did you limit Highly Compensated Employees deferrals and/or Post Tax Contribution amounts in a manner that was officially communicated to the HCE s? Yes No Question & Answer #47 Question & Answer #26 If yes, specify limit: Pretax: Max % _or Max $ _ Post Tax: Max % _or Max $ _ 9. Was your company a member of a controlled group? Yes No If Yes, please provide the following information: 9a. Was your company a member of a controlled group where all members participated in the same plan? Yes No 9b. Do you want to test all members together (one test) or separately (multiple tests)? One Test Multiple Tests Question & Answer #43-46 If 9a is No, please complete the following: 9c. Do all plans have their compliance testing completed by Prudential? Yes No 9d. Did any HCE participate across multiple plans? Yes No 10. Did the employer of this plan operate Qualified Separate Lines of Business (QSLOB)? Yes No Question & Answer #41 and #42 If Yes, please provide the following information: 10a.Total number of QSLOBs the employer operated: _ October

10 QUESTION 10b.Total number of QSLOBs with employees that benefited under this plan _ 10c. Will the employer apply minimum coverage requirements to this plan on an employer wide rather than a QSLOB basis? Yes No 11. Do you intend to use the three-year testing cycle for minimum coverage testing? Yes No 11a. If Yes, what is the plan year begin date for which the three-year testing cycle for minimum coverage testing applies? _ **does not apply for optional Mid Year Testing 12. Did the Employer sponsor any other Defined Contribution or Defined Benefit plans in which a key employee could participate? Yes (Plans must be aggregated for Top-heavy purposes) No 12a. If yes, are all plans administered by Prudential? Yes No **does not apply for optional Mid Year Testing 13. If applicable, please provide your discretionary matching formula that was used throughout the plan year. Discretionary Match Formula: $ _for every $1.00 up to _% of compensation. Other formula _ 14. Please indicate if you would like Prudential to calculate any of the following employer contributions, and identify any outstanding contributions not yet funded: Allocation Type Prudential Calculate Intended Funding Date Match Yes No _ Match True Up Yes No _ Non-elective Yes No _ Safe Harbor Match Yes No _ Safe Harbor Non-elective Yes No _ Please provide the Match Formula $ _for every $1.00 up to _% of compensation Please provide Non-Elective Details _ Additional Information This option can be utilized if there are no significant changes to the plan document, employer s workforce or compensation practices. Question & Answer #34 The IRS dictates that if an employer maintains more than one plan in which a Key Employee participates, they must be aggregated to determine top heaviness IRC 416(g)(2)(a)(i). The test performed will reflect only the assets of the plan(s) you have with Prudential. Question & Answer #36 This matching formula is needed if not officially stated in your plan document. Question & Answer #27-29 Prudential will not prepare an allocation unless directed. The fee for standard calculations is $300 per hour. The fee for allocations subject to 401(a)(4) testing is $1,500. The annual additions test cannot be performed until all contributions for the testing period are allocated. If you know the contribution allocation and submit the contributions on your data file, we will be able to perform this test. Question & Answer #27-29 **does not apply for optional Mid Year Testing October

11 QUESTION 15. If your plan requires that forfeitures are reallocated to participants, or you chose to reallocate forfeitures to participants instead of using them to offset expenses or non-elective and/or match contributions, please indicate if you would like Prudential to prepare the reallocation: Yes No Additional Information Prudential will not prepare an allocation unless directed. The fee for standard calculations is $300 per hour. The fee for allocations subject to 401(a)(4) testing is $1,500. Question & Answer #24-25 Your document may state that a forfeiture reallocation is required. **does not apply for optional Mid Year Testing 16. Please indicate if you made corrections for missed deferral opportunities/failure to make automatic contributions following Revenue Procedure : Prudential Prototype Document Clients: Prudential s Base Plan Document provisions indicate that any allocable forfeiture amount that exceeds the plan s expenses and nonelective and/or matching contributions should be reallocated to participants. Generally, a plan s forfeiture account balance should be used by plan year-end, but in no event, later than the end of the following plan year. Question & Answer #48. Yes No **does not apply for optional Mid Year Testing **When completing the Testing Questionnaire for optional Mid Year testing only, these questions do not apply. October

12 Data Specifications This section of the Compliance Testing Data Submission Guidelines booklet explains, in detail, how your plan s data should be formatted. The information in this section is most useful for your payroll administrator or for the MIS individual at your company who would be able to ensure that your data is formatted correctly. Please disregard this section if you utilize one of Prudential s automated data submission options. Data Specifications Part 1 (Spreadsheet) 1 For Prudential to complete the necessary compliance testing for your plan, you will need to submit the employee data file in the standard format listed below. Please work with your payroll provider to have your file formatted as specified below. If your data is not submitted within the format listed below, it will not be considered in good order. You will be notified that your file has been rejected and resubmission of your data file within the correct format will be required. 2 Only the following spreadsheet application will be accepted: Excel, version 16 (2016) or lower 3 For spreadsheet submissions: Generally, the file must include all employees that worked at least 1 hour during the testing period. Exceptions: excluded union, excluded non-resident aliens, employees who did not meet minimum age & service requirements. All column headings must be entered, but may be abbreviated; Data fields can be left blank if not applicable to your plan; and Dates must be entered in a MM/DD/CCYY format (e.g., 09/09/1974). Data Specifications Part 2 (Standard File Format) Part 2 of the data specifications provides instructions for setting up the standard file. The following information will help you use the Standard File Format Table: ** Item is required for all plans. Prudential will not begin the testing process if not provided. All other items are required if applicable to the plan. Standard File Format Spreadsheet Column A B Field Name & Comments **Social Security Number Number must be in format. Subplan Number - This should be the six digit subplan number associated with the Plan ID; or a unique identification of companies in a controlled group or multiple employer situations. October

13 Standard File Format Spreadsheet Column C D E F Field Name & Comments **Employee Name - Format must be Last Name, First Name. **Birth Date Enter the birth date in a MM/DD/CCYY format (e.g., 01/15/1949). This date is needed for all employees, not just those employees participating in the plan. **Hire Date Enter the original hire date (use column G for rehire dates) in a MM/DD/CCYY format (e.g., 09/09/1974). This date is needed for all employees, not just those employees participating in the plan. **Termination Date This is the employee's termination date. Enter the termination date even if the employee did not participate in the plan in MM/DD/CCYY format (e.g., 04/01/2004) or leave blank if not applicable. G Rehire Date - Enter the rehire date in a MM/DD/CCYY format. The date of termination must also be provided with any rehire date (e.g., 08/24/2007). H Hours Hours worked during the plan year must be in a number format, less than or equal to 3000, without decimals (Note: if decimals are provided, figures will be automatically rounded). If the plan has an hour s requirement for eligibility or allocations, this field must be completed. I J K L M Family Code Any person who owns stock in the company and has family members (Spouse, Child, Grandchild or Parent). Each Family group needs to be identified with the same number value (i.e. John Smith and Laura Smith coded with a 1 and Robert Jones, Marcia Jones and Paula Jones coded with a 2. Officer Indicator - Any company officer earning more than the allowable limit for the year being tested. If the test covers only part of a plan year, the limit should be prorated. This information is needed only if Prudential is determining Key Employees and performing your Top Heavy Test. This field is not required for ADP/ACP testing. Valid values are "Y" or "N". N/A for 403(b) Plans Highly Compensated Employee Indicator (HCE Indicator) - If Prudential is determining HCEs, leave this field blank. If you are determining who your HCEs are for the plan year being tested, enter values "Y" or "N". Exclusion Indicator - The plan may exclude or include only specific employee job classes. Use "Y" to indicate that the employee is excluded under the job class exclusions and "N" to indicate that an employee is not excluded. If the plan does not exclude any specific employee job classes enter "N" for all employees. This field is not to be used to identify eligibility status. Note: Part timers are not an excludible class of employees. Ownership Percentage - Any person employed by the company who owns, directly or indirectly, any employer stock, or other ownership interest, at any time during determination year, enter the actual percentage owned. Percentages are limited to a two-decimal number, otherwise enter zeros (ex: enter 10.50% as October

14 Standard File Format Spreadsheet Column N O P Q R S T U V W X Y Z Field Name & Comments Collectively Bargained Group # This information is used in performing the ADP/ACP test. If the plan has collectively bargained employees, enter a numeric union identification code (e.g. 1 for each employee of Union A; 2 for each employee of Union B, etc.). Otherwise enter zeros. Union Indicator This information is used in performing the ADP/ACP test. Enter Y if employee has collectively bargained for plan benefits, otherwise enter N. Non-Resident Alien Indicator - Enter Y if Non-Resident Alien with no U. S. source earned income. Valid values are "Y" or "N", otherwise leave blank **Compensation for Determining HCEs (HCE/415 Compensation) This compensation will be used by Prudential for various testing purposes (e.g. to determine the plan's HCEs for the upcoming testing year, 415 Annual Additions, 414(s) Compensation Testing, Top Heavy Minimum, etc.). This field represents the current testing year earnings per the plan's definition of HCE compensation. **ADP/ACP Compensation This compensation will be used in the ADP/ACP test to calculate the percentages associated with those tests. Per your plan document, enter this compensation amount for every employee who received compensation for the plan year being tested. Pre-Tax Compensation - This compensation will be used to verify that pre-tax contribution percentages did not exceed plan limits. Enter zeros if not applicable. Matching Compensation This compensation will be used to verify that matching contribution percentages did not exceed plan limits. Enter zeros if not applicable. Other Compensation This compensation will be used to verify that contribution percentages other than matching contributions did not exceed plan limits. Enter zeros if not applicable. Post Tax Compensation This compensation will be used to verify that post-tax contribution percentages did not exceed plan limits. Enter zeros if not applicable. Pre-Tax Contribution The dollar amount the employee has contributed on a pre-tax basis during the plan year. If we have been recordkeeping the plan for the entire plan year and you want to use contributions from our recordkeeping system, leave blank. NOTE: If providing pre-tax contributions, include any catch-up contributions in this amount. Post-Tax Contribution The dollar amount the employee has contributed on a post-tax basis during the plan year. If we have been recordkeeping the plan for the entire plan year and you want to use contributions from our recordkeeping system, leave blank. Match Contribution The dollar amount of Pre-tax/Roth related matching contributions the employee has received during the plan year. If we have been recordkeeping the plan for the entire plan year and you want to use contributions from our recordkeeping system, leave blank. Post-Tax Match Contribution The dollar amount the employee received as a post-tax match during the plan year. If we have been recordkeeping the plan for the entire plan year and you want to use contributions from our recordkeeping system, leave blank. October

15 Standard File Format Spreadsheet Column AA AB AC AD Field Name & Comments Non-Match Contribution This field is only used in 415 Annual Additions and Minimum Coverage testing. If we have been recordkeeping the plan for the entire plan year and you want to use contributions from our recordkeeping system, leave blank. Roth Contribution The dollar amount of Roth contributions the employee has contributed during the plan year. If we have been recordkeeping the plan for the entire plan year and you want to use contributions from our recordkeeping system, leave blank. Other Contribution This contribution was made to another DC plan, where Prudential was not the record keeper. Enter the amount for the plan year or zeros if not applicable. Non-recurring Comp (mid-year only) - This compensation will only be used in the mid-year ADP/ACP test to calculate the percentages associated with those tests. This compensation will not be projected out for the entire year. October

