401(k) Testing: A Different Perspective

S Mahood

R. Scott Mahood, J.D., CEBS

Vice President,
Retirement Services Relationship Manager



If you are like most plan administrators and employers, this is the time of year when you find yourself facing a baffling array of confusing testing regulations. The most onerous of these tests—the ADP/ACP Non-Discrimination Test—requires that we “test” the amount contributed by Highly Compensated Employees (“HCEE’s”--essentially the owners and top executives) to be sure that they do not exceed the amounts contributed by all other employees by more than a certain margin.

These tests are designed to ensure that all participants are benefiting equitably from the plan. However, because we have all been conditioned to avoid failing “tests”, they can have the unintended consequence of deterring owners and executives from making the maximum dollar contribution permitted in any given year ($17,500 during 2013). In other words, you may seek to “pass” this test, and as a result, you may “fail” to contribute fully to your plan, thereby giving up one of the your most effective and efficient long term investment opportunities.

The reality is that “failing” this test will result in some of an HCEE’s contributions being returned to him or her as regular, taxable compensation. But try viewing this from a different perspective. A test failure confirms that the owner and the executives at your company have made the maximum contributions permitted by the regulations. Alternately, when your company “passes” this test it is likely that you will find that one or more of your HCEE’s could have made larger contributions.

Does your plan have a “safe-harbor” provision? If so, a safe harbor plan allows HCEEs to make maximum contributions (tax savings) regardless of what the other participants contribute, and you can avoid these tests completely. With a safe harbor plan, you will need to commit to making either one of two alternative “safe-harbor” contributions mandated by the regulations. You will also avoid the necessity of testing and the sometimes inconvenient return of contributions to HCEE’s.

Investments are not bank deposits, are not obligations of, or guaranteed by Genesee Valley Trust Company and are not FDIC insured. Investments contain risk, including market capitalization risk, political and country risk and/or credit and interest rate risk. Investments may lose value. Past performance is not a reliable indicator or guarantee of future results.