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R&R Insurance Blog

Corrective Distributions:  Upsetting your Key Employees

Posted by the knowledge brokers

Businessman looking for connection between two things while standing in front of a wall

It’s the phrase that no HR Manager or CFO wants to hear, “The retirement plan failed it’s Non-Discrimination Testing.”  For your management team it means extra work, and perhaps fines and excise taxes, but it has an even bigger downside.  You now have angry key employees who could begin to search for perceived greener pastures.

In the first fiscal quarter of every year, every company that offers a 401(k) plan to their employees is required to file documents and undergo mandatory compliance testing.  These “non-discrimination tests” are in place to ensure that a company’s retirement plan is fair to all employees, and not just those who are highly compensated.  For purpose of clarity, an employee is considered a Highly Compensated Employee (HCE) if they made more than $125,000 per year (in 2019) OR own at least 5% of the company.

What happens when your plan fails its test, and needs to be corrected?  The short-term corrective measure is to work with your plan provider to calculate the amount of money that your HCE’s have “over contributed,” and then the plan sends checks back to them for that amount.  While the company can face potential fines or excise taxes, the bigger concern for HR Directors is the backlash from the highly compensated folks who are about to receive their money back.  Why are they so upset?

  • If the funds were deferred on a pre-tax basis, the correction has now increased the employee’s taxable income for the following year.
  • The amount of “excess contribution” that was returned to your employees has now reduced your employee’s retirement investment base, leaving them with less to work with.
  • Because their income is higher than most, your HCE’s likely cannot build a sufficient retirement asset base solely by maximizing their 401(k) plan contributions. By reducing their contribution limits, it only makes their task harder.
  • Companies that fail this ACP/ADP testing too often fall into a pattern, and this becomes the norm.

But there is good news, this does NOT have to continue.  While you cannot undo the damage to employee morale from the previous year, you can correct the problem for the current year and demonstrate to your key employees that you are always looking out for them.

If your plan provider is NOT being proactive in helping you to make your 401(k) plan the most effective plan for your employees that it can be, contact your R&R Insurance Agent, and let them put you in contact with the in-house Wealth Management team that can make you a hero to your employees.  We are prepared to make a difference for your employees, and to make sure that they know that you are always watching out for their best interests.