16 Compensation Glossary Qualified plans under section 401(a) [including section 401(k) plans]: With respect to qualified retirement plans under Internal Revenue Code (IRC) section 401(a), IRC section 415(c)(3) specifically Treasury Regulation section 1.415(c)-2(b)(1) & (d) defines Compensation for purposes of applying section 415 (i.e., the annual additions limitation) and other IRC rules that require a plan sponsor to use a definition of compensation as described in section 415(c)(3), such as identifying an employer s Highly Compensated Employees (HCEs). IRC section 415(c)(3) contains four separate definitions of Compensation from which a plan sponsor may choose: General 415: Compensation generally includes all compensation that is includable in gross income. Simplified 415: Compensation includes only those items commonly considered to be includable in wages. W-2 Wages 1 : Compensation generally includes the wages that are reported in Box 1 of Form W-2. (Note: Although W-2 Wages is the term used to describe this definition under 415(c)(3), a participant s compensation under this definition does not necessarily equal the compensation reported in Box 1 of that participant s Form W-2 for that year. For example, pre-tax elective deferral contributions are not reported as income, but are included in W-2 Wages for purposes of 415(c)(3).) 3401(a) Wages: Compensation includes all wages considered for federal income tax withholding purposes. The following chart identifies certain specific components of the four section 415(c)(3) Compensation definitions in detail. This chart is not intended to include all types of compensation includible or excludible under 415, and is not specific to any plan or employer. Inclusion of many of these compensation components depends upon individual facts and circumstances. Questions about the application of these general guidelines to your plan should be referred to the plan s legal or tax counsel. This information is provided only as general guidance. Plan sponsors should always consult legal or tax counsel about the application of any law specific to their retirement plans. Definitions of Compensation General 415 Simplified 415 W-2 Wages 3401(a) Wages Salary or Wages Yes Yes Yes Yes 1 Please note that if your plan year is an "off-calendar" year, actual calendar year W-2 information cannot be used, but rather this amount will need to be created by adding up the components (listed with a YES in the Definitions of Compensation table) for the period that the plan year covers. October

17 This information is provided only as general guidance. Plan sponsors should always consult legal or tax counsel about the application of any law specific to their retirement plans. Definitions of Compensation General 415 Simplified 415 W-2 Wages 3401(a) Wages Earned Income Yes Yes No 2 No 3 Overtime Payments Yes Yes Yes Yes Vacation Pay Yes Yes Yes Yes Bonus Payments Yes Yes Yes Yes Commissions Yes Yes Yes Yes Back Pay 4 Yes Yes Yes Yes Other Supplemental Wages Yes Yes Yes Yes Unallocated Tips Yes Yes Yes Yes Allocated (Pooled) Tips Yes Yes No Yes Non-U.S. Income 5 Yes Yes Only amounts Over $80,000, as adjusted Only amounts Over $80,000, as adjusted Sick Pay Yes No Yes Yes Accident & Health Reimbursements Yes No Yes Yes 2 Earned income is not included in the W-2 Wages definition of compensation described in Treasury Regulation section 1.415(c)-2(d)(4). However, many plan documents specifically include earned income as part of the plan s definition of compensation. If the plan s terms include earned income in conjunction with the W-2 Wage definition of compensation, the standard convention is to include earned income for all testing purposes. 3 Earned income is not included in the 3401(a) Wages definition of compensation described in Treasury Regulation section 1.415(c)-2(d)(3). However, many plan documents specifically include earned income as part of the plan s definition of compensation. If the plan s terms include earned income in conjunction with the 3401(a) Wage definition of compensation, the standard convention is to include earned income for all testing purposes. 4 Includible only for the limitation year to which the back pay relates. 5 As an alternative, a plan may exclude compensation earned by a nonresident alien that is neither taxable to the participant nor effectively connected with a trade or business in the U.S., but only if this rule is applied consistently to all employees. Note that foreign compensation for services is still treated as compensation under Sections 415(c)(3) & Section 1.415(c)-2(g)(5). October

18 This information is provided only as general guidance. Plan sponsors should always consult legal or tax counsel about the application of any law specific to their retirement plans. Definitions of Compensation General 415 Simplified 415 W-2 Wages 3401(a) Wages Deemed Section 125 Compensation Optional 6 Optional 4 Optional 4 Optional 4 Deemed Disability Compensation Optional Optional Optional Optional Section 83(b) Elections Yes No Yes Yes Nonstatutory Stock Options Taxable in the Tax Year Granted Yes No Yes Yes Contributions to Unfunded Non-Qualified Deferred Compensation Plans that are Subject to a Substantial Risk of Forfeiture Contributions to Unfunded Non-Qualified Deferred Compensation Plans that are not Subject to a Substantial Risk of Forfeiture Contributions to Funded Non-Qualified Deferred Compensation Plans that are Subject to a Substantial Risk of Forfeiture Contributions to Funded Non-Qualified Deferred Compensation Plans that are not Subject to a Substantial Risk of Forfeiture No No No No No No No Yes No No No No Yes Yes Yes Yes "Fringe Benefits" Nondeductible Moving Expenses Yes No Yes Yes Deductible Moving Expenses No No Optional 7 No Golden Parachute Payments 8 Yes Yes Yes Yes Taxable Fringe Benefits Yes Yes Yes Yes Group Term Life Insurance Over $50,000 Yes Yes Yes No Coverage in Discriminatory Self-Insured Medical Plans Yes No Yes Yes Employer-Paid Outplacement Services Yes Yes Yes Yes 6 A plan may include deemed section 125 compensation, but only if this rule is applied uniformly to all employees with respect to whom amounts subject to section 125 are included in compensation. 7 The W-2 Wage definition of compensation as described in Treasury Reg (c)-2(d)(4) may be modified to exclude amounts paid or reimbursed by the employer for moving expenses incurred by the employee if it is reasonable to believe these amounts are deductible by the employee at the time of payment. 8 Not included in General 415 or Simplified 415 if paid after the date of an employee s severance from employment. October

19 This information is provided only as general guidance. Plan sponsors should always consult legal or tax counsel about the application of any law specific to their retirement plans. General 415 Definitions of Compensation Simplified 415 W-2 Wages 3401(a) Wages Expense Allowance Paid Under Nonaccountable Plan Yes Yes Yes Yes "Elective Deferral Contributions" 9 401(k) Plan Elective Deferrals Yes Yes Yes Yes 403(b) Plan Elective Deferrals Yes Yes Yes Yes 125(a) Cafeteria Plan Elective Deferrals Yes Yes Yes Yes 408(k) SEP/SARSEP Elective Deferrals Yes Yes Yes Yes 408(p) Simple Retirement Account Elective Deferrals Yes Yes Yes Yes 457(b) Plan Deferred Compensation Yes Yes Yes Yes 132(f)(4) Qualified Transportation Fringe Benefits Yes Yes Yes Yes Post-Severance Amounts Severance Pay No No No No Regular Pay 10 Yes Yes Yes Yes Leave Cashouts 11 Optional Optional Optional Optional Nonqualified unfunded deferred compensation 12 Optional Optional Optional Optional Salary continuation payments for military service participants Optional Optional Optional Optional Salary continuation payments for disabled participants Optional Optional Optional Optional 9 For plan years and limitation years beginning after 1997, all deferral contributions must be included when looking at compensation for determining HCEs and Key Employees and for performing 415 and Top-Heavy testing. However, deferral contributions may be included in or excluded from compensation used in ADP/ACP testing. 10 These amounts may only be included to the extent such amounts are paid by the later of 2 ½ months after the severance from employment or by the end of the limitation year that includes the date of such severance from employment. 11 These amounts may only be included to the extent such amounts are paid by the later of 2 ½ months after the severance from employment or by the end of the limitation year that includes the date of such severance from employment. 12 Nonqualified unfunded deferred compensation payments made post-severance are not included in 415(c)(3) compensation unless payments would have been made at that time regardless of severance. However, a plan sponsor may choose to include nonqualified unfunded deferred compensation payments made by the later of 2 ½ months after severance of employment or the end of the limitation year that includes the date of severance if those amounts would have been included under the plan s definition of compensation if paid prior to the employee s severance from employment. October

20 Definitions of Component Items of Compensation Salary Wages paid in fixed payments at regular intervals to an employee for services rendered. Earned Income An individual's (sole proprietor, partner) net earnings (gross earnings less deductions) from self-employment determined in accordance with the rules set forth in Code section 401(c)(2). Overtime Payments Amounts paid for work performed during periods exceeding the established working periods. Vacation Pay Amounts paid to an employee while on vacation, including amounts paid even if the employee chooses not to take vacation. Vacation pay does not include sick pay or holiday pay. Bonus Payments Amounts paid to an employee for outstanding work, including prizes such as vacation trips for meeting sales goals. Commissions Amounts paid to an employee based on a percentage of the money taken in on sales, including commissions paid to salespeople and commissions on insurance premiums. Back Pay Payments awarded by an administrative agency or court pursuant to a bona fide agreement by an employer to compensate an employee for lost wages. Other Supplemental Wages Compensation paid in addition to an employee s regular wages. These wages include, but are not limited to, payments for accumulated sick leave, severance pay (if paid before date severance of employment occurs), awards, prizes, or back pay. Unallocated Tips Tips reported to the employer by an employee, including both tips paid over by the employer for charge customers and tips the employee received directly from customers. Allocated (Pooled) Tips Amounts allocated among employees who receive tips. Amounts may be allocated using hours worked, gross receipts or a good faith agreement. Non-U.S. Income Amounts received from sources within a foreign country attributable to services performed by the individual during either the entire taxable year or any portion of 12 consecutive months during which the individual was present in a foreign country for at least 330 full days. Sick Pay Amounts paid by either the employer or a third-party (such as an insurance company) under a plan because of an employee's temporary absence from work due to injury, sickness or disability (IRC 105(a)), and includes both short-term and long-term benefits. See IRS Publication 15-A or Circular E. Accident & Health Reimbursements Amounts received by an employee through accident or health insurance (or through an arrangement having the effect of accident or health insurance) for personal injuries or sickness. Accident or health reimbursements are taxable if: The reimbursement is an amount attributable to contributions made by the employer that were not taxable to the employee, or the reimbursement is paid directly by the employer. The reimbursement is for medical expenses that are deductible by the employee under IRC section 213(d) for any prior taxable year (i.e., the medical expenses meet the definition of medical care and exceed 7.5% of the employee s adjusted gross income). The reimbursement is made to a highly compensated employee from a self-insured medical reimbursement plan that is discriminatory with respect to either eligibility or benefits provided (i.e., an excess reimbursement under IRC section 105(h)(1). The reimbursement is made to certain S corporation employees Deemed Section 125 Compensation Employer provided coverage that is not available to the participant in cash in lieu of group health October

