Mercer 401(k) Compliance Testing Manual

Transcription

1 Retirement Plan Administration Mercer 401(k) Compliance Testing Manual A resource for testing information

2 2009 by Mercer HR Services, LLC. All contents are the confidential and exclusive property of Mercer. All rights reserved. No part of this work may be reproduced, transmitted, or transcribed by any means, electronic or mechanical, now known or hereafter invented, including but not limited to photocopying and recording, or by any information storage or retrieval systems, except as expressly permitted by the copyright owner. Developed by the Reporting & Testing Department. September 2009 M /09

3 TABLE OF CONTENTS INTRODUCTION... 1 DATA REQUIREMENTS FOR TESTING... 2 Identification of Certain Employees...2 A. Highly Compensated Employees (HCEs)...2 B. Highly Compensated Employees Using the Optional Top 20% Election...2 C. Key Employees...3 Correct Compensation for Testing...4 A. ADP/ACP Testing Compensation...4 B. 415 Compensation...4 C. Deferral Compensation...4 D. Post Severance Compensation...5 E. Employees Who Received Severance Pay...5 Correct Testing Population...6 A. Eligible Employees...6 B. Collectively Bargained Employees...6 C. Location Codes...6 D. Early Participation Rule...7 ANNUAL NONDISCRIMINATION TESTING... 8 Testing Overview...8 A. ADP/ACP Test...8 B. 410(b) Minimum Coverage Test...11 C. Section 415 Annual Additions Test...12 D. Top Heavy Test...12 Scenarios that May Affect Your Test Results...13 A. Mergers, Acquisitions, Spin-offs, and Other Workforce Changes...13 B. Plan Amendments or Discretionary Changes...13 C. Controlled Group Status...13 Four-Year COLA Summary...15 SAFE HARBOR PLANS...16 Qualified Automatic Contribution Arrangement (QACA)...17 ELIGIBLE AUTOMATIC CONTRIBUTION ARRANGEMENT (EACA)...18 SHORT PLAN YEARS AND THE IMPACT ON TESTING...19 Determining Highly Compensated Employees...19 Annual Limits Must Be Prorated...19 IMPORTANT DATES AND DEADLINES...20 Correction Timing and Penalties...20 FAILED TESTS...22 Guide to Correction Methods...22 A. ADP/ACP Nondiscrimination Testing...22 B. Section 415 Annual Additions Limits...24 C. Requirements for Top Heavy Plans...25 D. Catch-up Contributions...26 INTERIM NONDISCRIMINATION TESTING...27 A. Compensation for Interim Testing...27 B. Plan Aggregation...28 C. Interim Testing of Matching Contributions...28 D. How Are Contributions and Compensation Projected for Interim Testing?...28 E. What to Do With Your Test Results...29 PUERTO RICO PLANS...30

4 FORMS AND SAMPLE TEST...31 Demo Test...32 Compliance Testing Services Waiver...48 Tax Withholding Waiver...49 HCE List...50 Compliance Testing Manual

5 INTRODUCTION Mercer is pleased to offer you an online resource to provide the information needed before and after compliance testing is performed for your plan. This document is designed to provide you with a readily available resource for testing information. 1 Compliance Testing Manual

6 DATA REQUIREMENTS FOR TESTING Identification of Certain Employees A. HIGHLY COMPENSATED EMPLOYEES (HCEs) The Actual Deferral Percentage/Actual Contribution Percentage (ADP/ACP) tests compare deferral and matching contribution percentages of HCEs to those of Non Highly Compensated Employees (NHCEs). As such, the correct identification and coding of HCEs is critical to an accurate test. For the current plan year, an HCE is any employee who was: Actually paid over the gross compensation limit determined by COLA (see Four-Year COLA Summary and Correct Compensation for Testing section), during the prior plan year (or prior 12-month period, if the prior plan year was shorter than 12 months also known as the look-back period ), regardless of the amount of compensation actually paid during the plan year being tested; or An owner of more than 5% of a company sponsoring the plan, either during the plan year being tested or the look-back period; or A family member of an over-5% owner. Note: Certain family members of over-5% owners are treated as having the same share of ownership, under Section 318 of the Internal Revenue Code; this includes the over-5% owner s spouse, parents, grandparents, and children. For example, the child of an over-5% owner is also considered an over-5% owner, and is therefore an HCE regardless of the child s compensation. Mercer will perform a preliminary determination of HCEs and Key Employees for your review and validation based on the data in our recordkeeping system and any additional information you provide regarding ownership, family members, and officers. It is your responsibility to provide updates to Owner and Officer information, as well as any updates to compensation or employee data, annually to your Client Service Representative. Failure to provide this information could result in delayed and/or inaccurate test results. B. HIGHLY COMPENSATED EMPLOYEES USING THE OPTIONAL TOP 20% ELECTION If your plan document requires you to use the Top 20% Election, the determination of this group of employees will need to be done as described below. Mercer will perform the preliminary determination of your plan s HCEs for your review and validation based on data in our recordkeeping system along with any additional data we may need to collect from you. If there are other companies in the Controlled Group whose records are not kept at Mercer, the list of HCEs must be provided to Mercer. 1. In computing the number of employees in this top-paid 20% group (Top-Paid Group), begin with all employees who were employed at any time during the look-back period, including those ineligible to participate in the plan (and including all employees of other companies in a Controlled Group or Affiliated Service Group). However, the following may be excluded: Employees with less than six months of service by the end of the look-back period; or Part-time or seasonal employees scheduled to work less than 17½ hours per week, or less than six months per year; or Employees under 21 years of age as of the end of the look-back period; or Employees in a collective bargaining unit (if 90% or more of all employees are collectively bargained members and they were excluded from the plan); or Non-resident aliens with no U.S.-source income. 2 Compliance Testing Manual

