This chapter contains these topics:
To run the nondiscrimination tests to comply with governmental regulations for deferred savings, or 401(k), plans
Many companies offer 401(k) plans for contributions in retirement investment plans. Frequently, the company provides a partial, or matching, contribution for each dollar the employee contributes to the plan. The government defers the taxes due for the amounts contributed to and earned by 401(k) plans until the employee withdraws money from the plan.
401(k) plans are subject to special government regulations. To ensure that companies comply with the regulations, you must run nondiscrimination tests to identify key, or highly compensated, employees (HCEs). A highly compensated employee is one who meets at least one of the following criteria:
Owned at least 5 percent of the company during the current year or the preceding year
During the preceding year, had compensation in excess of $80,000, indexed for inflation, and was in the top 20 percent of the employees ranked by compensation
Nondiscrimination tests ensure that highly compensated employees do not take substantially greater advantage of this tax savings than lower-paid employees. The industry uses the term HCE, or highly compensated employee, interchangeably with key employee and non-HCE for an employee who is compensated at a lesser amount than an HCE or key employee.
In nondiscrimination testing for 401(k) plans, the first of two major factors is the average deferral percentage (ADP). This percentage is calculated per employee, per annum. ADP represents the average amount of money deferred into the plan and allocated to the employees' accounts. This amount is expressed as a percentage of their compensation. The ADP of the non-HCE group determines the maximum ADP of the HCE group. If the difference between the two groups is too high, the plan is considered discriminatory.
The second major factor is the average contribution percentage (ACP). The ACP represents the average amount of employer-matching funds and employee post-tax contributions and is expressed as a percentage of compensation. The ACP test is applied in the same manner as the ADP test and measures the amounts contributed and allocated to employees' accounts.
The tests that determine HCEs and non-HCEs use gross earnings for the compensation. The ADP/ACP test uses eligible plan earnings. If your company considers hours worked as a criteria for participation in the 401(k) plan, you must run the Determine Eligibility by Hours test.
In addition to the 401(k) related tests, you can review the 415 Report. The 415 Report identifies all employees, on a pay-period by pay-period basis, who have withheld more on a pretax basis than the government allows. Run this report in conjunction with the Payroll Reports Only program.