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Nondiscrimination Requirements: Part Three

Nondiscrimination Requirements: Part Three. Fundamentals I of Retirement Plan Issues Chapter Eight, Part Three/Week 12. Permitted Disparity Rules of IRC §§401(a)(5) and 401(l).

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Nondiscrimination Requirements: Part Three

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  1. Nondiscrimination Requirements: Part Three Fundamentals I of Retirement Plan Issues Chapter Eight, Part Three/Week 12

  2. Permitted Disparity Rules of IRC §§401(a)(5) and 401(l) • Social Security mandates a 7.65% FICA tax rate for both ERs and employees – 5.7% for Social Security retirement benefits and 1.45% for Medicare benefits • Due to the maximum wage ceiling on Social Security benefits and FICA taxes, the ER paid 5.7% of the employee’s wages up to the FICA wage ceiling • If the ER’s privately provided retirement plan contribution % could be “integrated” with Social Security, the ER could provide 0% under its private plan for wages up to the maximum wage ceiling + 5.7% for wages over the maximum wage ceiling. The end result was that the ER contributed a total of 5.7% of all compensation for retirement benefits (either through Social Security or the employer’s private plan).

  3. Original Integration Rules • Concepts that existed under the original integration rules: • Integration level: the plan’s cutoff for compensation purposes – compensation below such level would receive $0 or a lesser allocation as compared to compensation above such level • Maximum taxable wage base: Social Security’s maximum taxable wage base for the current year • Covered compensation: the average of the maximum taxable wage bases that a hypothetical employee always at that wage base earned over his/her 35-year career average • OASDI rate: portion of the FICA tax attributable to retirement benefits (5.7%) and to health benefits (1.45%).

  4. TRA ’86 Revisions to the Rules • TRA ‘86 totally modified the integration rules and replaced them with the permitted disparity rules • The notion of not providing any benefits/allocations for wages below the maximum taxable wage base (MTWB) was expelled • Instead, a “two for one” comparison was adopted whereby the allocation rate applied to wages above MTWB was dependent upon the allocation rate applied to wages below the MTWB

  5. Comparability Testing • The TRA ‘86 Act ‘s ABP coverage test requires that all allocations and accruals for NHCEs and HCEs be aggregated and tested under the 70% test – as such DC plan allocations must be aggregated with DB accruals to accomplish this test – this brought about the cross-testing rules.

  6. Cross Testing Rules • Byproduct of ABT of the ABP coverage test • Method to convert a DB plan to a DC plan to aggregate with other DC plans/to convert a DC plan to a DB plan to aggregate with other DB plans • When you convert, age becomes a determinative factor, not salary

  7. Cross Testing Rules • Two ees: ages 30 and 50, $10,000, covered under both plans DC allocation = 5% of pay = $500 DB benefit = 5% of pay/65/life only = $500/65/life • If both plans were viewed as DB plans: Take current allocation, project to NRA, determine EBAR (equivalent benefit accrual rate) Age 30: DC 5% allocation is worth 24% of pay as a DB, so combined rates are 5% + 24% = 29% Age 50: DC 5% allocation is worth 2% of pay as a DB, so combined rates re 5% + 2% = 7% • If both plans were viewed as DC plans: Age 30: DB 5% benefit is worth 2% of pay as a DC, so combined rates are 5% + 2% = 7% Age 50: DB 5% benefit is worth 12% of pay as a DC, so combined rates are 5% + 12% = 17%

  8. Design Considerations • Intent of the owner/employee • Maximizes the owner’s % more efficiently • Demographics of the employer • Ages • Turnover • Size of the employer • Family members working for employer • HCE status of one may result in HCE status for younger family member

  9. Computing EBAR Actuarial Assumptions: 8.5% and UP-84 Mortality Table and NRA =65 and monthly annuity purchase rate is 95.3829 Owner: age 52 with $245,000 comp Profit sharing allocation % = $22,050÷ $245k = 9% EBAR = [$22,050 × (1.085)13]÷ 95.3829 × 12 = $8,011.35 – annual annuity at 65 EBAR accrual rate = $8,011.35 ÷ $245,000 = 3.27%

  10. New Comparability Rules • Minimum Gateway Allocations • Broadly Available Allocation Rates • Age-Based Allocations • Still have to satisfy RP or ABP for rate groups on either a DC or DB analysis

  11. IRS LRM 94 Listing of Required Modifications • The plan document must set forth each allocation group used in the cross tested comparability design. • The plan document must set forth which gateway minimum is being used. • The employer must provide annual written notification the contributions to each allocation group. • The plan document must define the Allocation Groups used in the cross testing; no required disclosure in the plan of the allocation percentages, but employer must disclose % each year.

  12. Minimum Gateway Allocation • Minimum gateway allocation must be made for every NHCE • Provided to any employee who benefits as an employee for the PY • Minimum gateway is most commonly used (e.g., NHCEs get at least 5% of 414(s) pay)

  13. Broadly Available Allocation Rate • This test is utilized when there are a wide range of allocation rates attributable to HCEs and NHCEs alike • Each allocation rate is treated as a benefit, right or features and thus tested as if available to a valid 410(b) coverage group • Least utilized method

  14. Age-Based Allocations • Plans that explicitly use graded age or service conditions for allocation purposes are subject to a separate test to assure that the bands used are “smooth and regular” • The spreads between the bands are subject to the following constraints: • The allocation rate for each band cannot exceed the rate for the preceding band by more the 5%; • The ratio of the allocation rate for the band compared to its immediately preceding band cannot exceed 2%; and • The ratio of the allocation rate for the band compared to its immediately preceding band may not exceed the ratio of the allocation rates between the two immediately preceding bands.

  15. Cross Tested PS Plan Name Age 2010 Pay PS Allocation Alloc % EBAR % % of Total ER $ HCE 1 52 245K 22,500 9% 3.27% 84.29% HCE 2* 46 50K 1,500 3% 1.78% 5.73% NHCE 1 36 45K 1,350 3% 4.02% 5.16% NHCE 2 45 16K 480 3% 1.93% 1.84% NHCE 3 30 26K 780 3% 6.56% 2.98% 382K 26,160 Results of RP? Results of ABP? Cross testing rules? * Spouse of HCE 1

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