Tag Archives: nondiscrimination testing

Will the proposed overtime pay changes affect your retirement plan compensation?

Smith-SuzanneThe U.S. Department of Labor (DOL) announced a proposed rule on July 6, 2015, that would change who qualifies for overtime pay.

Today, only 8% of salaried workers qualify for overtime pay—those workers who earn less than $23,660. The proposed rule will extend overtime pay to salaried workers who earn less than about $50,440 next year. The proposed change is estimated to cover 4.6 million workers, more than the current regulations.

What does this mean for the retirement plans of employers that will be affected by this proposed rule?

While many employers use gross compensation or total pay for retirement plan purposes, some employers provide retirement benefits only on base pay, excluding additional pay such as overtime, bonuses, or premiums for shift differentials.

Generally, excluding overtime pay for retirement plan purposes is OK if the plan’s definition of compensation passes nondiscrimination testing.

Nondiscrimination testing on compensation is done by comparing the average includable compensation for highly compensated employees (HCEs) to the average includable compensation for non-highly compensated employees (NHCEs). If the HCE average percentage exceeds the NHCE average percentage by more than a de minimis amount, the plan will fail the test. A de minimis amount is generally thought to be no more than 3%, but there is no formal guidance so plan counsel should be involved.

2015 example: Plan excludes overtime pay and bonuses from plan compensation

HCE Average Includable Compensation 95%
NHCE Average Includable Compensation 93%

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by no more than 3%, the plan passes the test.

But what happens next year if many of the NHCE participants are suddenly eligible for overtime pay? The increase in excludable overtime pay will cause the NHCE inclusion ratio to drop, and the disparity between HCE and NHCE includable compensation will exceed 3%—and thus fail the test.

2016 example: Plan excludes overtime pay and bonuses from plan compensation

HCE Includable Compensation 95%
NHCE Includable Compensation 86%

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by more than 3%, the plan fails the test.

Failed testing is never good. More complex testing would have to be done, and the plan may have to take corrective action if the complex testing doesn’t pass.

Employers with salaried workers who would qualify for overtime under the proposed changes will want to check their retirement plan compensation definitions and keep an eye on what happens with the proposed overtime regulations.

Interested parties can submit comments on the proposed rule at www.regulations.gov (RIN: 1235-AA11) on or before September 4, 2015. The DOL is expected to make a final rule next year.

Nondiscrimination testing: Minimum allocation gateway

Peatrowsky-MikeA defined contribution (DC) plan can test on a benefits basis if it meets any of the following criteria:

• Provides broadly available allocation rates
• Provides age-based allocations
• Provides a minimum allocation gateway to non-highly compensated employees (NHCE)

A plan satisfies the minimum allocation gateway test if each NHCE has an allocation rate, which is determined using Internal Revenue Code (IRC) Section 414(s) compensation, that is at least one-third of the highest allocation rate of any highly compensated employee (HCE) participating in the plan.

Alternatively, a plan is deemed to satisfy the gateway test if each NHCE receives an allocation of at least 5% of the employee’s IRC Section 415 compensation. Therefore, a DC plan designed to provide a minimum allocation of at least 5% to NHCEs will always be eligible to be cross-tested for nondiscrimination testing.

Aggregated DB/DC plans
To satisfy the minimum gateway for an aggregated defined benefit (DB)/DC plan, each NHCE must have an aggregate normal allocation rate (ANAR) that meets the following requirements:

Nondiscrimination testing graph

Instead of using each NHCE’s equivalent allocation rate under a DB plan in calculating the aggregate allocation rate, it is permissible to use the average of the equivalent allocation rates of all NHCEs benefiting under the DB plan.

Who must receive the minimum allocation gateway?
Employees who receive a safe harbor nonelective contribution, a top-heavy minimum contribution, or a qualified nonelective contribution (QNEC) must receive a minimum allocation gateway contribution, unless they are separately tested under 401(a) as part of a disaggregated group.

If you have questions regarding the minimum allocation gateway, please contact your Milliman consultant.

Benefits Perspectives: Nondiscrimination testing and nonqualified deferred compensation plans

Milliman Benefits Perspectives explores a broad range of employee benefits practices. The August 2012 issue contains articles on:

  • Nondiscrimination testing, illustrating some of the challenges that plan sponsors can encounter, along with possible counter measures
  • Nonqualified deferred compensation plans (NDCPs), highlighting some of the toughest timing tests for the satisfactory operation and administration of NDCPs under section 409A of the tax code

Download and read the entire issue here.

Nondiscrimination (part 3): Benefit testing

This post marks the third in a three-part series on nondiscrimination testing. See Part 1 here and Part 2 here.

Benefits testing demonstrates that the level of benefits provided by a plan does not discriminate in favor of highly-compensated employees (HCEs). Certain benefit structures that make use of a “safe harbor” design (such as a defined benefit [DB] plan that provides 1% of final average pay for each year of service, or a defined contribution [DC] plan with an employer contribution of 4% of compensation) are exempt from benefit testing. 

If the safe harbor design is not met, then detailed testing is required. §401(k) deferrals are subject to the average deferral percentage (ADP) test, and §401(m) matching contributions are subject to the average contribution percentage (ACP) test. All other types of benefits (such as DB plan accruals or DC profit-sharing allocations) will be subject to a numerical test known as the general nondiscrimination test (GNT). Catch-up deferrals are exempt from testing requirements.

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Nondiscrimination (part 2): What testing needs to be done?

Earlier this week we offered Part 1 of a three-part series on nondiscrimination testing. Today, Part 2 looks at the kinds of testing required.

The three main nondiscrimination tests are:

  • Participation
  • Coverage
  • Benefits

Participation testing is designed to ensure that a defined benefit (DB) plan is not excessively small for the size of the organization (the testing is not required for defined contribution [DC] plans). Defined benefit plans that are currently providing accruals must generally provide them to (at a minimum) the lesser of 50 employees or 40% of all employees.

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A basic guide to nondiscrimination testing (part 1)

Employers who sponsor qualified defined benefit (DB) and defined contribution (DC) plans are responsible for making sure that their plans remain in compliance with IRS requirements, as failure to do so can result in excessive costs, penalties, or even plan disqualification. These requirements include the nondiscrimination rules, which are complex and can cause problems for plan sponsors that are unfamiliar with the details.  Part 1 of this series outlines the framework for the testing.  Parts 2 and 3 will explain the basic requirements of the testing and describe common pitfalls to be avoided. UPDATE: Part 2 is available here and Part 3 is available here.

Part 1

What is nondiscrimination testing?

Certain benefit plans may be deemed qualified by the IRS and therefore eligible for favorable tax treatment, as long as they do not provide excessive benefits to upper management at the expense of the lower-paid employees. The nondiscrimination rules were established to give plan sponsors a framework for demonstrating that their plans do not provide benefits that discriminate in favor of the highly compensated employees (HCEs).

HCEs are generally those employees with total compensation in excess of a specified limit. For example, if an employee earns more than $110,000 in 2011, the employee would be considered to be an HCE in 2012. (There is an alternative “top 20%” definition that applies for some plans.) Employees who own more than 5% of the organization are also considered to be HCEs. The remainder of the employees would be non-highly compensated employees (NHCEs).

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