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Planning for Retirement Needs. Coverage, Eligibility, and Participation Rules Chapter 7. Coverage 410(b) 401(a)(26) Aggregation Participation 21-and-one rule 2-year/100 percent Rules for SEP, SIMPLE, 403(b). Overview. 5-percent owners in current or previous year

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planning for retirement needs

Planning for Retirement Needs

Coverage, Eligibility, and Participation Rules

Chapter 7






21-and-one rule

2-year/100 percent

Rules for SEP, SIMPLE, 403(b)

highly compensated employee
5-percent owners in current or previous year

Earn over indexed limit in previous year

$100,000 (2006 limit)

$100,000 (2007 limit)

Election to limit to top 20 percent

Highly Compensated Employee
410 b
Perform test once a year

Perform not counting “excludibles”


Less than 1,000 hours

Age 21

Less than 1 year

Collectively bargained

percentage test
Cover at least 70 percent of all NHCEs

Block, Meyers and Andrews

24 employees, 4 are part-time

Plan covers all 12 HCE’s and 6 of 8 non-HCEs

Plan covers 75% of the non-HCEs

Percentage test
ratio test
NHCE percentage must be at least 70 percent of the of HCE percentage

Thunder Company

100 eligible employees

15 of 30 HCEs are covered (50%)

40 of 70 non-HCEs are covered (57%)

Minimum coverage is 50% x 70% ((35%)

Ratio Test
average benefits test
Must satisfy three tests

Reasonable job classification

Percentage test

Average benefits test—average benefits of NHCEs are at least 70 percent of the benefits of the HCEs (looking at all qualified plans)

Average Benefits Test
401 a 26
Only applies to defined benefit plans

Covers the lesser of

50 employees

40 percent of the employees

If two employees, must cover both

401 a 269
If the company has 50 employees, how many have to be covered?

If the company has 1,000 employees, how many have to be covered?

excluding employees

Age 21

Less than one year

Less than 1,000 hours

Collectively bargained


At least 30 percent of the NHCEs

Excluding Employees
separate lines of business
Separate operating units

A unit must have 50 employees to be treated separately

Separate lines of business can be tested separately

Separate Lines of Business
Controlled groups

All members of the controlled group are treated as one employer

Parent subsidiary (80 percent ownership)

Brother-sister (80 percent/50 percent test)

brother sister
One person owns 100% of both companies

10 people each own 10 percent of two companies

Husband-wife each own 100% of their won companies

brother sister example
Joe 20% of X and 12% of Y = 12%

Sally 60% of X and 14% of Y = 14%

Ralph 20% of X and 74% of Y = 20%

Brother-Sister Example
affiliated service groups
All members of the affiliated service group are treated as one employer

A org-B org affiliation

Work together to produce a product

One is a service organization

Some common ownership

Management services

Affiliated Service Groups
leased employees
Agreement with third party

Substantially full-time basis (1,500 hours) for at least one year

Services are performed under primary direction or control of recipient

If less than 20 percent leasing company can maintain safe harbor

10 percent fully vested money purchase

Leased Employees
practical considerations
Identify the issue

Ask lots of general questions

If any common ownership send issue to lawyer or accountant

Be concerned if client actively seeks to avoid the coverage rules

Practical Considerations
21 and 1 rule

2 year / 100 percent vesting

Enter within 6 months after eligibility

Defining service

1,000 hours

Numerous equivalencies

Choose counting method that works with payroll records

defining service
1000 hours worked or entitled to pay

870 actual hours

750 regularly scheduled hours

Elapsed time

Time-period method

10 hours for each day

45 per week

95 semimonthly

190 hours

Defining Service
coverage other plans

Exclude for 3 years

Must cover part-timers earning $500 (counting affiliated companies)


Exclude for 2 years

Must cover part-timers earning $5,000


Same rule as qualified plans

Deferral election to those working 20 hours per week

Coverage—Other Plans
coverage case study 1
Given the following eligibility provisions, does the Small Corporation profit-sharing plan have coverage problems?

“All non-union employees who have attained age 21 and have earned one year of service will be eligible to participate on the January 1 or July 1 following completion of one year of service.”

Coverage Case Study #1
case study 1 answer
As long as there are no other companies that must be aggregated under the control group rules and affiliated service group rules and there are no “leased employees,” this plan covers 100 percent of the nonexcludible employees. Case Study #1 Answer
coverage case study 2
Are there any additional coverage problems if the Small Corporation’s plan is a 401(k) plan with salary deferrals and matching contributions and only 40 percent of the employees make salary deferral contributions?Coverage Case Study #2
case study 2 answer
There are no additional coverage problems because eligibility to make salary deferrals in a 401(k) plan is considered eligibility to participate.Case Study #2 Answer
coverage case study 3
Mega Corp. has 10,000 employees and about 20 different defined-benefit and defined-contribution plans covering different groups of employees. Describe some of the steps necessary in determining whether or not the plans satisfy the coverage requirements.Coverage Case Study #3
case study 3 answer
Determine who is the employer.

Identify any leased employees.

Eliminate excludible employees.

Test 410(b) coverage using the ratio test.

If any plan fails, look to average benefits test.

If failure, refer to separate line of business rules.

Test defined-benefit plans under 401(a) 26.

Case Study #3 Answer
coverage case study 4
Joe owns ABC and DEF companies. He is considering a SEP or SIMPLE for ABC company. Explain to Joe the coverage rules for each type of plan.Coverage Case Study #4
case study 4 answer
A SEP plan will have to cover all employees of both companies who have earned at least $500 (indexed for 2007) in 3 of the 5 preceding years.

A SIMPLE plan will have to cover all employees of both companies who have earned at least $5,000 in any 2 previous years.

Case Study #4 Answer
true false questions
An adoption agreement contains all the requirements necessary for a plan to be a qualified plan.

An employer wanting to elect a large number of customized design features can generally use an adoption agreement.

An individual who is a 5-percent owner in the current year earning $35,000 a year is considered a highly compensated employee for the current year.

An individual who is a new employee earning $150,000 in 2007 will be a highly compensated employee for 2007.

True/False Questions
true false questions32
Sorry Corp. has 20 employees meeting the minimum age and service requirements, and four are HCEs. The Sorry Corp. pension plan covers two HCEs and eight non-HCEs. The plan satisfies the minimum-coverage-ratio test.

Each plan of a large corporation operating separate lines of business must satisfy the 410(b) coverage test, taking into consideration all employees of the corporation.

True/False Questions
true false questions33
Divided Corporation has two plants, each with 100 employees. Because Divided Corporation’s profit-sharing plan only covers the employees of one plant, the plan does not satisfy the requirements of 401(a)(26).

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 eligibility provision in a qualified plan can provide that employees earn 3 years of service before participation as long as the plan satisfies the coverage requirements of Code Sec. 410(b).

The percentage test requires a plan to benefit at least 70 percent of employees who are not highly compensated.

True/False Questions
true false questions34
Long-term full-time leased employees must be covered under a qualified plan.

A defined-contribution plan that covers no highly compensated employees can cover any number of non-highly compensated employees.

A qualified plan can exclude all employees who do not complete a 1,000 hours of service in a year.

True/False Questions