Improved ADP and ACP Safe Harbor Plan Designs

Transcription

1 Imprtant Infrmatin Plan Administratin and Operatin April 2000* Imprved ADP and ACP Safe Harbr Plan Designs WHO'S AFFECTED This infrmatin applies t defined cntributin plans with a 401(k) feature r emplyer matching cntributins that must satisfy the actual deferral percentage (ADP) r actual cntributin percentage (ACP) test each year. BACKGROUND AND SUMMARY The Small Business Jb Prtectin Act f 1996 (SBJPA) created a new "safe harbr" 401(k) plan design that eliminated the need t perfrm the ADP test if certain cntributin requirements are met. SBJPA als created a safe harbr design that wuld autmatically satisfy the ACP test with respect t emplyer matching cntributins. In late 1998, and early 2000, the IRS prvided guidance fr designing plans t meet the safe harbr requirements. This issue f Pensin Analyst summarizes these requirements. ACTION AND NEXT STEPS Yu shuld review this guidance carefully and cmpare it with yur current plan design befre making any decisins. In additin, yu shuld als cmpare the csts f yur current plan design t the cst f the safe harbr plan design, including the assciated administrative csts. After yur analysis, if yu are still interested in a safe harbr plan design, yu shuld cntact yur Prudential Retirement Representative wh will discuss yur plan design ptins with yu. *Republished December 2004 t reflect Prudential Financial's acquisitin f CIGNA's retirement business. 2004, The Prudential Insurance Cmpany f America, all rights reserved.

2 IN THIS ISSUE ADP Safe Harbr Plans Eligible t Use ADP Safe Harbr Design ADP Safe Harbr Cntributins Restrictins n Deferral Cntributins Under the ADP Safe Harbr Ability t Abandn an ADP Safe Harbr Design Sample ADP Safe Harbr Designs ACP Safe Harbr Plans Eligible t Use ACP Safe Harbr Design Restrictins n the Use f the ACP Safe Harbr Design ACP Safe Harbr Cntributins Participant Ntice Requirements Methd f Delivery Cntent Requirement Timing Requirement Other Testing Requirements Plan Dcument Cnsideratins Next Steps Imprved ADP and ACP Safe Harbr Plan Designs T simplify nndiscriminatin testing rules that apply t 401(k) plans, the Small Business Jb Prtectin Act f 1996 (SBJPA) intrduced safe harbr plan designs fr these plans. A plan that uses a safe harbr design des nt need t perfrm the annual actual deferral percentage (ADP) and actual cntributin percentage (ACP) tests as lng as it als meets specific plan dcument and participant ntice requirements. ADP Safe Harbr Plans Eligible t Use ADP Safe Harbr Design In general, a 401(k) plan may use the ADP safe harbr design t avid ADP testing nly if it: Has a full 12-mnth plan year; and Prvides ne f the permissible safe harbr cntributins. In the case f a new 401(k) plan, the initial plan year des nt have t be 12 mnths lng t take advantage f the ADP safe harbr, but des have t be at least three mnths lng. This exceptin t the 12-mnth plan year requirement als applies where an existing prfit sharing plan adds a 401(k) feature. Fr example, a prfit sharing plan with a calendar plan year may add a safe harbr 401(k) feature effective Octber 1, In general, the plan dcument must be amended befre the first day f the applicable plan year t specify that the safe harbr design will be used. In additin, the plan spnsr must distribute ntices t participants befre the first day f the plan year t tell them this design is in effect. 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 2

