HCE limits

[ratherbereading]

I have a large plan that failed ADP/ACP testing for 2019.  They have 11 HCEs and 200 plus NHCEs -- they want to know now how much HCEs can put away in 2020 in order to pass the test. Not sure how to figure this out.   They do current year testing and are less than 5 years old so they can't switch to prior, correct?

[Larry Starr]

1 hour ago, ratherbereading said:

I have a large plan that failed ADP/ACP testing for 2019.  They have 11 HCEs and 200 plus NHCEs -- they want to know now how much HCEs can put away in 2020 in order to pass the test. Not sure how to figure this out.   They do current year testing and are less than 5 years old so they can't switch to prior, correct?

The question confuses me.  You know they are doing current year testing, and you are asking about 2020. Since current year numbers can't be known until the year is over, you CAN'T know now how much HCEs can put away in 2020, and I assume you do know that. You CAN'T "figure it out" in advance because you CAN'T have the needed information "in advance".

So, what is the real question here?

[Mr Bagwell]

Rather,

Doesn't really matter if Current of Prior.  Prior allows you to approximate a little closer because you know the target goal.  With current, I guestimate 2020 based on the numbers from 2019.

You have to look at the NHCE ADP % and analyze where the HCE are going to need to be for Average deferral %.  So if NHCE is at 4%, you know a target range for HCE is 6%.  The real analysis is if/how many HCEs are catch up eligible.  Ideally, I have the catch-up eligible defer the most (maybe leave some catch up room for potential "refunds") because the refunds go to the participants that put in the most.  So even if the ADP test fails, maybe the excess goes to catch up and no refunds are needed.

As a practice, I don't tell the HCEs to defer 6% and hold steady (the above example) because that might leave potential deferrals out.  I would rather have a refund happen than to tell them a hard cap and then an HCE could have deferred thousands more.  My sales tactic is to fail by small amounts.

Of course, we all have plans where the HCEs load the wagons and let the chips fall where they may......

[rr_sphr]

back in the dinosaur days (before there was prior year ability if I remember correctly), we did estimated comp/deferrals and ran a nondiscrimination test several times each year for some clients to minimize refunds or max deferrals for HCEs.   And yes, we used some information from the prior year to help with those estimates.  I agree with failing by the smallest amounts possible.  And we did this for clients with 1000s of employees.....

[Larry Starr]

18 minutes ago, rr_sphr said:

back in the dinosaur days (before there was prior year ability if I remember correctly), we did estimated comp/deferrals and ran a nondiscrimination test several times each year for some clients to minimize refunds or max deferrals for HCEs.   And yes, we used some information from the prior year to help with those estimates.  I agree with failing by the smallest amounts possible.  And we did this for clients with 1000s of employees.....

All of this estimating is fine and we all do it; that was not the question that was asked.  The question that was asked was "they want to know now how much HCEs can put away in 2020 in order to pass the test" and that is unknowable until the year has ended. Estimating is all that can be done, but I believe ratherbereading knows that, so that is why I asked "what is the real question here". 

[ratherbereading]

Larry - yes, I am aware that it's unknowable - just wanted to make sure I didn't miss something.  So yes, that was my real question, as much as I should have known better than to ask.  Thanks, all!

[BG5150]

Is it a problem that the test fails? 

The only issue (to me) for a failing test is that the HCEs will defer income tax on some of their deferrals until the following year.

[ratherbereading]

21 hours ago, BG5150 said:

Is it a problem that the test fails? 

The only issue (to me) for a failing test is that the HCEs will defer income tax on some of their deferrals until the following year.

The problem being the HCEs don't want refunds.  They have little non-HCE participation. Nor do they want to go safe harbor, though.

[Belgarath]

Maybe I'm misreading your post, but I don't see why they can't amend to prior year testing for the 2020 plan year? It sounds like the plan is less than 5 years old, and has always been current year tested  - is that correct? If so the plan satisfies the "5 year rule" and they could amend to prior year testing for 2020.

[Bill Presson]

RBR, I understand that the HCEs don't want refunds. We get that as well. But I tell them (as BG mentioned) that the worst part of getting refunds is that they deferred some taxes until the next year. The worst part of NOT getting refunds is that they left contributions on the table.

I tell them that when they get a refund, they know that they deferred the maximum amount they were allowed by law. If they don't get a refund, then they were short.

Usually works.

 

It's actually one of the rare times we encourage clients to "prefund" and we have the ability to adjust to the perfect number after the end of the year.

[BG5150]

And remember, with prior years testing, you know how much the HCEs can put away AS A GROUP.  So if the NHCE % was 1.5% last year, the top group can put away 3% on average.  That's great if everyone is on board.  However, say, all the HCEs decide to put away 3% for the year, then one of them decides to spot for whatever reason halfway through the year.  The the other HCEs can have the % raised a little.  But nobody is going to really know that.  The plan administrator cannot say, "hey guys, Erica decided to stop deferring for now, so you can go a little higher on your contributions."

I like to reiterate to the clients that if the plan fails testing it's not a red flag with the IRS or anything; and no one is going to turn them into the DOL.  It's a fact of life.