7 DATA REQUIREMENTS FOR TESTING 2. Determine the total number employed at any time during the look-back period, excluding any in the above categories. 3. Multiply this total by 20%, rounding up or down to a whole number, to get the total number in the Top-Paid Group (apply the same rounding rule consistently each year). 4. Look at all employees, regardless of whether they are eligible, in the order of gross compensation paid for the year before the year being tested. Starting with the highest paid employees, count down the Top-Paid Group number to determine which employees are in your Top-Paid Group. If employees that are not actually eligible for the plan are included in this count, they will not be included in the test, but are still included as HCEs in your Top-Paid Group. 5. Finally, the test will also include any eligible employees who are over-5% owners (including certain family members), whether or not they are in your Top-Paid group. C. KEY EMPLOYEES A Key Employee is any employee who, at any time during the plan year, was: An officer with total gross compensation in excess of the annual compensation limit, (see Four-Year COLA Summary); or An over-5% owner (including certain family members); or An over-1% owner (including certain family members) with gross compensation in excess of the annual compensation limit. Note: Certain family members of owners are treated as having the same share of ownership under Section 318 of the Internal Revenue Code; this includes the owner s spouse, parents, grandparents, and children. For example, the child of a 1% owner is also considered a 1% owner, and the child would be a Key Employee if his or her compensation was also over the annual compensation limit. An officer for Top Heavy purposes means a key administrative executive of the company, not necessarily anyone who has a corporate title. For purposes of the Top Heavy test, Internal Revenue Service (IRS) guidelines allow you to limit those considered officers to 10% of the total number of employees (but not fewer than 3 or more than 50). Only officers with gross compensation over the annual compensation limit, (see Four-year COLA Summary), are treated as Key Employees. In order for Mercer to perform a preliminary determination of HCE and Key Employees for your review and validation, you will need to provide additional information regarding ownership, family members, and officers. It is your responsibility to provide updates to Owner and Officer information annually to your Client Service Representative. Failure to provide this information could result in delayed and/or inaccurate test results. 3 Compliance Testing Manual

8 DATA REQUIREMENTS FOR TESTING Correct Compensation for Testing A. ADP/ACP TESTING COMPENSATION Please review your plan document for the definition of compensation used by your plan for ADP/ACP testing. This may or may not be the same definition used by your plan for other purposes, such as Section 415 testing or determining contribution amounts. For example, some plans exclude compensation paid before the date an employee became eligible for the plan. If your plan contains this provision, testing compensation paid for the period before the employees become eligible could be excluded for ADP/ACP testing, but must still be included for section 415 testing (see below). Compensation earned during any period in which an employee was eligible must be included (even if he or she elected not to make salary deferrals to the plan). B. 415 COMPENSATION Annual 415 compensation data is needed for all employees who were eligible to participate in the plan at any time during the plan year being tested. Compensation for Section 415 testing is defined by IRS regulations. It includes all federal taxable compensation, plus any before-tax deductions contributed to a 401(k), Section 125, or similar tax-qualified plan. Other amounts not currently taxable to the employee (e.g., stock options, non-qualified deferred compensation, or moving expenses deductible by the employee) are not included in this definition. The 415 compensation provided will be used to determine your Highly Compensated Employees (HCEs). (View the definition of a Highly Compensated Employee.) If your plan s definition of ADP/ACP compensation is also 415 compensation, then you only need to provide one compensation amount for each eligible employee. C. DEFERRAL COMPENSATION If your plan document allows for catch-up contributions for employees age 50 and over, and your plan limits deferrals (either for all employees or for HCEs only) to a certain percentage of compensation less than 75%, you should also check your plan s definition of the compensation on which these deferral limits are based. It may be the same as 415 compensation or ADP/ACP testing compensation, but if it is not, you should arrange to provide us with the deferral compensation amounts as well. Otherwise, we will not be able to determine whether catch-up amounts have been accurately calculated. This can impact the validity of your other testing, since catch-up amounts can be excluded from testing only if the participant had actually exceeded a regulatory or plan-specific limit as of the end of the plan year. This is not an issue if your plan s deferral limits have been eliminated or raised to 75% or higher. 4 Compliance Testing Manual