21 coverage under a section 125 arrangement solely because that participant is not able to certify he/she has other health coverage. Such amounts are only included if the employer does not otherwise request or collect information regarding the participant s other health coverage as part of the enrollment process for the health plan. See Treas. Reg (c)-2(g)(6). Deemed Disability Compensation The compensation a permanently and totally disabled (as defined in section 22(e)(3)) participant in a defined contribution plan would have received for the year if the participant was paid at a rate of compensation paid immediately before becoming disabled if: 1. Participant is not a highly compensated employee before becoming disabled, or the plan provides for continuation of compensation on behalf of all participants who are permanently and totally disabled; 2. Contributions are nonforfeitable when made; and 3. The plan provides for such compensation to disabled participants. Section 83(b) Elections Amounts included in income when an employee elects to have the value of restricted property taxed to him immediately in the year it is received even though the property remains nontransferable or subject to a substantial risk of forfeiture. Nonstatutory Stock Options Taxable in the Tax Year Granted The value of stock options that do not meet the definition of an incentive stock option under Treas. Reg. section and are therefore includable in the employee's gross income for the tax year in which granted. Nonstatutory stock options do not include stock options granted under an employee stock purchase plan. Non-Qualified Deferred Comp Plans Deferred compensation plans that do not meet the requirements of Code section 401(a), including excess benefit plans, nonqualified stock options, top-hat plans, Rabbi trusts, and Code section 457 plans. A funded plan is one for which assets are set aside with a trustee or other third party, beyond the reach of the employer s general creditors, to make future benefit payments. An unfunded plan is one in which the employer merely promises to pay an amount to the employee at a future time, including a plan where assets are set aside to make future payments if those assets remain subject to the claims of the employer s general creditors. Non-qualified deferred compensation is subject to a substantial risk of forfeiture if it is nonvested and rights to the deferred compensation will be lost upon termination of employment for reasons other than retirement, death or permanent disability. Nondeductible Moving Expenses Amounts paid or reimbursed by the employer to the employee for moving expenses that, at the time of payment, it is reasonable to believe are not deductible by the employee (e.g., reimbursement for a loss on the sale of a home). There are many different rules regarding the deductibility of moving expenses. See IRS Publication 521, Moving Expenses, for details. Deductible Moving Expenses Amounts paid or reimbursed by the employer to the employee for moving expenses that the employee could deduct if he paid or incurred them directly. These include only the reasonable expenses of: 1. moving household goods and personal effects from the former home to the new home, and 2. travel (including lodging) from the former home to the new home. See IRS Publication 521, Moving Expenses for details. Golden Parachute Payments Payments of compensation or benefits, made pursuant to rules contained in Code section 280G, to certain employees or independent contractors when: 1. the payment is contingent on a change of ownership or effective control of the October

22 corporation, or in the ownership of a substantial portion of the assets of the corporation, and 2. the aggregate present value of payments is equal to or exceeds three times the individual's annualized compensation. Certain exceptions apply to small corporations and payments under certain qualified plans. Taxable Fringe Benefits In general, fringe benefits include a wide variety of items, such as the furnishing of company cars and employee meals. Taxable fringe benefits do not include the value of no-additional-cost services, qualified employee discounts, working condition fringe benefits, de minimus fringe benefits, certain qualified transportation fringe benefits, and on-premises gyms or other athletic facilities. For details on taxable fringe benefits, see IRS Publication 525, Taxable and Nontaxable Income. Group Term Life Insurance Over $50,000 The cost of group term life insurance provided by the employer to an employee, which exceeds: 1. the cost of $50,000 group term insurance, minus 2. any amount paid by the employee towards the purchase of the insurance. An exception applies to certain S corporation shareholders. Coverage in Discriminatory Self-Insured Medical Plans Reimbursements made by the employer to the employee under a self-insured medical plan that discriminates in favor of highly compensated individuals, for medical expenses not reimbursed through an insured accident and health plan. Employer-Paid Outplacement Services The value of outplacement services (e.g., career counseling, resume assistance, or skills assessment) if the employer receives no additional benefit from providing the services, or if the services are not provided on the basis of employee need. Outplacement services received in exchange for reduced severance pay (or other taxable compensation) is also included. Expense Allowance Paid Under a Nonaccountable Plan A reimbursement or allowance arrangement considered to be made under a "nonaccountable plan" as further described at Treas. Reg. section (c). Payments are treated as under a nonaccountable plan if: 1. The employee either does not submit or is not required to timely submit receipts or other documents to substantiate the expenses, 2. The employee is either not required to return allowance amounts not used for business expenses, or does not return the excess allowance timely., 3. The amount is advanced or paid to the employee regardless of whether the employer reasonably expects the employee to have related business expenses, or4. The employer pays a reimbursement to an employee that would otherwise have been paid as wages. 401(k) Plan Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 401(k) qualified cash or deferred arrangement, which are not includable in the employee's gross income. 403(b) Plan Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 403(b) taxsheltered annuity program, which are not includable in the employee's gross income. 125(a) Cafeteria Plan Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 125 cafeteria plan, which are not includable in the employee's gross income. This also includes any medical or dental pre-tax premiums made under the cafeteria plan. 408(k) SEP/SARSEP Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 408(k) salary reduction simplified employee pension plan (SARSEP), which are not includable in the employee's gross income. October

23 457(b) Plan Deferred Compensation Compensation deferred by an employee under a Code section 457(b) eligible deferred compensation plan sponsored by a state or local government or a tax-exempt organization. 132(f)(4) Qualified Transportation Fringe Benefits Compensation deferred by an employee under Code section 132(f)(4) to reflect the amount of compensation reduction elected for qualified transportation fringes. Post-Severance Amounts Compensation paid after an employee incurs a severance from employment. Severance Pay Amounts paid to an employee upon involuntary separation from service with the employer, including a lump-sum payment made for cancellation of an employee's employment contract. See Other Supplemental Wages for amounts paid prior to severance of employment. Regular Pay Amounts paid to an employee for services during the participant s regular working hours, or compensation for services outside the participant s regular working hours (such as overtime or shift differential), commissions, bonuses, or other similar payments that would have been paid to the participant prior to a severance of employment if the participant had continued in employment with the Employer. Leave Cashouts Amounts paid for unused accrued bona fide sick, vacation, or other leave, if the employee could have used the leave if employment continued. Salary Continuation Payments for Military Service Participants Amounts paid to an individual who does not currently perform services for the Employer by reason of qualified military service (as defined in Code Section 414(u)(1)) to the extent those payments do not exceed the amounts the individual would have received if the individual had continued to perform services for the Employer rather than entering qualified military service. Salary Continuation Payments for Disabled Participants Regular Pay as defined above paid to a participant who is permanently and totally disabled (as defined in Code Section 22(e)(3)) if: 1. Participant is not a highly compensated employee before becoming disabled, or the plan provides for continuation of compensation on behalf of all participants who are permanently and totally disabled; 2. Contributions are nonforfeitable when made; and 3. The plan provides for such compensation to disabled participants. October

24 Section 415 (Annual Additions Limitation) for Qualified Plans under Section 403(b) With respect to qualified retirement plans under Internal Revenue Code (IRC) section 403(b), IRC section 403(b)(3) defines Compensation for purposes of applying section 415 (i.e., the annual additions limitation) to a qualified plan under section 403(b). For employees of a plan sponsored by a section 501(c)(3) organization, compensation for purposes of applying section 415 includes all the following: Taxable income for federal income tax purposes, Non-U.S. income, Deemed Disability Compensation, Elective Deferral Contributions under 401(k), 403(b),125(a), 408(k), 457(b), and 132(f)(4), and Compensation deemed to continue to a former employee for nonelective contributions. For self-employed ministers, compensation includes Earned income as defined in section 401(c)(2), including all foreign earned income. For nondiscrimination and compliance testing other than 415 annual additions limitations, please see the compensation definitions described in the chart above, under the Compensation Glossary section. Definitions of Component Items of Compensation Non-U.S. Income Amounts received from sources within a foreign country attributable to services performed by the individual during either the entire taxable year or any portion of 12 consecutive months during which the individual was present in a foreign country for at least 330 full days. Deemed Disability Compensation The compensation a permanently and totally disabled (as defined in section 22(e)(3)) participant in a defined contribution plan would have received for the year if the participant was paid at a rate of compensation paid immediately before becoming disabled if: 1. Participant is not a highly compensated employee before becoming disabled, or the plan provides for continuation of compensation on behalf of all participants who are permanently and totally disabled; 2. Contributions are nonforfeitable when made; and 3. The plan provides for such compensation to disabled participants. 401(k) Plan Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 401(k) qualified cash or deferred arrangement, which are not includable in the employee's gross income. 403(b) Plan Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 403(b) tax-sheltered annuity program, which are not includable in the employee's gross income. 125(a) Cafeteria Plan Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 125 cafeteria plan, which are not includable in the employee's gross income. This also includes any medical or dental pre-tax premiums made under the cafeteria plan. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

25 408(k) SEP/SARSEP Elective Deferrals Elective contributions made by an employer on an employee's behalf to a Code section 408(k) salary reduction simplified employee pension plan (SARSEP), which are not includable in the employee's gross income. 457(b) Plan Deferred Compensation Compensation deferred by an employee under a Code section 457(b) eligible deferred compensation plan sponsored by a state or local government or a tax-exempt organization. 132(f)(4) Qualified Transportation Fringe Benefits Compensation deferred by an employee under Code section 132(f)(4) to reflect the amount of compensation reduction elected for qualified transportation fringes. Compensation deemed to continue for nonelective contributions A former employee is deemed to have monthly includible compensation for the period through the end of the taxable year of the employee in which he or she ceases to be an employee and through the end of each of the next five taxable years. See Treas. Reg. section 1.403(b)-4(d). Earned Income An individual's (sole proprietor, partner) net earnings (gross earnings less deductions) from self-employment determined in accordance with the rules set forth in Code section 401(c)(2) October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

26 Compliance Testing Definitions The compliance testing service offered by Prudential can help your plan comply with the nondiscrimination requirements and retain its tax-qualified status. The information below provides definitions of certain compliance testing terms you will see in Prudential s materials, and a brief overview of each test or limit. Actual Deferral Percentage The Actual Deferral Percentage (ADP) for a group of employees is the average of the actual deferral ratios of each employee eligible to make pretax and/or Roth elective deferral contributions. The actual deferral ratio of each employee is the sum of that employee s elective contributions (pretax and Roth) divided by the employee s compensation for the year. Actual Contribution Percentage The Actual Contribution Percentage (ACP) for a group of employees is the average of the actual contribution ratios of each employee eligible to receive/make employer matching (including forfeitures reallocated as a match), and/or after-tax contributions. The actual contribution ratio of each employee is the sum of that employee s matching and/or after-tax contributions divided by the employee s compensation for the year. Catch Up Contribution Catch-Up Contributions are elective deferrals made to either a Section 401(a) or Section 403(b) plan by a participant who is at least age 50 (or will reach age 50 by the end of the calendar year) that exceed one of the following limits: Elective deferral limit (IRC Section 402(g)), Deferral limit set by the plan, Annual additions limit (IRC Section 415(c)), or ADP limit (IRC Section 401(k)) IRC Section 414(v) imposes an indexed limit on the total amount of catch-up contributions that may be made each year. The catch-up contribution limit is $6,000 for In addition, a special 15 years of service catch-up rule applies to certain Section 403(b) plans. Under this rule, participants with 15 years of service may make elective deferral contributions that exceed the elective deferral limit by the least of: $3,000, $15,000 minus the total of all pretax and Roth elective deferrals made under the special 15 years of service provision for all prior years, or The result of $5,000 multiplied by the participant s years of service after subtracting the pretax and Roth deferrals made for prior years. Only participants in a Section 403(b) plan sponsored by a qualified organization are eligible to make 15-year catch-up contributions. This term includes any educational organization, hospital, home health service agency, health and welfare service agency, church or convention or association of churches. October

