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Charles Lockwood ASC Institute, LLC Littleton, CO asc-net

Qualified Plans in a Down Economy. Charles Lockwood ASC Institute, LLC Littleton, CO www.asc-net.com. Presented by:. Plan Design in Down Market. Dealing with EE concerns Elimination of match/ER contributions Addition/elimination of SH 401(k) plan

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Charles Lockwood ASC Institute, LLC Littleton, CO asc-net

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  1. Qualified Plans in a Down Economy Charles Lockwood ASC Institute, LLC Littleton, CO www.asc-net.com Presented by:

  2. Plan Design in Down Market • Dealing with EE concerns • Elimination of match/ER contributions • Addition/elimination of SH 401(k) plan • Dealing with layoffs/downsizing • Modifying eligibility or allocation conditions during the year • Correction of ADP/ACP failures

  3. Dealing with EE Concerns • Now is not the time to pull out of 401(k) plan • Do not move all money to money market • Do not borrow from 401(k) if don’t absolutely need to • No double taxation on loan amounts • Could lose rollover option if terminate employment • Will miss out on market recovery on withdrawn amounts • More important than ever to monitor investments and EE communications

  4. Reduction of ER Contributions • Watson Wyatt survey • 52% of responding companies laid off EEs • 42% implemented pay reduction strategy • 12% suspended or reduced match with another 12% planning to reduce or suspend match in the near future • Survey by Diversified Investment Advisors • 46% of ERs (with more than 1,000 EEs) planning to reduce or eliminate ER contributions / match • Hewitt Survey = 251 of Fortune 500 ERs have suspended or reduced match • Even AARP is eliminating match for 2009

  5. Elimination of Match • May ER eliminate/reduce a fixed match? • Depends on whether EEs have satisfied any allocation conditions on match • If EEs have not satisfied allocation conditions – can eliminate match retroactively • If EEs have satisfied allocation conditions – must fund match through date of amendment • Amendment must limit comp to date of amendment • May have significant EE relations issues if try to eliminate match retroactively • Will require plan amendment and SMM = no other amendment required • What if match on a payroll basis?

  6. Elimination of Match • May ER eliminate/reduce discretionary match during year? • Must be careful of EE relations issues • May have problems if already contributed match • Should review prior EE communications = make sure match is designated as discretionary • No specific notice required to eliminate discretionary match = may want to fund “expected” match through date of amendment • May want to notify EEs once decide not to make match to allow change in deferral elections

  7. SH 401(k) Plans • ER maintains a 401(k) plan. ER wishes to amend plan to be a SH 401(k) plan, effective 1/1/2009. Can ER add SH feature for 2009? • What if plan were a PS-only plan? • Suppose instead ER would like to eliminate SH feature for 2009. May ER amend plan to eliminate SH matching contribution?

  8. Reduction of SH Match • Must provide supplemental notice to EEs • Amendment may be effective no earlier than 30 days after EEs are provided supplemental notice (or 30 days after the amendment is adopted, if later). •  EEs must have a reasonable opportunity to change deferral elections • Plan must protect match on deferrals already made • Plan must satisfy ADP/ACP test for entire plan year

  9. Example • ER Y amends plan to eliminate SH match effective 7/1/2009. Y provides 30-day advance notice and provides ample opportunity for EEs to change deferrals. The Plan provides for a SH match equal to 100% of deferrals up to 4% of comp. • Jane earns $50,000 for the year ($25,000 from 1/1 – 6/30) and defers 5% of comp ($1,250 from 1/1 – 6/30). • How much is Jane entitled to as a match? • If Plan uses full year comp = $1,250 [100% of deferrals up to 4% of full year compensation] • If Plan uses comp while a participant = $1,000 [100% of deferrals up to 4% of $25,000]

  10. Example • ER Y amends plan to eliminate SH match effective 7/1/2009. Y provides 30-day advance notice and provides ample opportunity for EEs to change deferrals. The Plan provides for a SH match equal to 100% of deferrals up to 4% of comp. • Bill earns $200,000 by July 1 and defers $16,500 in first half of year. • How much is Bill entitled to as a match? • $9,800 [100% of deferrals up to 4% of $245,000] • $8,000 [100% of deferrals up to 4% of $200,000] • $4,900 [100% of deferrals up to 4% of $122,500]

  11. SH 401(k) Plans • ER maintains a 401(k) plan. ER wishes to amend plan to be a SH 401(k) plan, effective 1/1/2009. Can ER add SH feature for 2009? • What if plan were a PS-only plan? • Suppose instead ER would like to eliminate SH feature for 2009. May ER amend plan to eliminate SH matching contribution? • What about a SH ER contribution?

