Tag Archives: nondiscrimination testing

Key nondiscrimination provisions of SECURE

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act became law as part of the Further Consolidated Appropriations Act, 2020. Most SECURE provisions are for defined contribution (DC) pension plans. However, the SECURE Act also provides relief for the nondiscrimination and minimum coverage requirements applicable to closed defined benefit (DB) pension plans. This is good news for plan sponsors who wish to continue providing accruals in closed DB plans. The relief generally falls into one of two categories: (1) deemed compliance, and (2) additional testing flexibility under the coverage and nondiscrimination regulations for those situations that will require continued testing.

Below are some key provisions related to the nondiscrimination testing requirements under Treasury Regulation 1.401(a)(4) that are modified by the SECURE Act:

  • A closed DB plan can be aggregated with a DC plan for testing on a benefits basis without satisfying a gateway requirement.1 Prior to the enactment of the SECURE Act, the high cost to meet a gateway could lead to premature plan freezes. The closed group needs to meet the following requirements for testing relief:
    • For the plan year in which the closed group closes and the two succeeding plan years, the plan meets the coverage and nondiscrimination requirements of 410(b) and 401(a)(4)
    • After the date the closed group was closed, any plan amendment that modifies the closed group or the benefits does not significantly discriminate in favor of highly compensated employees (HCEs)
    • The closed group was created before April 5, 2017, or the plan has been in effect for at least five years as of the date the closed group is created and there has not been a substantial increase in the coverage or value of the benefit, right, or features (BRFs)
  • Matching and nonelective contributions in a 401(k) or a 403(b) plan can be used in the general test;2 further, matching contributions can be treated as if they are nonelective contributions.
  • DC plans with different plan years are allowed to be aggregated with a DB plan.
  • DC plans with different BRFs are allowed to be aggregated with a DB plan.
  • A closed DB plan is deemed to satisfy the nondiscrimination requirements for BRFs under 1.401(a)(4)-4 if the plan meets the requirements as noted above.
  • A closed DB plan is deemed to satisfy the requirements for minimum participation3 under §401(a)(26) if the plan amendment was adopted prior to April 5, 2017:
    • To cease all benefit accruals
    • To provide future benefit accruals only to a closed group

Prior to the SECURE Act, the Internal Revenue Service (IRS) had provided regulatory guidance that was meant to alleviate some of the difficulties in satisfying these technical tests. While plan sponsors appreciated the effort, the regulatory guidance was temporary and limited, which is why the SECURE Act addressed these issues. During the last few years, plan sponsors had implemented some or all of following changes to their DB plans to meet the nondiscrimination and minimum coverage requirements:

  • Provided additional nonelective contributions under the DC plan at a potentially significant cost to employers in order to continue DB accruals
  • Extended participation in the DB plan for some non-HCEs who were previously not eligible under the plan
  • Froze accruals for participants who are HCEs
  • Froze accruals for all participants under the plan

Plan sponsors can elect to apply the relief provisions of the Secure Act retroactively for plan years beginning after December 31, 2013. However, in certain situations, the plan document must be formally amended. Plan sponsors may amend their plans to provide previously eliminated BRFs or to provide benefit accruals to a closed group if a sponsor is forced to change a plan because of prior testing limitations that were relieved as a result of the SECURE Act.


1 The minimum aggregate allocation gateway, as described under Treasury Regulation §1.401(a)(4)-9(b)(2)(v)(D), requires each benefiting non- HCE to receive aggregate benefits from the combined DB/DC plan at a minimum level determined by the highest benefiting HCE as follows:
Highest value of combined DB/DC benefits for a HCE Minimum value provided to each non-HCE benefiting under the combined DB/DC plan
Less than 15% 1/3 of the value to the highest benefiting HCE
15% to 25% 5%
25% to 30% 6%
30% to 35% 7%
35%+ 7.5%
A plan is permitted to treat each non-HCE who benefits under the DB plan as having the same value of benefits under the DB plan by replacing the individual DB benefit by the average of benefits for all non-HCEs. The individual DC benefit value (if any) is then added to the average DB value for non-HCEs to determine whether the gateway requirement above has been passed.
2 The nondiscrimination regulations outline “safe harbor” formulas for providing benefits in a DB plan, or participant allocations in a DC plan. If the benefits or allocations are not provided using a safe harbor approach, then the benefits or allocations are subject to the general test in order to demonstrate that the benefits do not discriminate in favor of HCEs.
3 Minimum participation rules under §401(a)(26) require a DB plan to benefit the lesser of 50 employees or 40% of all employees within a controlled group. 

Nondiscrimination (Part 4): Time for employers to brush up again on nondiscrimination testing?

Many employers have modified their traditional defined benefit (DB) plans by moving to a “soft frozen” plan (or “closed” plan), where the existing participants continue to accrue benefits, but plan participation is closed to new employees. One common design is to maintain the DB plan for a closed group of employees and to establish or enhance a defined contribution (DC) plan for newer (and future) employees. In Part 2 of our earlier series on nondiscrimination testing, we explored the issues faced by a typical plan sponsor electing this route.

As an example of how circumstances change, many years ago Employer F permitted a “grandfathered” group of longer-service employees to continue accruals under its DB plan, and established a profit-sharing plan for all of the remaining employees. New employees joined the profit-sharing plan when eligible. At the time of the program change, the plans met the three main nondiscrimination tests, which are:

• Participation (only applicable to the DB plan)
• Coverage
• Benefits

A number of years have passed since the change, and the DB plan population has now declined and become more heavily weighted toward highly compensated employees (HCEs). The DB plan is no longer passing the 70% ratio percentage test, and is currently meeting the coverage requirement via the more complex average benefits test. Employer F is concerned that the average benefits test is in danger of failing in the near future, and is now looking for alternative ways to ensure that the DB plan continues to meet the coverage requirements.

In many circumstances, the nondiscrimination rules will currently allow plan sponsors to consider two or more plans to be a single combined (or “aggregated”) plan for purposes of meeting the coverage and benefit requirements (but not the participation requirements). If this is done for a DB plan and a DC plan, the combined plan is known as a “DB/DC” plan.

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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%
PASS

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%
FAIL

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

 

AlexKaplanPhoto.comThis 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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