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Employer Matches & Profit Sharing Contributions – It’s Not So Easy Anymore

Employer Matches & Profit Sharing Contributions – It’s Not So Easy Anymore. Presented by Pamela Noble Noble –Davis Consulting , Inc . 30275 Bainbridge Road Solon, Ohio 44139 440-498-8408. CURRENT IRS CLIMATE. IRS to issue 1200 401(k) questionnaires in the month of May

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Employer Matches & Profit Sharing Contributions – It’s Not So Easy Anymore

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  1. Employer Matches & Profit Sharing Contributions – It’s Not So Easy Anymore Presented by Pamela Noble Noble –Davis Consulting , Inc. 30275 Bainbridge Road Solon, Ohio 44139 440-498-8408

  2. CURRENT IRS CLIMATE • IRS to issue 1200 401(k) questionnaires in the month of May • Initial step in maximizing guidance and enforcement efforts • There are nearly half a million 401(k) plans in America covering over 50 million participants • Per IRS –”401(k) plans are by far the most non-compliant plan type in the retirement plan universe”

  3. COMPLIANCE • $ and % limitations set by law • Subject to annual cost of living increases • Non-discrimination testing • Comparison of HCE benefits to NHCE benefits • Operational compliance with your plan document

  4. COMPLIANCE AND NON-DISCRIMINATION TESTING • 1. Annual additions • 2. Deferral limits • 3. Compensation limits • 4. Deduction Limits • 5. Average deferral percentage test (ADP test) • 6. Average contribution percentage test (ACP test) • 7. Top Heavy • 8. 401(a)(4) - allocation of profit sharing contribution • 9. Coverage

  5. COMPENSATION • TWO BASIC APPLICATIONS: • Testing Compensation • Allocation Compensation

  6. TESTING COMPENSAION • TWO BASIC DEFINITIONS • 415 Compensation – as defined in an amendment to your plan that was effective for the plan year beginning on or after July 1, 2007 • 414(s) Compensation – starts with 415 Compensation and allows non-discriminatory modifications, such as: • Limiting compensation to date of participation • Exclusion of elective deferrals • Exclusion of taxable fringe benefits

  7. APPLICATION OF 415 COMPENSATION • Determination of HCEs and Keys • Determination of top heavy minimums • Application of annual additions • Determination of post-severance pay eligible for elective deferral contributions

  8. APPLICATION OF 414(s) COMPENSATION • Non-Discrimination Testing • ADP/ACP Testing • 401(a)(4) – Amount of profit sharing contribution

  9. ALLOCATION COMPENSATION • Must be stated in the plan document • Sample permitted modifications: • Recognition of date of participation compensation • Inclusion or exclusion of elective deferrals • Exclusion of taxable fringe benefits • Exclusion of bonus/overtime/commission pay (if non-discriminatory)

  10. SURPRISE RESULTS • Employer allocates a 4% profit sharing contribution on date of participant compensation • Allocation is in compliance with the plan document • Allocation satisfies 414(s) testing compensation so is not discriminatory • Plan is top heavy – • Non-key employees must receive 3% of total year compensation • So affected non-key employees need to receive an additional top heavy contribution

  11. SURPRISE RESULTS • Employer allocates a match based on compensation that does not include overtime pay: • Allocation is in compliance with the plan document • Allocation does not violate 415 requirements • Only NHCEs receive overtime so the definition of compensation is discriminatory and does not satisfy 414(s). • Allocation compensation may not be used for ACP test

  12. MATCHING CONTRIBUTIONS • Formula should be discretionary in plan document (unless plan is a safe harbor) • May change formula from year to year (without cost of plan amendment) • May change formula mid-year (without cost of plan amendment) • May decide after the end of the plan year to make a contribution • Still need to comply with verbal commitments made to employees • Hard coded safe harbor match formula • Modifications require a plan amendment and 30 day advance participant notice • Plan then becomes subject to non-discrimination testing

  13. SURPRISE RESULTS • Plan has allocated a safe harbor match for 6 years. In the middle of the 7th year the plan eliminates the safe harbor match due to economic conditions. Proper amendments and notifications are processed. • Allocation is in compliance with plan document • Plan is now subject to ACP testing which passes • Owner elected a 5% deferral and the plan is top heavy • Employer is now obligated to make a top heavy contribution equal to 3% of non-key compensation • Safe harbor match does count toward 3% obligation • Plan document may require a 3% contribution to all employees

  14. MATCHING CONTRIBUTIONS …continued • Should your document require a per pay calculation or an annualized calculation? • Depends on what you are trying to accomplish • Budgeting your match obligation • Maximizing the allocation • Always use a per pay calculation if a payroll company is computing your match and you do not want to make true-up contributions

