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Retirement Planning and Employee Benefits for Financial Planners

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

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Retirement Planning and Employee Benefits for Financial Planners

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  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.

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