FEBRUARY 2009 Pension Plan tip of the month...

Nondiscrimination Testing (ADP/ACP Test)

Each year, retirement plans are required to pass certain nondiscrimination tests in order to maintain their qualified status.  Shortly following the close of each plan year, The Paragon Alliance Group requests census information for your retirement plan so that we can perform the various tests applicable to your plan. If your plan passes this testing, you are provided the good news by your Account Executive. When your plan fails, you may be thinking about ways that your plan can pass this test in the future.

When your Account Executive prepares your nondiscrimination testing, there are many steps or options explored before you are presented with a failing test. Some of these options may involve alternative plan designs that may assist you in passing these tests and maintaining your plan’s compliance.

NOTE: For the purposes of this tip, “participant” can also mean “eligible employee”

Some important items to note:

• Target Average Deferral Percentages – Each year when you are provided the results of your ADP test, a target percentage is provided in regards to what the highly compensated employees (“HCE”) can defer in the next plan year. If testing is done on a prior year method, this will give you the exact amount to which the HCEs, on average, should be limited. If current year method is utilized, this percentage will provide you with a guideline for HCEs.
• HCE Group Analysis – Each year, the nondiscrimination tests are evaluated to determine the impact of any participants moving in or out of the HCE group. This information is particularly helpful when current year testing is used as it provides a more accurate guideline for HCEs.
• Projected ADP /ACP testing – Each year Paragon offers to do a projected ADP/ACP test for the plan midway through the plan year. This is especially helpful for those plans using current year testing so the non-highly compensated employee (“NHCE”) contribution rates can be evaluated.
• Alternate testing methods – Your Account Executive will review your test results and see if other testing options would help the plan pass nondiscrimination testing. Some of these options would include:
• Statutory Exclusions - This method can be used if your plan’s eligibility is less then the IRS required age 21 and 1 year of service. Under this method, participants under 21 and with less than 1 year of service do not have to be considered for testing purposes as that group usually does not include any HCEs.
• Shifting or Borrowing Method – When a plan is failing ADP or ACP testing, we may use the borrowing or shifting method. This method allows us, for testing purposes only, to borrow or shift matching contributions to the deferral or ADP test. These matching contributions would become 100% vested and would have withdrawal restrictions. We also have the option to move deferral contributions to the matching or ACP test. In order for this method to work, the ADP or ACP test must be passing before and after the contributions are moved into the other test to make it pass.
• Top Paid Group Election –We may be able to limit the number of HCEs considered for testing in your plan, if more than 20% of your plan participants earn above the HCE compensation limit and if permitted by your plan document. This election ranks all participants in order of compensation and then considers only the top 20% as HCEs, provided all of those participants are over the compensation limit.  Please note that owners will always be considered HCEs even if they do not fall within the top paid group.  If this election is not currently in your plan document, your Account Executive will recommend a plan amendment if it is determined that this provision will benefit your plan.
• QNEC or QMAC – If your plan is failing and the HCEs do not want to receive refunds; it may be possible to fund an employer contribution to the plan that will allow the plan to pass ADP /ACP testing. This option is typically only available for those plans using the current year testing method and if utilized, would require 100% vesting.
• Plan Design Changes – In order to avoid or help your plan pass nondiscrimination testing each year, your Account Executive is available to discuss the following plan design options:
• Safe Harbor Plan – By making a required employer contribution each year, it is possible for your plan to automatically satisfy the ADP/ACP tests. This contribution would be 100% vested and a participant notice would be required.  Paragon prepares this annual notice on your behalf and sends it to you for distribution to plan participants. Also, this plan feature must be adopted before the plan year begins.
• Automatic Enrollment – This plan option automatically deducts a certain deferral percentage from participants’ compensation each pay period that would be invested in a default investment option selected by the Plan Sponsor, unless the participant opts out or elects a different percentage or investment option. Normally this percentage is set at 3%. This feature could increase the number of participants contributing to the plan which could help to raise the NHCE deferral percentage and permit HCEs to defer more. This option does not allow you to avoid the ADP/ACP testing, but is designed to assist in obtaining a passing result.  An annual notice must be distributed to your employees; Paragon prepares this master notice and sends it to you for distribution to plan participants.
• Automatic Increase – In addition to the automatic enrollment feature, a plan may provide that, each year, the deferral percentage being deducted from those automatically enrolled employees increases by 1%. This escalation feature typically provides annual automatic increases up to 10% of compensation. Again, this may help the HCEs to defer more into the plan. This option does not allow you to avoid the ADP/ACP testing and does require an annual notice, prepared by Paragon, to your employees.   
• Employer Matching Contribution – Many times, adding a match to the plan or modifying the match formula encourages participants to contribute to the plan. This could increase the NHCE average deferral percentage which would help in obtaining a passing result on the nondiscrimination tests.

Please remember that the sooner you can provide your census information to Paragon, the more time we will have to review the data and assist you in passing your nondiscrimination testing.

As always, please feel free to contact your Account Executive to discuss this information in more detail.