Correcting 401(k) Testing and Errors The New EPCRS. Charles D. Lockwood, J.D., L.LM ASC Avaneesh Bhaget, Group Manager, IRS

Transcription

1 Correcting 401(k) Testing and Errors The New EPCRS Charles D. Lockwood, J.D., L.LM ASC Avaneesh Bhaget, Group Manager, IRS 1

2 Charles D. Lockwood, J.D., L.LM ASC Charles D. Lockwood, J.D., and LL.M. (Taxation), has over 20 years experience in the employee benefits field. Charles is currently a principal with the ASC Institute (ASCi). Prior to joining ASCi, Charles was a principal with the pension consulting firm Global Benefit Advisors, LLC (GBA). Prior to entering private consulting, Charles worked in the Employee Plans Division in the National Office of the Internal Revenue Service (IRS) as a Tax Law Specialist. Charles also was a Vice President with Pension Publications of Denver, Inc. (PPD) and a senior consultant with the benefit consulting practice of Coopers & Lybrand. 2

3 Avaneesh Bhagat, Group Manager, IRS Avaneesh is the Group Manager for the Voluntary Compliance Group in El Monte, California. His responsibilities include assisting with the resolution of applications made under VCP, assisting with the development of the revenue procedure relating to the correction programs for qualified plans, providing information on correction programs, and responding to inquiries relating to plan corrections and potential VCP applications. Avaneesh has worked with the examination, determination letter and voluntary compliance functions of the IRS' Employee Plans Division since

4 Plan Restatements Current PPA restatement period for pre-approved plan adopters ends April 30, 2016 To avoid numerous individual late amender filings = IRS will allow financial institutions and other service providers to submit for umbrella closing agreement to correct non-amender failure for all ERs as a group Umbrella closing agreement parameters: Minimum of 20 plans covered by closing agreement $10,000 fee for the first 20 plans plus $250 for each additional plan. Maximum amount: $50,000 (similar to the Group Submission fee arrangement under VCP) 4

5 Plan Restatements Service provider must certify they have record of: ER s affirmative agreement to participate in the closing agreement program ER s timely adoption of EGTRRA document or proof of correction Execution of PPA restatement using the service provider s pre-approved document Financial institutions or service providers that apply and are approved must provide list of ERs covered by closing agreement by later of 120 days from closing agreement execution date or May 1,

6 Rev. Proc New correction option for elective deferrals (other than automatic contributions) If missed deferrals begin within 3 months from date of failure = no corrective QNEC required If after 3 months (but before end of 2 nd PY) = corrective QNEC equal to 25% (instead of 50%) of missed deferrals ER must make QNEC for missed match, plus earnings, by end of second PY following failure ER must send 45-day notice to affected EEs 6

7 Rev. Proc Provides new SH correction method for failure to implement automatic contributions on a timely basis No corrective QNEC required if correct error within 9½ months after end of PY or date ER is notified of failure, if earlier o Ties into filing deadline for Form 5500 ER must make QNEC for missed match, plus earnings, by end of 2 nd PY following failure o Must send notice to affected EEs detailing correction within 45 days after correction 7

8 Rev. Proc Modifies correction process for overpayments o Allows ER to make plan whole (including applicable earnings) without demanding repayment from participant o If applicable, ER may make retroactive amendment allowing for distribution from plan EPCRS allows plan to correct improper hardship distribution or loans by amending plan to add hardship distributions or loans Must ER make plan whole if improper hardship distribution is made to participant and participant does not repay distribution? 8

9 Documentation Requirement Is documentation required for SH hardship? o In recent Employee Plans News, IRS stated plan sponsor must obtain and keep hardship records o Failure to have records available for examination is a qualification failure corrected under EPCRS o Records should be retained in paper or electronic format, including documentation that substantiates EE s immediate and heavy financial need Not sufficient for plan participants to keep their own records of hardship distributions 9

10 Documentation Requirement Employee Plan News article also advises ERs to keep documentation on plan loans o Records should be maintained in paper or electronic format for each plan loan granted to a participant, including evidence of loan application o If applicable, documentation verifying loan proceeds were used to purchase primary residence If loan will exceed 5 years, should receive documentation regarding purchase of primary residence before loan approved Self-certification not permissible to document eligibility for primary residence loan exception 10