9 D. POST-SEVERANCE COMPENSATION The final rules limit a plan s ability to count compensation after a participant severs employment. In general under the new regulations, compensation does not include compensation paid after an employee severs employment. However, there are 2 exceptions: 1. A plan can count compensation paid to former employees who are in the US military or permanently and totally disabled. 2. A plan can count compensation paid by the later of 2½ months after severance of employment or the last day of the limitation year in which the employee severed employment if: a. The payment was for services rendered (e.g., salary, commissions, overtime, bonus, etc.), which the employer would have paid if employment had continued, or b. The payment was for unused accrued sick leave, vacation pay, or other leave, which the employee could have taken if employment had continued, or c. The payment was from an unfunded nonqualified deferred compensation plan, to the extent includible in income, if the employee would have received the payments at the same time if employment had continued. Payments in 2.b. and 2.c. count as compensation only if they would have been compensation if the employment had continued. Compensation does not include any of the following amounts paid after employment termination: severance pay, parachute payments, or payments from unfunded deferred compensation plans that are triggered by severance. E. EMPLOYEES WHO RECEIVED SEVERANCE PAY Unless your plan document specifically allows it, when employees are awarded severance pay after terminating employment, elective deferrals should not be withheld from that compensation and it should not be included in compensation for testing purposes. If the definition of ADP testing compensation used by your plan includes severance pay, we suggest you include it in testing compensation for employees who terminated during the plan year being tested. However, employees who terminated in the prior plan year and have only residual compensation or severance pay in the plan year being tested would generally not be included in the testing population since they would be considered ineligible. 5 Compliance Testing Manual

10 DATA REQUIREMENTS FOR TESTING Correct Testing Population A. ELIGIBLE EMPLOYEES Except as noted below, the ADP/ACP test must include all employees who were eligible to participate in the plan at any time during the plan year being tested, including those who terminated during the year and those who elected not to participate. Testing compensation should be provided for all employees who met the eligibility requirements of the plan and entered the plan according to the plan s entry date provision. This would include employees who met the eligibility requirements and reached an entry date but chose not to defer. These employees would be included in the ADP/ACP test at zero percent. B. COLLECTIVELY BARGAINED EMPLOYEES A Collectively Bargained plan is a plan (or portion of a plan) that is maintained pursuant to a collectively bargained agreement. Special coverage and nondiscrimination testing rules are applicable. Collectively bargained employees must not be included in the same nondiscrimination test with non-collectively bargained employees. If your plan covers both collectively bargained and non-collectively bargained employees, separate ADP tests must be performed for each group. Because of this requirement, correct identification of collectively bargained employees is critical to completing an accurate test. This is typically done by setting the employee s division/location code or a special collectively bargained identifier on our recordkeeping system. These codes need to be provided for all eligible collectively bargained employees, not just those who participate in the plan. As always, please work with your Client Service Representative to review your plan s data needs and the method of data collection. C. LOCATION CODES If employees are tested by location (e.g., multiple employer plans), it is critical to the accuracy of each test that all employees be identified with the correct location code. Employees with incorrect location codes will not be tested with the correct population and this could impact the overall test results. Please work with your Client Service Representative to ensure all employees are identified with an accurate location code. 6 Compliance Testing Manual

11 DATA REQUIREMENTS FOR TESTING D. EARLY PARTICIPATION RULE Plans are allowed to exclude employees who are under age 21, have not yet completed a full 12 months of service or who have never worked 1,000 hours during any plan year (the statutory minimum ). Today, most plans have less restrictive eligibility requirements, often making employees eligible as soon as they are employed, or after completing only a few months of service. If your plan does not impose the most restrictive eligibility requirements allowed by law, you may still exclude from the ADP/ACP tests any NHCEs who have not met those requirements, even though they are able to participate in the plan. Since recently hired employees and those under age 21 typically have lower-than average deferral rates, it is often advantageous to exclude this group from testing. In performing your ADP/ACP tests, Mercer will determine whether this optional rule can improve your test results, to the extent we can accurately determine this population of excludable NHCEs. If you provide accurate birth and hire dates to our recordkeeping system for all eligible employees (including those who do not elect to defer), we will be able to apply this rule to maximum advantage. Since plan documents typically do not specify how to determine this excludable group, and IRS regulations do not provide guidance in this area, our standard practice is to exclude any NHCEs who would not have reached age 21 or would not have completed 12 months of service as of the last semi-annual entry date in the plan year (regardless of the plan s actual entry dates). For example, in testing for a calendar year plan, we will exclude NHCEs who were not yet age 21 or had not completed 12 months of service as of July 1st of the Testing year. 7 Compliance Testing Manual

