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Plan Design Solutions to Satisfy ADP/ACP Tests

Sep 26, 2022

Your 401(k) plan clients’ mid-year test results will help you gauge which plans might be heading toward a failing grade on their year-end nondiscrimination testing. If a plan fails ADP, ACP, or top-heavy testing at year-end, the plan sponsor must take corrective actions such as returning deferrals to highly compensated employees (HCEs) or making additional employer contributions for non-HCEs. If you have plans that fail–or barely squeak by–each year, introduce them to the safe harbor plan design options that could guarantee them a pass on their next test.
 
Existing 401(k) plans that fail nondiscrimination testing are not the only candidates for a safe harbor plan design. Businesses with multiple owners and few lower-paid employees, a young or low paid workforce that contributes little to the 401(k) plan, or a desire to improve the participation and contribution rates for their employees can benefit from these plan design options.
 
Now is the time to discuss these options with 401(k) plan sponsors so there is enough time to take any necessary actions before the next plan year.
 
Benefits of Safe Harbor Plan Design
  • Plan is deemed to pass the ADP and ACP tests.
  • Business owners and HCEs can contribute the maximum level of deferrals without being limited by the contribution rate of other employees.
  • Plan is deemed to pass the top-heavy requirements if only safe harbor contributions are made.
  • No additional employer contributions are required even if key employees hold more than 60% of plan assets.
  • Employee participation and contribution rates may increase when a matching contribution is provided or when employees are automatically enrolled with automatic increases of deferral rates.
  • Administrative tasks associated with testing and corrections are reduced for the plan administrator.
 
Two Types of Safe Harbor Plans
In exchange for the guaranteed pass on nondiscrimination testing, plan sponsors must satisfy a few requirements to have a safe harbor plan, including a mandatory employer contribution subject to vesting and distribution restrictions, and a notice for employees. There are two “flavors” of safe harbor designs to choose from, each with its own requirements: a traditional 401(k) safe harbor plan and a Qualified Automatic Contribution Arrangement (QACA).
  Traditional Safe Harbor QACA
Automatic Enrollment
 
Not required Required – Default deferral rate must be at least 3% and can be as high as 10% in the first year
Automatic Escalation
 
Not required Required – Minimum increase of 1% each year until 6% deferral rate is reached (maximum rate permitted is 15%)
Employer Contribution
 
 
 
 
 
 
 
Required – must pick one
Basic match – 100% match on elective deferrals up to 3% of compensation, plus 50% match on elective deferrals between 3% and 5% of compensation (4% match)

OR
 
Enhanced match – a match that is equal to or exceeds the basic match at any rate of deferrals, and does not increase as rate of deferrals increases; the rate of match for HCEs cannot be greater than for non-HCEs; to avoid ACP testing, matching contributions cannot be based on deferrals or after-tax contributions that exceed 6% of compensation

OR

Nonelective contribution – 3% of compensation, allocated to eligible employees, regardless of whether the employee is contributing to the plan
Required – must pick one
Basic match – 100% match on elective deferrals up to 1% of compensation, plus 50% match on elective deferrals between 2% and 6% of compensation (3.5% match)

OR
 
Enhanced match – same as for Traditional Safe Harbor 401(k) Plan
 
 
 
 
 
 

 
 
OR
 
Nonelective contribution – same as for Traditional Safe Harbor 401(k) Plan
 
 
 
Vesting
 
100% immediate vesting
 
2-year vesting schedule permitted
 
Caution: Any additional non-safe harbor employer matching contribution, profit sharing contribution, or forfeiture allocation may subject the plan to ADP and/or ACP testing and top-heavy testing
 
Distribution Restrictions
Safe harbor contributions for both design options are subject to the same distribution restrictions that apply to salary deferrals, which limit distribution of safe harbor contributions to the following triggering events:
  • Severance from employment
  • Attaining age 59½
  • Death
  • Disability
  • Plan termination
  • Financial hardship
If Matching Contributions Will Be Made
If a plan sponsor will be making safe harbor matching contributions, the choice to become a safe harbor 401(k) plan must be made prospectively. The safe harbor feature generally must be adopted before the first day of a plan year and remain in effect for a full 12-month period.[1] This means that for a plan sponsor to become a safe harbor plan for the 2023 calendar plan year, with a matching contribution, the plan sponsor must amend the plan to add the safe harbor feature before the end of 2022.
 
Plan sponsors must also provide notice to their employees about the safe harbor plan features within a reasonable amount of time before the start of each plan year. The timing requirement is deemed to be satisfied if the notice is provided at least 30 days, and no more than 90 days, before the plan year. For newly eligible employees, the timing requirement is deemed to be satisfied if provided no more than 90 days before the employee becomes eligible and no later than the employee’s eligibility date.
 
If Nonelective Contributions Will Be Made
The SECURE Act of 2019 made it easier for plan sponsors to choose when to adopt a safe harbor feature if the company will be making a nonelective safe harbor contribution.
 
  1. For a traditional safe harbor plan, a safe harbor notice is not required.[2] A QACA safe harbor plan must still provide the automatic enrollment notice, which is generally due early enough so that the employee has a reasonable period to opt out or to change their deferral rate.
  2. A plan sponsor may amend to become a safe harbor 401(k) plan any time during the current plan year up until the 30th day before the end of the plan year if the company makes a 3% nonelective safe harbor contribution for that plan year. For example, a plan could avoid nondiscrimination testing at year-end 2022 by adding a traditional safe harbor plan design with 3% nonelective contribution by November 30, 2022.
  3. A plan sponsor may wait to amend to become a safe harbor 401(k) plan for the current plan year until the end of the following plan year if the company makes a 4% nonelective contribution for that prior plan year. (Note that an employer’s contributions are only deductible for a prior tax year if made by the business’s tax-filing deadline plus extensions for that tax year.)
 
Involve Plan Service Providers in the Discussions
Plan sponsors considering whether a safe harbor 401(k) feature might be beneficial for their plan should consider the financial impact of mandatory employer contributions, as well as how automatic enrollment/automatic escalation could benefit their workforce. As you discuss the safe harbor options with your clients, you may want to facilitate a meeting with a plan design expert who can create projections that illustrate the cost of each option as well as when each type of contribution would have to be made. The plan’s document provider and recordkeeper should also be consulted so the plan sponsor understands the cost for amending the plan document and for providing participant notices if required, as well as the length of time required to process the plan changes.
 
[1]Businesses with an existing profit-sharing plan that add a deferral feature, and businesses that establish a new 401(k) plan that is not a successor plan, may add a safe harbor feature after the start of the plan year if the deferral option is effective at least 3 months prior to the end of the plan year.
² A notice is required to preserve the right to make a mid-year reduction or suspension of the safe harbor contribution. A notice is also required if a traditional safe harbor plan also provides a safe harbor matching contribution.

 
This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own tax, legal and accounting advisors before making any decisions. Newport and its affiliates do not provide tax, legal or accounting advice.

Newport Group, Inc. and its affiliates provide recordkeeping, plan administration, trust and custody, consulting, fiduciary consulting, insurance and brokerage services. 20220921-2434173
 

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