How to Stay Compliant with Discrimination Testing ADP/ACP: 401(k) and 401(m)
Discrimination testing is a crucial component of maintaining compliance with Internal Revenue Service (IRS) regulations for 401(k) and 401(m) plans. These tests are performed to ensure that the plans do not unfairly benefit highly compensated employees (HCEs) at the expense of non-highly compensated employees (NHCEs). Failure to comply with IRS regulations can result in significant penalties for the plan sponsor.
ADP Test
The average deferral percentage (ADP) test is used to ensure that HCEs do not contribute a disproportionate amount to the plan. Under the IRS regulations, HCEs are subject to limitations on the amount they can contribute to the plan, based on the amount contributed by NHCEs. The ADP test calculates the average percentage of salary that HCEs and NHCEs contribute to the plan, and if the difference between the two is too large, the plan may be considered discriminatory.
If the plan fails the ADP test, HCEs may have to return some of their contributions to the plan. Therefore, it is crucial for employers to regularly perform discrimination testing to ensure compliance with IRS regulations and avoid any potential penalties.
ACP Test
In addition to the ADP test, the average matching contribution percentage (ACP) test is used for 401(m) plans. These plans require the employer to match a portion of the employee’s contributions, and the amount of the match must be the same for all employees. However, the plan can be discriminatory if the match disproportionately benefits HCEs.
The ACP test compares the average matching contribution percentage of HCEs to that of NHCEs. If the difference between the two is too large, the plan may be considered discriminatory, and HCEs may have to return some of their matching contributions. Like the ADP test, it is crucial for employers to regularly perform discrimination testing to ensure compliance with IRS regulations and avoid any potential penalties.
Automated Discrimination Testing
Collection and Storage of Data
Automated discrimination testing involves the collection and storage of data necessary for the ADP/ACP test. This information is crucial for calculating contributions and identifying highly compensated employees (HCEs).
Real-Time ADP/ACP Test
Automated discrimination testing allows for real-time ADP/ACP testing to ensure that the plan remains compliant with IRS regulations. This helps plan administrators to quickly identify issues and take corrective action.
Delivery of Annual ADP/ACP Compliance Testing Package
Automated discrimination testing provides an annual ADP/ACP compliance testing package for plan administrators. This package contains information on compliance requirements and test results.
Quarterly ADP/ACP Testing and Corrective Action
Automated discrimination testing includes quarterly ADP/ACP testing to ensure that the plan remains compliant throughout the year. If issues are identified, corrective action can be taken immediately.
Monitoring of Elective Deferrals
Automated discrimination testing includes monitoring of elective deferrals to ensure that they meet IRS regulations. This helps to identify and correct any issues before they become problematic.
Top-Heavy Testing
Automated discrimination testing includes top-heavy testing, which ensures that the plan does not favor highly compensated employees. This helps to maintain compliance with IRS regulations.
Identifying HCEs
Automated discrimination testing helps to identify highly compensated employees (HCEs) by using data such as salary and ownership percentages. This information is used to calculate contributions and ensure compliance with IRS regulations.
Coverage Testing for Controlled Groups
Automated discrimination testing includes coverage testing for controlled groups, which ensures that all employees within the group have equal access to the plan. This helps to maintain compliance with IRS regulations.
Compensation Definition Testing
Automated discrimination testing includes compensation definition testing, which ensures that compensation is properly defined and calculated for the ADP/ACP test. This helps to maintain compliance with IRS regulations.
Cross Testing
Automated discrimination testing includes cross testing, which helps to identify whether contributions made to one group are proportionate to the contributions made to other groups. This ensures compliance with IRS regulations and helps to maintain fairness among plan participants.
How to Stay Compliant with Discrimination Testing ADP/ACP: 401(k) and 401(m)
Staying compliant with Discrimination Testing ADP/ACP for 401(k) and 401(m) plans is critical to avoid penalties and maintain the plan’s tax-qualified status. Here are some tips to stay compliant:
Regular Discrimination Testing: Conduct regular ADP/ACP testing, preferably quarterly, to identify any discrepancies between HCEs and NHCEs’ contribution rates.
Corrective Action: If the plan fails the ADP/ACP test, take corrective action to bring the plan into compliance. Corrective action can include returning excess contributions, adjusting contribution rates, or implementing a qualified non-elective contribution (QNEC) to meet the minimum contribution requirements.
Monitor Elective Deferrals: Keep a close eye on the elective deferrals made by HCEs to ensure they don’t exceed the annual contribution limits set by the IRS.
Top-Heavy Testing: Perform annual top-heavy testing to ensure the plan doesn’t favor HCEs and meets the minimum contribution requirements for NHCEs.
Coverage Testing for Controlled Groups: If the plan is part of a controlled group, perform coverage testing to ensure that all eligible employees have access to the plan.
Compensation Definition Testing: Ensure that the compensation definition used in the plan document is consistent with the IRS’s definition of compensation for ADP/ACP testing.
Cross Testing: Consider implementing cross-testing to allocate contributions based on projected benefits rather than contribution percentages. This can help the plan meet the minimum contribution requirements for NHCEs while still providing meaningful benefits to HCEs.
By following these tips, plan sponsors can help ensure their 401(k) and 401(m) plans remain compliant with ADP/ACP testing requirements and avoid costly penalties.
Final Notes
In conclusion, discrimination testing is a necessary step to ensure that 401(k) and 401(m) plans are in compliance with IRS regulations. The ADP and ACP tests are used to prevent plans from unfairly benefiting HCEs, and failure to comply with these regulations can result in significant penalties for the plan sponsor. Therefore, it is essential for employers to regularly perform discrimination testing and take corrective action as needed to avoid any potential penalties.
Any Questions?
If you are a plan administrator or employer, staying compliant with IRS regulations for 401(k) and 401(m) plans is crucial. Regular discrimination testing is essential to ensure that your plan is not discriminatory and to avoid any potential penalties.
At RWM Financial Group, we understand the importance of compliance and can help you navigate the complexities of discrimination testing. Our team of experienced professionals can assist with automated discrimination testing, monitoring of elective deferrals, and quarterly testing and corrective action.
Contact us to learn more about our services and how we can help you stay compliant with IRS regulations for your 401(k) and 401(m) plans. Don’t wait until it’s too late, contact us today to have our team review your current retirement plan.
