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Correcting 401(k) Testing and Errors – The New EPCRS

Charles D. Lockwood, J.D., L.LM

ASC

Avaneesh Bhaget, Group Manager, IRS

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Charles D. Lockwood, J.D., L.LM ASC

Charles D. Lockwood, J.D., and LL.M. (Taxation), has over

20 years experience in the employee benefits field. Charles

is currently a principal with the ASC Institute (ASCi). Prior to

joining ASCi, Charles was a principal with the pension

consulting firm Global Benefit Advisors, LLC (GBA). Prior to

entering private consulting, Charles worked in the

Employee Plans Division in the National Office of the

Internal Revenue Service (IRS) as a Tax Law Specialist.

Charles also was a Vice President with Pension

Publications of Denver, Inc. (PPD) and a senior consultant

with the benefit consulting practice of Coopers & Lybrand.

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Avaneesh Bhagat, Group Manager, IRS

Avaneesh is the Group Manager for the Voluntary

Compliance Group in El Monte, California. His

responsibilities include assisting with the resolution of

applications made under VCP, assisting with the

development of the revenue procedure relating to the

correction programs for qualified plans, providing

information on correction programs, and responding to

inquiries relating to plan corrections and potential VCP

applications. Avaneesh has worked with the examination,

determination letter and voluntary compliance functions of

the IRS' Employee Plans Division since 1988.

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• Current PPA restatement period for pre-approved

plan adopters ends April 30, 2016

• To avoid numerous individual late amender filings =

IRS will allow financial institutions and other service

providers to submit for umbrella closing agreement

to correct non-amender failure for all ERs as a group

• Umbrella closing agreement parameters:

• Minimum of 20 plans covered by closing agreement

• $10,000 fee for the first 20 plans plus $250 for each

additional plan. Maximum amount: $50,000 (similar to the

Group Submission fee arrangement under VCP)

Plan Restatements

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• Service provider must certify they have record of:

• ER’s affirmative agreement to participate in the closing

agreement program

• ER’s timely adoption of EGTRRA document or proof of

correction

• Execution of PPA restatement using the service provider’s

pre-approved document

• Financial institutions or service providers that apply

and are approved must provide list of ERs covered

by closing agreement by later of 120 days from

closing agreement execution date or May 1, 2017

Plan Restatements

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Rev. Proc. 2015-28

New correction option for elective deferrals (other than automatic contributions)

• If missed deferrals begin

within 3 months from date

of failure = no corrective

QNEC required

• If after 3 months (but before

end of 2nd PY) = corrective

QNEC equal to 25% (instead

of 50%) of missed deferrals

• ER must make QNEC for missed match, plus earnings, by

end of second PY following failure

• ER must send 45-day notice to affected EEs

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Rev. Proc. 2015-28

Provides new SH correction method for failure to implement automatic contributions on a

timely basis

• No corrective QNEC

required if correct error

within 9½ months after

end of PY or date ER is

notified of failure, if

earlier

o Ties into filing deadline for

Form 5500

• ER must make QNEC for

missed match, plus

earnings, by end of 2nd PY

following failure

o Must send notice to affected

EEs detailing correction

within 45 days after

correction

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• Modifies correction process for overpayments

o Allows ER to make plan whole (including applicable

earnings) without demanding repayment from

participant

o If applicable, ER may make retroactive amendment

allowing for distribution from plan

• EPCRS allows plan to correct improper hardship distribution

or loans by amending plan to add hardship distributions or

loans

• Must ER make plan whole if improper hardship

distribution is made to participant and participant

does not repay distribution?

