![]() In exchange for getting an automatic pass on the ADP and ACP tests and the extra administrative duties that go with the testing process, business owners must make a minimum contribution to the plan each year-which must be immediately 100% vested (nonforfeitable). The IRS has fix-it guides for both ADP/ACP failure and Top Heavy failure, but it’s best to prevent problems before they happen. But hurry if you take too long to make the plan corrections, you’ll owe a 10% penalty. You may have to return a portion of the contributions made to HCEs or make additional contributions for the lower paid employees. If your plan fails one of these tests, it’s an administrative ordeal filled with costly correctives and piles of paperwork. What happens if my business fails a compliance test? If your plan is Safe Harbor, but a discretionary profit-sharing or matching contribution were deposited, the plan is NOT exempt from top heavy testing. If the only contributions you make to your plan are Safe Harbor contributions and employee deferrals, your 401(k) plan is exempt from top heavy correction requirements. If you and your key employees cumulatively hold 60% or more of the total balance plan, then the plan is top heavy. The top test is similar to the ADP and ACP tests but is focused on plan balances. This ensures that the employer matching contributions and any after-tax employee contributions contributed for HCEs are not disproportionately higher as compared to non-highly paid employees. The Actual Contribution Percentage (ACP) test: This is the test that is most likely to impact small business plans. This limits the percentage of compensation that HCEs can defer into their 401(k) based on the average contribution rates of the non-highly paid employees. The Actual Deferral Percentage (ADP) test: (These groups of high earners are referred to as highly compensated employees or HCEs.)Ī Safe Harbor plan is designed to pass the two required nondiscrimination tests that prove your plan is not providing a more significant benefit to HCEs than to the rest of your employees. There are three annual tests given by the IRS to make sure your plan is run fairly and benefits everyone–not just the people at the top. ![]() The business can take a tax deduction for employer contributions.The 401(k) plan is deemed to pass both IRS nondiscrimination tests, along with meeting the top-heavy minimum contribution requirements (see more below).The business owners and other high earners can maximize their retirement plan contributions without worrying about the contributions of lesser-paid employees.Under a Safe Harbor 401(k) plan, if the business owner makes a minimum contribution to their employees’ plan, the following occurs: Unfortunately, if the testing failure is not corrected promptly, the business owner will owe a 10% excise tax. If a plan is not a Safe Harbor 401(k) plan and fails either of these tests, the business owner must either return a portion of the contributions made to HCEs or make additional contributions for the lower paid employees. A Safe Harbor 401(k) plan is deemed to pass the two nondiscrimination tests that 401(k) plans must typically pass to prove that the plan is not providing a more significant benefit to HCEs which guarantee those who earn at least $150,000 per year or who own more than 5% of the company. ![]()
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