Every 401(k) plan is subject to certain year-end testing requirements (even plans that have adopted a safe harbor design feature). As the sponsor of your company’s 401(k) plan, you must ensure that plan contributions have not exceeded the annual limits set by federal tax law and are not discriminatory against lower paid workers. Newport can help you meet these responsibilities by tracking contribution limits and performing year-end testing to determine whether your plan has satisfied these requirements each year. For calendar-year plans, we will soon be gathering payroll and census data for testing purposes.
To make sure your year-end testing runs smoothly, it’s important that you provide us with accurate and complete payroll and census data in a timely manner. Incorrect or incomplete data leads to inaccurate testing results, which can affect the tax-qualified status of the plan if not corrected.
To help you understand how your plan and participants may be affected by the year-end tests, this article provides an overview of the limits and tests that may apply to your 401(k) plan and the corrective measures you may need to take if your plan does not pass a test.
Salary Deferral Limit
A participant in a 401(k) plan may contribute up to $19,000 of their salary as pre-tax and Roth salary deferrals for 2019. If a participant is age 50 or older, they may save up to an additional $6,000 for 2019 if the plan permits catch-up contributions. This limit applies to an individual’s salary deferrals across all 401(k), 403(b), and SIMPLE plans in which they participate. You must confirm whether your plan allows for catch-up contributions and whether any of your participants have exceeded the salary deferral limit in your plan for 2019. Participants are responsible for making sure their aggregate deferrals do not exceed this limit if they participate in more than one plan for different employers.
If a participant’s contributions exceed this limit, the excess deferrals plus earnings must be distributed to the participant by April 15, 2020.
Annual Additions Limit
All employee and employer contributions allocated to a participant’s account in your plan for 2019 cannot exceed the lesser of:
- 100% of the participant’s compensation or
- $56,000, plus up to $6,000 catch-up contributions if the participant is age 50 or older.
If a participant’s contributions exceed this limit, excess deferrals or after-tax contributions must be distributed to the participant if an excess is discovered. Any associated matching contributions must be forfeited or held in a suspense account according to the terms of the plan document.
The ADP and ACP tests are the hallmark nondiscrimination tests for 401(k) plans. These tests ensure that the plan does not disproportionately benefit highly compensated employees (HCEs).
An HCE is generally an employee who:
- Owns more than 5% of the employer at any time during the year or preceding year (regardless of compensation), or
- Earned more than $125,000 from the employer (for 2019) and, if the employer elects, had compensation that ranked the employee in the top 20% of all employees.
The Actual Deferral Percentage (ADP) test limits the percentage of compensation the HCE group can defer into the 401(k) plan based on the deferral rate of the non-HCE group. The Actual Contribution Percentage (ACP) test ensures that the employer matching contributions and after-tax employee contributions for HCEs are not disproportionately higher than those for non-HCEs.
If your plan fails the ADP or ACP test – Excess contributions plus earnings should be distributed within 2½ months after the end of the calendar year (i.e., by March 15) to the affected HCEs. If distributed after 2½ months but within 12 months, you will owe a 10% excise tax. Alternatively, you may make additional contributions to the non-HCEs to correct a failed ADP or ACP test. Your plan document will describe the corrective measures you must use.
If your plan has difficulty passing the ADP/ACP tests, you may want to consider a plan design option that is deemed to satisfy these tests. A 401(k) plan that meets the requirements of a “safe harbor” 401(k) plan does not have to satisfy the ADP/ACP tests each year.
The top-heavy test focuses on account balances rather than contributions made each year. A plan is top-heavy if more than 60% of its total assets are held by or for the benefit of key employees as of the last day of the preceding plan year. If the plan fails the top-heavy test as of December 31, 2019, it will be considered top-heavy for 2020. For 2019, a key employee is one who:
- Owns more than 5% of the employer,
- Owns more than 1% of the employer and has annual compensation in excess of $150,000, or
- Is an officer of the employer and has compensation of more than $180,000.
If your plan is top-heavy, plan contributions must be made for non-key employees up to at least 3% of compensation for the entire plan year, including for participants who did not make deferrals. If you already make a 3% (or more) employer contribution, no further contribution may be required.
Reviewing Your Year-End Testing Results
Review and respond to any communication from Newport about your year-end testing data to make sure your testing is completed accurately and on time. When you receive your testing results, review them right away so you know if you have to take any corrective measures and the deadlines for making corrections. If your year-end testing results show that your plan has failed one or more of the plan limits or tests, work with your plan consultant and Newport to correct the problems to avoid potential penalties and qualification issues.
You may also want to consider ways to help your plan avoid testing failures in the future:
- Develop employee education initiatives to encourage more non-HCE and non-key employees to enroll in the plan or to increase their savings rates.
- Explore plan features that are designed to help your plan pass year-end testing, such as the safe harbor 401(k) plan design.
Newport Solution: Contact your Newport Representative right away if you have questions about your year-end testing results or you need help understanding the correction options available under your plan.
2020 Contribution & Retirement Plan Limits
Ensuring that your plan applies the correct contribution and other plan-related limits each year is the first step you can take to keeping your plan in compliance. Here is a list of the limits that will be changing from your 2019 plan year to your 2020 plan year.
Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services. Newport and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before making any decisions.
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