Rev. Proc. 2015-27

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• Is documentation required for SH hardship?

o In recent Employee Plans News, IRS stated plan sponsor

must obtain and keep hardship records

o Failure to have records available for examination is a

qualification failure corrected under EPCRS

o Records should be retained in paper or electronic format,

including documentation that substantiates EE’s immediate

and heavy financial need

• Not sufficient for plan participants to keep their own

records of hardship distributions

Documentation Requirement

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• Employee Plan News article also advises ERs to keep

documentation on plan loans

o Records should be maintained in paper or electronic format

for each plan loan granted to a participant, including

evidence of loan application

o If applicable, documentation verifying loan proceeds were

used to purchase primary residence

• If loan will exceed 5 years, should receive documentation

regarding purchase of primary residence before loan

approved

• Self-certification not permissible to document

eligibility for primary residence loan exception

Documentation Requirement

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ADP/ACP Test

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• Limits extent to which plans can be designed in favor

of HCEs = must pass both coverage and

nondiscrimination tests every plan year

• Coverage measures relative coverage of HCEs and

NHCEs at plan level

• Nondiscrimination measures level of benefits

provided to HCEs and NHCEs

o 401(a)(4) nondiscrimination test = ER contributions

o ADP test = elective deferrals

o ACP test = matching contributions / after-tax

Coverage and Nondiscrimination

Slide 12

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• Tests relative deferrals of HCEs and NHCEs

• Plan must satisfy one of the following tests:

o HCE ADP < 1.25 x NHCE ADP

o HCE ADP < Lesser of 2+ or 2x NHCE ADP

deferrals • ADP = Average of -----------------------------

414(s) compensation

• Can use prior year or current year deferral

percentages for NHCE group

ADP Test

Slide 13

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• Same as ADP test except tests matching and after-

tax employee contributions (Code§401(m))

• Must satisfy one of following tests:

o HCE ACP < 1.25 x NHCE ACP

o HCE ACP < Lesser of 2+ or 2x NHCE ACP

match / after-tax • ACP = Average of -----------------------------

414(s) compensation

• Can use prior year or current year deferral

percentages for NHCE group

ACP Test

Slide 14

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• NHCE ADP < 2% 2x TEST

• NHCE ADP 2% - 8% 2+ TEST

• NHCE ADP > 8% 1.25 TEST

Most Favorable Test

Slide 15

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• Prior year testing method

o Compare prior year ADP/ACP for NHCE group to current

year ADP/ACP for HCE group

o Allows some predictability of results

• Current year testing method

o Compare current year ADP/ACP for NHCE group to

current year ADP/ACP for HCE group

o More flexibility in correction methods

• Must state testing method in plan

o Make sure follow plan document

ADP / ACP Testing Methods

Slide 16

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• Distribution of excess contributions (ADP) or excess

aggregate contributions (ACP) and earnings

• Making QNECs

• Shifting QMACs into ADP test or shifting elective

deferrals into ACP test

• Recharacterization (only for ADP violation)

How to Fix a Failed ADP/ACP Test

Slide 17

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• XYZ Corp maintains a 401(k) plan for its EEs. The plan

defines compensation for deferral purposes as gross

compensation for full plan year. The ADP of HCE

group for 2015 is 7.5%. The ADP of NHCEs for 2015 is

4.3% and for 2014 is 4.9%.

o XYZ Corp has 4 HCEs and 6 NHCEs. The 4 HCEs each

make over the $265,000 compensation limit and deferred

$18,000 under the plan for 2015.

o Sally, an NHCE, first becomes a participant in July of 2015

and defers $2,000 (5% of her $40,000 annual compensation).

o XYZ declares a bonus twice a year (in June and December).

Generally, bonuses are paid to NHCEs.

Improving ADP/ACP Results

Slide 18

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• Plan can use any definition of comp for ADP / ACP

testing as long as satisfy Code 414(s)

o Definition does not need to be stated in plan

o Net compensation may provide better results where HCEs

earn above compensation limit

o Can exclude specific items of comp (e.g., bonuses)

• Plan can use full year or partial year comp

o If have NHCEs who become participants during year = use

partial year compensation (regardless of definition in plan)

• May be able to use top-paid group test

Creative Testing Options

Slide 19 Slide

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• Must have compensation > dollar amount in

lookback year and must be in top-paid group

o Top 20% of EEs ranked by compensation

o Election must be made in plan

o Can use any reasonable tie breaking method

• Allows plan to treat HCEs not in the top 20% as

NHCEs

o Be careful when defining allocation groups to ensure HCEs

do not lose benefits

o Once become NHCE = must receive gateway

• When must top paid group election be made?

o Before end of current plan year

Top Paid Group Test

Slide 20

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Corrective Distributions

• Correction period - 12 months following the close of

the plan year

• Amount to be distributed -- leveling method

o Based on highest dollar amount of deferrals

o Two-step method

o Must recharacterize as catch-up contributions prior to

making corrective distributions

• Allocable earnings

o Gap period earnings

o Treatment of net loss

Slide 21

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Refunds of Excess Contributions

HCEs

Age

Comp.

