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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

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


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”
  • $ 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
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
    • Testing Compensation
    • Allocation Compensation
testing compensaion
    • 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
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
application of 414 s compensation
  • Non-Discrimination Testing
    • ADP/ACP Testing
    • 401(a)(4) – Amount of profit sharing contribution
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)
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
surprise results11
  • 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
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
surprise results13
  • 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
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
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
matching contributions continued16
  • 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
surprise results17
  • 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)
matching contributions continued18
  • 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
surprise results19
  • 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
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
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.
profit sharing contributions continued22
  • 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
surprise results23
  • 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.
profit sharing contributions continued24
  • 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
surprise results25
  • 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
profit sharing contributions continued26
  • When to prefund employer profit sharing contributions?
    • When the contribution is mandatory
    • If allocation is cross-tested, when everyone is in their own group
surprise results27
  • 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
  • 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

Pamela S. Noble