12 ANNUAL NONDISCRIMINATION TESTING Testing Overview A. ADP/ACP TEST Except for plans that satisfy a 401(k) Safe Harbor or Automatic Enrollment Safe Harbor (see Safe Harbor Plans section), ADP/ACP testing is required for all 401(k) plans and for other qualified plans that allow for employee contributions or employer matching contributions. (Some plans meeting the ADP Safe Harbor requirements may still require ACP testing.) The ADP and ACP tests limit the average contribution percentages of the HCEs, in relation to the average contribution percentages of the NHCEs. Normally, the ADP (Actual Deferral Percentage) test measures before-tax salary and Roth deferrals while the ACP (Actual Contribution Percentage) test measures employee after-tax and employer matching contributions. See Correct Testing Population section for more specifics. How the ADP and ACP percentages are calculated. First, the before-tax and Roth deferrals made for each employee are divided by the employee s compensation to arrive at that individual s ADP. Each employee s ACP is obtained by dividing the total after-tax and matching contributions made to his or her account by his or her compensation. These percentages are then averaged among all NHCEs to determine the respective ADP/ACP for the NHCE group and among all HCEs to determine the respective ADP/ACP for the HCE group. Note that, if your plan has a last day and/or hours requirement to be eligible for a matching contribution, employees who do not meet these requirements may not be included in your ACP test. Plans that use the current-year testing method compare the HCE group averages for the current plan year against the NHCE averages for the same year. Plans that use the prior-year testing method compare the current year HCE averages against the NHCE averages for the previous plan year. Your plan can amend to change the Current or Prior Year testing method, but there are some limitations in doing so. Generally, the amendment should be executed before the end of the year being tested. For example, if your plan is a calendar year plan, you would need to amend by December 31st of the year being tested for the change in testing method to be effective for your current calendar year test. Switching from Current Year Testing method to Prior Year Testing method can only be done if your plan has used the Current Year Testing method for at least 5 plan years. Conversely, switching from the prior year to the Current Year method can be done any time. How ADP and ACP percentages are limited for HCEs. The HCE group averages for the ADP and ACP tests are compared to the respective NHCE percentages (either for the current plan year or the prior plan year depending on the testing method specified in the plan document). The average ADP or ACP for the HCE group must not exceed the greater of: The Basic Limit, which is the NHCE average times 1.25; or The Alternative Limit, which is the lesser of: The NHCE average ADP times 2, or; The NHCE average ADP plus 2 percentage points. Note: The requirement is that the test only pass one of these limits. 8 Compliance Testing Manual

13 ANNUAL NONDISCRIMINATION TESTING Below is an illustration that shows the maximum HCE ADP at different levels of NHCE ADP. NHCE Average 0.60% 1.80% 2.00% 4.30% 7.50% 8.00% 9.20% Highest Limit NHCE Avg. times 2 NHCE Avg. times 2 NHCE Avg. times 2 or plus 2 NHCE Avg. plus 2 NHCE Avg. plus 2 NHCE Avg. plus 2 or times 1.25 NHCE Avg. times 1.25 Maximum HCE Average 1.20% 3.60% 4.00% 6.30% 9.50% 10.00% 11.50% Note: In certain cases regulations allow shifting or borrowing contributions from the ADP test to the ACP test or vice-versa, to improve the results. For example, if the ADP test passes but the ACP test fails, we may be able to improve the result by including some before-tax deferrals in the ACP test instead of the ADP test. If your plan s matching contributions are immediately vested and meet the other requirements for QMACs (see Other Correction Methods), we may likewise be able to improve your ADP results by including some matching contributions in the ADP test. Failed ADP/ACP tests. If the average ADP or ACP for the HCE group exceeds both the Basic and the Alternative Limits, then the ADP/ACP test fails and corrections must be made as specified in the provisions of your plan document. If your plan allows catch-up contributions for employees who have reached age 50, then any excess amounts for HCEs who are eligible for catch-up will be recharacterized as catch-up contributions instead of being distributed, unless they have already reached the catch-up dollar limit in effect for the year (see Four-Year COLA Summary). The following correction methods are permitted in the regulations: 1. Returning excess contributions (adjusted for investment gain or loss) to the HCEs who received the highest dollar amount of contributions (see DEMO Part III - Correction Summary). Under this correction method the plan sponsor may incur a penalty tax equal to 10% of the total excess contributions, prior to gain/loss adjustment, on any distributions made (see Correction Period section and Important Dates and Deadlines section), or 2. Recharacterizing excess before-tax contributions as after-tax contributions (if after-tax contributions are allowed under the terms of the plan). Under the after-tax recharacterization method, before-tax deferrals become subject to taxation in the year they would otherwise have been distributed. Instead of being distributed as ROEs, they remain in the plan as after-tax contributions (see Important Dates and Deadlines). This correction method is only allowed within 2½ months after the end of the Plan Year being tested, or 3. Depositing a Qualified Non-Elective Contribution (QNEC) or Qualified Matching Contribution (QMAC) in the plan for all NHCEs. This correction method is typically available for plans using the Current Year testing method. Note: If the ADP or ACP test fails, corrections must be made within 12 months after the end of the plan year being tested. Failure to correct a failed test in a timely manner jeopardizes the plan s qualified status and may require additional corrections and communications to the IRS under the Employee Plans Compliance Resolution System (EPCRS). At a minimum, correcting a failed test after the 12-month deadline will likely require the employer to make additional QNEC contributions to the plan for NHCEs. 9 Compliance Testing Manual

14 ANNUAL NONDISCRIMINATION TESTING Aggregating separate 401(k) plans. If your company (or Controlled Group of companies) sponsors more than one 401(k) plan, you may have the option of aggregating the plans for purposes of ADP/ACP testing, as long as the plans have the same plan year and use the same testing method (current-year/prior-year). This means that two or more plans may be tested as though a single plan covered all their eligible employees. This may work to your advantage for example, if one plan fails the ADP test but another plan passes, aggregating the two tests may produce a more favorable result for the failing plan. Separate 401(k) plans sponsored by the same company or Controlled Group may also be aggregated for 410(b) coverage testing (see next page). Often, multiple plans must be combined and treated as a single plan in order to meet Minimum Coverage requirements in that case, the ADP/ACP tests for the plans must also be run on an aggregated basis. You may make a different decision about aggregating plans or testing them separately for each plan year, but for any given plan year the plans must be treated the same way in both ADP/ACP and 410(b) coverage tests. For this reason, it is critical that you inform Mercer of your inclusion in a Controlled Group or Affiliated Service Group. Failure to provide this information could result in delayed and/or inaccurate test results. See Scenarios that May Affect Your Test Results for more information. 10 Compliance Testing Manual

