ADP Test Correction Options for Puerto Rico Plan Sponsors

Puerto Rico-qualified retirement plans on a calendar plan year have until April 15, 2014 to choose their failing ADP test correction option.  The New PRIRC of 2011 has added a 10% excise tax on excess contributions for ADP testing violations that remain uncorrected after the allowable 3 ½ months following plan year end.  Luckily, Puerto Rico-qualified retirement plans still get a pass on any non-discrimination testing of employer match and post tax contributions; ACP testing is not required.

The Three Puerto Rico Plan Sponsor Correction Methods

(as permitted by the plan document)

• Return of Excess Contribution- Under this method, Highly Compensated Employees (HCE’s) would receive a portion of their plan year deferrals plus attributable earnings. This would reduce the HCE average deferral percentage to the necessary passing level in ratio to the Non-HCE average within the plan.  This amount is taxable to the participant in the year it is distributed.
• Re-characterization of Return Amount as a Post Tax Contribution– This option allows the HCE’s to keep their money invested in the plan by moving it into a post tax bracket. The HCE(s) would simply be responsible for the taxes on the excess amount instead of taking the full return as a distribution and losing the investment vehicle in addition to paying taxes on said amount.  This way the HCE’s can keep the money invested in the plan and at the time of distribution receive this amount tax free.
• Fund a Qualified Non-Elective (or QNEC) contribution-This would be a fully vested employer contribution to an employee or group of employees eligible to participate in the plan within the plan year.  The QNEC amount is determined based on the percentage required to increase the Non-HCE average to the minimum percentage allowable in order to satisfy the ADP test.  The “bottom-up” or reverse QNEC is a contribution allocated to the lowest compensated employee(s) and is still available to PR plan sponsors.  This method of allocating a corrective contribution will result in the lowest cost for the employer.

Contact Your Plan Administrator For Help!

There is really no penalty in failing to pass the ADP test if corrected in a timely manner. Consider what option best suits your company or consult your plan administrator for further explanation.