403(b) Plans: Things to Know about Average Contribution Percentage Testing

For example, 403(b)s that provide for employer matching or employee after-tax contributions have always been required to perform the Average Contribution Percentage (ACP) test. However, plan sponsors of new 403(b) plans or plan sponsors who have modified their plans to add employer matching or after-tax contributions as a result of the changing 403(b) landscape may be facing ACP testing for the first time this year.

Which Plans Must Test?

A matching contribution is defined as an employer contribution that is made to a plan on condition of an elective deferral. Some plan sponsors fall into a common trap whereby voluntary pre-tax deferrals are “required” in a plan but fail to satisfy the Code requirements for a mandatory contribution (e.g., as a condition of employment, or pursuant to a one-time irrevocable election to participate in the plan). They provide what they believe is a non-matching contribution, but require that the participant defer to the plan.

For example, the plan may provide for a 4% base employer contribution, but require an employee to contribute 5% in order to receive the employer contribution. If the 5% deferral is not a condition of employment, or not pursuant to a one-time election to participate, the 4% “base” contribution is actually a 4% matching contribution subject to ACP testing. (That might occur if, when the employee is first eligible, he either participates in the plan or does not, and is excluded from any future right to participate.)

Also note that after-tax contributions do not include Roth elective deferrals.

There are a host of exemptions to the ACP test requirements. All plans except for the following types are subject to the ACP test requirements:

• Plans that do not benefit any Highly Compensated Employees (HCEs), who are generally defined in 2009 as those employees who earned in excess of $105,000 in 2008. The $105,000 figure is subject to indexing each year.
• Church plans under section 3121(w) of the Code. Note that this exemption only applies to so-called “steeple” churches and qualified church controlled organizations (QCCO), which means that only the churches themselves and QCCOs such as church elementary and secondary schools are exempt from the ACP test requirements. Church hospitals, nursing homes, and other religious organizations under 414(e) must satisfy ACP testing.
• Governmental plans under section 414(d) of the Code, including public education institutions.
• Plans or portions of plans that benefit collectively bargained union employees.
• Plans that qualify for the ACP safe harbor. To qualify, the plan must contain special provisions, including the following:            
• Minimum required employer contribution of i) a 4% maximum match (100% of first 3%, 50% of next 2% of employee elective deferral) or ii) a 3% discretionary base contribution that would not require an employee elective deferral
• Contribution must be immediately vested
• Contribution would apply to all employees, existing and new
• Contribution must not be eligible to be distributed in the event of hardship
• Participant notice requirement of at least 30 days prior to beginning of plan year

• Plans that qualify for the QACA, or Qualified Automatic Contribution Arrangement safe harbor. To qualify, the plan must contain several provisions, including the following:

• Minimum required elective deferral of 3%, increasing to 4% after two plan years and each plan year thereafter, up to a maximum of 6%. Employees can opt out within 90 days, and contributions made on their behalf can be withdrawn within that timeframe should they do so.
• Minimum required employer contribution of i) a 3.5% maximum match (100% of first 1%, 50% of next 5% of employee elective deferral)  or ii) a 3% base contribution that would be made even to those who opt out of the automatic contribution
• Contribution must vest within two years
• Contribution would apply to all employees, existing and new, who have not made an affirmative election to defer a percentage of pay
• Two participant notice requirements, including  i) annual notice requirement at least 30 days prior to beginning of plan year and ii) notice to newly hired employees on first day of employment

 If your plan falls into one of these categories, congratulations, the rest of this article does not apply to you!