How May ACP Testing Results be Affected by COVID-19?

Experts from Groom Law Group and Cammack Retirement Group answer questions concerning retirement plan administration and regulations.

“We sponsor an Employee Retirement Income Security Act (ERISA) 403(b) matching plan that is subject to actual contribution percentage (ACP) testing. Our recordkeeper recently sent us an alert saying our 2020 test results could be affected by the COVID-19 pandemic, but failed to provide any details as to how that is possible. Can the Experts help us out here?”

Stacey Bradford, Charles Filips, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

Indeed we can! First of all, your recordkeeper is correct; because the ACP test compares the matching contribution of non-highly compensated employees (NHCEs) to highly compensated employees (HCEs), the ongoing pandemic can affect the ACP results in a number of ways, as follows:

  • The impact on the ACP test results depends on the matching contributions formula and any requirements to receive it (e.g., employment on the last day and/or 1,000 hours of service during the plan year) and who is laid off. Generally, if mostly NHCEs are laid off or furloughed, the test results could be negatively impacted if they have not satisfied the requirement(s) to receive the match. If mostly HCEs are laid off or furloughed, the test results would be positively impacted if they have not satisfied the requirement(s) to receive the match. However, if there are no requirements to receive the match other than making deferrals, the test results should not be significantly impacted as the laid off participant’s ACP would be relatively the same as if they had participated the entire year. For example, if a participant works half the year with a match of $1,500 and compensation of $30,000, the individual’s ACP is 5%. If the participant worked the entire year, the ACP would be the same 5% based on a $3,000 match and $60,000 in compensation. Yes, this is a very simplified example, but the general principle applies. Any change that would reduce the NHCEs’ ACP negatively impacts the testing results, and any change that would reduce the HCEs’ ACP positively impacts the results.
  • If you suspend matching contributions, all employees will have a lower matching contribution percentage based on full-year compensation. Though you would think this would not matter, since HCEs and NHCEs would be similarly affected, it actually does, since a different testing threshold might apply depending on the percentage of NHCE matching contributions. Usually we see an HCE match limit of 125% of the NHCE ACP or the NHCE ACP + 2%. However, the limits are actually the 125% limit and the lesser of the +2% test or 2x the NHCE ACP. If the NHCE ACP is low enough, the 2x limit might apply instead. For example, if the NHCE ACP is 1.2%, the upper limit for the HCE ACP is 2.4% rather than 3.2%. Also, if HCEs have disproportionately front-loaded their match in the early part of the year, it can be harder to pass the test. And keep in mind that if the plan uses a safe harbor match, there are a number of requirements to meet to change the match mid-year.
  • If you cut salaries, the mix of definition of who is an NHCEs and who is an HCEs will change, since that definition involves compensation. Some HCEs may become NHCEs due to a decrease in pay. The good news: this will not affect test results in the current year, as NHCE and HCE determinations are made on the basis of prior-year compensation.
  • If you reduce hours for hourly employees, those employees tend to be NHCEs who may reduce their deferrals to an amount insufficient to maximize the matching contribution, which also can have a negative impact on ACP test results.
  • Finally, even if you take none of the aforementioned actions in response to the COVID-19 pandemic, ACP test results may still be affected, as some people may no longer be able to make deferrals sufficient to maximize the matching contribution for other reasons related to the pandemic (e.g., they need more take-home pay because a spouse loses his/her job).          

As for WHEN your test results will be impacted, if you utilize prior year testing, the impact for 2020 should be minimal, since your NHCE ACP is based on 2019 pre-pandemic numbers; all you have to do is make certain that HCEs do not have an ACP in 2020 that would cause a test failure. In this scenario, it is the 2021 ACP test that may be impacted. However, if you utilize current year testing, your 2020 results are more likely to be impacted, since NHCE ACP is based on 2020 numbers.

At any rate, if you are not already performing mid-year testing to see where you stand in 2020 so that adjustments can be made as necessary, it would be a particularly good idea to perform such testing in 2020. One of the adjustments that can possibly be made, if necessary, is a switch from current to prior-year testing, but only if the plan has used current-year testing for each of the preceding five plan years (or the life of the plan, if shorter).

And finally, for plan sponsors who maintain a 401(k) plan, similar logic to what is stated here would apply to the actual deferral percentage (ADP) test that is required in 401(k) plans as well.


NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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