And again, if the HCEs did the absolute maximum under the testing rules, hit the numbers exactly, then whatever above that is going to be taxed in their paycheck anyway.  (And, if the funds go up during the year, they get the earnings in the refund, too.  Sure, they pay tax on it, but it's still extra money.  It's like saying "here's an extra hundred bucks, but I have to keep $35 for taxes, so I'm just gonna give you $65.  For doing nothing, really."  I'd take that.

[Bird]

13 minutes ago, BG5150 said:

And, if the funds go up during the year, they get the earnings in the refund, too.  Sure, they pay tax on it, but it's still extra money.  It's like saying "here's an extra hundred bucks, but I have to keep $35 for taxes, so I'm just gonna give you $65.  For doing nothing, really."  I'd take that.

And how much are they going to pay for the failed test and/or processing refunds?  I'm in the (apparently minority) camp that would rather be a little under.  There's an irritation (and cost) factor to all of this.

[BG5150]

I guess it depends on  if the TPA charges for a failed ADP test.

[Luke Bailey]

On ‎2‎/‎24‎/‎2020 at 8:16 AM, BG5150 said:

And remember, with prior years testing, you know how much the HCEs can put away AS A GROUP.  So if the NHCE % was 1.5% last year, the top group can put away 3% on average.  That's great if everyone is on board.  However, say, all the HCEs decide to put away 3% for the year, then one of them decides to spot for whatever reason halfway through the year.  The the other HCEs can have the % raised a little.  But nobody is going to really know that.  The plan administrator cannot say, "hey guys, Erica decided to stop deferring for now, so you can go a little higher on your contributions."

I like to reiterate to the clients that if the plan fails testing it's not a red flag with the IRS or anything; and no one is going to turn them into the DOL.  It's a fact of life.

And again, if the HCEs did the absolute maximum under the testing rules, hit the numbers exactly, then whatever above that is going to be taxed in their paycheck anyway.  (And, if the funds go up during the year, they get the earnings in the refund, too.  Sure, they pay tax on it, but it's still extra money.  It's like saying "here's an extra hundred bucks, but I have to keep $35 for taxes, so I'm just gonna give you $65.  For doing nothing, really."  I'd take that.

BG5150, your post is a good explanation of how prior year testing works and allows you to estimate more closely than current year. Very few plans seem to use prior year, however. Does anyone have a simple answer as to why so few plans use? Or is my experience skewed?

[shERPA]

I agree Luke.  I was an early fan of prior year testing when it became available.  Once the prior year is done, we'd know the HCE limit for the next year, and excepting any ownership changes we know next year's HCEs as well.  For the client who doesn't want to deal with refunds, we can tell them to limit the HCEs to X%.  For clients where some HCEs were deferring less than X%, we could help them estimate how much room this created for other HCEs to increase, with the tradeoff of increasing risk of test failure and refunds, especially if any HCEs increased their deferrals late in the game.  Most of the time they were content to just limit all HCEs to the max deferral allowed by the prior year NHCE rate. 

But I seem to have lost this particular battle.   I think partly because TPAs are programmed to work backwards on prior year stuff and not forward on future stuff.  Oh well.  

[Luke Bailey]

23 hours ago, shERPA said:

 I think partly because TPAs are programmed to work backwards on prior year stuff and not forward on future stuff.  Oh well.

So shERPA, the only explanations I have thought of over the years are either (a) there is a hope (which we know springs eternally) that NHCE deferral rates will go up, or (b) TPAs are in the business of selling services and employee meetings to bring HCE deferral rates up and/or counselling as to how to fix failed ADP's every year are more service-intensive.

[shERPA]

20 hours ago, Luke Bailey said:

So shERPA, the only explanations I have thought of over the years are either (a) there is a hope (which we know springs eternally) that NHCE deferral rates will go up, or (b) TPAs are in the business of selling services and employee meetings to bring HCE deferral rates up and/or counselling as to how to fix failed ADP's every year are more service-intensive.

Well from my experience in 5 TPA firms over 38 years (including 25 in my own firm),  most compliance TPAs don't do enrollment meetings.  Also TPAs generally operate on fixed fees, and even if there is some additional billing for processing refunds, that billing is at a very low realization rate that is a money loser/time waster.   The most profitable plans are those that don't go off the rails and need little to no ancillary work.  Process the annual admin, get paid, lather-rinse-repeat.  Throw in a restatement every few years to help make up for all the unbilled time for the plans that did go off the rails.  

[Luke Bailey]

So shERPA, I guess the take-away is that prior year testing is simply under-appreciated. Thanks.

[BG5150]

I can probably count on one hand the number of PYT plans that I've worked on that the company actually took heed of the PY numbers and adjusted the HCE deferrals accordingly.

I think as TPAs we should condition the clients that failing ADP/ACT testing is not a bad thing, and that given what the staff is doing, the highly paid workers can put the exact most into the plan the law allows.  Especially now that taxation of refunds come in the year of distribution.

[shERPA]

I understand the point that failing ADP is a "good" thing in that it means the HCE contributions are as high as legally allowed.  But only in aggregate.  This blows up on an HCE-by-HCE basis due to the dollar-down refunding methodology.   HCEs earnings $130K deferring 10% of pay can blow up the ADP test, and the owner(s) deferring 6.84% of pay take it in the ...., uh, I mean they get the refunds.