Deferrals

Deferral Percentage

1 55 $265,000 $18,000 6.79%

2 61 $265,000 $18,000 6.79%

3 50 $200,000 $16,000 8%

4 42 $150,000 $13,500 9%

5 41 $125,000 $10,000 8%

6 55 $120,000 $12,000 10%

$1,125,000 $87,500 7.93%

Black & Blue, Inc. maintains a calendar year 401(k)

plan. For 2015, the ADP of the NHCEs is 5% and the

HCE deferrals are as follows:

Slide 22

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HCEs

Age

Comp.

Deferrals

Deferral Percentage

Adjusted Percentage

1 55 $265,000 $18,000 6.79% 6.79%

2 61 $265,000 $18,000 6.79% 6.79%

3 50 $200,000 $16,000 8% 7.105%

4 42 $150,000 $13,500 9% 7.105%

5 41 $125,000 $10,000 8% 7.105%

6 55 $120,000 $12,000 10% 7.105%

$1,125,000 $87,500 7.93% 7%

The ADP of the NHCEs for 2015 is 5%. The plan uses current year testing method. To correct ADP test, must bring HCE-3, HCE-4, HCE-5 and HCE-6 down to 7.105%.


Slide 23

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HCE

Age

Comp.

Deferral

Deferral %

Adjusted %

Correction Amount

1 55 $265,000 $18,000 6.79% 6.79%

2 61 $265,000 $18,000 6.79% 6.79%

3 50 $200,000 $16,000 8% 7.105% $1,790

4 42 $150,000 $13,500 9% 7.105% $2,843

5 41 $125,000 $10,000 8% 7.105% $1,119

6 55 $120,000 $12,000 10% 7.105% $3,474

$1,125,000 $87,500 7.93% 7% $9,226

The total amount to be returned is $9,226 -- $1,790 to correct HCE-3 [.895% x $200,000] + $2,843 to correct HCE-4 [1.895% x $150,000] + $1,119 to correct HCE-5 [.895% x $125,000] + $3,474 to correct HCE-6 [2.895% x $120,000].


Slide 24

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HCE

Age

Comp.

Deferral

Correction Amount

Refund Amount

Adjusted Deferrals

1 55 $265,000 $18,000 $18,000

2 61 $265,000 $18,000 $18,000

3 50 $200,000 $16,000 $1,790 $16,000

4 42 $150,000 $13,500 $2,843 $13,500

5 41 $125,000 $10,000 $1,119 $10,000

6 55 $120,000 $12,000 $3,474 $12,000

$1,125,000 $87,500 $9,226 $83,500

Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount.


Slide 25

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HCE

Age

Comp.

Deferral

Correction Amount

Refund Amount

Adjusted Deferrals

1 55 $265,000 $18,000 $2,000 $16,000

2 61 $265,000 $18,000 $2,000 $16,000

3 50 $200,000 $16,000 $1,790 $16,000

4 42 $150,000 $13,500 $2,843 $13,500

5 41 $125,000 $10,000 $1,119 $10,000

6 55 $120,000 $12,000 $3,474 ______ $12,000

$1,125,000 $87,500 $9,226 $4,000 $79,500

Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. $2,000 refunded to HCE-1 and HCE-2.

Remaining refund = $5,226 [$9,226 - $4,000]


Slide 26

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HCE

Age

Comp.