11 ADP/ACP Test 11

12 Coverage and Nondiscrimination Limits extent to which plans can be designed in favor of HCEs = must pass both coverage and nondiscrimination tests every plan year Coverage measures relative coverage of HCEs and NHCEs at plan level Nondiscrimination measures level of benefits provided to HCEs and NHCEs o 401(a)(4) nondiscrimination test = ER contributions o ADP test = elective deferrals o ACP test = matching contributions / after-tax Slide 12 12

13 ADP Test Tests relative deferrals of HCEs and NHCEs Plan must satisfy one of the following tests: o HCE ADP < 1.25 x NHCE ADP o HCE ADP < Lesser of 2+ or 2x NHCE ADP deferrals ADP = Average of (s) compensation Can use prior year or current year deferral percentages for NHCE group Slide 13 13

14 ACP Test Same as ADP test except tests matching and aftertax employee contributions (Code 401(m)) Must satisfy one of following tests: o HCE ACP < 1.25 x NHCE ACP o HCE ACP < Lesser of 2+ or 2x NHCE ACP match / after-tax ACP = Average of (s) compensation Can use prior year or current year deferral percentages for NHCE group Slide 14 14

15 Most Favorable Test NHCE ADP < 2% 2x TEST NHCE ADP 2% - 8% 2+ TEST NHCE ADP > 8% 1.25 TEST Slide 15 15

16 ADP / ACP Testing Methods Prior year testing method o Compare prior year ADP/ACP for NHCE group to current year ADP/ACP for HCE group o Allows some predictability of results Current year testing method o Compare current year ADP/ACP for NHCE group to current year ADP/ACP for HCE group o More flexibility in correction methods Must state testing method in plan o Make sure follow plan document Slide 16 16

17 How to Fix a Failed ADP/ACP Test Distribution of excess contributions (ADP) or excess aggregate contributions (ACP) and earnings Making QNECs Shifting QMACs into ADP test or shifting elective deferrals into ACP test Recharacterization (only for ADP violation) Slide 17 17

18 Improving ADP/ACP Results XYZ Corp maintains a 401(k) plan for its EEs. The plan defines compensation for deferral purposes as gross compensation for full plan year. The ADP of HCE group for 2015 is 7.5%. The ADP of NHCEs for 2015 is 4.3% and for 2014 is 4.9%. o XYZ Corp has 4 HCEs and 6 NHCEs. The 4 HCEs each make over the $265,000 compensation limit and deferred $18,000 under the plan for o Sally, an NHCE, first becomes a participant in July of 2015 and defers $2,000 (5% of her $40,000 annual compensation). o XYZ declares a bonus twice a year (in June and December). Generally, bonuses are paid to NHCEs. Slide 18 18

19 Creative Testing Options Plan can use any definition of comp for ADP / ACP testing as long as satisfy Code 414(s) o Definition does not need to be stated in plan o Net compensation may provide better results where HCEs earn above compensation limit o Can exclude specific items of comp (e.g., bonuses) Plan can use full year or partial year comp o If have NHCEs who become participants during year = use partial year compensation (regardless of definition in plan) May be able to use top-paid group test Slide 19 19

20 Must have compensation > dollar amount in lookback year and must be in top-paid group o Top 20% of EEs ranked by compensation o o Election must be made in plan Can use any reasonable tie breaking method Allows plan to treat HCEs not in the top 20% as NHCEs o Be careful when defining allocation groups to ensure HCEs do not lose benefits o Once become NHCE = must receive gateway When must top paid group election be made? o Top Paid Group Test Before end of current plan year Slide 20 20

21 Corrective Distributions Correction period - 12 months following the close of the plan year Amount to be distributed -- leveling method o Based on highest dollar amount of deferrals o Two-step method o Must recharacterize as catch-up contributions prior to making corrective distributions Allocable earnings o Gap period earnings o Treatment of net loss Slide 21 21

