With a 6 month old son I’ve noticed I’ve had to start to prioritize how I spend my time much different than in the past. It’s amazing the changes that my little guy has gone through in just the first few months of life and the last thing my wife and I want to do is miss one of those memorable moments. Prioritizing my time to allow for quality family time involves trade-offs and finding the right balance.
Whether it’s life at home or work, the concept of prioritizing is a common theme. When our Consulting team gets the opportunity to work with our client group, we get an opportunity to witness just how unique each plan sponsors’ goals and objectives are. Understanding how to balance what a plan sponsor is trying to accomplish through their retirement plan(s) with barriers such as budget and human resource capabilities is key when moving through the prioritizing process.
One priority that many plan sponsors have to work through is how to pass Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) plan compliance nondiscrimination testing on an annual basis. The ADP and ACP nondiscrimination tests are performed to test whether the plan is discriminating in favor of highly compensated employees (HCE’s) in both the deferral and match contributions. The stipulations of these tests require the HCE percentages for each contribution be within a certain range of the non-HCE percentage.
The problems that plan sponsors face with failing these tests are refunds back to some or all of the HCE’s. This pain point tends to bear a heavy weight given the impacted group tends to be the company’s key decision makers. To avoid this pain point typically discussions go back to the plan sponsor prioritizing.
- Do I have a budget to change the testing results?
- Am I concerned that HCE’s are receiving refunds?
- Administratively can we change our plan design to help drive different results?
With so many variables that go into prioritizing how to handle ADP/ACP testing results, it’s also critical to understand potential solutions to consider addressing the pain point. When prioritizing how to address a current or potential future ADP/ACP issue, plan design plays a big part in driving a different outcome. Consider a couple of plan design options discussed below:
Automated Plan Features: Automatic enrollment and automatic escalation can help avoid participant inertia and assist in driving higher deferral rates. These higher deferral rates can help boost non-HCE ADP and ACP testing results. Finding the right balance of automatic deferral rate to use potentially coupled with an automatic escalation feature can help generate a plan design that works towards reducing the pain point of refunds to HCE’s.
Safe Harbor Plan Design: ADP and ACP testing can automatically be deemed to pass if certain benefit formula and allocation requirements are met. Two common examples of this type of plan design are contributing a 3% non-elective contribution to all eligible employees or to provide a matching contribution on deferrals of 100% up to the 1st 3% of compensation and 50% on the next 2% of compensation.
With so many variables going into carrying out a retirement plan, it’s critical for a plan sponsor to prioritize. Understanding how balancing the nondiscrimination requirements with a plan design within budget is key towards working through a plan design that maximizes the plan sponsor’s goals and objectives.
The subject matter in this communication is provided with the understanding that The Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
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