Basic ERISA Plan Compliance / Nondiscrimination Tests – Are You Prepared?
As the plan sponsor for your company’s retirement plan, you have certain fiduciary duties, including being compliant with IRS regulations. Non-compliance with these regulations could ultimately result in revocation of the tax-exempt status of the retirement plan. The following are some basic compliance requirements qualified retirement plans must abide by in order to satisfy the Internal Revenue Code.
402(G) TEST:
Section 402(g) of the Internal Revenue Code deals with the limitations of the amount a participant can defer from their salary. A plan with elective deferrals (i.e. 401(k) plan) must provide that for each participant, the cumulative amount of elective deferrals, under all plans to which the participant is eligible to participate, may not generally exceed the amount of the limitation in effect during the plan year. For 2010 and 2011, this limit is $16,500. In addition, participants who are age 50 and over are allowed to make additional elective deferrals to the plan. For 2010 and 2011, this additional deferral is $5,500.
415 MAXIMUM CONTRIBUTION/ BENEFIT LIMIT:
Section 415 of the Internal Revenue Code sets forth the contribution and benefit limits for retirement plans. For 2010 and 2011, the annual benefit limitation for a defined benefit plan is $195,000 for each participant. The limitation on annual contributions to a defined contribution plan is the lesser of 100% of the participant’s compensation or $49,000 for 2010 and 2011. This limit of annual contributions includes all contributions (employee and employer). Also, this limitation must take into account all contributions to all plans to which the participant is eligible to participate.
Plan sponsors should monitor cumulative employee and employer contributions throughout the year for each participant to make sure that the above limit tests are not exceeded or are going to be exceeded by the end of the year.
The following are some nondiscrimination tests that are generally performed to satisfy certain sections of the Internal Revenue Code as they relate to qualified retirement plans.
ACTUAL DEFERRAL PERCENTAGE TEST:
For plans qualified under section 401(k), they must satisfy the Actual Deferral Percentage (ADP) Test. The ADP Test requires that salary deferrals by highly compensated employees (HCE) be proportional to that for non-highly compensated employees (NHCE) within specified limits.
TOP HEAVY TEST:
In accordance with section 416 of the Internal Revenue Code, top-heavy testing must be performed each plan year by comparing the account balances of key employees to the total account balances of all employees. The plan is top heavy if the value of the account balances of key employees is greater than 60% of the value of the total account balances.
410(B) COVERAGE TEST:
Generally, section 410(b) sets out rules on who the plan must cover. Plans must determine if the group of employees covered under the plan satisfies one of the tests (percentage, average benefit percentage, or ratio) provided under section 410(b) of the Internal Revenue Code. Generally, these tests determine if the plan benefits a minimum threshold of non-highly compensated employees (NHCE) as compared to highly compensated employees (HCE).
In order to cure the above nondiscrimination tests, plan sponsors most commonly make an additional contribution to the accounts of the non-highly compensated employees and/or non-key employees, which would put the plan in compliance with the tests.
As part of an audit of the financial statements of the plan, we perform a review of the plan’s processes to meet these compliance and nondiscrimination testing requirements. A failure to pass these tests could have financial reporting ramifications, thereby causing delays in the completion of the financial statements.
Plan sponsors must prepare for these tests in order to stay in compliance. The key component that the plan sponsor must put emphasis on is having a complete and accurate employee census for the company.
Plan sponsors must prepare for these tests in order to stay in compliance. The key component that the plan sponsor must put emphasis on is having a complete and accurate employee census for the company. These compliance tests are usually performed by the third party administrator (TPA) for the company’s retirement plan.
TPAs perform the tests based on the employee census information provided by the plan sponsor. Typically, census information includes such information as total service time, annual compensation, annual employee and employer deferrals, and dates of birth. Without accurate census information, these tests would not be accurate and may result in non-compliance issues. Plan sponsors have the responsibility to make sure that their employee records are complete and accurate.
Plan sponsors should enact procedures to make sure salary and retirement benefit information for all their employees is accurately reported within their HR and payroll reporting systems. It could save you the time (and ultimately monetary fines) of dealing with the IRS and/or Department of Labor as they look at the compliance of your retirement plan with their laws and regulations.
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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your plan’s individual facts and circumstances.