27 501(c)(3) Organizations A 501(c)(3) Organization consists of corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h) of the IRS code), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. 5% Owner A 5% Owner is defined as: 1) If the employer is a corporation, any person who owns more than 5% of the outstanding stock of the corporation or stock possessing more than 5% of the total combined voting power of all stock of the corporation, or 2) If the employer is not a corporation, any person who owns more than 5% of the capital or profits interest in the employer. Highly Compensated Employee (HCE) A Highly Compensated Employee (HCE) is defined as an employee who: 1) Was a 5% Owner at any time during the determination year (i.e., the plan year) or preceding plan year (look-back year), or 2) For the preceding plan year: a. had compensation in excess of $120,000 (indexed for 2016) and b. if elected by the employer, was in the top 20% of employees when ranked by order of highest compensation for the preceding plan year. Key Employee A Key Employee is an employee who meets any of the following criteria in the determination year, (i.e., the plan year). Identification of Key Employees is necessary for Top Heavy testing. 5% Owner An employee who owns more than 5% of the employer or related employer as defined above. 1% Owner - An employee who owns more than 1% of the employer or related employer (defined by substituting 1% where 5% appears in the definition of 5% owner ) and has compensation in excess of $150,000. Officer Generally, an employee who has authority and performs duties as an administrative executive in accordance with Treas. Reg. Section , T-13, and has compensation in excess of $175,000 (for 2017). October

28 Non Highly Compensated Employee (NHCE) A Non-Highly Compensated Employee is defined as any employee not classified as a HCE. Minimum Coverage Test (IRC Section 410(b)) A plan qualified under Section 401(a) must benefit (i.e., cover) a proportionate number of NHCEs as compared to HCEs. If a plan s provisions prevent too many NHCEs from becoming eligible to participate in the plan or from receiving certain types of contributions, the plan will fail the minimum coverage requirement. A plan meets the minimum coverage requirement if it passes either the Ratio Percentage Test or the Average Benefits Test. Minimum coverage testing is performed annually for most plans. Ratio Percentage Test The ratio percentage test compares the percentage of NHCEs benefitting under the plan to the percentage of HCEs who benefit. If the percentage of NHCEs benefitting is at least 70% of the percentage of HCEs, the plan meets the minimum coverage requirement. A separate coverage test must be performed on the contributions funded under a Section 401(k) arrangement (i.e., elective deferrals), contributions made under Section 401(m) (i.e., post-tax contributions or employer matching contributions), and employer nonelective contributions because these contribution types are treated as separate plans for purposes of minimum coverage testing. Depending upon your employee demographics and plan type, groups of employees may also be required to be treated as a separate plan for minimum coverage purposes, and some employees might be excluded from the test altogether. For purposes of this test, any eligible employee is benefitting with respect to testing Section 401(k) or Section 401(m) contributions. When testing other contributions, employees are benefitting only if they receive a contribution or forfeitures. Note: Section 403(b) plans are not required to perform the minimum coverage test on the elective deferral (pre-tax and/or Roth 403(b)) portion of the plan (eligibility is universally available). However, the minimum coverage requirement does apply to any employer contributions made to a Section 403(b) plan. Average Benefits Test The Average Benefits test is a more complex alternative to demonstrate compliance with the minimum coverage requirement. In general, this test is performed only if the plan does not pass the ratio percentage test described above. Additional details about this test will be provided upon request. Elective Deferral Limit (IRC Section 402(g)) IRC Section 402(g) limits the total amount of deferral contributions credited to a participant under a qualified retirement plan to an indexed amount each calendar year ($18,000 for 2017). A participant s elective deferral limit includes the amount of pre-tax and Roth deferrals contributed to all qualified plans in which he/she participates. Elective deferrals credited to a October

29 participant may exceed the elective deferral limit if that participant is eligible to make catch-up contributions (see definition above). Annual Additions Limit (IRC Section 415(c)) IRC Section 415(c) limits the total amount of contributions and forfeitures that can be credited to a participant under a qualified Section 401(a) or Section 403(b) plan to the lesser of: 1) 100% of compensation, or 2) an indexed amount ($54,000 for 2017) each limitation year. The limitation year generally coincides with the plan year. Rollover contributions do not count toward a participant s annual additions limit. Compensation Nondiscrimination Test (IRC Section 414(s)) The contributions or benefits provided to a participant under the terms of a qualified Section 401(a) plan depend largely on that participant s compensation (e.g., a deferral election of 3% of compensation for one participant results in a greater contribution amount than for another participant who makes the same election, but is paid less). Consequently, the types of compensation included in (or excluded from) a plan s definition of compensation affect participant contribution and/or benefit amounts, creating the possibility of discrimination in favor of HCEs. The rules under IRC Section 415(c)(3) outline four safe harbor definitions of compensation that are deemed nondiscriminatory (see the Compensation Glossary). If the plan uses one of these definitions to determine contributions/benefits under the plan and compliance testing (e.g., the ADP test described below), no additional compensation testing is required. If, however, an alternative compensation definition is used, that definition must meet the requirements of Treasury Reg. Section 1.414(s)-1. As such, the alternative compensation definition may need to pass a separate nondiscrimination test that compares the average total compensation amount included under the plan s alternative definition of compensation for HCEs to the average total compensation included under the plan for NHCEs. ADP/ACP Test (IRC Section 401(k) & Section 401(m)) Elective deferral contributions (pre-tax and/or Roth) to a Section 401(k) plan are nondiscriminatory if the plan satisfies the Section 401(k) nondiscrimination requirement. The Section 401(k) nondiscrimination requirement is met if: The plan satisfies the Actual Deferral Percentage (ADP) Test, The plan meets the traditional design-based safe harbor contribution and notice requirements under Section401(k)(12), or The plan meets the Qualified Automatic Contribution Arrangement (QACA) design-based safe harbor contribution and notice requirements under Section 401(k)(13). The ADP Test is satisfied if: a) The ADP for eligible HCEs for the plan year is not more than the ADP of the eligible NHCEs for the preceding plan year* multiplied by 125%, or October

30 b) The HCE ADP for the plan year is no more than two percentage points greater than the NHCE ADP for the preceding plan year*, and the HCE ADP for the plan year is no more than two times the NHCE ADP for the preceding plan year*. *The plan sponsor may elect to use the percentage for the current plan year rather than the preceding plan year. Sponsors of a Section 403(b) plan are not required to perform ADP testing. Elective deferrals (pre-tax or Roth) are deemed nondiscriminatory because, generally, all employees of the sponsoring organization must be allowed to make elective deferrals to a Section 403(b) plan. Employer matching contributions and voluntary employee after-tax contributions are nondiscriminatory if the plan satisfies the 401(m) nondiscrimination requirement. The Section 401(m) nondiscrimination requirement is met if: The plan satisfies the Actual Contribution Percentage (ACP) Test, The plan meets the traditional design-based safe harbor contribution and notice requirements as described in Section 401(m)(11), or The plan meets the Qualified Automatic Contribution Arrangement (QACA) contribution and notice requirements as described in Section 401(m)(12). The ACP test is satisfied if: a) The ACP for eligible HCEs for the plan year is not more than the ACP of the eligible NHCEs for the preceding plan year* multiplied by 125%, or b) The HCE ACP for the plan year is no more than two percentage points greater than the NHCE ACP for the preceding plan year*, and the HCE ACP for the plan year is no more than two times the NHCE ACP for the preceding plan year*. *The plan sponsor may elect to use the percentage for the current plan year rather than the preceding plan year. Employer matching contributions made to a Section 403(b) plan are subject to the Section 401(m) requirements described above. Top Heavy Test (IRC Section 416) IRC Section 401(a) qualified plans must meet the top-heavy requirements under Section 416 to maintain the plan s taxexempt status. The top heavy requirements restrict Key Employees from accumulating a large percentage of the plan s overall assets. A plan is top heavy if the sum of account balances of Key Employees under the plan is greater than 60% of the sum of the account balances of all employees under the plan. Certain plan designs are exempt from performing the Top Heavy Test: Traditional design-based safe harbor plans that meet both the Section 401(k) and Section 401(m) contribution and notice requirements (i.e., the ADP and ACP safe harbor design under Sections 401(k)(12) and 401(m)(11); and A Qualified Automatic Contribution Arrangement (QACA) that meets the contribution and notice requirements under Sections 401(k)(13) and 401(m)(12). October

31 Note: These plans are not required to perform the top heavy test provided the plan does not fund employer contributions (e.g., profit sharing/discretionary) in addition to the safe harbor contributions. Top Heavy testing is based on the determination date, which is the last day of the plan year. This test result is applicable to the next plan year (e.g., if completing a 2017 top heavy test for a calendar year plan year, the determination date is December 31, 2017 and the test result is applicable to 2018). If a plan is Top Heavy, minimum contribution and vesting requirements apply. IRC Section 403(b) plans are not subject to the top heavy requirements. General Nondiscrimination Tests (IRC Section 401(a)(4)) Qualified Section 401(a) plans must not discriminate in favor of HCEs. More specifically, Section 401(a)(4) requires: Nondiscrimination in the amount of contributions or benefits provided under the plan; Nondiscrimination in the availability of benefits, rights and features provided under the plan; and Nondiscrimination in special circumstances (e.g., plan amendments and terminations). The first two bullet points above are covered in more detail below. General Nondiscrimination in Amounts Test for Defined Contribution Plans (General Test) The contributions or benefits provided under the plan must be nondiscriminatory. As with Minimum Coverage Testing, different contribution types are treated as separate plans for purposes of proving compliance with this general rule. Therefore, contributions funded under a Section 401(k) arrangement (i.e., elective deferrals), contributions made under Section 401(m) (i.e., post-tax contributions and/or employer matching contributions), and employer nonelective contributions must satisfy the general nondiscrimination requirement (Section 401(a)(4)) separately. Plans that meet the ADP (for elective deferrals) and/or ACP (for post-tax and/or employer matching contributions) requirements as described above are deemed to be nondiscriminatory in amount for purposes of Section 401(a)(4), so no additional testing with respect to these contributions is required. Plan sponsors are not required to perform an additional nondiscrimination test for nonelective contributions or benefits if: The plan meets an exemption (e.g., plans that benefit only collectively bargained employees), or The plan s provisions meet a safe harbor as outlined in Treasury Reg. Section 1.401(a)(4). The plan must meet the following to qualify for a safe harbor: Contain a uniform allocation formula (e.g., same percentage of plan year compensation, same dollar amount, an allocation that is integrated in accordance with the permitted disparity rules of Section 401(l)), Base allocations on a nondiscriminatory definition of compensation (as described above), Contain a uniform normal retirement age for all employees, Apply a uniform vesting schedule to all employees, and Apply uniform service crediting rules to all employees. Many plans, especially those that use a prototype plan document, meet the safe harbor and are not required to perform the General Test to prove contributions or benefits are nondiscriminatory. October