Deferral

Correction Amount

Refund Amount

Adjusted Deferrals

1 55 $265,000 $18,000 $3,742 $14,258

2 61 $265,000 $18,000 $3,742 $14,258

3 50 $200,000 $16,000 $1,790 $1,742 $14,258

4 42 $150,000 $13,500 $2,843 $13,500

5 41 $125,000 $10,000 $1,119 $10,000

6 55 $120,000 $12,000 $3,474 ______ $12,000

$1,125,000 $87,500 $9,226 $9,226 $78,274

Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. $1,742 refunded to HCE-1, HCE-2 and HCE-3.

Remaining refund = $0 [$5,226 - $5,226]


Slide 27

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HCE

Age

Comp.

Deferral

Correction Amount

Refund Amount

Adjusted Deferrals

1 55 $265,000 $18,000 $3,742 $14,258

2 61 $265,000 $18,000 $3,742 $14,258

3 50 $200,000 $16,000 $1,790 $1,742 $14,258

4 42 $150,000 $13,500 $2,843 $0 $13,500

5 41 $125,000 $10,000 $1,119 $0 $10,000

6 55 $120,000 $12,000 $3,474 _ $0__ $12,000

$1,125,000 $87,500 $9,226 $9,226 $78,274

Refunds are returned based on highest dollars of deferrals. Level to next lowest dollar amount. $1,742 refunded to HCE-1, HCE-2 and HCE-3.

Remaining refund = $0 [$5,226 - $5,226]


Slide 28

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HCEs

Age

Comp.

Deferrals

Catch-Up Contribution

ADP Deferrals

1 55 $265,000 $24,000

2 61 $265,000 $20,000

3 50 $200,000 $16,000

4 42 $150,000 $13,500

5 41 $125,000 $10,000

6 55 $120,000 $12,000

$1,125,000 $95,500

Suppose the B&B plan permits catch-up contributions. How would the availability of catch-up contributions affect the ADP refunds under the plan?

Application of Catch-Up Contributions

Slide 29

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HCEs

Age

Comp.

Deferrals


ADP Deferrals

1 55 $265,000 $24,000 $6,000 $18,000

2 61 $265,000 $20,000

3 50 $200,000 $16,000

4 42 $150,000 $13,500

5 41 $125,000 $10,000

6 55 $120,000 $12,000

$1,125,000 $95,500



Slide 30

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HCEs

Age

Comp.

Deferrals


ADP Deferrals

1 55 $265,000 $24,000 $6,000 $18,000

2 61 $265,000 $20,000 $2,000 $18,000

3 50 $200,000 $16,000

4 42 $150,000 $13,500

5 41 $125,000 $10,000

6 55 $120,000 $12,000

$1,125,000 $95,500



Slide 31

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HCEs

Age

Comp.

Deferrals


ADP Deferrals

1 55 $265,000 $24,000 $6,000 $18,000

2 61 $265,000 $20,000 $2,000 $18,000

3 50 $200,000 $16,000 $0 $16,000

4 42 $150,000 $13,500 $0 $13,500

5 41 $125,000 $10,000 $0 $10,000

6 55 $120,000 $12,000

$1,125,000 $95,500



Slide 32

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HCEs

Age

Comp.

Deferrals


ADP Deferrals

1 55 $265,000 $24,000 $6,000 $18,000

2 61 $265,000 $20,000 $2,000 $18,000

3 50 $200,000 $16,000 $0 $16,000

4 42 $150,000 $13,500 $0 $13,500

5 41 $125,000 $10,000 $0 $10,000

6 55 $120,000 $12,000

$1,125,000 $95,500

HCE-6 deferred 10% for 2015. The ADP of the NHCEs is 5%. To pass the ADP test, the ADP of the HCEs may not exceed 7%. May B&B treat any of HCE-6’s deferrals as catch-up contributions and exclude them from the ADP test?


Slide 33

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HCEs

Age

Comp.

