ADP/ACP Test

[Guest fender5150]

Two questions: Hopefully easy ones:

Under what circumstances can a plan switch from the prior year method to the current year method for testing? Does this require a change to the plan document?

I'm looking for an inexpensive source for current IRS Code Regulations. Does anyone have any suggestions?

I'm a small TPA. Just starting out.

Thanks!

Fender5150

[401_4_ever]

Yes, an amendment is required. It must be made during the plan year in question.

Plans can always amend from prior year to current year. In order to amend from current year to prior year, the plan has to be current year at least five years, or if lesser than five, the number of years the plan has been in existence.

I'm just curious, what background do you have that you decided to open a TPA?

[Below Ground]

Typically, the "switch" is documented by a resolution that serves (stated in document) as an amendment. Of course, an "amendment document" (not just resolution) can be used. I think how specific to the document you wish the amendment to be determines format. I suspect that on format you will hear 10 different opinions, including whether a resolution format can be used. Regardless, the document must be executed before the close of that year.

Changing from Prior to Current can be done at any time, subject to the need to have executed documentation prior to the close of that year. Current to Prior requires that plan has not used Prior for 5 years. Please note that a new plan, or a new deferral provision, can use either approach for that 1st year (given plan document terms). I note that the timing explanation of the prior post by 401_4_ever is stated perfectly.

Check this website (Benefitslink) for links to reference materials. Also you can obtain materials from several services including CCH, Thompson Publishing, etc... ASPPA is another site you should check out.

Good luck with your firm.

[Guest fender5150]

Thanks very much for the information!

The prior year method seems like the best method after the first year - from a planning perspective. I wonder why more people don't use it.

According to info. gathered from Other TPAs, about 65% of non-safe-harbor plans are using the current year method.

[austin3515]

My opinion is that prior year testing sucks. It is incredibly cumbersome on most software programs*, and in my experience, no one is using it the way it is intended anyway. What you should do if you use prior year testing is communicate to HCE's how much they are allowed to contribute to basically ensure that the test is not failed. If you're not doing that, why bother with the added aggrevation.

PLUS, any improvements in participation through education efforts, enhanced match, etc., have a one year delay in terms of benefitting the HCE's.

PLUS you can't use QNEC's even if you wanted to.

*In Relius, if you decide in the following year you want to run testing based on net comp, you have to "reverse eligibility" which is something a lot of TPA's are petrified of doing for fear that when reposted the outcome will change.

Contrary to your last post fender, the first year is the only year prior year testing often makes sense, because you can use the "3% deemed ADP" for the NHCE group.

[401_4_ever]

I strongly agree with Austin. While in principle, prior year testing is better,people don't use it's only advantage. Even then it is not always such a great advantage because if you have one HCE who isn't maxing out, it's difficult to accurately predict how high the the others can go. Plus if you have catch-up eligible HCE's it makes it tougher.

Additionally if you have a discretionary match and an employer doesn't make it for one year, your HCE's will not be happy with the ACP rates the following year.

[Below Ground]

Oh, I disagree. Prior Year works very well for some plans, and not well for others. You simply need to determine what works for the plan you are working on. Not always easy, but possible. There are some plans that benefit from the advance planning made possible by Prior Year for ADP. To say it always "sucks" doesn't make sense to me. I do agree that for discretionary employer matching, Current Year is almost always needed. If the Employer does no match in a given year I always switch to Current Year for ACP before the close of that next year (Volume Submitter Format).

I also agree that you should be communicating results in planning with HCE. If done right you can get the HCE to equitably share the DP Points that are known to be available.

Oh, having Catch-Ups shouldn't be screwing up results for you. Keep in mind that Prior Year simply lets you know what the Average for the HCE can be in this year in your testing. You can still use Catch-Up to mitigate Cutbacks.

Lastly, if your software gives you trouble, look at another package, or make your own.

[austin3515]

I think I sort of implied that if you're going to limit the HCE's than it would be worth it - at least you're getting the intended result. But that's the only scenario in which I would use it. In my experience, that just doesn't happen that often though.

[wsp]

Over time I've found that in most cases a plan is better off using current year and simply refunding the amount. Too many times I've passed on an ADP limit to the sponsor only to find out at the end of the year that one of the HCE's stopped a deferral, hired two of his children, or gotten married to his secretary. Funny how it's MY fault that money was left on the table.....communication is great but if it's not both ways and the plan sponsor isn't aware of the impact of various personnel issues on the test then it's not really worth the hassle.

I'll take current year and early year end data transfer any day of the week.

[Below Ground]

WSP, I really do share you sentiments. Isn't it always the TPA's fault? It may be rare, but sometimes you get a client that actually wants to work with you. When you do, it becomes their choice. Do they want to know what they can do ahead of time, or do they want to "aggressively run for failure" (failure is not always the result of course). Provided that you get data early enough (as you say) then the latter is fine. In my experience, getting good data early is almost as rare as having that client that wants to work with you.

My point was simply that Prior Year is not always bad. Like most things it must be considered when appropriate. If it fits, use it. If not, go with Current Year. Using Age-Weighted with a 27 year old principal and two 60 year old workers makes no sense -- but that does not mean Age Weighted is bad in a situations.

[Guest fender5150]

Austin - You mean the deamed ADP is 3%, not the deamed ADP limit? IE: The Deamed ADP limit is 5%?

I missed that somehow. Good thing I haven't setup a plan yet. : )

This has been a very informative thread. Thank you.

I like prior year testing for the planning aspect, but I understand that current year testing is the more aggressive choice - you just have to watch it CLOSELY. Everything changes every time you run payroll.

Failing a test by a small margin isn't so bad, as long as the HCEs understand what you're doing for them, and as long as you're being paid for your trouble.

I wish all TPAs were as well-informed as you guys:

I was CFO for a company that used the prior year method. Our TPA (A friend of the owner!), would only test once a year. He didn't want to pay Relius for testing, and he didn't like doing it in Excel. To keep the test from failing, he would radically restrict HCE contributions. I always opted out of the plan to give the owner a chance to participate. The guy didn't even know about Catch-up contributions!

Long Story short: I learned to do the test myself, then I got tired of doing it in Excel: So I took some time, did some reseach, spent some money, and did this www.401ktest.com.

The idea was to provide something for small TPAs and private companies, like mine. For more sophisticated companies, I'm hoping this site will put some of the responsibility in thier hands, so they won't be bugging the TPAs every other week.

401ktest only does prior year testing right now. When the current year testing routine is done, I'd like to get some of your opinions about it.

Also thanks for the suggestions regarding the best sources for research material.

Thanks,

Fender5150

Fender (my first guitar)

5150 (My employee number at job I had in College)

If anybody was curious