32 If a General Test is required, the plan sponsor can choose to perform the test based on either contributions or benefits. Most defined contribution plans test contributions to meet the general nondiscrimination requirement. Alternatively, the plan may test on a benefits basis. The performance of nondiscrimination testing in a defined contribution plan based on benefits rather than contributions is often referred to as cross-testing. To complete the General Test on a contribution basis, the employees are first sorted into rate groups. A rate group consists of one HCE and all other employees (HCE and NHCE) in the plan with allocation rates (i.e., total allocations for the plan year, generally expressed as a percentage of compensation for the plan year) that equal or exceed the HCE s allocation rate. To pass this test, each rate group must satisfy the minimum coverage requirements described above. A Section 403(b) plan must technically meet the general nondiscrimination requirements of Section 401(a)(4) with respect to contributions other than elective deferrals. Since matching contributions are subject to ACP testing, only employers making contributions other than matching contributions that do not fall under an exemption or safe harbor, will be required to perform the General Test. For this purpose, note that a General Test is not necessary for plans sponsored by governmental employers or qualified church controlled organizations, or plans that do not cover any HCEs for the year. Nondiscrimination in the Availability of Benefits, Rights, and Features (BRF Test) IRC Section 401(a)(4) requires benefits, rights, and features provided under the plan to be available on a nondiscriminatory basis. The BRF test is separate from the General Test. A plan that meets a safe harbor with respect to the General Test might still be required to perform the BRF Test to show certain benefits, rights or features are not discriminatory. Benefits, Rights and Features (BRFs) consist of: 1. Optional Forms of Benefit: A distribution alternative available under a plan with respect to an accrued benefit or retirement-type benefit. Different optional forms of benefit exist if a distribution alternative is not payable on substantially the same terms as another distribution alternative. For example, different optional forms of benefit may result from differences in benefit timing, commencement of the benefit, eligibility requirements with respect to the benefit, medium of distribution, election rights and payment schedules. 2. Ancillary Benefits: Includes Social Security supplements, disability benefits, ancillary life insurance, and death benefits under a defined contribution plan. 3. Other Rights or Features: Common protected rights or features include the right to direct investments, the right to a particular form of benefit, the right to make each rate of contributions allowed by the plan (elective deferrals, post-tax, match), and the right to make rollover contributions and elective transfers. The BRF Test is necessary if a plan does not make a benefit, right or feature available to all employees on the same terms. The BRF nondiscrimination requirement is met if the benefit, right or feature is found to be both currently available and effectively available. October

33 The BRF Test for current availability is passed if the group of employees to whom a BRF is available satisfies either: 1. The Ratio Percentage Test, or 2. The Nondiscriminatory Classification Test. A description of the Ratio Percentage Test and the Average Benefit Test are described in the Minimum Coverage section above. The Nondiscriminatory Classification Test is a portion of the Average Benefit Test. Whether a BRF is effectively available is based on the facts and circumstances. October

34 Employee Classifications Question and Answers Q1. WHAT IS THE DIFFERENCE BETWEEN UNION EMPLOYEES AND COLLECTIVELY BARGAINED UNION EMPLOYEES? A. Correctly categorizing collectively bargained employees is important because these employees are considered separately for nondiscrimination testing purposes. Plans or a portion of a plan covering collectively bargained employees are excluded when performing certain testing requirements. A collectively bargained employee is an employee covered by a collective bargaining agreement between bona fide employee representatives and one or more employers, provided there is evidence that retirement benefits were the subject of good faith bargaining. Such an employee is collectively bargained even if he/she does not benefit under any plan of the employer. An employee who is a union member is not a collectively bargained employee for purposes of a qualified retirement plan if that employee is covered under a collective bargaining agreement with the employer, but retirement benefits were not discussed as part of good faith bargaining. Q2. WHO IS A NON-RESIDENT ALIEN? A. Certain employees who are non-resident aliens are treated as excludable when performing nondiscrimination testing. For nondiscrimination testing purposes, an excludable non-resident alien is an individual who is neither a citizen nor a resident of the U.S. who receives no earned income from the employer that constitutes income from sources within the United States. IRS Publication 519 contains additional information with respect to identifying nonresident aliens. This publication is available on the IRS web site ( Q3. WHO IS AN INDEPENDENT CONTRACTOR? A. An independent contractor is an individual who performs services for a company in a non-employee capacity. An employer-sponsored retirement plan can only cover its employees. An independent contractor performing services for that company cannot participate in the plan. In addition, an independent contractor is defined differently than a leased employee (see below). Please refer to IRS Publication 15-A, which can be accessed at the IRS web site ( for additional information about classifying workers as an employee or independent contractor. True Independent Contractors should be removed from your data file. October

35 Q4. WHO IS A LEASED EMPLOYEE? A. A leased employee is any individual who provides services to an organization (the recipient) under an arrangement between the recipient and a leasing organization in a capacity other than as an employee and meets the following requirements: 1. Services of the individual were provided pursuant to one or more agreements between the recipient and the leasing organization. 2. The individual has performed services for the recipient on a substantially full-time basis for a period of at least one year; and 3. The services are under the primary direction or control by the recipient. If the individual meets the requirements above, he/she is considered an employee of the recipient and must be included in the testing data unless: The leased employees do not constitute more than 20% of the recipients non-highly compensated workforce and each leased employee is covered by a qualified money purchase pension plan maintained by the leasing organization that provides the following: A nonintegrated employer contribution of at least 10% of compensation. Full and immediate vesting. Immediate participation for all employees hired by the leasing organization. Please refer to IRS Publication 560, which can be accessed at for additional information about the treatment of leased employees in a qualified retirement plan. Q5. HOW DO EMPLOYEES WHO RESIDE IN PUERTO RICO AFFECT NONDISCRIMINATION TESTING? A. Individuals residing in Puerto Rico or other US possessions, who are considered US residents or citizens, do not meet the criteria of a non-resident alien and, as such, are not excludable employees. These employees must be included in the minimum coverage test and any other applicable nondiscrimination tests (e.g. the ACP test is required if the Puerto Rico resident makes post tax contributions to a U.S. qualified plan or receives employer matching contributions to such a plan). Q6. HOW DOES EXCLUDING CATEGORIES OF EMPLOYEES AFFECT NONDISCRIMINATION TESTING? A. The IRS prescribes several categories of employees who may be excluded from plan participation without affecting minimum coverage results. These categories, including non-resident aliens and collectively bargained employees, October

36 are referred to as excludable employees. Additional categories for 403(b) plans include individuals eligible to defer under another plan of the employer, work study students, and employees normally scheduled to work less than 20 hours per week. Any employee who is not covered in a category specifically described by the IRS as excludable is referred to as a nonexcludable employee. An employer may choose to exclude a nondiscriminatory class or category of nonexcludable employees from participating in the plan by including a specific exclusion in the plan document. Doing this, however, may cause the plan to fail the minimum coverage test because the employer is no longer covering 100% of nonexcludable employees under the plan. Note: 403(b) plans are not required to perform the minimum coverage test on the elective deferral (pre-tax and/or Roth 403(b)) portion of the plan (eligibility is universally available). Q7. WHAT IS USERRA? A. The Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA) contains provisions applicable to plan participants who perform military service. Some actions required under these provisions (e.g., make-up contributions) may require special attention as part of the nondiscrimination testing process. Further details about USERRA requirements related to qualified plan administration can be found in frequently asked questions published by the IRS on its web site at Regarding-USERRA-and-SSCRA. Q8. WHO IS AN OFFICER? A. For purposes of nondiscrimination testing, an "officer" generally means an administrative executive who is in regular and continuous service, not a nominal officer whose administrative duties are limited to a special and single transaction. An employee, who has the title of an officer but not the authority, is not considered an officer. Similarly, an employee with the authority of an officer is treated as an officer when performing nondiscrimination testing, regardless of whether that employee has the title of an officer. The maximum number of officers allowed to be designated as key employees for purposes of top heavy testing is as follows: Total Number of Employees Maximum Number of Officers Less than to % of employees 500 or more 50 When determining the maximum number of officers, the total number of employees includes all employees in the controlled group of corporations, group under common control or affiliated service group of the employer that October

37 sponsors the plan. However, the total number of employees excludes an employee who meets any of the following criteria (see IRC Section 416(i)(1)(A) and IRC Section 414(q)(5) for more details): 1. Is less than age Has not completed 6 months of service 3. Normally works less than 17 ½ hours per week 4. Normally does not work more than 6 months in a year 5. Most employees covered by a collective bargaining agreement Q9. WHAT ARE THE RULES FOR DETERMINING WHO MY HCES ARE? A. The plan document will specify the method to be used to determine HCEs using one of two methods: Option 1: An HCE is anyone who meets one or more of the following: a) Was a 5% Owner in the current determination year; b) Was a 5% Owner in the lookback year; or, c) Earned compensation in excess of $120,000 (indexed for 2016) Option 2: An HCE is anyone who meets one or more of the following: a) Was a 5% Owner in the current determination year; b) Was a 5% Owner in the lookback year; Or, c) Earned compensation in excess of $120,000 (indexed for 2016) and was in the top 20% of all employees ranked by compensation in the lookback year. Q10. WHICH EMPLOYEES ARE INCLUDED IN THE TOP 20% CALCULATION? A. The top 20% calculation is based on all employees of the employer. This means if the company is a member of a controlled group, all the employees of the controlled group must be used. When making the determination of the number of employees in the top-paid group, the following employees are excluded: a) employees who have not completed 6 months of service by the end of the year, b) employees who normally work less than 17 ½ hours per week during the year, c) employees who normally work 6 months or less during the year, d) employees who are not age 21 by the end of the year, and e) non-resident aliens with no US source of income. October

