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?
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.
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.)
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!
test calculates an “actual contribution percentage” for each participant.
Basically, that amount is the matching contribution an employee receives plus
the after-tax contribution an employee makes in a plan year, divided by his
compensation as defined in the plan document. Thus, if an individual receives a
matching contribution of $2,000, and his plan compensation is $40,000, his
actual contribution percentage is $2,000/$40,000, or 5%.
that the plan document definition of compensation must satisfy a
nondiscriminatory definition under 414(s) in order to be used in ACP testing. Suffice
it to say that the plan compensation definition could not include/exclude types
of pay that would favor HCEs as defined above. If, for example, only overtime
pay was excluded, and overtime pay was only earned by Non-Highly Compensated
Employees (NHCEs), such a definition of compensation would be discriminatory
and could not be used.
an employee is eligible to receive the match or to make after-tax deferrals,
but fails to participate, then the average contribution percentage would be
zero. The “zeros” will in fact have a negative impact on the testing, so the
greater the voluntary participation in the plan, the less likely it would be
for the ACP test to fail.
an actual contribution percentage is calculated for each employee, the
employees are then divided into two categories: HCEs (as defined above for 2009),
and Non Highly Compensated Employees (all other eligible employees).
The average of each category is taken and compared as follows:
If average NHCE% (ACP) is:
Then average HCE% (ACP) cannot exceed:
2% or less
2 x ADP of NHCEs
More than 2%, but less than 8%
ADP of NHCEs + 2
8% or more
1.25 x ADP of NHCEs
example, if the Average Contribution Percentage of the NHCEs amounts to 1.5%,
and the Average Contribution Percentage of the HCEs is 3.5%, the ACP test would
fail, since, according to the chart above, the ACP for HCEs could not exceed 2
x 1.5%, or 3%.
addition, for plans with less than a one-year waiting period to receive the
matching contribution, NHCEs with less than a year of service may be excluded
from ACP testing under what is called the “early participation” rule.
testing is extremely sensitive to participation level. If employees fail to
voluntarily participate in the plan in significant numbers, the test may fail
year after year. There are safe harbors to avoid such testing, but they require
the built-in expense of a required minimum contribution.
What happens if the plan fails ACP?
primary method of addressing the test failure is to distribute the excess aggregate
contributions to the HCEs by the end of the year following the plan year of the
failure. The distribution is taxable to the employee in the year distributed,
and is not eligible for rollover. If the plan provides, non-vested
contributions should be forfeited rather than distributed.
alternative method of correction is to make additional contributions to NHCEs
in lieu of HCE distributions, but this solution is not frequently utilized in
practice, due to its added cost.
that multiple tax-exempt entitles are under common control, so that they are
treated as one employer under Code Section 414(c). Different matching formulas among plans in the
same controlled group may necessitate a separate test under 401(a)(4) benefits
rights, and features testing that takes into account the right to a particular
form of matching contribution. However, depending on other nondiscrimination
tests, such as 410(b) coverage, it is possible to perform separate ACP tests
for each plan with a matching contribution within the controlled group.
ACP testing can be an administrative headache for plan sponsors, but fortunately, providers and advisers are willing and able to help facilitate the testing process.
Webb, Vice President, Retirement Services at Cammack LaRhette Consulting