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401k Plan Testing Rules for Compensation

401k Plan Testing Rules for Compensation

401k Plan testing rules require the plan sponsor to be vigilant throughout the year.  Retirement plan administration has always required the plan sponsor adhere to an intricate set of rules and regulations.  The definition of Compensation can appear simple on the surface; however, 401k plan sponsors have a history of frequently misinterpreting the word.  This is especially true – during an employee’s first year of employment.

After a recent Plan Sponsor University (TPSU) Fiduciary Education Program at University of Southern California Mr. Fred Barstein, Founder and CEO of TPSU interviewed TPSU Adjunct Lecturer, John Nelson.  Mr. Nelson, who previously worked as ERISA Counsel and Third-Party Administrator currently is an Investment Advisor.  During this interview, Mr. Nelson stresses the need for accurate data when adhering to 401k plan testing rules.

Full Transcript Here

This is Fred Barstein with 401kTV here at the University of Southern California, where we just completed a TPSU program led by our adjunct co-lecturer, John Nelson. John has started his career as an ERISA attorney, started a TPA and is now strictly a financial advisor with NFP Retirement, very, very experienced. Welcome, John.

Thank you, Fred.

And okay if we ask you a few questions?

Yeah please.

One of the things we talked about is how companies can, the way their planned documents about eligibility and how it can mess up with their testing so why don’t you explain that.

Yeah so one idea was often times it’s so important that you provide correct employee census data for the compliance testing because it’s the old adage, garbage in, garbage out. And I found that particularly with respect to a participant’s first year of eligibility, it’s important that you track compensation from their entry date into the plan, versus their employment commencement date.

I’ll give you an example. Let’s say you hire somebody on July 1st and you have a three month eligibility period, so I call it 90 days. The person would enter the plan on October 1st and let’s say they elected for 10% of salary, that’s good. They’re deferring 10% of salary for three months. Now when the time comes to submit data for testing, it’s important that the compensation number you give them is compensation from October 1st.

That way when they go into that 401(k) nondiscrimination test, they go in at the true 10% rate. If you’re submitting compensation though, from the date of hire July 1st, including periods when they weren’t eligible, you’re artificially lowering their deferral rate. Instead of it being 10%, if I use compensation from my example from July 1st, their effective deferral rate goes to down to 5, everybody in their first year is by definition a non-highly compensated employee.

That’s only going to hurt your testing, so I would say just one thing to be careful of is when you submit your data, make sure in that first year you’re using data from entry date versus hire date. I see it happen too regular and it does artificially depress the ADP 401(k) results.

Well, now you’re using your TPA background.

I am.

Well, that’s great advice, thank you. I would have never thought of that, so thanks for your time today.

Thanks, Fred.

Thanks for lecturing and thank you for watching 401kTV.

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