38 Collectively bargained employees are excluded only if they are 90% of the employer s workforce and the retirement plan being tested covers only non-collectively bargained employees. Q11. WHAT ARE THE FAMILY ATTRIBUTION RULES WITH RESPECT TO HCE AND KEY EMPLOYEE DETERMINATION? A. When determining whether an employee meets the ownership requirements to be considered an HCE or Key Employee, the constructive ownership rules under Internal Revenue Code Section 318 must be applied. The section 318 attribution rules are written in terms of stock ownership, so where the organization is not a corporation, consider profit or ownership interest rather than stock ownership. Under the constructive ownership rules, an employee is deemed to own the stock owned by his or her: Spouse (unless legally separated under a divorce decree or a decree providing for separate maintenance); Children (including those legally adopted) Grandchildren Parents The attribution rules apply even if a family member is not an employee of the company. However, an individual must be an employee to be considered an HCE or Key employee. Example #1: Employee % Direct Owner % Constructive Owner % Total Ownership John 6% 3% 9% Mike (John s son) 3% 6% 9% Jane (John s daughter) 0% 6% 6% Mike and Jane are deemed to own John s shares of stock and would be considered HCEs if employed by the company. John is also deemed to own Mike s shares of stock; however, Jane would not be deemed to own Mike s shares of stock since attribution does not apply between siblings. Example # 2: Employee % Direct Owner % Constructive Owner % Total Ownership Jim 4% 3% 7% Nancy (Jim s wife) 3% 4% 7% Jim is deemed to own Nancy s shares, and Nancy is deemed to own Jim s shares. Therefore, total ownership (directly and indirectly) for both Jim and Nancy is 7%, making them both HCEs. October

39 The constructive ownership rules are very complex. Prudential cannot provide legal advice and recommends that Plan Sponsors seek legal counsel in making determinations under these rules. Compensation Q12. WHAT DEFINITION OF COMPENSATION IS USED TO PERFORM THE ADP/ACP TEST? A. The plan document specifies which definitions of compensation may be used. Some plan documents may also contain a provision separate from the definition of compensation that excludes compensation earned prior to the employee becoming eligible to participate. Below are compensation definitions that may apply to your plan: 1. Any of the four basic definitions noted in the Compensation Glossary. 2. A safe harbor modified version of the four basic definitions. Specifically, you can choose one or more of the following modifications: a. Exclude fringe benefits (cash and noncash), reimbursements or other expense allowances, moving expenses, deferred compensation, and welfare benefits. All of these items must be excluded to be a safe harbor modification. b. Exclude all elective deferrals. All types of elective deferrals must be excluded to be a safe harbor modification. c. Exclude any portion of the compensation paid to some or all the HCEs (e.g. bonuses). 3. A definition other than described in 1. or 2. above if it is "reasonable" and satisfies the compensation ratio test prescribed under the regulations. Q13. HOW DO I DETERMINE THE COMPENSATION AND CONTRIBUTIONS INCLUDED FOR ADP/ACP TESTING PURPOSES? A. Generally, compensation paid during the testing period and any related pre-tax and employer matching contributions will be included for ADP/ACP testing purposes. (Please see the Compensation Glossary for the treatment of amounts paid after an employee s severance from employment.) The date for which services are performed and the date on which an employee is paid for the services could be different. Example: Testing period: 1/1/ /31/2017 Pay period end date: 12/31/2017 Paycheck date: 1/6/2018 October

40 Since the employees are paid on 1/6/2018, the compensation and any related pre-tax and employer matching contributions for that pay period would not be included in the ADP/ACP test for the 1/1/ /31/2017 testing period even though the pay period ended during the testing period. The compensation and contributions would instead be included in the ADP/ACP test for the 2018 testing period. If the plan has adopted the first few weeks rule as part of the final 415 amendment, amounts paid within the first few weeks of a limitation year (generally the same as the plan year) can be attributed to the prior limitation year. In the example above, the compensation paid on 1/6/2018 may be included in the 2017 test. Please review the plan s document to determine if this rule applies to your plan. Q14. WHAT COMPENSATION DEFINITION IS USED TO DETERMINE HCES? A. Generally, the plan document specifies which compensation definition to use. One of the four definitions outlined in section 415(c)(3) plus all deferral contributions must be used to determine HCEs. The four definitions are: General 415 Simplified 415 W-2 Wages 3401(a) Wages See the "Compensation Glossary" in this booklet for a list and description of the items included in each of these definitions. Q15. WHAT COMPENSATION MUST BE USED TO ALLOCATE A TOP HEAVY MINIMUM CONTRIBUTION? A. Top Heavy Compensation is any section 415(c)(3) Compensation as defined by your Plan Document. Safe Harbor and EACA Plan Designs Q16. WHAT IS A SAFE HARBOR PLAN DESIGN? A. The Small Business Job Protection Act of 1996 (SBJPA) created a safe harbor 401(k) plan design that eliminated the need to perform the ADP test if certain plan design and employee notice requirements are met. SBJPA also created a safe harbor design that would automatically satisfy the ACP test with respect to employer matching contributions. The final 401(k) and 401(m) regulations issued by the IRS in December 2004 incorporated guidance issued in Notice and and added several new rules impacting safe harbor plan design. October

41 The safe harbor established by SBJPA is now often referred to as a traditional safe harbor plan design. The Pension Protection Act of 2006 (PPA) added a new safe harbor plan design, Qualified Automatic Contribution Arrangement (QACA). Similar to the traditional safe harbor plan design, the ADP and ACP tests are automatically satisfied if certain plan design and employee notice requirements are met. To find a summary of the Safe Harbor Design requirements, please reference the April 2000 Pension Analyst titled Improved ADP and ACP Safe Harbor Designs and the June 2007 Pension Analyst titled, PPA: Pension Protection Act of 2006 Makes Additional Changes to Defined Contribution Plan Rules for 2008 and Beyond. You can obtain a copy of these documents on the Internet at and or call your Prudential representative. Q17. IF MY PLAN USES A SAFE HARBOR DESIGN, WILL IT REQUIRE ANY OTHER TESTING? A. Yes, plans that meet the ADP and ACP safe harbor requirements must still satisfy other non-discrimination tests such as minimum coverage, top-heavy*, compensation, annual additions, and if applicable, the general nondiscrimination in amounts and non-discriminatory availability of benefits, rights and features. * A top-heavy exemption applies on a year-by-year basis, and only if the plan consists solely of a safe harbor 401(k) arrangement (either a traditional safe harbor or a QACA) and any matching contributions under the plan meet the ACP safe harbor (traditional or QACA) requirements. Q18. WHAT IS AN ELIGIBLE AUTOMATIC CONTRIBUTION ARRANGEMENT (EACA)? A. An EACA is an automatic enrollment arrangement that is not exempt from ADP/ACP testing, but provides other advantages to the plan sponsor. Unlike a QACA, the sponsor of an EACA may: Distribute automatic contributions made to the plan within 90 days of the effective date of a participant s first automatic contribution, regardless of the participant s age or ability to take standard in-service distributions; and Distribute excess contributions and excess aggregate contributions to correct failed ADP and ACP tests within 6 months of the end of the plan year without incurring a 10% excise tax. The final rules clarify that an EACA is not required to reflect both special provisions. It may reflect both or just one of the provisions. Q19. WHAT MUST I DO TO USE AN EACA DESIGN? A. For plan years beginning after December 31, 2007, an automatic enrollment arrangement is an EACA if the plan: October

42 Provides for deferral contributions to be made automatically at a specified percentage of compensation, unless a participant specifically elects not to participate or elects a different deferral rate; Provides notice of the automatic contribution arrangement to all affected participants. Contributions Q20. WHAT ARE CATCH-UP CONTRIBUTIONS? A. If provided by the plan document, catch-up contributions are elective deferral (pre-tax and Roth) contributions made by eligible participants that are over and above certain limits of the Internal Revenue Code and/or of the plan document. To be eligible for catch up contributions, an employee must be eligible to participate in the plan and be age 50 or older within the calendar year in which the contributions are attributable. Catch-up contributions enable participants who are age 50 and older to catch-up in their retirement savings by allowing additional contributions to retirement plans. These contributions are disregarded for purposes of nondiscrimination testing. 15 Year Rule Catch-up (403(b) Plans Only) Elective deferrals made by a participant who has at least 15 years of service that exceed one of the limits above, and are reclassified as catch-up contributions, up to the lesser of: $3,000, $15,000 minus prior year 15 Year Rule catch-up contributions, or $5,000 times the employee s years of service minus prior year elective deferrals. Q21. HOW ARE DOLLARS IDENTIFIED AS CATCH-UP CONTRIBUTIONS? A. Catch-up contributions are those made by a participant who is at least age 50 and those contributions: Exceed the Plan's deferral limit; Exceed the 402(g) limit ($18,000 for 2017); Exceed the 415 Annual Additions limit (lesser of: $54,000 or 100% of compensation for 2017); and/or Are made by a participant whose account balance includes an ADP excess. Please note, if you are submitting contributions on your testing file, you must include catch-up contributions. Q22. WHAT ARE DESIGNATED ROTH ACCOUNTS? A. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) authorized the establishment of Roth 401(k) accounts beginning January 1, These rules allow for a participant to irrevocably designate some of their elective deferral contributions to be treated as Roth contributions. Unlike traditional pre-tax deferrals which are not subject to federal income tax when they are contributed to the plan, Roth contributions will be included in October

43 the employee s current taxable income. Generally, Roth contributions will not be taxable when they are later distributed from the plan. Q23. HOW DO DESIGNATED ROTH CONTRIBUTIONS AFFECT NONDISCRIMINATION TESTING? A. While Roth contributions are treated as post-tax contributions for income tax purposes, they will be treated as pretax contributions for purposes of the plan. This means that a participant s combined pre-tax and Roth contributions may not exceed the $18,000 maximum deferral limit ($24,000 for catch-up eligible participants) for the 2017 calendar year. In addition, Roth contributions must be included in the Actual Deferral Percentage (ADP) Test. Sponsors of a 403(b) plan are not required to perform ADP testing. Elective deferrals (pre-tax or Roth) are deemed nondiscriminatory because all employees of the sponsoring organization must generally be allowed to make elective deferrals to a 403(b) plan. Q24. WHAT ARE FORFEITURES? A. Forfeitures are nonvested employer monies moved into a suspense account generally when an employee incurs a severance from employment and receives a full distribution of the vested account. The balance in the forfeiture account should be used each year in the manner specified in the plan document. Q25. DO FORFEITURES IMPACT NONDISCRIMINATION TESTING? A. If the forfeiture monies are reallocated to participant s accounts as additional contributions, those amounts may need to be included in nondiscrimination testing. Q26. CAN A LIMIT BE PLACED ON THE AMOUNT AN HCE CAN CONTRIBUTE TO THE PLAN? A. Yes, if the plan document allows, a Plan Sponsor may administratively limit the amount of employee pre-tax or post-tax contributions made to the plan by an HCE. If the plan document does not specifically provide the Plan Administrator with the ability to administratively limit the HCEs employee pre-tax or post-tax contributions, the plan may not be able to consider the imposed limit as a plan limit. Q27. HOW DO I KNOW IF AN EMPLOYER CONTRIBUTION MAY BE ALLOCATED TO PARTICIPANTS? A. The plan document will outline which types of employer contributions may be made to the plan, and how they should be allocated to participants. Some employer contributions are discretionary in nature, meaning the employer October

