The ripple effect being caused by COVID-19 seems to cause a never-ending list of things for business owners to consider. One thing that you may not be thinking of yet is the impact COVID-19 is having on your company’s retirement plan. Here’s what retirement plan sponsors need to think about now to avoid surprises in 2021.
Plan sponsors must test traditional 401(k) plans each year to ensure the contributions made by and for rank-and-file employees (nonhighly compensated employees (NHCE)) are proportional to contributions made for owners and managers (highly compensated employees (HCE)).
These nondiscrimination tests for 401(k) plans are called the Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) tests. If you conduct an ACP test, your 2020 test results could be impacted by COVID-19.
The ACP test is met if the ACP for the eligible HCEs doesn’t exceed the greater of:
- 125% of the ACP for the group of NHCEs, or
- the lesser of:
- 200% of the ACP for the group of NHCEs, or
- the ACP for the NHCEs plus 2%.
One way to avoid an ACP test is by establishing a safe harbor 401(k) plan or by changing an existing plan from a traditional 401(k) plan to a safe harbor 401(k) plan. Under a safe harbor 401(k) plan, the employer isn’t required to perform the ADP and ACP tests, if it meets certain requirements.
But, if you don’t have a safe harbor plan in place, the following is a list of things that could cause testing issues for 2020:
- Compensation cuts
- Layoffs and/or furloughs
- Reduced hours for employees
- Suspension of matching contributions
- Impact of any of the above on the spouse of one of your participants that could cause the NHCE in your plan to readjust their deferrals downward
If you have been impacted by any of these situations, it could cost you money in terms of additional contributions you will need to make to “pass” testing or it will require HCEs to receive funds which are generally taxable so it could limit how much they contribute to their plan, especially impacting those who are making catch-up contributions.
The good news is that if you perform a mid-year test now, you can see where you stand in 2020 and make course corrections as needed. That could include switching from current to prior-year testing if you have used current-year testing for each of the five preceding years or the life of the plan, whichever is shorter.
Need to learn more about conducting an ACP nondiscrimination test or want to learn more about safe harbor plans? Start here.
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