15 ANNUAL NONDISCRIMINATION TESTING B. 410(b) MINIMUM COVERAGE TEST The IRS requires that a minimum number of Non-Highly Compensated Employees be covered under a qualified plan. Section 410(b) of the Internal Revenue Code prescribes a Ratio Percentage test to determine if the percentage of NHCEs covered under the plan is adequate in comparison to the percentage of HCEs who are covered. This test must be run separately with respect to each of the following contribution types: Employee before-tax deferrals (including Roth); Matching contributions and employee after-tax contributions; Profit sharing contributions or any other employer contributions. The 410(b) Ratio Percentage test takes into account all employees who received compensation for services during the testing year, including all employees of any other companies that belong to the same Controlled Group or Affiliated Service Group (see Scenarios that May Affect Your Test Results). As with all of the testing services provided by Mercer, coverage testing is performed only for plans that are record-kept at Mercer. If your company is a member of a Controlled Group that has additional plans not record-kept at Mercer, please keep in mind that the results provided to you may need to be aggregated with the data provided from the other recordkeeper. In addition to employees who were eligible for your plan during the year, if your company (or other companies in the same Controlled Group) employed any of the following types of employees and they were excluded from your plan, then the number of excluded employees in each group (as well as the number who were HCEs for this plan year) will need to be provided in order for us to complete your 410(b) test. 1. Leased employees who had worked full-time for at least one year. 2. Employees in any company or division that was excluded as a group from participation in your plan. 3. Any other group of employees who were ineligible for the plan for reasons other than the plan s minimum age and service requirements, or because of their status as collectively bargained employees or non-resident aliens. If your plan fails the ratio percentage test, the use of special methods such as Average Benefits testing may be required to meet the 410(b) requirements. If your plan does not appear to pass Ratio Percentage testing, based on the data available to us, your Client Service Representative will contact you to discuss what additional data or special testing may be required. Qualified plans are expected to be designed to meet Minimum Coverage requirements, so the regulations do not prescribe specific methods of correction if the 410(b) test fails. Any indication that your plan may not meet these requirements should be discussed with your legal counsel to determine an appropriate remedy. Generally this would involve a plan amendment allowing additional employees to participate in the plan or contributing additional employer contributions to the plan. 11 Compliance Testing Manual

16 ANNUAL NONDISCRIMINATION TESTING C. SECTION 415 ANNUAL ADDITIONS TEST The Section 415 annual additions test is conducted on an individual participant basis, and all qualified retirement plans are subject to this test. Under Section 415 of the Internal Revenue Code, the total annual additions to each participant s account for any Limitation Year cannot exceed the lesser of 100% of Section 415 compensation or the dollar limit indicated in the Four-Year COLA Summary. Annual additions include all employee and employer contributions and any forfeitures reallocated to a participant s account. Annual additions do not include catch-up contributions or rollover contributions. Where employees participate in more than one plan sponsored by the same or related employers, contributions made to all such plans must be taken into account in applying these limits. If a participant s annual additions exceed the maximum limit, correction should be made in accordance with your plan document as available under the EPCRS program. Any correction to participant allocations should be made as soon as possible after the excess has been identified, but no later than 12 months after the end of the plan year being tested. D. TOP HEAVY TEST Section 416 of the Internal Revenue Code defines a Top Heavy plan as one in which more than 60% of total plan assets are allocated to the accounts of Key Employees. All qualified plans, other than some of those meeting safe harbor requirements, are subject to Top Heavy testing. The Top Heavy determination made at the end of a plan year establishes whether or not your plan is considered Top Heavy for the next plan year. Top Heavy plans are subject to minimum vesting and contribution standards. Many plans, whether or not they are Top Heavy, already have a vesting schedule that meets the minimum vesting standards. If your plan is determined to be Top Heavy for the next plan year, you should implement the minimum vesting schedule as soon as possible. You will also be required to make a minimum employer contribution on behalf of all Non-Key Employees for that year if your employer contributions to the plan do not already satisfy this requirement. 12 Compliance Testing Manual