44 has discretion as to if a contribution will be made from year to year. Other employer contributions are fixed in nature, meaning the employer must allocate the contribution as outlined in the plan document. Q28. WHAT IS THE DIFFERENCE BETWEEN AN EMPLOYER MATCHING CONTRIBUTION AND AN EMPLOYER NONELECTIVE CONTRIBUTION? A. An employer matching contribution is dependent upon a participant making a pre-tax or post-tax employee contribution into the plan; whereas, an employer nonelective contribution is not dependent upon the participant making any type of employee contribution into the plan. An employer nonelective contribution may also be referred to as a profit sharing contribution. Q29. WHAT IS THE DEADLINE FOR ALLOCATING ANNUAL EMPLOYER MATCHING OR NONELECTIVE CONTRIBUTIONS TO PARTICIPANTS ACCOUNTS? A. While certain annual employer contributions must be allocated to participants accounts by 12 months after the end of the plan year, if the employer wishes to take a deduction for a specific tax year, the deadline may be much earlier. For an employer to take a deduction for a prior taxable year, the actual payment for the contribution must be made by the employer s federal tax filing deadline, including any extensions. In addition, the contribution must be allocated to that prior tax year, or in the event of matching contributions, must be related to employee deferrals for that prior tax year. Example: Both the plan year and the employer s taxable year end 12/31/2017. The employer, a corporation, has filed for extension of the tax filing deadline to 9/15/2018. The employer makes a nonelective contribution on 4/15/2018 allocated for the plan year ending 12/31/2017. Since the contribution is made prior to the tax filing deadline (including extension) of 9/15/2018 and the contribution was made for the plan year ended 12/31/2017, the contribution would be considered for the employer s 2017 tax year. Since Prudential does not provide tax advice, please review the timing of the deduction with your tax advisor. ADP/ACP & Minimum Coverage Testing Q30. PLEASE EXPLAIN EACH METHOD FOR DETERMINING THE MAXIMUM HCE ACTUAL DEFERRAL PERCENTAGE (ADP) AND ACTUAL CONTRIBUTION PERCENTAGES (ACP). A. ADP and/or ACP testing can be run based on either Current Year or Prior Year Non-Highly Compensated percentages. For plans electing the Current Year Method, the current year s HCE percentages are compared to the current year s non-hce Actual Deferral Percentages and Actual Contribution Percentages. October

45 Current Year Testing Method Pros HCE limit can reflect successful current year NHCE enrollment campaigns or other positive changes in current year NHCE participation. Test failures can be corrected via corrective QNECs after testing is completed. Cons Current year HCE limit is NOT a set target and is subject to NHCE participation during the testing year. If the sponsor s intent is to reduce the risk of failure, or minimize a test failure, the plan may need to perform mid year testing. Generally, a plan must use this method for a minimum of 5 years before it can change to the Prior Year Method. If the plan later changes to the Prior Year Method, it must recalculate ADP/ACP to avoid double counting of QNECs/QMACs and deferrals under the borrowing method. For plans electing the Prior Year Method, the current year s HCE percentages are compared to the prior year s NHCE Actual Deferral Percentages and Actual Contribution Percentages. For example: In 2015, the Actual Deferral Percentage for the non-hces was 5.4%. For the 2017 plan year the HCEs could be limited to contribute a maximum of 7.4% and still pass the test. Alternatively, some HCEs could be allowed to contribute more than the 7.4% if the average for the group was 7.4% or less. If this method is used, the test still needs to be performed to prove and document that the plan passed. Prior Year Testing Method Pros IRS standard approach. Can adopt Current Year Method at any time, within the plan year. Can calculate HCE limit for current year as soon as prior year testing is complete. Current year HCE limit is a set target, not a moving target subject to changes in current year NHCE participation. Plan sponsor may limit each HCE to the maximum percentage permitted, and thereby avoid testing failures. Cons Increases to NHCE enrollment will not be reflected until the following year. Cannot correct test failures via corrective QNECs after testing is completed. Ongoing QNECs made to NHCEs do not count until following year s test. Plan coverage changes may require recalculation of prior year NHCE ADP/ACPs. Failure to provide a Discretionary Match in one plan year may cause an ACP failure in the following plan year. October

46 If using the Prior Year Method, plans that were effective in the plan year being tested, or plans that added a source that would now require a first-time ADP or ACP test, may adopt one of the following options: 3% may be used for the NHCE ADP and ACP percentages. The current year averages may be used for the first prior year test. Q31. WHAT ARE THE RULES FOR SWITCHING TESTING METHODS? A. Generally, the plan will be locked in to the method stated in the document. The method can only be changed under the following circumstances: Switching from the Prior Year method to the Current Year method can be done through a plan amendment adopted by the end of the plan year being tested. Switching from the Current Year method to the Prior Year method can be done through a plan amendment adopted by the end of the plan year being tested if one of the following apply: 1. The plan is not the result of the aggregation of two or more plans, and the current year testing method was used under the plan for each of the five plan years preceding the plan year of the change (or if lesser, the number of plan years the plan has been in existence, including years in which the plan was a portion of another plan). 2. The plan is the result of the aggregation of two or more plans, and for each of the plans that are being aggregated, the current year testing method was used for each of the five plan years preceding the plan year of the change (or if lesser, the number of plan years since that aggregating plan has been in existence, including the years in which the aggregating plan was a portion of another plan). 3. If an acquisition or disposition of a related group member, or a merger, spin-off, asset or stock acquisition, or similar transaction which results in the acquisition or disposition of employees occurs, and because of the transaction, the employer maintains both a plan using the prior year method and the current year method, the plan using the current year method may switch to the prior year method within the transition period. The transition period begins on the date of the event and ends on the last day of the first plan year beginning after the date of the event. Q32. CAN I USE A DIFFERENT TESTING METHOD FOR MY ACP TEST THAN WHAT I USE FOR THE ADP TEST? A. The final 401(k) and 401(m) regulations confirmed that a plan may adopt different methods for its ADP and ACP tests. This provision may be helpful in situations where the plan provides a discretionary match that may not be funded every year, but the plan wishes to take advantage of the prior year method for testing elective deferrals. October

47 However, this must be allowed by your plan's document and there are some additional things to consider. For instance, if different testing methods are used, the plan cannot "borrow" deferrals to pass ACP testing or "borrow" qualified matching contributions (QMACs) for the ADP testing. Sponsors of a 403(b) plan are not required to perform ADP testing. Elective deferrals (pre-tax or Roth) are deemed nondiscriminatory because all employees of the sponsoring organization must generally be allowed to make elective deferrals to a 403(b) plan. Q33. WHAT IS OTHERWISE EXCLUDABLE TESTING AND CAN MY PLAN USE THIS METHOD OF TESTING? A. If the plan allows more liberal eligibility requirements than the maximum of age 21 or one year of service as permitted by the IRS, the plan may benefit from the otherwise excludable testing option. This testing option disaggregates participants into two testing groups, those participants who have not reached age 21 and/or have not completed one year of service and those participants who have attained the age of 21 and have 1 year of service. If the plan disaggregates otherwise excludable participants for minimum coverage purposes, there are two options for treating these participants under the ADP/ACP test. Under the early participation rule, the plan can disregard otherwise excludable NHCEs from the ADP/ACP test. Under the second option, disaggregated plans testing, two ADP/ACP tests are run, one covering those participants who have reached age 21 and one year of service and once covering those who have not. Q34. PLEASE EXPLAIN THE THREE-YEAR TESTING CYCLE AND THE 'SNAPSHOT' METHOD AS IT RELATES TO MINIMUM COVERAGE TESTING. A. A plan sponsor may demonstrate compliance with the minimum coverage testing based on its workforce on a single day during the plan year. This is referred to as a 'snapshot day'. The 'snapshot day' chosen must reasonably represent the employer's workforce and the plan's coverage throughout the plan year. The testing data only includes individuals employed on the 'snapshot' day. Another method plan sponsors may use is the three-year testing cycle for minimum coverage testing. If a plan meets the requirements of minimum coverage testing using either year-end data or snapshot data, it may rely on those results for the following two plan years if there are no significant changes to the plan provisions, the plan sponsor's workforce, or its compensation practices. The determination as to whether a change is significant depends upon the relative margin by which the plan passed the coverage requirements in the last year in which the plan was tested and the likelihood that the change would cause the plan to fail coverage testing. October

48 Top Heavy Testing IRC 403(b) plans are not subject to the top heavy requirements. Q35. WHAT IS A TOP-HEAVY PLAN? A. A plan is considered top-heavy for any plan year if, as of the "determination date," the sum of the account balances of participants who are key employees exceeds 60% of the sum of the account balances for all employees under the plan. A plan may also be a top-heavy plan if it is part of a top-heavy group. The "determination date" is either the last day of the preceding plan year; OR, in the case of a new plan, the last day of the first plan year. IRC 403(b) plans are not subject to the top heavy requirements. Q36. WHAT IS A REQUIRED AGGREGATION GROUP? A. All plans of the employer in which a Key Employee participates at any time during the determination period; or any other of the employer s plans that are combined with any plan in which a Key Employee participates to meet the IRS coverage and general nondiscrimination requirements. IRC 403(b) plans are not subject to the top heavy requirements. Q37. WHAT ARE ROLLOVER/TRANSFERS FOR TOP-HEAVY TESTING PURPOSES? A. Related Rollovers and Transfers are rollovers or transfers either made to a plan maintained by the same employer or not initiated by an employee. Once related rollovers are identified, all other rollovers will assume to be unrelated. Note: All related rollovers and transfers must be included in the account balances for top heavy testing. IRC 403(b) plans are not subject to the top heavy requirements. Q38. ARE THERE ANY SPECIAL RULES WHEN TESTING FOR TOP-HEAVY STATUS? A. For purposes of determining the top-heavy status of a plan, the following special rules apply: 1. Account balances of each employee as of the determination date must be increased to reflect any amounts distributed to the employee within the 1-year period ending on the determination date (5-year period for in-service distributions); 2. In the case of a new plan, account balances must be increased by contributions made after the determination date that are allocated for the first plan year; October