3 Hwever, a plan that uses the current year ADP testing methd may be amended as late as 30 days befre the end f the plan year t instead prvide the safe harbr nnelective cntributin fr that entire year. Fr example, a 401(k) plan with a calendar plan year may be amended as late as December 1, 2000, t prvide the safe harbr nnelective cntributin instead f perfrming the ADP test. T take advantage f this special rule, the plan spnsr must distribute ntices t participants befre the first day f the plan year, explaining that the plan may be amended during the upcming year t adpt the safe harbr nnelective cntributin. The plan spnsr must then prvide a supplemental ntice, n later than 30 days befre the end f the plan year, stating that this cntributin will be made. Fr administrative ease, this supplemental ntice may be prvided as part f the safe harbr ntice fr the fllwing plan year. ADP Safe Harbr Cntributins T qualify fr the ADP safe harbr, a 401(k) plan must prvide ne f the fllwing types f emplyer cntributins: A matching cntributin, using either The Basic Matching Frmula, r An Enhanced Matching Frmula; r A nnelective cntributin equal t at least 3% f cmpensatin. The "Basic Matching Frmula" is a frmula that matches 100% f Elective Cntributins up t 3% f Cmpensatin plus 50% f Elective Cntributins frm 3% t 5% f Cmpensatin. An "Enhanced Matching Frmula" is a frmula that prvides: 1. A rate f matching cntributins that des nt increase as the emplyee's rate f pre-tax deferral cntributins increases; and 2. At any rate f deferral cntributins, a ttal matching amunt equal t at least the ttal amunt f match that wuld have been prvided under the Basic Matching Frmula. The ADP safe harbr cntributin must als be: Required t be made under the terms f the plan dcument. A discretinary cntributin des nt cunt as a Safe Harbr cntributin. In additin, if these cntributins are made t a prfit sharing plan, the plan must nt require the existence f prfits fr the cntributin t be made. Hwever, unlimited additinal discretinary cntributins may be made t the plan, in excess f thse required t meet the safe harbr design rules. 100% immediately vested. Subject t the 401(k) withdrawal rules and therefre nt available fr hardship withdrawals. Based n a nndiscriminatry definitin f cmpensatin. This may be a safe definitin r ne that requires cmpensatin nndiscriminatin testing. The plan may nt limit the amunt f cmpensatin n which the cntributin is based, except in accrdance with the annual adjusted $150,000 cmpensatin limit. The plan may limit the cmpensatin 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 3

4 measurement perid t the perid during which the emplyee is eligible t participate in the plan. Made t each eligible Nn-Highly Cmpensated Emplyee (NHCE). The plan may nt require the NHCE t be emplyed n the last day f the plan year t receive the cntributin. In additin, if the plan prvides a safe harbr matching cntributin, the rate f matching cntributins fr any Highly Cmpensated Emplyee (HCE) cannt be greater than the rate f matching cntributins fr any NHCE with the same rate f pre-tax deferral cntributins. ADP safe harbr cntributins must be made t a defined cntributin plan but d nt have t be made t the same plan t which the emplyee pre-tax deferral cntributins are made. They may even be made t a mney purchase pensin plan r t an emplyee stck wnership plan (ESOP). Hwever, if the safe harbr cntributins are made t anther defined cntributin plan: Each emplyee wh is eligible fr the 401(k) plan must be eligible t participate under the ther plan under the same terms and cnditins; Bth the 401(k) plan and the ther plan must have the same plan year; and The safe harbr cntributin may nt be used t satisfy the safe harbr requirements under mre than ne plan. Restrictins n Deferral Cntributins Under the ADP Safe Harbr A 401(k) plan that wants t use the ADP safe harbr design may impse the fllwing restrictins n NHCEs' pre-tax deferral cntributins: The plan may limit the frequency and duratin f perids in which eligible emplyees may make r change cash r deferred electins. Fr example, a plan may permit emplyees t change deferral electins nly twice per plan year. Hwever, emplyees must have at least 30 days after receipt f the required annual ntice t make r change such electin fr the plan year. The plan may require emplyees t make their deferral electins in whle percentages f cmpensatin r whle dllar amunts. The plan may limit the amunt f elective cntributins that an emplyee may make. Fr example, the plan may limit deferrals t 15% f cmpensatin. Hwever, each eligible NHCE must be able t make elective deferrals in an amunt sufficient t receive the maximum available amunt f match and must be able t elect t make any lesser amunt f pre-tax cntributins. The plan may limit the types f cmpensatin that may be deferred as lng as each eligible NHCE may make elective cntributins under a "reasnable" definitin f cmpensatin. This definitin f cmpensatin des nt have t be a nndiscriminatry definitin f cmpensatin and can be different frm the cmpensatin n which the matching r nnelective cntributin is based. 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 4

