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Sew What, the best seamstress shop in town, sponsors a 401(k) plan. All the eligibleemployees and...

  1. Sew What, the best seamstress shop in town, sponsors a 401(k) plan. All the eligibleemployees and their elective deferral percentage are listed below.

Employee

Identification

Deferral Percentage

Lois

HC

6.97%

Frank

HC

8.33%

Karen

NHC

5.00%

Jeanette

NHC

8.00%

Joyce

NHC

2.00%

Ronnie

NHC

5.00%

Kali

NHC

0.00%

Will the company pass the ADP test? If not, what this firm can do to remedy this situation.

Solutions

Expert Solution

First we need to calculate average HC and NHC Deferral Percentage.

average HC Deferral Percentage = sum of Deferral Percentage/no. of employees = (6.97% + 8.33%)/2 = 15.3%/2 = 7.65%

average NHC Deferral Percentage =(5% + 8% + 2% + 5% + 0%)/5 = 20%/5 = 4%

2 tests need to be performed to pass the ADP test. average HC Deferral Percentage should not exceed average NHC Deferral Percentage limit set out by 2 tests to pass the ADP test.

1st test is average NHC Deferral Percentage*1.25 times: 4%*1.25 = 5%

2nd test is lesser of:

average NHC Deferral Percentage + 2% spread = 4% + 2% = 6%: or

average NHC Deferral Percentage times 2% spread = 4%*2 = 8%

lesser of these two is 6%.

NHC Deferral Percentage limit set out by 2 tests is greater of test 1 and 2 (5% or 6%) which is 6%.

To pass the ADP test, average HC Deferral Percentage of 7.65% should not exceed  average NHC Deferral Percentage limit set out by 2 tests of 6%. as average HC Deferral Percentage exceeds the limit (7.65% higher than 6%), company will not pass the ADP test.

to remedy this situation, firm can make distributions to HCs and refund of excess contributions.

jeff jeffy answered 3 months ago
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