22 Refunds of Excess Contributions Black & Blue, Inc. maintains a calendar year 401(k) plan. For 2015, the ADP of the NHCEs is 5% and the HCE deferrals are as follows: HCEs Age Comp. Deferrals Deferral Percentage 1 55 $265,000 $18, % 2 61 $265,000 $18, % 3 50 $200,000 $16,000 8% 4 42 $150,000 $13,500 9% 5 41 $125,000 $10,000 8% 6 55 $120,000 $12,000 10% $1,125,000 $87, % Slide 22 22

23 Refunds of Excess Contributions HCEs Age Comp. Deferrals Deferral Percentage Adjusted Percentage 1 55 $265,000 $18, % 6.79% 2 61 $265,000 $18, % 6.79% 3 50 $200,000 $16,000 8% 7.105% 4 42 $150,000 $13,500 9% 7.105% 5 41 $125,000 $10,000 8% 7.105% 6 55 $120,000 $12,000 10% 7.105% $1,125,000 $87, % 7% The ADP of the NHCEs for 2015 is 5%. The plan uses current year testing method. To correct ADP test, must bring HCE-3, HCE-4, HCE-5 and HCE-6 down to 7.105%. Slide 23 23

24 Refunds of Excess Contributions HCE Age Comp. Deferral Deferral % Adjusted % 1 55 $265,000 $18, % 6.79% 2 61 $265,000 $18, % 6.79% Correction Amount 3 50 $200,000 $16,000 8% 7.105% $1, $150,000 $13,500 9% 7.105% $2, $125,000 $10,000 8% 7.105% $1, $120,000 $12,000 10% 7.105% $3,474 $1,125,000 $87, % 7% $9,226 The total amount to be returned is $9, $1,790 to correct HCE-3 [.895% x $200,000] + $2,843 to correct HCE-4 [1.895% x $150,000] + $1,119 to correct HCE-5 [.895% x $125,000] + $3,474 to correct HCE-6 [2.895% x $120,000]. Slide 24 24

25 Refunds of Excess Contributions HCE Age Comp. Deferral Correction Amount Refund Amount Adjusted Deferrals 1 55 $265,000 $18,000 $18, $265,000 $18,000 $18, $200,000 $16,000 $1,790 $16, $150,000 $13,500 $2,843 $13, $125,000 $10,000 $1,119 $10, $120,000 $12,000 $3,474 $12,000 $1,125,000 $87,500 $9,226 $83,500 Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. Slide 25 25

26 Refunds of Excess Contributions HCE Age Comp. Deferral Correction Amount Refund Amount Adjusted Deferrals 1 55 $265,000 $18,000 $2,000 $16, $265,000 $18,000 $2,000 $16, $200,000 $16,000 $1,790 $16, $150,000 $13,500 $2,843 $13, $125,000 $10,000 $1,119 $10, $120,000 $12,000 $3,474 $12,000 $1,125,000 $87,500 $9,226 $4,000 $79,500 Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. $2,000 refunded to HCE- 1 and HCE-2. Remaining refund = $5,226 [$9,226 - $4,000] Slide 26 26

27 Refunds of Excess Contributions HCE Age Comp. Deferral Correction Amount Refund Amount Adjusted Deferrals 1 55 $265,000 $18,000 $3,742 $14, $265,000 $18,000 $3,742 $14, $200,000 $16,000 $1,790 $1,742 $14, $150,000 $13,500 $2,843 $13, $125,000 $10,000 $1,119 $10, $120,000 $12,000 $3,474 $12,000 $1,125,000 $87,500 $9,226 $9,226 $78,274 Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. $1,742 refunded to HCE- 1, HCE-2 and HCE-3. Remaining refund = $0 [$5,226 - $5,226] Slide 27 27

28 Refunds of Excess Contributions HCE Age Comp. Deferral Correction Amount Refund Amount Adjusted Deferrals 1 55 $265,000 $18,000 $3,742 $14, $265,000 $18,000 $3,742 $14, $200,000 $16,000 $1,790 $1,742 $14, $150,000 $13,500 $2,843 $0 $13, $125,000 $10,000 $1,119 $0 $10, $120,000 $12,000 $3,474 _ $0 $12,000 $1,125,000 $87,500 $9,226 $9,226 $78,274 Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. $1,742 refunded to HCE- 1, HCE-2 and HCE-3. Remaining refund = $0 [$5,226 - $5,226] Slide 28 28