  15. TRUE-UP MATCH CONTRIBUTION • Payroll company computes the match contribution each pay period. • The match formula is 50% on the first 6% of deferrals • The owner receives a $50,000 bonus on December 15th and elects to defer $16,500 in one pay • The owners annual salary is $200.000 • Owner’s match if a per pay calculation - $1,500 • $50,000 times 6% = $ 3,000 • 50% of $ 3,000 = $1,500 • Owner’s match if an annual calculation - $6,000 • $200,000 times 6% = $12,000 • 50% of $12,000 = $6,000

  16. MATCHING CONTRIBUTIONS …continued • Prior year testing versus Current Year Testing • Prior year testing: • HCE deferrals and match limitations are determined based on the NHCE averages from the prior year. • Current year testing: • HCE deferrals and match limitations are determined based on the NHCE averages for the current year. • Prior year testing popular with employers because it limits end of the year surprises

  17. SURPRISE RESULTS • Employer match is discretionary • Plan document requires prior year testing for both the ADP/ACP test • Employer does not make a match in 2008 due to economic conditions • Employer declares a match for 2009 • Allocation is in compliance with the plan document • ACP prior year testing would completely eliminate any 2009 match for the HCEs • Suggestion – modify plan document so ADP is tested on prior year data and ACP is tested on current year data (if document permits)

  18. MATCHING CONTRIBUTIONS …continued • Allocation of forfeitures: • Law permits • Reduce future contributions • Use to pay administration expenses • Allocate in the same manner as profit sharing contribution • Document specific • Forfeitures must be allocated per the document

  19. SURPRISE RESULTS • Plan has 25 eligible participants • Document allocates forfeitures pro rata based on compensation • Currently the plan only has deferral and match accounts • One participant terminates and forfeits $250 • Plan document now requires that the forfeiture be allocated between all 25 eligible participants • Allocation to some participants may be under $5. • New accounts need to be established for participants who never completed an investment election form • Administration fees may be effected

  20. PROFIT SHARING CONTRIBUTIONS Allocation Conditions • Last day of the plan year and/or 1000 hour requirement subject to coverage testing • If plan document does not contain fail safe language must retroactively amend your plan to increase participation in allocation

  21. PROFIT SHARING CONTRIBUTIONS …continued • Definition of allocation compensation • Taxable fringe benefits – to exclude or not • Examples: Personal use of auto or term life insurance coverage exceeding $50,000 • Depends on who receives fringe benefits • If the owners are the only employees receiving taxable fringes then including them in compensation will only enhance testing and provide potentially increased contributions. • If the employer has ten sales persons whose compensation includes personal use of auto, then you might want to exclude taxable fringes.

  22. PROFIT SHARING CONTRIBUTIONS …continued • Determination of allocation compensation • Who is responsible for determining allocation compensation? • Ultimately the employer • IRS audits always require copies of W-2 forms • Important to furnish a year-end payroll report to your TPA

  23. SURPRISE RESULTS • Employer sends a payroll file every two weeks to their TPA. The payroll file does not include YTD totals. The TPA computes the 3% safe harbor contribution and transmits all contributions to the custodian every pay. The payroll provider processed multiple corrections during the year. The TPA does not request a year-end payroll report. • Most payroll corrections are recorded in YTD totals not in current pay totals. • Consequently, the 3% safe harbor was not calculated on total compensation – plan disqualification if not corrected. • Employee elective deferrals not paid timely . Imputed interest due the plan and employer pays excise tax.

  24. PROFIT SHARING CONTRIBUTIONS …continued • Cross-tested allocations • Contributions allocated to “groups” • Complex testing • Age sensitive • Suggestion • Make everyone their own group (if volume submitter document) • Limit safe harbor contributions to NHCEs

  25. SURPRISE RESULTS • 3% safe harbor allocated to all participants • Cross-tested profit sharing allocation. • Employer hires twenty-two year old daughter • Daughter earns $30,000 and defers $1,200. • Daughter turns out to be the youngest participant. • Allocations are in compliance with the plan document • Elective deferral contributions pass non-discrimination testing • Cross-tested profit sharing allocation is seriously impacted because the daughter is an HCE

  26. PROFIT SHARING CONTRIBUTIONS …continued • When to prefund employer profit sharing contributions? • When the contribution is mandatory • If allocation is cross-tested, when everyone is in their own group

  27. SURPRISE RESULTS • Employer sponsors a profit sharing plan • The participant accounts are participant directed on a daily valuation platform • Employer contributes a discretionary 3% of compensation each pay for budgetary reasons • Employer stops the contribution in the middle of 2008 for economic reasons • Plan document requires a pro-rata allocation of contribution • If one terminated employee received 3% of compensation, then all employees must receive 3% of compensation for the entire year

  28. CONCLUSIONS • Hire a competent TPA • Ask questions and have a basic understanding of your plan, for example, how many of you know …. • Definition of allocation compensation • Is the plan top heavy • Which employees drive the cross-testing

  29. QUESTIONS? Pamela S. Noble psn@noblepension.com 440-498-8408

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