To avoid failing ADP and ACP testing, industry experts recommend employers utilize mid- or quarter-year projection testing. Doing so can foresee outcomes.
BECAUSE OF THE ECONOMIC IMPACTS of the COVID-19 pandemic, defined contribution (DC) plan sponsors may be making changes that can affect actual deferral percentage (ADP) and actual contribution percentage (ACP) test results—laying off or furloughing employees, reducing employees’ salaries, reducing or suspending company matches, for example, says Dave Stinnett, principal and head of Vanguard Strategic Retirement Consulting.
In addition, plan participants may make changes to their deferral rates, which can also affect nondiscrimination testing, he says.
Because of these changes, plan sponsors may want to consider sample testing to project outcomes and take steps to avoid failed testing. “Plan sponsors may want to consider performing mid-year projection testing to help them gauge whether they can expect test failures for the 2020 plan year and determine if they want to limit the amount that highly compensated employees (HCEs) can contribute for the remainder of the year,” says the Fidelity Investment non-discrimination testing team in a joint statement.
Projection testing may be especially beneficial for 403(b) or 401(k) safe harbor plans that choose to suspend or eliminate employer match and safe harbor nonelective contributions, the Fidelity Non-Discrimination Testing team adds, as these plans will be required to perform testing using the current year’s examination method. It’s important to note that plan sponsors that suspend their safe harbor contributions also lose out on the top heavy testing exemption. “Plans that allocate nonelective contributions that do not meet a design-based safe harbor allocation formula must consider the impact that reducing nonelective contributions may have on the plan’s ability to satisfy gateway and rate group testing,” Fidelity says.
Stinnett notes that it may be challenging to effectively assess the impact of corporate actions on employee savings behaviors. Instead, the best approach may be to keep current plan design practices—automatic enrollment, re-enrollment sweeps and targeted participant communications—in place for this year and make corrections as needed at year-end. He explains that while mid-year projection testing is based on an assessment of the typical savings patterns for employee populations, this current year has been anything but typical given COVID-19.
Therefore, adding an HCE cap can risk overly restricting savings opportunities for those that need to save maximally, he says. Instead, employers can discuss their options with a consultant or financial adviser to understand what their testing results may be. “Vanguard recommends engaging with a plan consultant to discuss the likely outcomes for compliance testing, reviewing the plan document to ensure maximum flexibility on resolving testing issues, exploring options to mitigate test failures and developing a plan to complete the 2020 plan year ADP and ACP tests in a timely matter, to minimize any employer costs related to late refunds,” he says.
Fidelity says employers that do suspend or reduce their match should consider amending to a current year testing method for the plan year once they reinstate their matching contributions, otherwise HCEs’ matching contributions will be severely limited as a result of the prior year’s non-highly compensated employees (NHCE) rate. The team notes that a common issue that was seen during the economic downturn in 2008 was the negative impact on plans that stopped or decreased their match and then used the prior year testing method for ACP testing.
Fidelity reminds sponsors of top heavy plans that “even if they reduce or suspend discretionary employer contributions, they are still on the hook for allocating top heavy minimum contributions.”
It’s important for plan sponsors to ensure that 2020 plan year-end testing is completed in a timely fashion to allow for sufficient time to issue corrective distributions for ADP/ACP test failures, according to Fidelity. Distributions for test failures must be paid within 2 1/2 months following the end of the plan year.