49 3. Account balances of participants who have not performed any services for the employer during the 1-year period ending on the determination date must be disregarded; 4. Account balances of participants who were key employees prior to the look back year, but were not key employees during the look back year, are disregarded. 5. Amounts rolled over (or otherwise transferred) between plans of the same group are included in the employee's account balance of the receiving plan but are disregarded by the distributing plan. If the rollover or transfer is made between plans of unrelated employers, the rollover distribution amount must be added back to the distributing plan for a one-year period ending on the determination date and generally is disregarded by the receiving plan. IRC 403(b) plans are not subject to the top heavy requirements. Q39. ARE THERE SPECIAL TOP-HEAVY RULES FOR OTHER TYPES OF RETIREMENT PLANS? A. Yes, special rules apply for Governmental, 403(b), Collectively-Bargained, Multiple Employer and Defined Benefit Plans. Governmental Plans, under IRC 414(d), are exempt from the top-heavy rules. 403(b) Plans are exempt from the top-heavy rules. The top-heavy minimum contribution rules and vesting rules of IRC 416 do not apply to any employee included in a unit of employees covered by a collective-bargaining agreement in which retirement benefits were the subject of good faith bargaining. (See IRC 416(i)(4) and Regs , T-3 and T-38) A multiple employer plan is subject to the top-heavy rules on an employer by employer basis. If one member of the multiple employer plan is top-heavy, the top-heavy rules will only apply to that one member. It is extremely important to note that the failure for one employer to meet the top-heavy rules can disqualify the entire multiple employer plan. The determination of whether a terminated or frozen plan is top-heavy is the same as for any other plan. For IRC Section 416 purposes, a terminated plan is a plan that has been formally terminated, no longer credits service for vesting, and distributed or is distributing, all plan assets as soon as administratively possible. The terminated plan must be aggregated with other plans of the employer if it was maintained within the last five years ending on the determination date of the plan under examination. Note: Distributions from the terminated plan which have taken place within the last one year ending on the determination date must be added back in determining whether the required aggregation group is topheavy. If the required aggregation group is, in fact, top-heavy, no further contributions or accelerated vesting is required for participants in the terminated plan. However, the successor plans must satisfy the top-heavy rules. October

50 If you maintain a Defined Benefit (DB) Plan, please seek guidance from your actuary or benefits consultant to determine the top-heavy rules specific to this type of plan. IRC 403(b) plans are not subject to the top heavy requirements. Q40. WHY AND HOW DO I DETERMINE MY TOP-HEAVY EMPLOYEE LIFE COUNT TO LIMIT THE NUMBER OF OFFICERS IN MY TOP-HEAVY TEST? A. The number of individuals that may be considered key employees due to their officer status is limited to: Plans with fewer than 30 employees: no more than 3 individuals should be considered Key Employees by the officer definition. Plans with greater than 30 but fewer than 500 employees: no more than 10% of the employees should be considered Key Employees by the officer definition. Plans with more than 500 employees: no more than 50 individuals should be considered Key Employees by the officer definition. In calculating 10% of employees to determine the number of officers that are Key Employees, the following employees can be excluded: any employee who had less than 6 months of service; any employee who normally works less than 17 ½ hours per week; any employee who does not work more than 6 months during the year; any employee under the age of 21; any employee who is a non-resident alien with no U.S. income; and any employee covered by a collectively bargained agreement if 90% or more of all employees are covered by collective bargaining agreements and the plan does not benefit any employees covered by a collective bargaining agreement. Note: The above limits are for the maximum number of officers who are Key Employees. There is no minimum number of officers that must be included as Key Employees. IRC 403(b) plans are not subject to the top heavy requirements. October

51 Related Employers Q41. WHAT IS A "QUALIFIED SEPARATE LINE OF BUSINESS" (QSLOB)? A. A 'Line of Business' (LOB) is a portion of an employer's total business. One LOB is distinguished and identified from other LOBs based on the property and services each one provides to its customers. To meet the 'Separate Lines of Business (SLOB) status, each LOB must meet four 'separateness' criteria: 1. Must be formally organized as a separate organizational unit or group of separate organizational units within the employer on every day of the testing year. 2. Must be a separate profit center or group of separate profit centers within the employer on every day of the testing year. 3. Must have separate employee workforce. 4. Must have separate management. In addition to meeting the 'separateness' requirements, to be considered a Qualified Separate Line of Business, the following requirements must be met. The SLOB must have at least 50 employees on each day of the testing year who do not provide services to any other LOB; The employer must notify the IRS that it is operating as a QSLOB for the calendar year via form 5310-A; and The SLOB must satisfy administrative scrutiny under one of six safe harbor tests or by IRS determination. The rules for determining QSLOB status are very complex. Please consult legal counsel to assist with making this determination. Q42. HOW DOES A QSLOB DETERMINATION AFFECT NONDISCRIMINATION TESTING? A. The minimum coverage requirements of 410(b) are applied separately to a QSLOB. To apply these requirements separately though, the plan must also satisfy a gateway test to demonstrate that the plan covers a nondiscriminatory group of employees on an employer-wide basis. Q43. WHAT IS A CONTROLLED GROUP? A. A controlled group is a related employer group. The types of controlled groups are: Parent /Subsidiary Relationship- parent company owns 80% or more of the voting stock or value of all classes of stock with one or more entities. October

52 Brother/Sister Relationship- two or more entities are owned by the same five or fewer individuals and the same five or fewer individuals own at least 80% of the voting stock or value of all classes of stock in the entities and common ownership equals more than 50%. Combined Group- there is a group of three or more corporations which: 1) Two or more corporations are part of a parent/subsidiary and, 2) Two or more in that controlled group are part of a brother/sister; and 3) One corporation in the group is both the parent corporation and a parent/subsidiary controlled group and part of a brother/sister controlled group. While the controlled group rules are written in terms of stock ownership, these rules may apply to unincorporated businesses as well. When considering unincorporated business, substitute ownership or profit interest for the term stock. The rules to determine controlled group status are very complex. If you believe the controlled group rules may apply, please consult legal counsel to assist with making this determination. Prudential will perform nondiscrimination testing only for the retirement plan for which it provides recordkeeping services. Therefore, you will not be able to rely on these test results if the plan must be aggregated with another qualified plan for one or both plans to pass. Q44. WHAT IS AN AFFILIATED SERVICE GROUP? A. An affiliated service group is another type of related employer group. This type of related employer group refers to two or more employers that have a service relationship and, potentially, an ownership relationship. Affiliated service groups can fall into one of three categories: A-org groups, B-org groups, and management groups. While the affiliated service group rules are written in terms of stock ownership, these rules may apply to unincorporated businesses as well. When considering unincorporated business, substitute ownership or profit interest for the term stock. The rules to determine affiliated service group status are very complex. If you believe the affiliated service group rules may apply, please consult legal counsel to assist with making this determination. Prudential will perform nondiscrimination testing only for the retirement plan for which it provides recordkeeping services. Therefore, you will not be able to rely on these test results if the plan must be aggregated with another qualified plan for one or both plans to pass. Q45. HOW DO THE RELATED EMPLOYER RULES AFFECT NONDISCRIMINATION TESTING? A. Employers related under the controlled group or affiliated service group rules are considered a single employer for qualified plan purposes. This means that all employees of the employer need to be considered for nondiscrimination testing purposes regardless of whether those employees participate in your plan. October

53 If a controlled group or affiliated service group impacts your plan, you will want to ensure Prudential is aware of all the controlled group or affiliated service group members and all qualified plans maintained by the members. Q46. HOW DOES AN HCE PARTICIPATING IN MULTIPLE PLANS SPONSORED BY THE SAME OR BY RELATED EMPLOYERS AFFECT NONDISCRIMINATION TESTING? A. If an HCE participates in more than one plan sponsored by the same or related (under the controlled group or affiliated service group rules) employers, the salary deferrals and/or voluntary after-tax and employer matching contributions to all plans are combined for ADP/ACP testing of each plan. For example, if Employee A earns $200,000 and defers $2,000 to one plan and $5,000 to another, the aggregate ADP of 3.5% must be used in testing each plan. In effect, that employee's total deferrals in both plans impact the deferrals available to all other HCE(s). Notes: 1. If two or more plans are permissively aggregated for purposes of satisfying the minimum coverage requirements under Section 410(b) of the IRC, then they must be aggregated for ADP and ACP testing. 2. Prudential will perform nondiscrimination testing only for the retirement plan for which it provides recordkeeping services. Therefore, you will not be able to rely on these test results if the plan must be aggregated with another qualified plan for one or both plans to pass. Determining whether the employer or its plans are part of a controlled group or affiliated service group is a complex issue and will impact how compliance tests are performed. As plan sponsor, you may want to consult with your plan s legal advisors to determine if this classification is applicable to your plan. Q47. WHAT DATA SHOULD BE SENT TO PRUDENTIAL IF A MERGER, ACQUISITION OR SPIN-OFF OCCURS DURING THE PLAN YEAR? A. If your company was involved in a merger, acquisition or spin-off during the plan year, this may have a substantial impact to your plan s nondiscrimination testing. It is important that you provide specific details about the transaction to Prudential to ensure the nondiscrimination testing for the impacted year is completed appropriately. These details may include, but are not limited to: Type of transaction (stock or asset purchase or disposition), Effective date of transaction, Names and EINs of companies involved in transaction, Other DC plans terminated or merged because of the transaction, and Other DC plans maintained after the effective date of the transaction. October

54 The IRS has provided little guidance on how to determine HCEs and perform the ADP/ACP test in the year of a plan merger or spin-off. If your plan was involved in either type of transaction, you will need to provide us with instructions on how to perform these tests. Since every merger, acquisition or spin-off situation can vary, you may want to consult with your plan s legal advisors to determine your options. Q48. WHAT IS A CORRECTION FOR A MISSED DEFERRAL OPPORTUNITY/FAILURE TO MAKE AUTOMATIC CONTRIBUTIONS FOLLOWING REVENUE PROCEDURE ? A. If the plan failed to make automatic contributions and funded missed deferrals during or related to the testing year, additional information may be necessary to ensure contributions are correctly captured for testing and/or match calculation purposes. For more information, please review the attached Prudential Retirement s ( Prudential ) Pension Analyst titled, IRS revises correction programs, October

55 Testing Results and Corrective Distributions When testing results are available, we will send you an with a link to the Testing Results tab. Please complete the following steps: Click on each Test/Limit to download the files for your records. Two years of testing results will be available on the Sponsor Center. Review the Additional Info for the IRS corrective methods for the failed test. Review the Result column and take action on each Failed item. The Further Steps column has a link to See Corrective Distributions that will guide you on how to approve the corrective distributions for processing. Select the desired action: Process all corrective distributions on date indicated* Process all corrective distributions now (it will be as of the current date)* - Select the check box to process these corrective distributions and choose Submit * If one of the two options above is selected, checks will be processed and sent directly to employees by Prudential. If special arrangements need to be made, please contact your Compliance Testing Specialist to make those arrangements before clicking Submit. Do not process distributions - Please enter an explanation and call your Client Service Manager or Compliance Testing Specialist Click Submit to process the corrective distributions. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions

56 For further information regarding Corrective Distributions for the various tests, please click on the Summary of corrective alternatives link. Quick Links This box has links to reference documents: Events Calendar - a snapshot of compliance testing events and deadlines for the year. Compliance Testing Guide - provides insight with respect to the online compliance testing process; annually updated with dates, data specs, compensation glossary, definitions, Q&A. Compliance Testing Data Template links to a template in the standard data file format. Corrective Action Guide describes testing failures and corrective actions. IRS Corrections Programs - links directly to IRS website for self-correction information. Form 5330 & Instructions - links directly to IRS website for Form 5330, for testing done after the recommended period. If you have any questions about completing your plan s compliance testing requirement, please contact your Compliance Testing Specialist at , or Compliance.Testing.Reporting@prudential.com. Please include your Plan ID in the subject line. October Prudential Financial, Inc. and its related entities. Prudential, the Prudential logo, the Rock symbol and Bring Your Challenges are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions