The Ratio Percentage Test
As we discussed in our last installment, the purpose of the coverage rules is to ensure that each group of employees subject to discrimination testing includes at least a minimum number of lower-paid employees relative to the number of higher-paid employees in the group. Although there are two methods available, the vast majority of retirement plans satisfy the coverage rules by complying with the ratio percentage test.
The coverage testing rules allow us to ignore any employees who are excluded under the plans statutory exclusions . The remaining employees are the nonexcludable employees who constitute the coverage-testing group.
A plan will pass the ratio percentage test if the plans NHCE ratio divided by the HCE ratio is least 70%.
The WHCE ratio is the percentage of nonexcludable NHCEs who are benefiting under the plan. The HCE ratio is the percentage of nonexcludable HCEs who are benefiting. Arithmetically the ratio percentage test would look like this:
# of NHCEs Benefiting ÷ # of HCEs Benefiting = Ratio Percentage
# of Nonexcludable NHCEs # of Nonexcludable HCEs
What does this formula tell us? If your plan is having trouble with its discrimination testing tests), you may want to review your plans statutory exclusions particularly its eligibility requirements in order to exclude ineligible employees from the testing.
Later on in this article we will examine specific cases of how this formula works.
Automate Your 401 Eligibility Tracking
Doing things manually is all well and good – especially if you have a good process and lots of time on your hands.
For the rest of us though, thankfully, theres a better way.Some forward-thinking 401 providers are already offering automated eligibility tracking. Theyll essentially keep track of your employees – when they were hired, and when they become eligible – and will then send notices as required. As you can imagine, this can save you a lot of time and all but eliminate the risk of making a mistake.
Sound good? We think so too.
Next step: Ask your Third-Party Administrator or Recordkeeper if they offer an automation solution. Or…
When Does Vesting Eligibility Begin
IRS Notice 2020-68 clarifies that employers can disregard the 12-month periods before 2021 when determining 401 participation eligibility, but not when determining years of vesting service for employer contributions. So, when figuring vesting eligibility based on years of service, you must consider the employees total employment meaning all years of service.
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Make A Contribution To A Traditional Ira
Virtually anyone at any income level can make a contribution. But the tax deduction for a contribution if youre already covered by an employer plan phases out at $125,000 for married couples, in $76,000 for single filers. But if HCE status limits your 401 contributions, this will be a way to take advantage of tax deferral of investment income.
Contributions arent nearly as generous as they are for 401 plans, at just $6,000 per year , but every little bit helps.
How To Avoid The Mistake:
- Review your plan document for the definition of employee and provisions of employee eligibility.
- Provide proper training about the plan document to in-house personnel who determine employee eligibility.
- Look at your payroll records for the total number of employees, birth dates, hire dates, hours worked, and other pertinent information. Also inspect Form W-2 and state unemployment tax returns and compare employee data on these records with the payroll records to see if employee counts are accurate.
- Establish protocols and a corrective action plan that will be triggered when errors are identified.
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Has The Law Changed Or Is The Current Employer Wrong
To a certain extent, 401 regulations allow employers to determine what is defined as “eligible compensation/pay” for contributions to a 401 plan. For instance, some plans may include overtime pay in the definition of compensation for salary deferral purposes, while others may not. Indeed, many may only include so-called “straight time pay” i.e., earnings from working normal hours.
Plan Compensation What Employers Need To Know
According to the IRS, one of the most common mistakes that employers make when administering their 401 plan is allocating plan contributions to participant accounts using the wrong employee compensation. Usually, this mistake involves the employer excluding forms of compensation that the definition of compensation specified in their plan document includes shortchanging plan participants.
Employers must properly apply other definitions of employee compensation when testing the contributions made to their 401 plan too. When the wrong compensation is used, a plan can fail a test it would have passed using correct compensation or vice versa.
401 administration mistakes related to employee compensation can be expensive for employers to fix. To stay out of trouble, employers should confirm theyre processing payroll contributions using the correct compensation and supplying their 401 provider with the compensation they need to complete year-end testing and/or contribution allocations correctly.
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Contributions Or Benefits Must Not Discriminate
Under the plan, contributions or benefits must not discriminate in favor of highly compensated employees. Generally, employees with compensation of $130,000 or more from the employer in the prior year are considered highly compensated for 2021 and for 2020 . In order to satisfy this requirement with regard to elective deferrals and employer matching contributions, 401 plans may provide minimum employer contributions or meet the Actual Deferral Percentage and Actual Contribution Percentage tests.
Employees Other Than Full
It is important to consider how the terms of the plan affect the participation of employees working under special situations, such as rehired participants, employees working on a part-time or temporary basis, seasonal employees, leased employees, and contract employees.
If there is any question regarding how these types of employment situations should be handled for purposes of plan participation, the plan sponsor should request legal advice or other professional assistance in working through the appropriate treatment of these individuals under the law and the terms of the plan.
Here again, it is important to develop internal control procedures to confirm that all eligible employees are timely included in the plan .
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Example Of Participation And Vesting Eligibility
In 2020, Mary worked 700 hours. At that time, you excluded Mary from your 401 plan because she did not work at least 1,000 hours in a 12-month period and was not at least 21 years old.
But pursuant to the SECURE Act, you must start tracking Marys time in 2021, through to 2023 to determine whether shes eligible to participate in your 401 plan in 2024.
Lets say Mary works the following hours from 2020 to 2023:
Based on the above information, you must include Mary in your 401 plan starting 2024, because she turns 21 before the end of the previous 3-year period and works between 500 and 999 hours during each of those 3 years. As the IRS stated, with regard to participation, you would not count Marys work hours for 2020.
In terms of vesting, any contributions Mary makes to her 401 as a part-time employee is immediately vested, meaning the funds immediately belong to Mary 100% at the time of payroll deduction. However, you require that employees work at least 1,000 hours for the year, in order to qualify for matching contributions. So long as Mary keeps working less than 1,000 hours in a year, you do not have to make matching contributions to her 401 account.
Avoiding Costly Compensation Mistakes Can Be Easy
To keep a 401 plan in compliance with ERISA, correct compensation must be used when allocating and testing participant contributions. Otherwise, a costly correction can result.
To stay out of trouble, employers must understand the plan and test compensation applicable to their 401 plan. Employers with questions should talk to their 401 provider. An experienced provider can make using the correct compensation easy.
About Eric Droblyen
Eric Droblyen began his career as an ERISA compliance specialist with Charles Schwab in the mid-1990s. His keen grasp on 401k plan administration and compliance matters has made Eric a sought after speaker. He has delivered presentations at a number of events, including the American Society of Pension Professionals and Actuaries Annual Conference. As President and CEO of Employee Fiduciary, Eric is responsible for all aspects of the companys operations and service delivery.
- Connect with Eric Droblyen
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I Have Or Will Soon Have Full
- You need to stop contributions. Your company plan is no longer eligible for a Solo 401.
- You will need to rollover your self-directed Solo 401 to a Self-Directed IRA or Self-Directed SEP-IRA within one year.
- Rocket Dollar can assist you in rolling over your self-directed 401 account to a Self-Directed IRA OR a Self-Directed SEP-IRA Please call us at
What Happens To Nonvested Employer Contributions When Participants Leave An Organization
The money must be moved into the plans forfeiture or suspense account, where it can be used to:
- Cover other employer contributions already payable by the plan
- Restore the accounts of rehired employees, subject to certain criteria
- Pay ERISA-approved plan expenses
- Make additional employer contributions for existing plan participants
Regardless of which option a plan sponsor uses, ERISA specifies that any forfeited contributions be used for an appropriate purpose by the end of the plan year.
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Additional Safe Harbor Requirements
Making contributions to your employees 401 is the most notable Safe Harbor requirement, but there are additional rules surrounding when and how you offer your plan.
Safe Harbor deadlinesFor new plans, October 1 is the final deadline for starting a new Safe Harbor 401. But dont wait until a few days before the deadline to set up your plan, because if youre making a matching contribution, youre also required to notify your employees 30 days before the plan starts, and it can take a week or more to set up your plan. So, make sure you talk to your 401 plan provider well before September 1. For existing plans, the deadlines depend on the type of Safe Harbor contribution you are adding to the plan and are detailed below.
Important dates for new plans:
It is important to be aware that if a Safe Harbor feature is added to a new plan, it must be in place for the entire plan year. If the plan year is set up retroactive to January 1, contributions will be required based on eligible compensation for the entire year.
Important dates for existing plans-Safe Harbor match
If you want to add a Safe Harbor matching provision to an existing 401, your administrator can make a plan amendment that goes into effect January 1 of any future year. Remember, there is an employee 30-day notice requirement, and it may take some time for your administrator to amend the plan, so try to get this taken care of by the end of November to go into effect January 1. to take effect 2022.)
The Risks Of Excluding Part
As more and more businesses are using part-time workers to address their hiring needs, it is important that employers consider how such workers affect their qualified retirement plans. In particular, employers and their service providers need to be very mindful of IRS guidance on the exclusion from qualified retirement plans of employees classified by the employer as part-time, seasonal, or temporary.