17 ANNUAL NONDISCRIMINATION TESTING Scenarios that May Affect Your Test Results Below are examples of corporate actions and other scenarios that may occur during a plan year and may impact your annual testing. The effect of these on your testing may be seen in the year of the transaction as well as in future years. A. MERGERS, ACQUISITIONS, SPIN-OFFS, AND OTHER WORKFORCE CHANGES If a significant number of employees enter or leave the plan through a company merger, acquisition, or spinoff, this may have an impact on your test results. The number of employees, their rates of deferral, their account balances, and the HCE/NHCE breakdown could all have an impact on any or all of the tests being performed in the current year or in future years. Other changes to the workforce, such as layoffs or early retirement programs, may also make a significant difference in testing, particularly if HCEs are involved. Questions often arise as to the appropriate method of defining HCEs in recently acquired or spun-off companies, or about whether 401(k) plans that merge into or spin off from a parent company s plan may still be tested as part of that plan for the year in which the change occurs. Mercer s Reporting & Testing Specialists are available to discuss your testing options in such situations; however, because IRS guidance in this area is limited, you should also seek advice from legal counsel to be sure you are giving us appropriate instructions on testing your plan. B. PLAN AMENDMENTS OR DISCRETIONARY CHANGES Changes to your plan may also affect your test results. Changes to eligibility requirements and match formulas are two of the most common changes that could impact your test results but there are others. Please contact your Client Service Representative if you have any questions regarding any amendments to your plan. C. CONTROLLED GROUP STATUS If your company is a member of a Controlled Group or Affiliated Service Group, you must inform Mercer, as there may be an impact to your testing services. In this situation, please keep in mind that the test results provided to you may not be final results, as they may need to be aggregated with that of the other members of the Controlled Group or Affiliated Service Group. If your company becomes a member of a Controlled Group during the plan year, your Minimum Coverage test and your ADP/ACP tests may be impacted. The rules surrounding Controlled Groups are complex. Although Mercer cannot make the determination as to your Controlled Group status, some of the ways your company may become a member of a Controlled Group are noted below. Your company acquires another company in whole or in part. Your company is acquired in whole or in part by another company. There is a change in the percentage of common ownership between your company and another entity. There is a change in the percentage of ownership in your company by another entity. 13 Compliance Testing Manual

18 ANNUAL NONDISCRIMINATION TESTING Generally, all members of a Controlled Group are considered when performing your nondiscrimination testing. Companies within a Controlled Group may be tested separately for nondiscrimination purposes only if they meet certain Minimum Coverage requirements, taking into account the entire employee population of the Controlled Group. If your company becomes a member of a Controlled Group during the plan year and other members of the Controlled Group also maintain qualified retirement plans for their employees at other service providers, all plans may need to be tested together. In addition, if employees of a member of the Controlled Group are not covered by any plan, those employees will impact the results of the Minimum Coverage test. If you know that your company became a member of a Controlled Group during the plan year, please notify your Client Service Representative. If you are unsure whether your company is part of a Controlled Group, please contact your controller, tax preparer, or legal counsel. These rules may also apply if a new member joins a current Controlled Group during the plan year. Therefore, if your company is already part of a Controlled Group and a new member joins, your testing may be affected. 14 Compliance Testing Manual

19 ANNUAL NONDISCRIMINATION TESTING Four-Year COLA Summary Qualified Plan Limits (k) Limit (402(g)) $16,500 $15,500 $15,500 $15,000 Catch-Up for 401(k) 5,500 5,000 5,000 5,000 DC Annual Contributions (415) Maximum Compensation Limit 401(a)(17) Highly Compensated Employees Compensation Threshold Key Employees and Officers Compensation A More Than 1% Owner 49,000 46,000 45,000 44, , , , , ,000* 105,000* 100, , , , , , , , , ,000 Taxable Wage Base 106, ,000 97,500 94,200 * For example: The compensation limit from the prior year applies to the current testing year. Therefore, an employee who earned $102,000 in 2007 would be an HCE for the 2008 testing year. However, an employee who earned $102,000 in 2008 would not be an HCE for 2009, since the HCE compensation limit that must be earned in 2008 to be an HCE in the next testing year (2009) is $105, Compliance Testing Manual

20 SAFE HARBOR PLANS An effective way of eliminating some of a 401(k) plan s annual nondiscrimination testing is to adopt a 401(k) safe harbor matching or profit-sharing contribution formula under the plan. A 401(k) plan that makes either a safe harbor matching or safe harbor profit-sharing contribution may be relieved of the need to perform any ADP or ACP tests. Additionally, for a plan that may become Top Heavy, the Top Heavy rules may automatically be satisfied, if the safe harbor requirements are met. Safe Harbor Matching Contributions. A plan meets the safe harbor matching requirements if matching contributions are made on behalf of every Non-Highly Compensated Employee, equal to 100% of his or her deferrals up to 3% of compensation, plus 50% of his or her deferrals of more than 3% and up to 5% of compensation. (Other, equivalent formulas can satisfy the matching safe harbor, too, but only if the rate of matching does not increase as the rate of deferrals increases, and so long as the amount of matching contributions at each rate of deferral is at least equal to the amount that would be made if the basic formula were used.) Safe Harbor Profit-Sharing Contributions. A plan can also meet the 401(k) safe harbor requirements if the plan requires the employer to make a non-elective profit-sharing contribution equal to at least 3% of compensation, on behalf of every eligible Non-Highly Compensated Employee regardless of whether the Non-Highly Compensated Employee has made any before-tax elective deferrals or after-tax contributions. Notice Requirement. In either case, a plan can only meet the safe harbor requirements for a certain year if all eligible employees are given an accurate, understandable, written notice of their rights and obligations under the plan, within a reasonable period before the beginning of the plan year. Vesting Requirements. Any contributions used to satisfy the safe harbor requirements must be 100% vested immediately. Withdrawal Restrictions. All safe harbor contributions are subject to withdrawal restrictions. Like elective deferrals, they must not be distributed from the plan prior to age 59½ unless the participant severs from employment or certain other circumstances are met. Safe harbor contributions must also not be available for hardship withdrawal prior to age 59½. Note: Operating a safe harbor plan requires a written amendment to the plan document. Although a plan may contain the required features of the safe harbor plan design, the document must state that the plan is a safe harbor plan. In addition, safe harbor plans are not exempt from the 415 Annual Additions test or the 410(b) Minimum Coverage test. 16 Compliance Testing Manual

