PLANSPONSOR - February/March 2018 - 61

NHCEs is covered, the benefits, rights and
features of the plan need to be assessed to
ensure they are nondiscriminatory-this
is done via the actual deferral percentage
(ADP) and actual contribution percentage
(ACP) tests.
The third type of test determines
whether the 401(k) plan is top-heavy. This
test looks at overall benefits accumulated
by key employees-different from HCEs.
Robert Kaplan, director of technical
education for the American Retirement
Association, based in the New York City
area, and formerly national retirement
consultant for Voya Retirement Solutions,
describes the ADP test as comparing the
average of salary deferral percentages for
HCEs with the average of salary deferral
percentages for NHCEs. The test applies
to pre-tax and Roth elective deferrals
but not catch-up deferrals. Kaplan says
the purpose of this test is to ensure that
all participants, regardless of income,
benefit from the plan.
If an HCE wants to maximize his
deferrals, then NHCEs will also need
to make deferrals, Richter points out.
So, it is an incentive for the employer to
encourage participation by NHCEs. The
most common incentive is to provide for
matching contributions.
The ACP test compares the average of
the percentage of matching contributions
and after-tax employee contributions for
HCEs vs. NHCEs. Matching contributions
and voluntary employee after-tax contributions-but
not Roth elective deferrals-
are included in this test. The purpose of
the ACP is to ensure that the actual usage
of the plan feature is widespread and not,
in essence, confined to the HCEs. " Plans
subject to testing work only if employees
across the entire income spectrum participate, "
Kaplan notes.
The test that gauges whether the
plan is top-heavy looks to see whether
more than 60% of the overall plan assets
are attributable to key employees. If the
plan fails, certain minimum benefits
may need to be provided to the non-key
employees.
As defined by the IRS, a key employee
is any former or deceased employee who
at any time during the plan year was an
officer making more than $170,000 (the
amount being indexed each year); was an
owner of more than 5% of the business; or
was an owner of more than 1% of the business
and making more than $150,000 for
the plan year.
Methods
Basically, the coverage test compares the
percentage of eligible HCEs who benefit
from the plan with the percentage of
eligible NHCEs who benefit. If the
ratio obtained by dividing the average
percentage for each group is greater than
70%, the plan passes the test. If the ratio
of the two falls below 70%, then the test
compares the average benefit for NHCEs
with that for HCEs to see if that ratio is
70% or greater.
The ADP and ACP tests have two
additional performance methods, in
which the averages of the applicable ratios
of HCEs and of NHCEs are compared. A
plan needs to satisfy one of the two tests
and may generally use either the prior-year
or current-year percentage for the NHCEs.
The first method requires that the
ratio comparing the average contribution
of an HCE with that of an NHCE does not
exceed 125%. For example, if the average
NHCE contribution is 3%, then that for an
HCE may be no more than 3.75%.
Under the second method, the
average contribution for the HCEs may
not exceed the lesser of the average contribution
of the NHCEs plus 2% or the
average contribution of the NHCEs times
two. For example, if the average contribution
for NHCEs is 3%, then the average
contribution for HCEs may not exceed
5%-i.e., the average contribution of the
NHCEs plus 2%. If NHCEs contribute an
average of 1%, then the average contribution
for the HCEs may not exceed 2%-1%
times two is less than 1% plus 2%.
Repercussions of Failing
If the 410(b) coverage test is failed, plan
sponsors must bring the plan into retroactive
compliance by the end of the plan
year, either by extending coverage to a
broader group of NHCEs or by modifying
contribution allocations or benefit accruals.
For the ADP and ACP tests, Kaplan
says, " If the plan fails either test, the
employer must take corrective action in
the 12-month period following the close
of the plan year in which the oversight
occurred. "
The IRS explains two methods for
correcting a failed ADP or ACP test:
* Determine the amount necessary
to raise the ADP or ACP of the NHCEs
to the percentage needed to pass the tests,
and make a qualified nonelective contribution
(QNEC) to all eligible NHCEs in
that amount, or
* Distribute excess contributions,
adjusted for earnings, to the HCEs. If
any excess matching contributions are
not 100% vested for the participant, the
applicable percentage must be forfeited.
Kaplan notes that, for calendar year plans,
distributions must be made by March
15-i.e., 2 1/2 months after the end of the
plan year-to avoid excise taxes.
If a plan is found to be top-heavy, the
sponsor must make a minimum contribution
to the non-key employees-generally
3% of compensation. -PS
KEY POINTS
* The IRS has rules to ensure
broad coverage of plan
participants-both highly
and non-highly compensated
employees; those rules comprise
the 410(b) coverage test.
* The average deferral
percentage test determines
whether an employer plan
is discriminating in favor of
HCEs with respect to employee
deferrals. The average
contribution percentage
test determines whether
discrimination is occurring with
respect to employer matching
contributions.
* If the 410(b) coverage test is
failed, sponsors must bring the
plan into retroactive compliance
by the end of the plan year.
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