29 Application of Catch-Up Contributions HCEs Age Comp. Deferrals 1 55 $265,000 $24, $265,000 $20, $200,000 $16, $150,000 $13, $125,000 $10, $120,000 $12,000 $1,125,000 $95,500 Catch-Up Contribution ADP Deferrals Suppose the B&B plan permits catch-up contributions. How would the availability of catch-up contributions affect the ADP refunds under the plan? Slide 29 29

30 Application of Catch-Up Contributions HCEs Age Comp. Deferrals Catch-Up Contribution ADP Deferrals 1 55 $265,000 $24,000 $6,000 $18, $265,000 $20, $200,000 $16, $150,000 $13, $125,000 $10, $120,000 $12,000 $1,125,000 $95,500 Suppose the B&B plan permits catch-up contributions. How would the availability of catch-up contributions affect the ADP refunds under the plan? Slide 30 30

31 Application of Catch-Up Contributions HCEs Age Comp. Deferrals Catch-Up Contribution ADP Deferrals 1 55 $265,000 $24,000 $6,000 $18, $265,000 $20,000 $2,000 $18, $200,000 $16, $150,000 $13, $125,000 $10, $120,000 $12,000 $1,125,000 $95,500 Suppose the B&B plan permits catch-up contributions. How would the availability of catch-up contributions affect the ADP refunds under the plan? Slide 31 31

32 Application of Catch-Up Contributions HCEs Age Comp. Deferrals Catch-Up Contribution ADP Deferrals 1 55 $265,000 $24,000 $6,000 $18, $265,000 $20,000 $2,000 $18, $200,000 $16,000 $0 $16, $150,000 $13,500 $0 $13, $125,000 $10,000 $0 $10, $120,000 $12,000 $1,125,000 $95,500 Suppose the B&B plan permits catch-up contributions. How would the availability of catch-up contributions affect the ADP refunds under the plan? Slide 32 32

33 Application of Catch-Up Contributions HCEs Age Comp. Deferrals Catch-Up Contribution ADP Deferrals 1 55 $265,000 $24,000 $6,000 $18, $265,000 $20,000 $2,000 $18, $200,000 $16,000 $0 $16, $150,000 $13,500 $0 $13, $125,000 $10,000 $0 $10, $120,000 $12,000 $1,125,000 $95,500 HCE-6 deferred 10% for The ADP of the NHCEs is 5%. To pass the ADP test, the ADP of the HCEs may not exceed 7%. May B&B treat any of HCE-6 s deferrals as catch-up contributions and exclude them from the ADP test? Slide 33 33

34 Application of Catch-Up Contributions HCEs Age Comp. Deferrals Catch-Up Contribution ADP Deferrals 1 55 $265,000 $24,000 $6,000 $18, $265,000 $20,000 $2,000 $18, $200,000 $16,000 $0 $16, $150,000 $13,500 $0 $13, $125,000 $10,000 $0 $10, $120,000 $12,000 $0 $12,000 $1,125,000 $95,500 $8,000 $87,500 HCE-6 deferred 10% for The ADP of the NHCEs is 5%. To pass the ADP test, the ADP of the HCEs may not exceed 7%. May B&B treat any of HCE-6 s deferrals as catch-up contributions and exclude them from the ADP test? Slide 34 34

35 Application of Catch-Up Contributions HCE Age Comp. Deferral Catch-Up Contribution Refund Amount 1 55 $265,000 $24,000 $6,000 $3, $265,000 $20,000 $2,000 $3, $200,000 $16,000 $0 $1, $150,000 $13,500 $0 $ $125,000 $10,000 $0 $ $120,000 $12,000 $0 $0 $1,125,000 $93,500 $8,000 $9,226 Adjusted Refund Slide 35 35

36 Application of Catch-Up Contributions HCE Age Comp. Deferral Catch-Up Contribution Refund Amount Adjusted Refund 1 55 $265,000 $24,000 $6,000 $3,742 $3, $265,000 $20,000 $2,000 $3, $200,000 $16,000 $0 $1, $150,000 $13,500 $0 $ $125,000 $10,000 $0 $ $120,000 $12,000 $0 $0 $1,125,000 $93,500 $9,226 Slide 36 36

