Retirement Planning and Employee Benefits for Financial Planners

1. Retirement Planning and Employee Benefits for Financial Planners Chapter 5: Profit Sharing Plans

2. Seven Types of Profit Sharing Plans • Profit Sharing Plans • Stock Bonus Plans • Employee Stock Ownership Plans • 401(k) Plans • Thrift Plans • Age Based Profit Sharing Plans • New Comparability Plans

3. Characteristics • Defined contribution plan. • Established and maintained by an employer. • Provides for employee participation in profits. • Utilizes a definite predetermined formula for allocating the contributions to the plan. • Must be nondiscriminatory. • Either noncontributory or contributory. • Noncontributory: Employee does not contribute to the plan and all contributions to the plan are from the employer. • Contributory: Employee contributes to the plan.

4. Contributions and Deductions • Contributions must be made by the due date of the company’s income tax return (including extensions) • Plan must be established by end of year, however • Contributions are discretionary, but must be “substantial and recurring.” • No requirement of company profit for contribution. • Limited to 25% of total employer covered compensation. • Limited to the lesser of 100% of compensation, or $49,000 for 2010 per employee per year.

5. Allocation of Contributions • Standard Allocation • Equal percentage of comp to all participants. • Social Security Integration • Provides higher allocations to employees whose earnings are greater than the Social Security Wage base. • Excess rate: < of double base rate or 5.7% if integration is at Social Security wage base ($106,800 in 2010) • Everyone: 5%; top dogs 10% on salary above $106,800 up to $245,000 • Everyone: 7%; top dogs 12.7% on salary above $106,800 up to $245,000 • Profit sharing plans can only use the excess method.

6. Allocation of Contributions • Age-Based Profit Sharing Plans • Use a combination of age and compensation to allocate the plan contribution. • Take comp x PV of $1 from age 65 based on • Current age • Discount rate of 7.5% to 8.5% • What rate would you select? • This equals age-weighted comp which is used to allocate contribution • Example: Flintstone Quarry • Fred: age 55, comp $100,000 • Barney: age 25, comp $80,000 • Company contributes $50,000

7. Cash or Deferred Arrangements (CODA) – 401(k) • Most prevalent type of plan established today. • Predominantly funded by employee deferral contributions. • Attaches to a profit sharing plan or stock bonus plan. • Permits employees to defer compensation to a qualified plan. • Limited to $16,500 for 2010 per year, or $22,000 for 2010 for those age 50 and over ($5,500 additional contribution). • Employers may (buy are not required to) match the employee’s deferral.

8. Establishing a 401(k) • May be established by: • Any legal form of business • Cannot be established by governmental entities. • 457 plans

9. Qualification Requirements • Eligibility – Same as Chapter 3 • Vesting • Employee deferral contributions • 100% at all times • Employer matching contributions • Must vest at least as rapidly as • 2 to 6 graduated or 3-year cliff • See Example 5.8 on pages 199.

10. Contributions to CODAs (1 of 2) • Employee Contributions • Elective deferral contributions • Limited to $16,500 for 2010 per year. • Additional $5,500 for 2010 for age 50 and older. • Subject to payroll taxes. • After-tax contributions available. • Roth contributions allowed after 2005. • Employer contributions: not Roth

11. Contributions to CODAs (2 of 2) • Employer Contributions • Matching contributions • Profit sharing contributions • Contributions to meet ADP/ACP • CODAs are not permitted to use Social Security integration.

12. Tax Impact • Contributions are not currently subject to income tax. • Employee deferral contributions are subject to payroll taxes. • Employer contributions are not subject to payroll taxes.

13. Negative Elections • Negative Elections: the employee is deemed to have elected a specific employee deferral unless the employee elects out. • In 2008, 20% of eligible employees don’t participate • 40% of plans now include automatic enrollment for new hires • 15% also auto-enroll non-participating employees • Employee contribution: 3% in year 1 increasing 1% a year to 6% • Match: 100% of 1% + 50% above 1% • And top dog match = peon match • Investment: default investment • 53% now use target-date fund; in 2007 35% used money market funds as default • 70% of negative elections stay in default • Annual notices/Ability for employee to get funds back

14. Nondiscrimination Testing • Benefits must be provided to a certain percentage of rank-and-file employees. • Two tests for 401(k) in addition to qualified plan tests • Actual Deferral Percentage Test (ADP Test) • Actual Contribution Percentage Test (ACP Test)

15. Actual Deferral Percentage Test (ADP Test) • Limits the employee elective deferrals for the HC based on the elective deferrals of the NHC. • Top Dogs: >5% owner; or comp>$100K • Peons < 2%; Top Dogs= 2 x Peon% • Peons 2 – 8%; Top Dogs= 2 + Peon% • Peons >8%; Top Dogs= 1.25 x Peon%

16. Failing the ADP Test • Corrective Distributions: Give Them Back • Decreases ADP of HC • Recharacterization: After-Tax • Decreases ADP of HC • Impact ACP test • Qualified Non-elective contributions (QNEC): to everyone • Increases ADP of NHC • 100% vested • Qualified matching contributions (QMC) • To those who participated • Increases ADP of NHC • 100% vested

17. Actual Contribution Percentage (ACP) • Like ADP, but determined utilizing: • Employee after-tax contributions, and • Employer matching contributions • Uses same scale as ADP • Uses same corrective procedures as ADP

18. Safe Harbor 401(k) Plans • Not required to pass ADP or ACP tests. • Employer must provide any one of the following: • 3% nonelective contribution • To all eligible employees • Matching contribution • 100% up to 3%, and • 50% from 3% to 5% • Employer contributions are 100% vested at all times.

19. Distributions • Hardship Distributions • Distribution for immediate and extreme financial need: • Medical Expenses • Funeral Expenses • Purchase of principal residence • No other sources of funds are available. • May be subject to income tax and early withdrawal penalties.