If some of your employees are receiving refunds from your company’s 401k plan, chances are your plan failed the annual IRS required compliance (nondiscrimination) tests.
Although 401k plans have emerged as one of the most popular retirement plans in the US, they still come with a complex set of rules that can limit some businesses, caused by the nondiscrimination rules.
401k refunds or corrective distribution are a headache for plan sponsors like you and employees alike.
The Why of Non-Discrimination Testing
The IRS tests on your plan provide for equal tax breaks to all participating employees, both the highly compensated employees (HCEs) and non-highly compensated employees (NHCEs).
Although your HCEs may be willing and able to contribute more, the IRS requires that both the HCEs and the NHCEs contribute to the 401k plan at similar rates.
There are several tests conducted on your plan. They include
- ADP testing (actual deferral percentage) analyzes the average of your salary deferral percentages for HCEs and NHCEs
- ACP testing (actual contribution percentages) tests employers matching contribution
- The top-heavy test looks at the amount HCEs contribute to the plan as contrasted to everyone else
Consider using our Retirement Plan Evaluator to see if a Safe Harbor makes sense for your company.
If your plan fails the ADP and ACP tests, take corrective action for your plan during the statutory correction period to cause the test to pass.
You have two-and-a-half months after the end of the plan year being tested to correct excess distribution with the excess contribution distributed any time during the 12 months period of the plan.
After the 12 months, you can correct this by making a qualified nonelective contribution to the plan for NHCEs.
Consider a Safe Harbor 401k
A safe harbor plan dispenses the need for nondiscrimination testing. They automatically pass the ADP and ACP tests when safe harbor plan requirements are met, which are certain contributions and participant notices.
There are three variations of the safe harbor plan, which require the employer to make one of the following contributions to the plan
- Basic matching
- Enhanced matching
- QACA safe harbor match
Additionally, it requires that all safe harbor matching contributions be 100% vested.
If your plan fails the testing, get your plan advisor and record keeper to come up with a plan to address the problem. It’s equally crucial to consider factors beyond cost by considering a safe harbor plan for your business.