5 The plan may limit the amunt f deferral cntributins t cmply with the annual elective deferral limit ($10,000 fr 1999) r the annual additins limit r n accunt f a suspensin due t a hardship withdrawal. All ther standard 401(k) rules apply t a plan that uses the ADP safe harbr design. Fr example, benefits ther than matching cntributins may nt be cntingent n an emplyee's electin t make pre-tax cntributins. Ability t Abandn an ADP Safe Harbr Design In general, nce a plan spnsr has decided t prvide ADP safe harbr cntributins and has prvided the required participant ntices, the plan is cmmitted t this design fr the entire plan year. Hwever, if a plan begins the year with a safe harbr matching cntributin, it may be amended during that year t reduce r eliminate the matching cntributins, prvided certain requirements are met. T abandn a safe harbr matching cntributin, the plan spnsr must prvide a supplemental ntice t all eligible emplyees, which: Explains the cnsequences f the amendment; Identifies the effective date f the reductin r eliminatin f matching cntributins; and Prvides emplyees with a reasnable pprtunity t change their pre-tax deferral and, if applicable, emplyee pst-tax cntributin electins. This ntice may be prvided as a written paper dcument r thrugh an electrnic medium (such as , an internet/intranet site, r an autmated telephne system). The rules fr prviding electrnic ntices are discussed later in this publicatin. The plan dcument must be amended t reflect this change, which may be effective n earlier than the later f: 30 days after the supplemental participant ntice is prvided; r The amendment adptin date. The amendment must prvide that the ADP test (and, if applicable, the ACP test) will be perfrmed and satisfied fr the entire plan year, using the current year testing methd. Fr example, a 401(k) plan with a calendar plan year may begin the 2000 plan year with an ADP safe harbr Enhanced Matching Frmula. On May 1, 2000, the plan spnsr decides that it is t expensive t cntinue prviding this cntributin and will take its chances with perfrming the ADP and ACP tests n a current year basis. If eligible emplyees are prvided with the required supplemental ntice by May 15, 2000, and the required plan amendment is als adpted n May 15, 2000, the amendment may be effective n earlier than June 14, While a safe harbr nnelective cntributin may be added mid-year, the nnelective cntributin may nt be abandned mid-year. Sample ADP Safe Harbr Designs 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 5

6 Assuming that the plan amendment and participant ntice requirements are met alng with all ther basic design requirements described abve, the fllwing cntributin frmulas wuld meet the ADP safe harbr rules: A matching cntributin f 100% f the emplyee's pre-tax deferral cntributins up t 4% f cmpensatin. This design uses an Enhanced Matching Frmula. A matching cntributin f 150% f the emplyee's pre-tax deferral cntributins up t 3% f cmpensatin. This design als uses an Enhanced Matching Frmula. ACP Safe Harbr Plans Eligible t Use ACP Safe Harbr Design A plan may use the ACP safe harbr design t avid ACP testing if it: Prvides emplyer matching cntributins; Uses an ADP safe harbr design; Has a full 12-mnth plan year; and Prvides ne f the permissible safe harbr cntributins. Here t, there is an exceptin t the 12-mnth plan year requirement fr new plans, as lng as the initial plan year is at least three mnths lng. Hwever, there is n exceptin fr the additin f a matching cntributin feature t an existing 401(k) plan. As in the case f the ADP safe harbr, the plan dcument must be amended befre the first day f the applicable plan year t specify that the safe harbr design will be used. In additin, the plan spnsr must distribute ntices t participants befre the first day f the plan year t tell them this design is in effect. Restrictins n the Use f the ACP Safe Harbr Design Due t the eligibility requirements nted abve, the ACP safe harbr design may be unavailable r unattractive t a plan that permits r requires emplyee pst-tax cntributins: A plan that has emplyee pst-tax cntributins that are subject t the ACP test, but des nt prvide emplyer matching cntributins, may nt use the ACP safe harbr design. A plan that prvides emplyer matching cntributins and als requires r permits emplyees t make emplyee pst-tax cntributins, may use the ACP safe harbr design, but will still have t perfrm an ACP test n the emplyee pst-tax cntributins. In additin, the ACP safe harbr design is nt available t: A 401(k) plan that actually perfrms the ADP test; r A plan that des nt permit emplyee pre-tax deferrals (fr example, a nn-401(k) prfit sharing plan that matches emplyee pst-tax cntributins). 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 6