37 Application of Catch-Up Contributions HCE Age Comp. Deferral Catch-Up Contribution Refund Amount Adjusted Refund 1 55 $265,000 $24,000 $6,000 $3,742 $3, $265,000 $20,000 $5,742 $3,742 $ $200,000 $16,000 $0 $1, $150,000 $13,500 $0 $ $125,000 $10,000 $0 $ $120,000 $12,000 $0 $0 $1,125,000 $93,500 $9,226 Slide 37 37

38 Application of Catch-Up Contributions HCE Age Comp. Deferral Catch-Up Contribution Refund Amount Adjusted Refund 1 55 $265,000 $24,000 $6,000 $3,742 $3, $265,000 $20,000 $5,742 $3,742 $ $200,000 $16,000 $1,742 $1,742 $ $150,000 $13,500 $0 $ $125,000 $10,000 $0 $ $120,000 $12,000 $0 $0 $1,125,000 $93,500 $9,226 Slide 38 38

39 Application of Catch-Up Contributions HCE Age Comp. Deferral Catch-Up Contribution Refund Amount Adjusted Refund 1 55 $265,000 $24,000 $6,000 $3,742 $3, $265,000 $20,000 $5,742 $3,742 $ $200,000 $16,000 $1,742 $1,742 $ $150,000 $13,500 $0 $0 $ $125,000 $10,000 $0 $0 $ $120,000 $12,000 $0 $0 $0 $1,125,000 $93,500 $13,484 $9,226 $3,742 Slide 39 39

40 What if EE Makes Excess Deferrals? If EE defers more than Code 402(g) limit (i.e., $18,000 for 2015/2016) = must distribute excess deferrals from plan o Distribution must occur before April 15 of next calendar year to avoid adverse tax consequences o Corrective distribution must include allocable earnings or loss Excess deferrals are taxable in year of deferral and if distributed after April 15 are taxable again in year of distribution 402(g) limit is applied on individual basis Slide 40 40

41 What if EE Makes Excess Deferrals? If EE defers to more than one plan = limit applies to all deferrals made in same year EE is responsible for determining whether 402(g) limit has been exceeded and taking appropriate corrective steps o If EE makes deferrals under multiple plans = EE must decide which plan holds the excess o EE must give notice to plan by March 1 following calendar year so distribution can be made by April 15 o Excess deferrals will not disqualify a plan if excess is made under plans of unrelated ERs Slide 41 41

42 Affect of Code 402(g) Limit If HCE has excess deferrals = excess amount is included in ADP test (even if distributed) o Catch-up contributions not included for purposes of determining whether have excess deferrals o Excess deferrals of NHCEs are not included in ADP test When apply two-step leveling method = include excess deferral in HCE s deferral percentage (even if refunded to correct 402(g) violation) Slide 42 42

43 Affect of Code 402(g) Limit What if HCE is entitled to distribution of both excess deferrals and excess contributions? o Excess contributions distributed to correct ADP failure are reduced by any corrective distribution of excess deferrals for calendar year ending in plan year o Plan gets credit for distributing full amount of ADP correction even though reduced by excess deferral correction o For taxation purposes, treat portion of distribution attributable to excess deferrals as distribution of excess deferrals Slide 43 43

44 Forfeiture of Related Contributions If excess aggregate contributions are not fully vested = non-vested portion (including earnings) is forfeited instead of distributed If matched deferrals are distributed as excess contributions = related match (plus earnings) may be forfeited to prevent discriminatory rate of match (even if vested) o How do forfeited match affect ADP/ACP test? Forfeit match first, then run ACP test = forfeited match not taken into account under ACP test Run both ADP/ACP tests, then forfeit, if necessary = no forfeiture required to extent distributed under ACP Slide 44 44

45 Allocable Earnings Excess contributions or excess aggregate contributions must be adjusted for allocable earnings Plan may use any reasonable method to calculate allocable earnings for plan year PPA eliminated gap period earnings for post-2007 plan years If allocable earnings are a net loss, amount distributed is reduced by loss amount and is not taxed to HCE Slide 45 45