Deferrals


ADP Deferrals

1 55 $265,000 $24,000 $6,000 $18,000

2 61 $265,000 $20,000 $2,000 $18,000

3 50 $200,000 $16,000 $0 $16,000

4 42 $150,000 $13,500 $0 $13,500

5 41 $125,000 $10,000 $0 $10,000

6 55 $120,000 $12,000 $0 $12,000

$1,125,000 $95,500 $8,000 $87,500

HCE-6 deferred 10% for 2015. The ADP of the NHCEs is 5%. To pass the ADP test, the ADP of the HCEs may not exceed 7%. May B&B treat any of HCE-6’s deferrals as catch-up contributions and exclude them from the ADP test?


Slide 34

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HCE

Age

Comp.

Deferral


Refund Amount

Adjusted Refund

1 55 $265,000 $24,000 $6,000 $3,742

2 61 $265,000 $20,000 $2,000 $3,742

3 50 $200,000 $16,000 $0 $1,742

4 42 $150,000 $13,500 $0 $0

5 41 $125,000 $10,000 $0 $0

6 55 $120,000 $12,000 $0 $0

$1,125,000 $93,500 $8,000 $9,226


Slide 35

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HCE

Age

Comp.

Deferral


Refund Amount

Adjusted Refund

1 55 $265,000 $24,000 $6,000 $3,742 $3,742

2 61 $265,000 $20,000 $2,000 $3,742

3 50 $200,000 $16,000 $0 $1,742

4 42 $150,000 $13,500 $0 $0

5 41 $125,000 $10,000 $0 $0

6 55 $120,000 $12,000 $0 $0

$1,125,000 $93,500 $9,226


Slide 36

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HCE

Age

Comp.

Deferral


Refund Amount

Adjusted Refund

1 55 $265,000 $24,000 $6,000 $3,742 $3,742

2 61 $265,000 $20,000 $5,742 $3,742 $0

3 50 $200,000 $16,000 $0 $1,742

4 42 $150,000 $13,500 $0 $0

5 41 $125,000 $10,000 $0 $0

6 55 $120,000 $12,000 $0 $0

$1,125,000 $93,500 $9,226


Slide 37

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HCE

Age

Comp.

Deferral


Refund Amount

Adjusted Refund

1 55 $265,000 $24,000 $6,000 $3,742 $3,742

2 61 $265,000 $20,000 $5,742 $3,742 $0

3 50 $200,000 $16,000 $1,742 $1,742 $0

4 42 $150,000 $13,500 $0 $0

5 41 $125,000 $10,000 $0 $0

6 55 $120,000 $12,000 $0 $0

$1,125,000 $93,500 $9,226


Slide 38

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HCE

Age

Comp.

Deferral


Refund Amount

Adjusted Refund

1 55 $265,000 $24,000 $6,000 $3,742 $3,742

2 61 $265,000 $20,000 $5,742 $3,742 $0

3 50 $200,000 $16,000 $1,742 $1,742 $0

4 42 $150,000 $13,500 $0 $0 $0

5 41 $125,000 $10,000 $0 $0 $0

6 55 $120,000 $12,000 $0 $0 $0

$1,125,000 $93,500 $13,484 $9,226 $3,742


Slide 39

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• If EE defers more than Code §402(g) limit (i.e.,

$18,000 for 2015/2016) = must distribute excess

deferrals from plan

o Distribution must occur before April 15 of next calendar

year to avoid adverse tax consequences

o Corrective distribution must include allocable earnings or

loss

• Excess deferrals are taxable in year of deferral and if

distributed after April 15 are taxable again in year of

distribution

• 402(g) limit is applied on individual basis

What if EE Makes Excess Deferrals?

Slide 40

41

• If EE defers to more than one plan = limit applies to all

deferrals made in same year

• EE is responsible for determining whether 402(g) limit

has been exceeded and taking appropriate corrective

steps

o If EE makes deferrals under multiple plans = EE must

decide which plan holds the excess

o EE must give notice to plan by March 1 following calendar

year so distribution can be made by April 15

o Excess deferrals will not disqualify a plan if excess is made

under plans of unrelated ERs

What if EE Makes Excess Deferrals?

