Getting around discrimination clause on 401K contributions?
Can employer discriminate 401k contributions?
These safeguards require employers to pass 401k discrimination tests, also referred to as 401k nondiscrimination tests, which show that their plans do not favor highly compensated and key employees over non-highly compensated employees. In other words, plans cannot discriminate against non-highly compensated employees.
What happens if a 401k plan fails to pass the nondiscrimination tests?
If your plan fails the ADP or ACP test, you must take the corrective action described in your plan document during the statutory correction period to cause the tests to pass. The plan has 2 ½ months after the end of the plan year being tested to correct excess contributions.
Can 401k plans discriminate?
To ensure a 401(k) plan isn’t “discriminating” or favoring specific employees, it must pass a set of annual tests. This responsibility falls on the company offering the 401(k) to its employees.
Are 401k catch up contributions subject to discrimination testing?
Catch-up contributions are excluded because not all employees are eligible to make them in any given year. Including them in ADP testing risks skewing the results.
What happens if you fail nondiscrimination testing?
Consequences of Nondiscrimination Testing Failure
No matter the cause, you’ll need to act to fix the issues. If you don’t, your plan can lose its qualified status. That means that all the tax benefits related to your 401(k) plan would go away, and you and all of your employees could be left with a hefty tax bill.
How does 401k discrimination testing work?
According to the IRS, this annual test “compares the average salary deferrals of highly compensated employees to that of non-highly compensated employees. Each employee’s deferral percentage is the percentage of compensation that has been deferred to the 401(k) plan.”
How do you fix failed compensation ratio test?
Methods for Correcting a Failed Test
If the Plan is unable to demonstrate both a passing Compensation Ratio Test and a passing Average Benefits Test, then the plan must be amended to change the definition of compensation to something that will result in a passing Compensation Ratio Test.
Are terminated employees included in nondiscrimination testing?
For non-Discrimination Testing purposes, all employees, including any terminated, part-time and/or leased employees of the Plan Sponsor, any related entity or other business that is a member of a related group of corporations or businesses, must be included in the data submitted.
How much can a highly compensated employee contribute to a 401k?
401(k) contribution limits for HCEs
The 401(k) contribution limits for 2021 are $19,500 (or $20,) or $26,000 (or $27,) if you’re 50 or older. HCEs may be able to contribute up to these limits or they may not, depending on how much the company’s non-HCEs contribute to their accounts.
Which test is used to satisfy the nondiscrimination in contributions requirement?
The Major 401(k) Nondiscrimination Tests
401(k) nondiscrimination tests must be passed to demonstrate that annual contributions do not impermissibly discriminate in favor of HCEs.
What happens if you fail a 401k audit?
The penalties for filing a late 401k plan audit can be very costly. Depending upon the size and nature of the 401k plan, penalty fees for late Form 5500 filings are around $25 for each day that’s passed after your deadline, up to $15,000.
What is the top heavy test for 401k?
A 401(k) plan is considered top heavy when the account balances of “key employees” exceed 60% of total plan assets. This ratio is tested every year based on account balances as the last day of the prior plan year (the “determination date”).
How often should nondiscrimination testing be done?
It is recommended that employers do one test mid plan year in order to determine whether additional steps must be taken before the end of the plan year so that the plan passes the nondiscrimination tests and preserves the tax treatment for the key and highly compensated.
How do you do a non discrimination test?
To calculate this test, add the average employer contribution and after-tax contribution to the employee’s deferrals. Then divide by their average annual compensation. Compare the HCE and NHCE percentages to ensure all employees are receiving fair compensation.
When should nondiscrimination testing be done?
Nondiscrimination testing typically occurs during the 4th quarter of the plan year because the IRS requires that the tests pass as of the last day of the plan year.
Who can be excluded from nondiscrimination testing?
There are two categories of prohibited groups recognized in the nondiscrimination rules — “highly compensated” individuals and “key employees.” An individual will be considered highly compensated and/or a key employee based on one or more of the following: Status as an officer. Ownership interest. Compensation.
What to do if you are a highly compensated employee?
How to minimize the HCE pain
- Catch-up contribution. …
- Contribute to a Health Savings Account (HSA) …
- Make Non-Deductible Traditional IRA Contributions. …
- The Backdoor Roth IRA strategy. …
- Deferred Compensation. …
- Open a Taxable Account. …
- Deferred variable annuity. …
- Spouse max out benefits.