It’s been a hectic year. If you had to furlough or lay off employees, suspend your plan’s safe harbor status, or reduce your match, it’s a good time to revisit the impact on your plan’s 2020 nondiscrimination testing.
I suggest reviewing your ADP (Actual Deferral Percentage) and ACP (Actual Contribution Percentage) test status before the end of the year so that you will know if your plan risks failing 2020 testing and can think through how to respond. Failing testing isn’t the worst thing, but being surprised by a testing failure can cause headaches for sponsors.
So let’s talk about a couple of scenarios:
• You suspended your plan’s safe harbor status: Maybe your company had to cut costs and faced a hard choice between pausing the plan’s match expense or laying off employees. If you decided to forego the safe harbor, your plan now is subject to testing for the entire 2020 plan year. If you had been a safe harbor plan as many sponsors did to avoid the need to pass ADP and ACP tests, some of these plans could fail testing for 2020. If you fail testing, you may need refund the excess contributions of highly compensated employees (HCEs) by March 15, 2021 (this deadline can be later for certain automatic enrollment plans).
If you’re in this group, it’s smart to explain to your HCEs now that they may get a partial refund for their 2020 contributions in 2021, and that this isn’t unusual for a 401(k) plan. The last thing you want is for your highly compensated employees to feel surprised and frustrated by getting a refund.
- You furloughed or laid off employees: This can have a major effect on a plan’s ADP and ACP testing, since the impacted participants stop deferring, and these tests focus on average participant deferrals. (Likewise, when a plan temporarily reduces its match, some financially stressed participants may see keeping up their contribution level as less important, so they lower their deferral. That also can affect testing.) To limit the impact, some plan sponsors may automatically enroll furloughed employees when they return, but not all employers feel comfortable doing that. Instead, as these employees come back, you can view this as an educational opportunity to remind them of the benefits of participating. It can help to emphasize the “free money” value of getting the employer match, something that resonates with a lot of people.
Employers facing testing issues during a plan year have the option to address it by capping highly compensated employees’ contributions for the rest of that plan year. But I’ve never been a big fan of this approach, because when you do testing projections during the year, it’s a moving target. You’re essentially trying to predict the future, and a plan could look at some point during the year like it’s going to fail, but end up passing by year’s end. And what if you stop HCEs’ 2020 contributions, but your plan ends up passing testing? Your HCEs miss out on building up additional retirement savings.
Some Good News
We’ve talked so far about financially strained employers making tough choices, but there’s good news this year, too: Some companies have come back strong the past few months and could make employees whole on the employer match for 2020. It all depends on how your plan document reads. If it’s allowed, the employer can make a year-end discretionary contribution to participants’ accounts.
It sends a great message to your employees, if you can do it: Your company has weathered the storm, and you care enough to want to “true up” the contribution you give your employees for their retirement savings. Depending on what your plan document permits, this contribution could take different forms, such as a flat-dollar amount or an additional percentage-of-pay match.
And if you’ve got 2020 testing issues and want to avoid problems for 2021, you can take steps now. I recommend digging more deeply into your 2020 testing issues with your plan’s consultant. Plans fail testing for different reasons: At one company it may stem from high employee turnover, and at another, it may be an issue of widely diverging savings behaviors between highly and non-highly compensated employees. It’s important to identify your plan’s testing “hotspots,” and then you can look at how to use plan design and employee education to deal with the issues. There is a right answer for every plan on how to fix testing issues—but it’s not the same answer for every plan.