Slide 41

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• If HCE has excess deferrals = excess amount is

included in ADP test (even if distributed)

o Catch-up contributions not included for purposes of

determining whether have excess deferrals

o Excess deferrals of NHCEs are not included in ADP test

• When apply two-step leveling method =

include excess deferral in HCE’s deferral percentage

(even if refunded to correct 402(g) violation)

Affect of Code §402(g) Limit

Slide 42

43

• What if HCE is entitled to distribution of both excess

deferrals and excess contributions?

o Excess contributions distributed to correct ADP failure are

reduced by any corrective distribution of excess deferrals for

calendar year ending in plan year

o Plan gets credit for distributing full amount of ADP correction

even though reduced by excess deferral correction

o For taxation purposes, treat portion of distribution attributable

to excess deferrals as distribution of excess deferrals

Affect of Code §402(g) Limit

Slide 43

44

• If excess aggregate contributions are not fully vested

= non-vested portion (including earnings) is forfeited

instead of distributed

• If matched deferrals are distributed as excess

contributions = related match (plus earnings) may be

forfeited to prevent discriminatory rate of match (even

if vested)

o How do forfeited match affect ADP/ACP test?

• Forfeit match first, then run ACP test = forfeited match not

taken into account under ACP test

• Run both ADP/ACP tests, then forfeit, if necessary = no

forfeiture required to extent distributed under ACP

Forfeiture of Related Contributions

Slide 44

45

• Excess contributions or excess aggregate

contributions must be adjusted for allocable earnings

• Plan may use any reasonable method to calculate

allocable earnings for plan year

• PPA eliminated gap period earnings for post-2007

plan years

• If allocable earnings are a net loss, amount

distributed is reduced by loss amount and is not

taxed to HCE

Allocable Earnings

Slide 45

46

• Must correct ADP/ACP test within 12 months following

end of plan year

• If do not correct, what are ER’s options?

o Do nothing and hope don’t get audited by IRS

• Should give ER correction options (in writing?) and decision to

not correct should be ER decision

o Self correct = IRS suggested correction is to use one-to-one

correction method

• Self-correction available through last day of second plan year

following failure

• Failure occurs at end of 12-month period = allows for 3-year

correction period

• May correct anytime if de minimis (probably not)

Correction After 12-Month Period

Slide 46

47

• If correct after end of 12-month period = what is

correction method?

o IRS suggested correction method = one-to-one correction

• Determine excess for HCEs (including earnings) and make

appropriate refunds

• Make QNEC on behalf of all NHCEs equal to refunded

amount and allocate on basis of compensation

Does ER have to give QNEC to terminated EEs?

Could ER just give refunds to HCEs?

Could ER use targeted QNECs?

Can ER disaggregate otherwise excludible EEs?

Correction After 12-Month Period

Slide 47

48

• ER contribution that looks like deferral

o 100% vested when made

o Subject to 401(k) distribution restrictions

o Special nondiscrimination rules

• Must be made within 12 months following end of plan

year

o Current year method

o Prior year method

• Bottom-up QNECs eliminated

o Can now provide for targeted QNECs

Using QNECs in ADP Test

Slide 48

49

• Plan must satisfy nondiscrimination requirements

with and without QNECs used in ADP test

• Example: ER makes 3% QNEC to all EEs. May ER

treat 1% of NHCE QNECs in ADP test?

o Plan must be able to satisfy 401(a)(4) after “carving out”

QNECs

o Could test by imputing permitted disparity or using “cross-

testing”

• If use cross-testing = must satisfy minimum gateway based

on contributions being tested

Using QNECs in ADP Test

Slide 49

50

• Employer X maintains a 401(k) plan and runs its

2015 ADP test on 3/1/16 and fails ADP test based on

prior year testing.

• Employer X would like to correct the ADP test by

making a QNEC to the NHCEs.

• By when must Employer X contribute the QNEC to

correct the 2015 ADP test?

• End of 2015 plan year (12 months following end of 2014

plan year)

• Not permitted to use QNEC to correct prototype / VS

plans that use prior year testing

Use of QNECs with Prior Year Testing

Slide 50

51

• Targeted QNEC = can only use QNEC in ADP or

ACP test to extent does not exceed greater of:

o 5% of compensation

o 2x plan’s “representative contribution rate”

• The lowest QNEC rate of any NHCE, taking into account at

least 50% of total eligible NHCEs

• The lowest QNEC rate of any NHCE employed as of the

last day of the plan year

Targeted QNECs

Slide 51

52

• ABC Corp. has 44 NHCEs eligible for plan. For 2015

PY, ABC plan fails the ADP test. ABC Corp. would like

to make a QNEC for Joe, the lowest paid EE. How

much may ABC Corp. give Joe (and include in ADP

test) without making a QNEC for any of the other

NHCEs?

o 5% of compensation

• If ABC Corp. gives Joe 15% QNEC, how much must it

give to the other NHCEs?

o At least 22 NHCEs must receive a QNEC of at least 7½%

of compensation

Example

Slide 52

53

Correcting Coverage Failures

54

Coverage Tests

Percentage

test

At least 70% of

NHCEs benefit

Ratio test

% of NHCEs ------------------ > 70% % of HCEs

Average benefits

test

• Three coverage tests = only need satisfy one test

under Code §410(b)

• Minimum coverage tests also used to determine if

rate groups are nondiscriminatory under Code

§401(a)(4)

Slide 54

55

Ratio Percentage Test

• NHCE ratio ----------------- > 70% HCE ratio NHCEs benefiting • NHCE ratio = ------------------------- total NHCEs HCEs benefiting • HCE ratio = ---------------------- total HCEs

• Only include “nonexcludable” employees in ratio percentage test = may exclude certain “excludable” employees from coverage tests

Slide 55

56

Average Benefits Test

Nondiscriminatory

classification

test

Average

benefit

percentage

test

• Two parts to average benefits test = must satisfy

both parts to pass test

• Different rules apply for coverage / nondiscrimination

o Reasonable classification test does not apply for

nondiscrimination test = changed under proposed regs

o Can use midpoint between safe and unsafe harbors

Slide 56

57

• Reasonable classification

o Based on business criteria = e.g., job classification, nature

of compensation, geographic location

o Naming individuals is not reasonable classification

o Reasonable classification test does not apply under

nondiscrimination tests (unless proposed regs become

final)

• Nondiscriminatory classification

o Use same ratio as under ratio test

o Must satisfy safe harbor percentage = see chart

o If between safe harbor and unsafe harbor = facts and

circumstances

Nondiscriminatory Classification Test

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• Safe harbor / unsafe harbor based on NHCE

concentration percentage

• NHCE concentration percentage is determined by

dividing total number of NHECs of ER by total

number of EEs of ER

o When determining number of EEs, disregard NHCEs

and HCEs who are excludable EEs

• If two or more plans are permissively aggregated =

determine excludable EEs as if the plans are a single

plan

Safe Harbor / Unsafe Harbor

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NHCE concent. SH % UH % Midpoint NHCE concent. SH % UH % Midpoint

0-60 50.00 40.00 45.00 80 35.00 25.00 30.00

61 49.25 39.25 44.25 81 34.25 24.25 29.25

62 48.50 38.50 43.50 82 33.50 23.50 28.50

63 47.75 37.75 42.75 83 32.75 22.75 27.75

64 47.00 37.00 42.00 84 32.00 22.00 27.00

65 46.25 36.25 41.25 85 31.25 21.25 26.25

66 45.50 35.50 40.50 86 30.50 20.00 25.50

67 44.75 34.75 39.75 87 29.75 20.00 24.875

68 44.00 34.00 39.00 88 29.00 20.00 24.50

69 43.25 33.25 38.25 89 28.25 20.00 24.125

70 42.50 32.50 37.50 90 27.50 20.00 23.75

71 41.75 31.75 36.75 91 26.75 20.00 23.375

72 41.00 31.00 36.00 92 26.00 20.00 23.00

73 40.25 30.25 35.25 93 25.25 20.00 22.625

74 39.50 29.50 34.50 94 24.50 20.00 22.25

75 38.75 28.75 33.75 95 23.75 20.00 21.875

76 38.00 28.00 33.00 96 23.00 20.00 21.50

77 37.25 27.25 32.25 97 22.25 20.00 21.125

78 36.50 26.50 31.50 98 21.50 20.00 20.750

79 35.75 25.75 30.75 99 20.75 20.00 20.375

Nondiscriminatory Classification Test

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General Nondiscrimination Test

