401(k) plans have become the standard for companies to help their employees save for retirement; however, the rules for participating present challenges for employers and their executives who usually meet the definition of a highly compensated employee (“HCE”). The contribution limits apply to all employees, including HCEs, and permit a participant to contribute up to $20,500 or, if age 50 or older, $27,000, in 2022. In reality, due to required compliance testing, many executives either are not permitted to save the full amount or are excluded from participating altogether. Increasingly, employers are seeking solutions which allow HCEs to put aside more money for retirement.
At the Cowart Group, our team of retirement professionals works with companies to design and implement retirement plans for employees at all levels.
The Savings Problem
Each year, 401(k) plans must undergo compliance tests to ensure they are not discriminating in favor of HCEs, those earning $135,000 or more in 2022. These tests must be passed to ensure plan benefits and contributions fall within the IRS’ permitted ranges:
IRC §401(b) Minimum Coverage. Tests the population of HCEs versus the rest of the employees benefiting from the plan to ensure there is enough non-HCE participation.
Actual Deferral Percentage (“ADP”). Tests plan deferrals to ensure the HCEs may not exceed the ADP of the non-HCEs by more than two percentage points. In addition, the combined contributions of all HCEs may not be more than two times the percentage of non-HCE contributions.
Actual Contribution Percentage (“ACP”). Test uses a similar method as the ADP test except that it uses matching contributions or employee after-tax contributions.
Top Heavy. Tests the account balances of plans to ensure that HCEs do not own more than 60% of the value of the plan assets.
All these tests provide many chances for a 401(k) plan to fail. When this happens and non-HCEs are not saving enough as a group, the amount HCEs are allowed to save is reduced or an employer may have to make “corrective distributions” and return some of the HCEs’ saving in the form of taxable compensation. Worse yet, recordkeepers and plan administrators will usually conduct testing for the year in the first quarter, so a testing failure may not be known until the year has ended.
The Cowart Group specializes in assisting employers in educating, designing and implementing savings strategies for their top talent.
Employers Must Remain Vigilant
Even during average years, 401(k) plan compliance testing is complex and burdensome. There are many components employers must consider, including determining HCE and non-HCE status and applying the correct definition of compensation. At present, inflation is soaring, and the economy is uncertain and this could lead to employers making difficult employment decisions that could negatively impact the testing of their 401(k) plans and the ability of their HCE to meet their retirement goals. Given this environment, it is critical employers closely monitor:
- Employment status in terms of layoffs and furloughs
- Any reduction in compensation and hours
- Reduced employee contributions
- Reduction or elimination of employer contributions
- Employment status of rehired employees for plan purposes
In times of economic hardships, the lowest paid employees are typically the first to lower or discontinue plan deferrals and this will directly impact the ability for HCEs to participate.
Employers are going on the defensive and working with the Cowart Croup to mitigate the impact of potential plan testing failures.
Executive Compensation Solutions
Whether a company has 10 employees or thousands, there are strategies to meet the retirement funding needs of key talent. Many executive benefit solutions fall into the category of nonqualified plans. Nonqualified plans are retirement plans offered by employers that are exempt from the discriminatory and top-heavy testing in qualified plans and are often designed for executives whose needs are not entirely met by qualified plans.
Some types of nonqualified plans allow participants to make unlimited deferrals and to defer taxation until retirement when they access the funds in their plan. Plans can be customized for certain groups of employees or even structured for specific individuals.
Employers can benefit by including plan features which tie nonqualified plan contributions and benefits to performance. Employers can even place restrictions on some plans such as a vesting schedule. Structured correctly, a nonqualified plan can return all outlays to the employer, making the plan cost neutral. Better still, the costs of setup and administration are minimal – there are no special annual costs, and the IRS does not require any filings.
Experts in executive compensation, specialists at the Cowart Group are helping their corporate clients implement a number of nonqualified benefit solutions, including:
- Split Dollar Arrangements
- Restricted Executive Bonus Arrangements
- Nonqualified Deferred Compensation Plan
- Supplement Executive Retirement Plan
Integrating a nonqualified plan with a current 401(k) plan can assist an employer in resolving potential nondiscrimination testing issues and prevent testing failures, while allowing HCEs to maximize their retirement savings. Adding a nonqualified plan also helps companies maintain a competitive benefit package that can recruit, reward, retain and retire key talent.
Let us help you plan for the future.
The financial professionals with the Cowart Group provide tailored financial solutions to families and businesses that count on our experience and dedication to their success. Our aim to deliver quality advice derives from our relationships with insurers, our underwriting advocacy, and technology resources. We provide strategies and solutions designed to assist our clients in benefiting from and optimizing existing and changing government regulations.