Why is my participant getting a refund from the retirement plan?
To maintain its tax qualified status, a 401(k) plan must abide by many laws and regulations that govern retirement plans. Testing rules and individual limits determine how much can be contributed into a plan to ensure the plan benefits all employees, not just owners and highly paid individuals. If tests fail or limits are exceeded, a common method of correction is to return some of the contributions including earnings to the participant. If your participant received a refund, it may be due to a failure of one or more of the following tests:
Average Deferral Percentage (ADP) Test: One of several nondiscrimination tests, the ADP test compares the average deferral rate of Highly Compensated Employees (HCE) and to the average deferral rate of the Nonhighly Compensated Employees (NHCE). Refer to our previous Translator issue that described the ADP test in more detail. If the ADP test fails, a plan correction method may be to refund some of the elective 401(k) deferrals from one or more HCE.
Average Contribution Percentage (ACP) Test: The ACP test is another nondiscrimination test similar to the ADP test. However, instead of comparing average deferral rates, the ACP test compares average contribution rates which include regular matching contributions. The IRS website provides a good summary of the ADP and ACP tests and applicable correction methods.
Section 402(g) Limit: Participants may defer a limited amount to all of their 401(k) plans in one year. The 2018 limit was $18,500 ($19,000 for 2019). Participants attaining age 50 or more during the calendar year may contribute an additional catch-up deferral amount of $6,000 (for both 2018 and 2019).
Section 415 Limit: All of the participant’s annual contributions to all sources in plans maintained by one employer are limited to the lesser of 100% of their compensation or $55,000 ($61,000 including catch-up contributions) in 2018 (increased $1,000 in 2019). Refunds due to exceeding the annual additions limit are rare.
If refunds are a common occurrence, our TSC Retirement Plan Administration Consultants may suggest options to make the retirement plan more successful.
Paul Erickson, Manager Retirement Plan Consulting