21 SAFE HARBOR PLANS Qualified Automatic Contribution Arrangement (QACA) For plan years beginning on or after 1/1/2008, certain qualified auto enrollment plans, as set forth in the Pension Protection Act of 2006, can receive an exemption from ADP/ACP testing, and, in some cases, top-heavy testing. AUTOMATIC ENROLLMENT Employees must be initially automatically enrolled at 3% of pay or greater. These contributions must automatically increase annually by 1% after the first full plan year to a minimum of 6% but no more than 10% of pay. MATCHING OR NON-ELECTIVE CONTRIBUTIONS Employers may make matching or non-elective contributions. Matching contributions for NHCEs must equal 100% of the first 1% contributed by the participant, plus 50% of the next 5% for a maximum match of 3.5%. The rate of match for HCEs may not be greater than the rate of match for NHCEs at each level of employee contribution. Nor can the rate of match increase as employee contributions increase. In addition, employee contributions of greater than 6% of pay cannot be matched. The employer may choose to make non-elective contributions to NHCEs instead, but they must be greater than or equal to 3% of pay. VESTING Both matching and non-elective auto enrollment safe harbor contributions are subject to a 2-year or less vesting schedule. WITHDRAWAL RESTRICTIONS All safe harbor contributions are subject to withdrawal restrictions. Like elective deferrals, they must not be distributed from the plan prior to age 59½ unless the participant severs from employment or certain other circumstances are met. Safe harbor contributions must also not be available for hardship withdrawal prior to age 59½. NOTICE REQUIREMENT A plan can only meet the QACA designation for a certain year if all eligible employees are given an accurate, understandable, written notice of their rights and obligations under the plan, within a reasonable period before the beginning of the plan year. The notice must explain the right to opt out and how contributions will be invested in the absence of participant direction. In addition, employees must have a reasonable amount of time to make contribution and investment elections before the first contribution is made. 17 Compliance Testing Manual

22 ELIGIBLE AUTOMATIC CONTRIBUTION ARRANGEMENT (EACA) In order to meet the requirements for an Eligible Automatic Contribution Arrangement, your plan would have had to implement all of the provisions below during While an EACA plan is not exempt from testing, certain deadlines are extended for EACA plans. a. Auto Enrollment for all new AND existing participants who had not previously completed an enrollment form b. Provided an adequate initial notice of auto enrollment provisions to these new and existing participants c. Designated a Qualified Default Investment Alternative (QDIA) (as defined by the IRS) for investment of the automatic enrollment contributions d. Provided an adequate annual notice of QDIA and automatic enrollment to all participants e. Amended your plan document for the automatic enrollment feature by the end of your 2008 plan year If your plan meets all of the requirements above, and your ADP/ACP testing fails, you now have until 6 months into the new plan year (vs. the previous 2½ months) to process returns of excess to your Highly Compensated Group before you are subject to a 10% excise tax on the amount of the returns. 18 Compliance Testing Manual

23 SHORT PLAN YEARS AND THE IMPACT ON TESTING Short plan years may occur in a number of situations including when a new plan is established, when a plan amends its plan year, when a plan is terminated, or when a plan merger takes place. Determining Highly Compensated Employees Highly Compensated Employees (HCEs) are determined on the basis of gross compensation earned for the 12-month period preceding the plan year being tested (unless the plan has an off-calendar plan year and adopts a special election to define its HCE group based on calendar-year gross compensation). The HCE group for a short plan year is determined as usual, based on gross compensation earned in the prior plan year. However, the HCE group for the plan year following the short plan year must still be based on gross compensation for the previous 12 months, not just the previous short plan year period. For example, assume a plan is being amended from a 10/31 plan year-end to a 12/31 plan year-end. The period from 11/1 to 12/31 becomes a short plan year. When determining HCEs for the short plan year, gross compensation from 11/1 to 10/31 will be used. For the next plan year, gross compensation from 1/1 to 12/31 will be used to determine the HCE group. The same is true when a new plan is established. Assume a new calendar-year plan is created with an effective date of 5/1. The period from 5/1 to 12/31 is a short plan year. Compensation used to determine HCEs will be compensation paid from 5/1 to 4/30 of the prior plan period (unless the plan document includes a calendar-year election for its first plan year). Annual Limits Must Be Pro-rated Some annual limits used in testing must be pro-rated for short plan years. These include the 401(a)(17) Annual Compensation Limit and the 415 Annual Additions Limit. (View the Four Year COLA Summary for specific annual limits.) For example, the 2009 Annual Compensation Limit when determining plan calculations is $245,000. This limit must be pro-rated for a short plan year. Using the example from above with a plan year beginning on 5/1/09 and ending on 12/31/09, the maximum compensation to be used is $163,333 ($245,000/12) X 8; the number of months in the plan year being tested). The Annual Additions Limit for a short plan year would be determined in the same way. To determine the applicable limit for the short plan year, divide the annual limit by 12 and then multiply by the number of months in the short plan year. Because the 402(g) Deferral Limit and the 414(v) Catch-up Limit are always applied on a calendar-year basis, these limits do not change for a short plan year. Likewise, the compensation thresholds for HCEs and Key Employees are not pro-rated since they are always based on a 12-month period. 19 Compliance Testing Manual

