Actual Deferral Percentage / Actual Contribution Percentage - ADP/ACP Test
Categories: Tax, Retirement, Trusts and Estates
This complex concept refers to continued tax deductible qualification for 401K plans, and specifically targets the most well-paid employees at the company. The basic notion in creating rules around the amount that the highest paid could defer in taxes revolved around the notion of "progressive" tax. That is, the CEO making a million bucks a year shouldn't be able to defer 500 grand, year after year; the taxpayers need her taxes today. Not in two decades. And the whole notion or rationale for the 401k system in the first place was to focus on the middle class wanting to save for retirement so that they could golf with the grandkids and have a decent quality of life until they had that heart attack in bed with the 27-year-old hottie. Anyway, the ADP/ACP rules dictate that, in order for employees and the company to continue benefitting from 401k tax deductibility, they must adhere to some maximum salary deferral percentages, such that the ratios compress the spread from the highest earners to the lowest earners.
The IRS defines a highly compensated employee, or HCE, as an employee who owns more than 5% of the company (and that 5% can happen even for 14 seconds at any time during that year), or that that employee has earned more than $120,000. In order to qualify for maxing out the 401k, a bunch of financial metrical tests are done to cover the highest earners. One is what's called a 410b coverage test, which basically just makes sure that all of the employees of a given status have access to that 401k plan. Like...it wouldn't be fair to only offer it to the top three earners in the company, and then the next 12,000 toil and suffer paying taxes.
Another test, the ADP (Average Deferral Percentage) test, compares the actual salary deferral percentage of highly compensated with non-highly compensated people. To figure out what the max cap is on comp, the ADP test just uses the same rules that already exist in Roth IRAs as they apply to pretax savings of dough. Because of the way in which the caps are defined and structured as to what the highest earners can tax-defer, companies are financially encouraged to make matching contributions in many cases. That is, if it's the CEO's dough at stake, and the rest of the company has to get some deal relatively close at least in structure to what she is getting, then the IRS is betting that the CEO will take care of herself along with the others so that everyone's compensation is tax-optimized. And as an outgrowth of these issues, a few other tests in qualifying for 401k treatment have evolved, like the ACP test, where the actual contribution percentage test compares average of the percentage of after-tax and matching contributions for highly compensated and non. There has to be some minimum and maximum ratio that gets tax-deferred among all employees in the company, again because Boss Hog was hogging a lot of the tax deferrals in a few cases, so amendments to the structure had to be made.
The goal was to make sure actual usage of the program was high across the whole company. And lastly, another set of tests evolves to make sure the benefits go deep in the organization, not just living or being deployed for tax deferral at the top. Specifically, if more than 60% of the assets go to to key employees (often a somewhat different group from those defined as "highly compensated") then the org is too top heavy. The broader goal? Fairness. Egalitarianism. Something like that, anyway.
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Finance: What is a redemption charge?7 Views
Finance allah shmoop what is a redemption charge All right
well when you redeem shares of a mutual fund in
a deferred commission purchase structure there's a charge like you're
not paying your commission upfront you pay it later Remember
that most mutual funds are sold as a shares meaning
that the commission of the fund you're buying is paid
up front That is if you've invested ten grand on
a three percent up front commission structure while when you
step up on the swimming pool starting blocks and the
money is actively starting to be invested your actually starting
the race with ninety seven percent of that ten grand
or ninety seven hundred bucks with three hundred dollars having
gone to the broker for the pleasure of selling you
that fund but some mutual funds are sold as b
shares where there is essentially an exit fee or rather
where there is a charge when you redeem the fund
either because you just want to sell it or you
die in your estate liquidates it or martians kidnap you
and force you at martian gunpoint to call in a
sell order right Well in many cases redemption fees are
waived if you hold the mutual fund some extended period
of time like a year a few years five years
something like that If you hold the fund an extended
period the annual management fee paid to the people buying
and selling securities on your behalf can then cover the
broker's commission So the money managers aren't actually losing money
in the form of that three hundred dollar commission paid
you a broker who sold you ten grand of fund
only to have you three weeks later dump it and
move on to another funds Well there are other benefits
and having this system set up because it encourages mohr
careful selection of mutual funds and longer duration in holding
them And yes the obvious marriage and dating allegories apply
here But we just won't go So when you hop
in bed with a given mutual fund read the fine
print because well all kinds of hidden feed germs exist
in bedrooms airport bathrooms and glass elevators Well all around 00:02:02.98 --> [endTime] the world
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