Compliance Requirements for Qualified Retirement Plans

The Internal Revenue Code sets a multitude of requirements a retirement plan must meet in order to be considered qualified. Retirement Plans are subject to these regulations to assure the contributions and benefits are allocated fairly to each eligible participant. This article is intended to provide you with a brief description of some of the compliance tests required. Information and results pertaining to each of the tests Benefit Planning Consultants performs for your plan is located in the Compliance section of your annual report binder.

IRC §401(a)(4) - General Test
All benefits provided by retirement plans must pass this test or its equivalent. Plans using "new comparability", "cross-tested", "super-integrated", or "age-weighted" allocation formulas must demonstrate actuarially that the long-term value of benefits being provided to highly compensated employees are not unfairly higher than the long-term value of benefits being provided to non-highly compensated employees. Plans using the uniform "points" allocation method must show the average contribution provided to highly compensated participants does not exceed the average contribution provided to participants who are non-highly compensated.

IRC §401(a)(9) - Minimum Distribution Requirements
Participants who have terminated/retired and still maintain a balance in the plan or those who are 5% or more owners and have reached age 70 1/2 must begin taking minimum annual distributions from all retirement plans in which benefits have accumulated for them.

IRC §401(a)(17) - Maximum Compensation Limit
The amount of compensation taken into account for determining contributions under a retirement plan is limited to $245,000 for 2010 and 2011. This amount may increase from year to year. Compensation in excess of this amount is disregarded.

IRC §401(k) and 401(m) - Average Deferral Percentage/Average Contribution Percentage
Salary deferrals and matching contributions made on behalf of highly compensated employees may not exceed a specific ratio of the salary deferrals and matching contributions made on the behalf of non-highly compensated employees. The ADP and ACP tests are performed to ensure the highly compensated employees do not derive more of a benefit from a qualified plan than non-highly compensated employees.

The ratios are determined by first calculating the salary deferral % and the matching contribution % of each highly compensated employee and then totaling those calculated percentages for the entire highly compensated group (HC Group). This total is divided by the number of members of the group to obtain an average deferral percentage (ADP) or average contribution percentage (ACP). The same calculations are made for each non-highly compensated employee. The total of these calculated percentages is divided by the number of members in the non-highly compensated group (NHC Group).

The deferral or matching contribution % for highly compensated employees may not exceed the following ratio:

BPC includes a projected average deferral and matching contribution percentage for the highly compensated group each year to allow highly compensated employees to plan ahead for the amount they may defer into the plan.

IRC §402(g) - Maximum Deferral Limit
The amount an individual may contribute to all 401(k) and 403(b) plans during any taxable (calendar) year is limited to a specific dollar amount. An individual has only one 402(g) limitation per taxable year; therefore, contributions include contributions made to all retirement plans by the employee. For 2010 and 2011, this limit is $16,500. This limit may increase from year to year.

IRC §404(a)(3)(A) - Maximum Profit Sharing Contribution
Annual contributions to a profit sharing plan may not exceed 25% of taxable compensation of all eligible participants. As with the §415 limits, "taxable compensation" means gross pay, including pre-tax contributions made to Sec. 125 flexible benefit plans, Sec. 403(b) Plans, and 401(k) plans. "Annual contributions" include employer profit sharing contributions and matching contributions.

IRC §410(b) - Minimum Coverage Requirements
In any Plan Year, the plan must pass one of two coverage tests, either the ratio percentage test or the average benefit test. For the ratio percentage test, if 100% of the highly compensated employees are given a benefit, the plan is required to provide contributions for at least 70% of the non-highly compensated employees. If less than 100% of the highly compensated employees receive a contribution, the plan must give a contribution to at least as many non-highly compensated employees as 70% of the percentage of highly compensated employees who were given a contribution. In order to meet this requirement, contributions may have to be made for employees who do not meet the hours requirement or who terminated their employment during the plan year, even though the plan states an employee must work a certain number of hour or work for you on the last day of the plan year in order to receive a contribution. If the plan does not meet the ratio percentage testt, it must be tested under the average benefit test. Under this test, the employer must meet two separate non-discrimination tests. The plan must benefit a class of employees the IRS finds not to be discriminatory in favor of highly compensated employees. Second, the average benefit percentage of the non-highly compensated employees must be at least 70% of the average benefit percentage of the highly compensated employees.

IRC §414(s) - Compensation Testing
If the Plan uses an alternative definition of compensation which does not fall within the definition of compensation found in IRC §414(s), such as excluding bonuses, overtime, premiums, etc., for purposes of calculating and determining benefits, then the plan is subject to compensation testing to ensure the plan does not discriminate in favor of highly compensated employees. Total compensation is compared to plan compensation for each highly compensated and non-highly compensated employee. If the non-highly compensated employee average percentage is equal to or greater than the average percentage for the highly compensated employees, the plan will pass this testing requirement.

IRC §415 - Limit on Annual Additions
In any Plan Year, a participant in a retirement plan may not receive contributions exceeding the lesser of 100% of taxable pay or $49,000 for 2010 and 2011. This limit may increase from year to year. "Taxable pay" is gross pay, including pre-tax contributions made to Sec. 125 flexible benefit plans, Sec. 403(b) Plans, and 401(k) plans. "Contributions" include contributions made by the business to all retirement plans on behalf of the employee, matching contributions made by the employer, all contributions (both pre-tax and after-tax) the employee makes on his own behalf to all retirement plans of the business, and forfeitures allocated to the employee's accounts in all retirement plans of the employer.

IRC §416 - Top Heavy Minimums
If the total account values of key employees for all retirement plans of a business exceed 60% of the total account values of all participants, the Plans are considered to be "top-heavy." When this occurs, each plan's vesting schedule must be changed so the participants become fully vested in at least six years.

Further, a minimum contribution is required to be made on behalf of all non-key participants who are still employed on the last day of the plan year. For money purchase and target benefit plans, this minimum is 3% of salary.

For profit sharing plans, the minimum contribution is the lesser of 3% of salary or the highest % contributed on behalf of key employees. If key employees receive only a 1% contribution, only 1% is required to be deposited for all non-key employees. If no contribution is made on behalf of key employees, no minimum contribution is required for all non-key employees.

For 401(k) plans, the "highest % contributed on behalf of key employees" is determined as the highest % of 401(k) contribution made by any key employee. Therefore, if a key employee defers 5% in a top-heavy 401(k) plan, a 3% minimum contribution will be required to be made for all non-key employees. If the maximum deferred to the 401(k) plan by any key employee is only 2% of salary to the 401(k) plan, the top-heavy minimum contribution is only 2% for all non-key employees.

The preceding is an overview of compliance requirements for retirement plans and should not be relied upon as being all-inclusive. This information is presented only to give you a general idea of the purpose behind the discrimination test results presented in the compliance section of your annual report.

Note: These rules either do not apply or are modified for SIMPLE and Safe Harbor 401(k) plans.

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