7 ACP Safe Harbr Cntributins T qualify fr the ACP safe harbr, a plan must meet bth f the fllwing requirements fr the entire plan year: Each eligible NHCE is als an eligible emplyee under a 401(k) plan that satisfies the ADP safe harbr requirements; and The plan satisfies the Matching Cntributin Limitatins, described belw. The Matching Cntributin Limitatins require the plan t prvide ne f the fllwing types f matching cntributins: ADP Safe Harbr Basic Matching Frmula cntributins. The plan may prvide n ther matching cntributins. ADP Safe Harbr Enhanced Matching Frmula cntributin that matches deferrals nt exceeding 6% f cmpensatin. The plan may prvide n ther matching cntributins. Matching cntributins that meet all f the fllwing requirements: The rate f matching cntributins des nt increase as the rate f emplyee pre-tax r pst-tax cntributins increases; At any rate f emplyee pre-tax r pst-tax cntributins, the rate f matching cntributins fr any eligible HCE des nt exceed the rate applicable t an eligible NHCE with the same rate f emplyee pre-tax r pst-tax cntributins. There is n match n emplyee pre-tax r pst-tax cntributins that in ttal exceed 6% f an emplyee's cmpensatin. The plan impses n emplyee pre-tax and pst-tax cntributins nly thse restrictins permitted under the ADP safe harbr design and discussed abve. A plan wuld lk t this design ptin t meet the ACP safe harbr if it: Meets the ADP safe harbr by making a 3% (r greater) nnelective cntributin; r Meets the ADP safe harbr using either the Basic Matching Frmula r an Enhanced Matching Frmula and makes additinal discretinary matching cntributins; r Meets the ADP safe harbr using an Enhanced Matching Frmula that matched deferrals exceeding 6% f cmpensatin. Under this design ptin, matching cntributins may be subject t a vesting schedule and may be eligible fr hardship withdrawals. In general, an ACP safe harbr plan may make discretinary matching cntributins nly t the extent they d nt exceed a dllar amunt equal t 4% f any emplyee's cmpensatin. 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 7

8 Participant Ntice Requirements Methd f Delivery A plan spnsr must ntify all eligible emplyees if it intends t use a safe harbr plan design r if it wants t be able t switch frm a current year ADP testing basis t the safe harbr nnelective cntributin during the upcming plan year. This ntice may be prvided as a written paper dcument r thrugh an electrnic medium (such as , an internet/intranet site, r an autmated telephne system). If the ntice is prvided electrnically: The electrnic medium must be reasnably accessible t the emplyee. The medium used must prvide the ntice in a manner that is n less understandable t the emplyee than a written paper dcument. At the time the ntice is prvided, the emplyee is ntified that he may request and receive a written paper ntice at n charge. The plan spnsr must, in fact, prvide the written ntice at n charge, upn request frm an emplyee. The ntice must be written in a manner s it can be understd by the average eligible emplyee. It must als satisfy bth cntent and timing requirements. Cntent Requirement The ntice must be sufficiently accurate and cmprehensive t infrm the emplyee f his rights and bligatins under the plan. In general, the ntice must accurately describe: The Safe Harbr Matching r Nnelective Frmula used, including a descriptin f the levels f Match prvided, if any, and state that these cntributins (as well as the deferral cntributins) are fully vested when made; Any ther cntributins under the plan (including the ptential fr discretinary Match) and cnditins under which these cnditins are made; The plan t which the Safe Harbr Cntributin will be made (if ther than the plan cntaining the cash r deferral arrangement); Type and amunt f Cmpensatin; Hw t make cash r deferred electins, including applicable administrative requirements; Perids available fr making cash r deferred electins; and Withdrawal and vesting prvisins applicable t plan cntributins. A shrter safe harbr ntice may be prvided if it crss-references an up-t-date Summary Plan Descriptin fr prvisins describing: Nn-Safe Harbr Cntributins prvided under the plan; 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 8