46 Correction After 12-Month Period Must correct ADP/ACP test within 12 months following end of plan year If do not correct, what are ER s options? o Do nothing and hope don t get audited by IRS Should give ER correction options (in writing?) and decision to not correct should be ER decision o Self correct = IRS suggested correction is to use one-to-one correction method Self-correction available through last day of second plan year following failure Failure occurs at end of 12-month period = allows for 3-year correction period May correct anytime if de minimis (probably not) Slide 46 46

47 Correction After 12-Month Period If correct after end of 12-month period = what is correction method? o IRS suggested correction method = one-to-one correction Determine excess for HCEs (including earnings) and make appropriate refunds Make QNEC on behalf of all NHCEs equal to refunded amount and allocate on basis of compensation Does ER have to give QNEC to terminated EEs? Could ER just give refunds to HCEs? Could ER use targeted QNECs? Can ER disaggregate otherwise excludible EEs? Slide 47 47

48 Using QNECs in ADP Test ER contribution that looks like deferral o 100% vested when made o Subject to 401(k) distribution restrictions o Special nondiscrimination rules Must be made within 12 months following end of plan year o Current year method o Prior year method Bottom-up QNECs eliminated o Can now provide for targeted QNECs Slide 48 48

49 Using QNECs in ADP Test Plan must satisfy nondiscrimination requirements with and without QNECs used in ADP test Example: ER makes 3% QNEC to all EEs. May ER treat 1% of NHCE QNECs in ADP test? o Plan must be able to satisfy 401(a)(4) after carving out QNECs o Could test by imputing permitted disparity or using crosstesting If use cross-testing = must satisfy minimum gateway based on contributions being tested Slide 49 49

50 Use of QNECs with Prior Year Testing Employer X maintains a 401(k) plan and runs its 2015 ADP test on 3/1/16 and fails ADP test based on prior year testing. Employer X would like to correct the ADP test by making a QNEC to the NHCEs. By when must Employer X contribute the QNEC to correct the 2015 ADP test? End of 2015 plan year (12 months following end of 2014 plan year) Not permitted to use QNEC to correct prototype / VS plans that use prior year testing Slide 50 50

51 Targeted QNECs Targeted QNEC = can only use QNEC in ADP or ACP test to extent does not exceed greater of: o 5% of compensation o 2x plan s representative contribution rate The lowest QNEC rate of any NHCE, taking into account at least 50% of total eligible NHCEs The lowest QNEC rate of any NHCE employed as of the last day of the plan year Slide 51 51

52 Example ABC Corp. has 44 NHCEs eligible for plan. For 2015 PY, ABC plan fails the ADP test. ABC Corp. would like to make a QNEC for Joe, the lowest paid EE. How much may ABC Corp. give Joe (and include in ADP test) without making a QNEC for any of the other NHCEs? o 5% of compensation If ABC Corp. gives Joe 15% QNEC, how much must it give to the other NHCEs? o At least 22 NHCEs must receive a QNEC of at least 7½% of compensation Slide 52 52

53 Correcting Coverage Failures 53

54 Coverage Tests Three coverage tests = only need satisfy one test under Code 410(b) Percentage test At least 70% of NHCEs benefit Ratio test % of NHCEs > 70% % of HCEs Average benefits test Minimum coverage tests also used to determine if rate groups are nondiscriminatory under Code 401(a)(4) Slide 54 54

55 Ratio Percentage Test NHCE ratio > 70% HCE ratio NHCEs benefiting NHCE ratio = total NHCEs HCEs benefiting HCE ratio = total HCEs Only include nonexcludable employees in ratio percentage test = may exclude certain excludable employees from coverage tests Slide 55 55

56 Average Benefits Test Two parts to average benefits test = must satisfy both parts to pass test Nondiscriminatory classification test Average benefit percentage test Different rules apply for coverage / nondiscrimination o o Reasonable classification test does not apply for nondiscrimination test = changed under proposed regs Can use midpoint between safe and unsafe harbors Slide 56 56

57 Nondiscriminatory Classification Test Reasonable classification o Based on business criteria = e.g., job classification, nature of compensation, geographic location o Naming individuals is not reasonable classification o Reasonable classification test does not apply under nondiscrimination tests (unless proposed regs become final) Nondiscriminatory classification o Use same ratio as under ratio test o Must satisfy safe harbor percentage = see chart o If between safe harbor and unsafe harbor = facts and circumstances Slide 57 57

