Planning for Retirement Needs

1. Planning for Retirement Needs Designing Benefit Formulas and Employee Contributions Chapter 8

2. Nondiscrimination rules Defined-contribution plans Defined-benefit plans Employee contributions Chapter 8: Benefit Formulas

3. 401(a)(4) Plan can not discriminate in favor of HCEs with regard to benefits or contributions OK to give participants a level percent of pay OK to integrate with Social Security However, can you give one group of employees one rate of contribution and another a different rate? Nondiscrimination

4. Established objective tests Either satisfy a safe-harbor design Or test for nondiscrimination annually Allows for cross-testing Nondiscrimination Regulations

5. Accrued benefits Under regulations, test accruals for the year Cannot backload Calculating service Must credit partial year for 1,000 hours Full year at 2,000 Can use past service Can eliminate pre-participation service Total compensation to satisfy design safe harbors Benefit formulas—can change prospectively Ground Rules

6. 2 percent of FAC x years of participation plus 1 percent of FAC for years of service prior to plan Compensation is W2 plus salary deferrals FAC is high 3 years Year of service for 1,000 during plan year Joe has $100,000 FAC, 5 years of preplan service, 10 years of participation, and 10 years until normal retirement. Benefit accrual for current year is 2 percent of FAC Current accrued benefit is $25,000 Projected benefit at normal retirement age is $45,000 Example

7. Level-percentage safe harbor Integration safe harbor Target-benefit safe harbor Age weighting (tested annually) Cross testing (tested annually) Defined Contribution Plans

8. Contribute 5.7 percent of total compensation—can contribute an additional 5.7 percent of compensation in excess of the current year’s taxable wage base (see text) Contribute more than 5.7 percent of total compensation —still limited to 5.7 percent on excess Contribute 3 percent of total compensation—can contribute 3 percent of excess compensation Integration

9. If you integrate at lower than taxable wage base the maximum disparity is reduced See table in text Integration Level

10. Step 1: Allocate first 3 percent on a comp/comp basis to all participants Step 2: Allocate next 3 percent of excess compensation to those earning more than TWB Step 3: Allocate next 2.7 percent of total compensation plus 2.7 percent of excess compensation Step 4: Allocate remaining on a comp/comp basis to all participants Integrated Profit-Sharing Allocation

11. With compensation cap, integration does not result in tremendous disparity Generally appropriate when HCEs earn more than the compensation cap Choosing an Integrated Plan

12. Larger contribution to “buy” the same benefit for an older worker than a younger worker Basic elements Mathematical test Retroactive compliance Costs more to administer Cross-testing

13. Age-weighted means contributions result in level benefit accrual for each participant. Cross-tested—choose an allocation formula and test. It is not unusual to be able to contribute $45,000 for older owners and 5 percent for NHCEs. Cross-tested also referred to as “new comparability Age-weighted vs Cross-tested

14. Profit sharing Level percentage and integrated Age weighted and cross tested 401(k) ADP ACP 401(a)(4) Specific Plans

15. Money purchase Target benefit SEP SIMPLE Specific Plans (continued)

16. Uniform percentage Integrated (see example in text) Other Defined-Benefit Pension Plans

17. Voluntary after-tax contributions Allowed in all qualified plans Common prior to 1987 No nondiscrimination requirements 10% in addition to other limitations Rule changes in 1987 Nondiscrimination—now contributions are subject to ACP test (with matching contributions) Contributions counted under Code Sec. 415 Generally only find in large company 401(k) plans Employee Contributions

18. A plan integrated with Social Security will provide disproportionately higher contributions or benefits to the rank-and-file employees. A defined-contribution plan with a formula of 4 percent of total compensation and 2 percent of compensation earned in excess of $60,000 satisfies the integration requirements. If the integration level in a defined contribution plan is $85,000 the maximum contribution based on compensation in excess of the integration level is 5.7%. An age weighted allocation formula is quite flexible and will generally work regardless of the employee census. If the integration level in a defined-contribution plan is the taxable wage base and 3% of compensation is contributed for each participant an additional contribution of 5.7% of compensation in excess of the taxable wage base is allowed. True/False Questions