Key Census and Compliance Testing Considerations

Brittany Morgan

Regional Sales Director

A new year is here and businesses are hard at work closing books and tax planning. The first quarter of the year also adds an extra sense of urgency for businesses who sponsor a qualified retirement plan. This article will focus on key considerations for these plan sponsors when completing the annual census and compliance testing.

Annual Plan Maintenance

It’s important to understand that qualified retirement plans are like machines. They require annual maintenance to ensure they are running smoothly and no operational failures exist. An annual census is essentially a “data dump” of the business’s year-to-date payroll records. These are combined with employee demographic data for the plan year and remitted to the third-party administrator (TPA) to calculate employer contributions and/or perform compliance testing for the plan.

While preparing an annual census, it is imperative that the data provided not only contains accurate information, but that it aligns with the provisions of the legal plan document.

Compensation

Compensation is a common source of questions from plan sponsors. The plan document outlines the definition of compensation, so it’s important to review this prior to preparing the census. Below are the most common provisions to consider when determining which compensation to include on the census:

  • Compensation from Plan Entry. Some plans exclude compensation prior to participants becoming eligible for the plan. In this case, the plan administrator will require the employee’s compensation from the plan entry date until the end of the plan year.
  • Compensation Exclusions.
    • Statutory Pay. The IRS allows a qualified plan to exclude certain statutory types of pay, such as taxable fringe benefits and post-severance compensation. Statutorily excludible compensation does not require additional compensation testing.
    • Non-Statutory Pay. It is important to review any custom compensation exclusions in the plan document to determine if they are considered “non-statutorily excludible” by the IRS. Any non-statutorily excludible types of pay are required to be reported as “excluded compensation” on the annual census. Then, compensation testing can be performed to ensure that the plan is using a non-discriminatory definition of plan compensation.

Hours

Year-to-date hours may not seem important, but this is a key consideration for several factors of the plan, including coverage testing, vesting determinations, breaks-in-service and the calculation of employee eligibility. If the company is tracking employee hours, actual hours should be reported on the census.

If a business contains only full-time employees, it is likely there is not a mechanism in place to track their hours worked. In this case, the TPA will require an estimate of hours broken down into three categories:

  1. less than 500 hours
  2. greater than 500 hours, but less than 1,000 hours
  3. greater than 1,000 hours

Before estimating employee hours, a review of the plan document should be done to confirm if hours equivalency is used for plan purposes. When using hours equivalency, the plan document will specify the number of hours credited within a certain period of time within the plan year. The accumulation of hours under this method should be used for census purposes.

If the plan contains hourly or part-time employees, the census should reflect actual hours worked within the applicable plan year.

If completing an annual census seems cumbersome, time-consuming, and just plain confusing,we have a solution. Plan sponsors can engage Goldleaf Partners for 3(16) Fiduciary Services and/or Payroll Services. By integrating one or both of these services, Goldleaf can pre-fill the annual census and save the plan sponsor time. 

ADP/ACP Testing

Once the TPA collects the annual census, compliance testing will be performed on the plan.

ADP/ACP testing must be performed within 2.5 months after the close of the plan year. This testing compares the actual deferral percentage (ADP) of the highly compensated employees (HCEs) against the actual deferral percentage of the non-highly compensated employees (NHCEs). Highly compensated status is outlined by the IRS and indexed for cost of living adjustments.

The actual percentages used in ADP testing are determined by averaging the deferral rate of the HCEs and comparing this rate to the average deferral rate of the NHCEs. The plan must be able to pass this test: 

If NHCE’s ADP % is:                                    Then HCE’s maximum allowable ADP% is:
0-2%                                                                       2 times more
2-8%                                                                       2% more
Over 8%                                                                 1.25 times more

If the plan provides a match, ACP testing will be run to test the actual contribution percentage (ACP) of the HCEs against the actual contribution percentage of the NHCEs in a similar manner as ADP testing.

If the plan contains a safe harbor provision, it will be deemed to pass ADP/ACP testing provided the plan operates within the safe harbor guidelines.

What if my plan fails ADP/ACP Testing?

If the plan fails testing, there are a handful of options a plan sponsor may have to correct the failure. These options will be communicated by the TPA with further detail, including cost and tax consequences. The most common correction methods are:

  1. Distribute refunds to the affected HCEs within 2.5 months after the close of the applicable plan year (March 15 for calendar year plans)
  2. Fund a Qualified Non-Elective Contribution (QNEC) to the plan to bring the plan up to a passing rate
  3. If the plan document has an age 50 catch-up provision, the TPA may be able to re-characterize a portion or all of the excess deferrals as catch-up contributions

It is important to consult with your TPA regarding testing failures, as the options for correction are dependent upon the provisions of the plan and the company demographics.

In conclusion…

While it’s not always fun, submitting a complete Annual Census file so compliance testing is done accurately is important. Goldleaf Partners is also here to help our clients in any way we can throughout this process. We can also eliminate this work if clients integrate with our payroll and 3(16) services, too. Please reach out with questions. We’re here to help.

Interested in a detailed description of ADP and ACP testing and correction methods? Request more info here