58 Safe Harbor / Unsafe Harbor Safe harbor / unsafe harbor based on NHCE concentration percentage NHCE concentration percentage is determined by dividing total number of NHECs of ER by total number of EEs of ER o When determining number of EEs, disregard NHCEs and HCEs who are excludable EEs If two or more plans are permissively aggregated = determine excludable EEs as if the plans are a single plan Slide 58 58

59 Nondiscriminatory Classification Test NHCE concent. SH % UH % Midpoint NHCE concent. SH % UH % Midpoint Slide 59 59

60 General Nondiscrimination Test Each HCE is in his/her own rate group for purposes of general nondiscrimination test Each HCE rate group must satisfy a minimum coverage test under Code 410(b) o Rate group includes all equal or higher allocation or equivalent benefit rates Rate groups may be expressed as allocation rates or equivalent benefit rates If using average benefits test = special rules apply o May use midpoint between safe and unsafe harbors o Reasonable classification test does not apply = but see new proposed regulations Slide 60 60

61 New Proposed Regulations Potentially eliminates some of the flexibility to use every EE in own group o Modifies average benefits test to apply reasonable classification test to rate group test o To satisfy average benefit test, rate group must be based on reasonable objective business criteria or rate group must satisfy ratio test (i.e., benefit percentage must be 70% or higher) Naming of individual EEs is not reasonable Not effective until final regulations issued Slide 61 61

62 Average Benefit Percentage Test NHCE average benefit percentage > 70% HCE average benefit percentage Include benefit percentages of all non-excludable EEs (even if not benefitting) May test on basis of allocation rates or benefit rates o Determine allocation or benefit rates as percentage of 414(s) compensation Must include benefits under all plans of the employer -- including 401(k)/401(m) plans Slide 62 62

63 What if Fail Coverage / Nondiscrimination Test? If fail coverage or nondiscrimination test = may make retroactive corrective amendment within 9½ months after end of PY [ 1.401(a)(4)-11(g)] o May not bring EEs in by name for coverage test unless satisfy ratio test = can bring in EEs by name to correct nondiscrimination violation (for now) o Amendment must expand coverage or increase benefits o 401(k)/401(m) plan = must make QNECs to make up deferrals/match based on ADP or ACP for plan year Special 50%/25% rule for determining QNECs does not apply May QNECs be provided to lowest paid EEs? What if not corrected within 9½ months? Slide 63 63

64 1.401(a)(4)-11(g) Amendment Can amend plan within 9½ months after end of Plan Year to correct violation o Amendment may not reduce benefits under Plan Increase in benefits must satisfy 401(a)(4) independently o Always satisfied if increase is for NHCEs only Amendment must have substance cannot apply increase to terminated non-vested EEs Can amend plan to provide additional contribution necessary to pass nondiscrimination Slide 64 64

65 Correcting 415 Violations Correct under EPCRS = regulatory correction methods may still apply under EPCRS o If excess relates to elective deferrals or after-tax EE contributions = correction is to distribute excess amount (with earnings) o If excess relates to ER contributions or match = reallocate to other EEs (if discretionary) or suspense account (if fixed) and reduce future contributions o Distribution is reported as distribution on Form 1099-R for year of distribution (Code E ) o Amounts distributed as excess annual additions are disregarded for ADP/ACP test and Code 402(g) Slide 65 65

66 Correcting 415 Violations Is there a deadline for making corrective distributions to correct 415 violation? No formal deadline under EPCRS Need to make corrective distributions before can properly correct ADP/ACP test = within 12 months after close of plan year Must make corrective distribution by end of second plan year in order to use SCP Earnings continue to accrue until corrective distribution is made from plan Slide 66 66

67 Correcting 415 Violations Can ER use SCP to correct Code 415 violation in multiple years? o In order to use SCP = must have established procedures in place to prevent repeat violations o If fail Code 415 under plan that has both elective deferrals and ER contributions = can use SCP to correct excess by distributing elective deferrals each year to correct Code 415(c) violation within 2½ months after end of limitation year Plan will be treated as having established procedures even if it has repeated violations Slide 67 67