Earlier this year, the IRS issued a Quality Assurance Bulletin to its employee plan agents regarding qualified retirement plans excluding part-time employees. In the QAB, the Service indicated that, effective with the opening of the EGTRRA Pre-Approved and Determination Letter Programs, agents will begin requesting that plan administrators remove or clarify language if a plan includes a provision that defines an exclusion classification by service and the plan provision could result in the exclusion, by reason of a minimum service requirement, of an employee who has completed a year of service. In particular, any plan containing a part-time, seasonal, temporary, or any other classification of employees will be scrutinized.1
The IRSs Position Develops
The 1,000 Hour Exception
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The Safe Harbor Solution
One way avoid ADP and ACP testing is to adopt a Safe Harbor plan. The plain becomes exempt from the tests in exchange for regular contributions to all eligible employees.
There are a few ways to gain the Safe Harbor test exemption. One way is to match employee contributions dollar-for-dollar on the first 3% of deferrals, and 50% on the next 2%. That results in a maximum 4% match.
Another option is to make a 3% non-elective contribution to each eligible employee even if not in the plan. The two approaches are similar. But actual employee participation and deferrals affects the cost of the first.
Yet another approach includes automatic enrollment and specific employer contribution levels. This is a qualified automatic contribution arrangement . This plan matches dollar-for-dollar on the first 1% of an employees deferral, plus a 50% match on deferrals up to 6%. That comes out to a maximum 3.5% mandatory match.
Adopting a Safe Harbor plan means that your highly compensated employees can max out their contributions no matter how much others contribute. But dont forget the trade-off. The company commits to regular contributions.
Minimum Age & Service Requirements
As with simply enrolling into the plan, employers may set minimum age or service requirements that must be met before an employee is eligible to receive employer contributions. The maximum allowed age requirement is 21 years old. The maximum allowed service requirement is 1 year or 1 year with 1000 hours worked. However, if the employer contributions are 100% vested immediately, the maximum allowed service requirement is 2 years .
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Is Providing A 401 Plan To Interns And Part
From a recruiting and retention standpoint, its worth it to offer part-time employees and interns the option to participate in your companys 401 plan. The alone are very cost-effective, but providing this type of benefit demonstrates your commitment to all employees, regardless of their title or classification. Given todays , many people just entering the workforceor working fewer hoursare worried about their retirement in a way that previous generations werent.
At the same time, its more likely that part-time employees and interns wont be earning as much discretionary income that they can use to make investments in their 401. According to the United States Department of Labor, interns in the for-profit private sector who qualify as employees rather than trainees typically must be paid at least the minimum wage and overtime compensation for hours worked over forty in a workweek. While most interns are being paid for their time, the amount they can contribute to their retirement may be minimal after deducting standard living expenses.
Employers can support employees regarding these issues in a few ways:
to help employees learn how they can budget and save for their retirement
so that employees dont have to contribute out of their own paychecks. This is a good way to raise employees pay thanks to tax savings, while also being cost-effective for the company due to tax deductions.
Eligibility: What It Is And Why Its So Important To Get It Right
The almighty Internal Revenue Code mandates that 401 retirement plans abide by specific regulations for participant eligibility.
401 eligibility determines who can participate in your 401 retirement plan, when they can participate, whether or not they get employer contributions, and when theyre eligible to receive those contributions.
As you can imagine, 401 eligibility rules have pretty major implications for your plans success. They can make or break a plan – both in terms of the work required to run it , and in the overall success and usefulness of the 401.
Here are the top reasons why getting 401 eligibility right is so important:
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Do My Interns And Part
Interns and part-time employees are allowed to participate in a 401 program, depending on whether or not they meet plan eligibility requirements. An employee must generally be allowed to participate in a qualified 401 plan after meeting the following conditions:
The employee meets the minimum age requirement of 21 years.
The employee has worked for at least one year of service .
One year of service is considered 1,000 hours of work performed during the plan year. If an employee works for a 12-month period but doesnt meet the minimum 1,000 hours worked, they arent considered to have performed one year of service. The Employee Retirement Income Security Act also specifies that a plan cant require more than 1,000 hours to be worked during a year to be eligible to participate in the plan.
While most 401 providers dont offer a lot of wiggle room when it comes to adjusting eligibility periods and age requirements , offers custom plan design. The team at Human Interest can also help consult on the compliance and legal impact of these custom requests.
Read more about how the SECURE Act affects employers and part-time employees.
Which Types Of Vesting Schedules Are Availableand Are There Limits On How Long They Can Last
There are two types of vesting schedules, and each one sets a limit on how long it takes for participants to become fully vested in their employers contributions.
- With cliff vesting, participants flip from 0% vested to 100% vested when the service requirement period is reached. Three years is the maximum cliff vesting period.
- With graded vesting, the percentage of vested assets increases incrementally over time. A graded schedule must provide for at least 20% vesting within two years and full vesting within six.
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