24 IMPORTANT DATES AND DEADLINES Correction Timing And Penalties All plans are subject to correcting their testing failures within 12 months of the end of the plan year being tested. Failure to do so will result in an operational defect and a more expensive correction method as outlined in the Employee Plan Compliance Resolution System (EPCRS). EXCISE TAX PERIOD: In addition, correction after a certain date following the plan year would result in a 10% excise tax on the amount of excess contributions and excess aggregate contributions that are distributed by the plan. This excise tax is imposed on you, the plan sponsor. For plan years beginning on or after 1/1/2008, plans may be subject to one of two dates for this purpose: Plans without an Eligible Automatic Contribution Arrangement (EACA); (see Safe Harbor Plans) - If excess contributions and excess aggregate contributions are distributed prior to 2½ months after the end of the plan year being tested, the plan sponsor is NOT subject to the 10% excise tax. Plans with an Eligible Automatic Contribution Arrangement (EACA); (see Safe Harbor Plans) - If excess contributions and excess aggregate contributions are distributed prior to 6 months after the end of the plan year being tested, the plan sponsor is NOT subject to the 10% excise tax. TAXATION OF EXCESS CONTRIBUTIONS/EXCESS AGGREGATE CONTRIBUTIONS: This has been changed. Effective for plan years beginning on or after 1/1/2008, excess contributions and excess aggregate contributions are taxable in the year they are distributed. GAP PERIOD EARNINGS: Also effective for plan years beginning on or after 1/1/2008, gap period earnings are NOT required to be calculated on excess contributions and excess aggregate contributions (but are still required for contributions in excess of the annual 402(g) limit), but your plan document may still require GAP earnings. Please indicate on the Correction Response Form whether or not you want gap earnings calculated on your excess contributions and excess aggregate contributions. In order to make corrective distributions in a timely manner to avoid the 10% excise tax penalty, you will need to provide Mercer with complete and accurate testing data by specific deadlines that correspond with the specifics of your plan: If you intend to make refunds within the 2½ month deadline, Mercer will need complete and accurate testing data within 4 weeks from the end of your plan year. If you intend to make refunds within the 6 month deadline, Mercer will need complete and accurate testing data within 4 ½ months from the end of your plan year. 20 Compliance Testing Manual

25 IMPORTANT DATES AND DEADLINES The advantages and disadvantages of making corrections within the applicable deadline are outlined below. If your plan fails the ADP/ACP Test and you refund excess to HCEs: Within 2½ months (or 6 months for plans with EACA) after the end of the plan year being tested Pros No 10% penalty tax to the plan sponsor Cons None After 2½ months (or 6 months for plans with EACA), but within 12 months of the end of the plan year being tested More than 12 months after the end of the plan year being tested Meet IRS requirement to correct within a 12-month period. None Employer must pay penalty tax equal to 10% of the excess contributions (excluding gain/loss). This penalty must be paid using Form 5330, which must be filed by the end of the 15th month following the plan year being tested The plan may lose its tax qualification. Also, the employer incurs the cost of additional contributions (QNECs) for NHCEs, to avoid plan disqualification, in addition to the 10% penalty on any excess amounts refunded 21 Compliance Testing Manual

26 FAILED TESTS Guide to Correction Methods Note: All corrections must be authorized by returning the Correction Response Form to your Client Service Representative. Please complete and return to your Client Service Representative. A. ADP/ACP NONDISCRIMINATION TESTING If the ADP/ACP test fails, the average deferral percentages for HCEs (or in the ACP test, the average contribution percentages) are too high in comparison with the averages for the NHCEs. The most common correction method is to return excess amounts to the HCEs who deferred or received the highest dollar amount of contributions. Investment gain or loss must be allocated and distributed with the excess amounts. RETURNING EXCESS CONTRIBUTIONS If correction is made by distributing excess amounts, the following rules govern penalties and tax consequences of the distributions, depending on when they are made. If any HCEs have already received a distribution of their entire vested balance before the correction is made, their corrective distributions are considered as having been completed with that distribution. These HCEs must be notified in writing that the excess contributions are not eligible for rollover. Corrective distributions made within 2½ months (or 6 months for plans with EACA) of the testing year-end. (see Correction Timing and Penalties) Corrective distributions made after the 2½ month (or 6 months for plans with EACA) deadline. (see Correction Timing and Penalties) Corrective distributions made more than 12 months after the end of the plan year. If corrective distributions are not completed within 12 months of the end of the plan year being tested, a qualification failure will occur and the test must be corrected under the IRS Employee Plans Compliance Resolution System (EPCRS). This may not require any notification or filing with the IRS; however, it does generally require making additional 100% vested employer contributions (QNECs or QMACs) to NHCEs, in addition to or instead of returning excess amounts to HCEs. You should seek legal advice to ensure you meet all EPCRS requirements to avoid the tax consequences or plan disqualification. 22 Compliance Testing Manual