• Each HCE is in his/her own rate group for purposes

of general nondiscrimination test

• Each HCE rate group must satisfy a minimum

coverage test under Code §410(b)

o Rate group includes all equal or higher allocation or

equivalent benefit rates

• Rate groups may be expressed as allocation rates or

equivalent benefit rates

• If using average benefits test = special rules apply

o May use midpoint between safe and unsafe harbors

o Reasonable classification test does not apply = but see

new proposed regulations

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• Potentially eliminates some of the flexibility to use

every EE in own group

o Modifies average benefits test to apply reasonable

classification test to rate group test

o To satisfy average benefit test, rate group must be based

on reasonable objective business criteria or rate group must

satisfy ratio test (i.e., benefit percentage must be 70% or

higher)

• Naming of individual EEs is not reasonable

• Not effective until final regulations issued

New Proposed Regulations

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• NHCE average benefit percentage ------------------------------------------------ > 70% HCE average benefit percentage

• Include benefit percentages of all non-excludable

EEs (even if not benefitting)

• May test on basis of allocation rates or benefit

rates

o Determine allocation or benefit rates as percentage

of 414(s) compensation

• Must include benefits under all plans of the employer

-- including 401(k)/401(m) plans

Average Benefit Percentage Test

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• If fail coverage or nondiscrimination test = may make

retroactive corrective amendment within 9½ months

after end of PY [§1.401(a)(4)-11(g)]

o May not bring EEs in by name for coverage test unless

satisfy ratio test = can bring in EEs by name to correct

nondiscrimination violation (for now)

o Amendment must expand coverage or increase benefits

o 401(k)/401(m) plan = must make QNECs to make up

deferrals/match based on ADP or ACP for plan year

• Special 50%/25% rule for determining QNECs does not apply

• May QNECs be provided to lowest paid EEs?

• What if not corrected within 9½ months?

What if Fail Coverage / Nondiscrimination Test?

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§1.401(a)(4)-11(g) Amendment

• Can amend plan within 9½ months after end of Plan

Year to correct violation

o Amendment may not reduce benefits under Plan

• Increase in benefits must satisfy 401(a)(4)

independently

o Always satisfied if increase is for NHCEs only

• Amendment must have substance – cannot apply

increase to terminated non-vested EEs

• Can amend plan to provide additional contribution

necessary to pass nondiscrimination

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• Correct under EPCRS = regulatory correction

methods may still apply under EPCRS

o If excess relates to elective deferrals or after-tax EE

contributions = correction is to distribute excess amount

(with earnings)

o If excess relates to ER contributions or match = reallocate

to other EEs (if discretionary) or suspense account (if fixed)

and reduce future contributions

o Distribution is reported as distribution on Form 1099-R for

year of distribution (Code “E”)

o Amounts distributed as excess annual additions

are disregarded for ADP/ACP test and Code §402(g)

Correcting 415 Violations

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• Is there a deadline for making corrective distributions

to correct 415 violation?

• No formal deadline under EPCRS

• Need to make corrective distributions before can properly

correct ADP/ACP test = within 12 months after close of plan

year

• Must make corrective distribution by end of second plan

year in order to use SCP

• Earnings continue to accrue until corrective distribution is

made from plan


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• Can ER use SCP to correct Code 415 violation in

multiple years?

o In order to use SCP = must have established procedures in

place to prevent repeat violations

o If fail Code §415 under plan that has both elective

deferrals and ER contributions = can use SCP to correct

excess by distributing elective deferrals each year to correct

Code §415(c) violation within 2½ months after end of

limitation year

• Plan will be treated as having established procedures even if

it has repeated violations


Slide 67

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