REQUIREMENTS: Non-Safe Harbor Plans

Defining The Terms

Before we can go any further it is important to define the terms. These terms are utilized for evaluating the non-discrimination testing for a standard 401(k).

Highly Compensated Employee (HCE)

  • Ownership: The employee owned more than 5% of the interest in the business at any time during the year or the preceding year.
  • Compensation: The employee’s annual compensation was $120,000 or more and, if the employer so chooses, was in the top 20% of employees when ranked by compensation.

 

Non-Highly Compensated Employee (NHCE)

  • Everyone else who does not qualify as a HCE

 

Key Employees

  • Compensation: Any officer whose annual compensation is $170,000 or more.
  • Ownership OR Relationship: Any employee who owns more than 5% of the company, or is directly related to someone who is.
  • Ownership AND compensation: Any employee who owns more than 1% of the company and earns more than $150,000.

 

The Non-Discrimination Tests

For your 401(k) to pass discrimination testing, it must pass all three tests below.

Top-Heavy Test

  • If the combined balances of Key-Employees are greater than 60% of the 401(k)-plan value, then the plan is considered Top-Heavy.

 

ADP Test – Actual Deferral Percentage

  1. Annual HCE Contribution Rate: Combine the HCEs and calculate their average annual employee contribution rate as a % of their total compensation.
  2. Annual NHCE Contribution Rate: Combine the non-HCEs and calculate their average annual employee contribution rate as a % of their total compensation.
Maximum Annual (NHCE) Deferral Rate Maximum Annual (HCE) Deferral Rate
2% or less NHCE% x 2
2-8% NHCE% + 2
more than 8% NHCE% x 1.25

NOTE: use prior year for all calculations However, for a new 401(k), you will not have a “prior year”. The IRS allows businesses to use 3% as the non-highly-compensated employee average (thus highly-compensated employees will be able to contribute up to 5% of their compensation on average).

 

ACP Test – Actual contribution Percentage

Similar to ADP Testing above except with the ACP Test, both employer match and after-tax contributions are utilized to calculate the average contribution rate.

  1. Annual HCE Contribution Rate: Combine the HCEs and calculate their average annual employee and employer match contribution rate as a % of their total compensation.
  2. Annual NHCE Contribution Rate: Combine the non-HCEs and calculate their average annual employee and employer match contribution rate as a % of their total compensation.
Maximum Annual NHCE Contribution Rate Maximum Annual HCE Contribution Rate
2% or less NHCE% x 2
2-8% NHCE% + 2
more than 8% NHCE% x 1.25

 What is my plan fails these tests? Read more at IRS.GOV

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