9 The plan t which the Safe Harbr Cntributin will be made; The type and amunt f Cmpensatin that may be deferred; and The withdrawal and vesting prvisins applicable t plan cntributins. The shrter safe harbr ntice must still accurately describe: The Safe Harbr Matching r Nnelective Frmula used, including a descriptin f the levels f Match prvided, if any, and state that these cntributins (as well the deferral cntributins) are fully vested when made; Hw t make cash r deferred electins, including applicable administrative requirements; and The perids available fr making cash r deferred electins. It must als prvide infrmatin that makes it easy fr eligible emplyees t btain infrmatin abut the plan. This infrmatin may include telephne numbers, addresses and, if applicable, electrnic addresses f individuals r ffices wh can prvide the plan infrmatin. Timing Requirement In general, the plan spnsr must give the ntice t emplyees within a reasnable perid befre the beginning f the plan year. Fr an emplyee wh becmes eligible t participate in the plan after the beginning f the plan year, the emplyee must receive the ntice within a reasnable perid befre the emplyee becmes eligible. A reasnable perid is based n all relevant facts and circumstances. Hwever, a plan satisfies the timing requirement if the ntice is given at least 30 days and n mre than 90 days befre the beginning f each plan year. In additin, if the emplyee becmes eligible after the 90th day befre the beginning f the plan year, the timing requirement is satisfied if the ntice is prvided mre than 90 days befre the emplyee becmes eligible and n later than the date the emplyee becmes eligible. If a plan spnsr adpts an ADP safe harbr design fr the first time fr a plan year beginning n r after January 1, 2000, and befre June 2, 2000, a special ntice deadline f May 1, 2000 applies. Other Testing Requirements Plans that use the ADP r ACP safe harbr designs must still satisfy ther nndiscriminatin tests such as cverage, tp heavy, cmpensatin, annual additins and, if applicable, nndiscriminatry availability f benefits, rights and features. Hwever, if a plan satisfies bth the ADP and the ACP safe harbr design rules and des nt accept emplyee pst-tax cntributins, it des nt have t perfrm a "Multiple Use" test. 2004, The Prudential Insurance Cmpany f America, all rights reserved. Page 9

10 Plan Dcument Cnsideratins If a plan spnsr chses t use a safe harbr design, the plan must specify which f the alternatives it is using. If safe harbr matching cntributins r nnelective cntributins are made t anther plan, the name f the ther plan must be stated in the plan dcument. Generally, a plan spnsr that intends t use the safe harbr prvisins fr a plan year must adpt thse prvisins befre the first day f that plan year. In additin, the ther plan must als adpt, befre the first day f that plan year, prvisins specifying that safe harbr cntributins will be made and prvide fr vesting and withdrawal restrictins. Hwever, if a plan spnsr wants t use the ADP r ACP safe harbr design fr the 1999 r 2000 plan year, that amendment des nt need t be adpted befre the start f the year. Instead, it must be adpted by the SBJPA amendment deadline, which is generally the last day f the 2000 plan year, and must be effective retractively t the first day f the apprpriate plan year. Next Steps If yu are interested in using the design-based safe harbr methd fr meeting ADP and ACP testing requirements, yu shuld first cmpare yur current plan design with the safe harbr methd. This cmparisn als requires analyzing the current cst f yur plan against the cst f implementing a safe harbr methd. After yu have cmpleted yur analysis, if yu wish t adpt a safe harbr design, yu shuld cntact yur Prudential Retirement Representative wh will discuss yur plan design ptins with yu. Pensin Analyst by Prudential Retirement The Pensin Analyst is published by Prudential Retirement, a Prudential Financial business, t prvide clients with up-t-date infrmatin n current legislatin and regulatry develpments affecting qualified retirement plans. This publicatin is distributed with the understanding that Prudential Retirement is nt rendering legal advice. Plan spnsrs shuld cnsult their attrneys abut the applicatin f any law t their retirement plans. Prudential Financial is a service mark f The Prudential Insurance Cmpany f America, Newark, NJ and its affiliates. Editr: Mitzi Rman (860) , The Prudential Insurance Cmpany f America, all rights reserved. Page 10