  12. Elimination of SH ER Contribution • Under proposed regs = in addition to requirements for eliminating SH match, must have substantial business hardship • ER is operating at an economic loss; • There is substantial unemployment or underemployment in the trade or business and in the industry concerned; and • The sales and profits of the industry concerned are depressed or declining • Must prorate Code §401(a)(17) comp limit when calculating amount of SH ER contribution

  13. Elimination of SH ER Contribution • Need to make sure ADP/ACP tests will be run = may result in additional costs • Must make sure ER is providing appropriate data to perform ADP/ACP tests  • Since plan loses status as SH plan = plan would also no longer be eligible for ACP test waiver • Make sure participants have "reasonable opportunity“ to change deferral elections • ER should be aware of possible negative EE reaction • ER may wish to establish special communications to ensure EEs relations are not strained • Possible new statement in SH notice

  14. SH 401(k) Plans • May ER terminate a SH 401(k) plan during year? • Similar restrictions apply as with elimination of SH match • Must provide EEs with 30-day supplemental notice • ER must make SH contribution through date of termination • Plan is subject to ADP/ACP tests for entire year • ER may avoid ADP/ACP testing if terminates due to substantial business hardship or due to aquisition or disposition • No advance notice required

  15. Hardship Distributions • Immediate and heavy financial need • Deemed to be immediate and heavy financial need if meets safe harbor definition • Medical expenses for EE, spouse or dependents • Tuition payments (including room and board) for EE, spouse, children or dependents • Purchase of primary residence for EE (does not include mortgage payments) • Prevent eviction or foreclosure on EE’s primary residence • Under final 401(k) regulations = 2 new events • Funeral expenses for parent, spouse, children or dependents • Repair of catastrophic loss to primary residence

  16. Hardship Distributions • Hardship distribution must be necessary to satisfy the financial need • Facts and circumstances test • ER may rely upon EE’s written representation that need cannot be reasonably relieved through other sources • Written representation cannot be relied upon if ER has actual knowledge to contrary • Safe harbor test = no written representation required

  17. Hardship Distributions • Safe harbor test • Distribution may not exceed amount of financial need = may include taxes or penalties reasonably anticipated to result from distribution • EE must take all available loans and distributions from the plan • EE is prohibited from deferring or making EE contributions to all plans maintained by ER for 6 months after hardship distribution • Does not apply to contributions made to purchase health or welfare benefits under a cafeteria plan • Does Plan Administrator (or other responsible party) need documentation of hardship event/financial need?

  18. Layoffs / Turnover • Need to determine whether EE has terminated employment • May determine eligibility for contribution under plan • Layoffs and other terminations may result in a partial termination • If partial termination occurs = plan must 100% vest all affected EEs • If there is a 20% or more turnover rate in the plan due to ER-initiated action = presumption of partial termination • Partial termination can occur over multiple years

  19. Case Study • XYZ Corp maintains a 401(k) plan for its EEs. The plan defines comp for deferral purposes as gross comp for full plan year. • Joe, the CEO of XYZ makes $500,000 per year and defers $15,500 into the plan for 2008. The remaining 4 HCEs make over $125,000 and defer between $10,000 and $15,500 into the plan. • Sally, an NHCE, first becomes a participant in the plan in July of 2008 and defers $2,000 (5% of her $40,000 annual compensation). • XYZ declares a bonus twice a year (in June and December). Generally, bonuses are only paid to NHCEs. • The ADP of the HCE group for 2008 is 7.5%. The ADP of the 10 NHCEs for 2008 is 4.3% and for 2007 is 4.9%. The plan is tested using current year testing.

  20. Switching Testing Methods • Can always switch from prior year testing to current year testing -- no abuse • Can only switch from current year testing to prior year testing with IRS approval • Must have used current year testing for at least five years (or for all years in existence) • There is a change in controlled group member and - as a result - employer maintains plans using different testing methods

  21. Timing of Plan Amendment • Once plan reflects testing method = must be amended to change methods • Final 401(k) regulations silent on when plan must be amended to change methods • Rev. Proc. 2007-44 requires discretionary amendments to be made no later than last day of plan year in which amendment is effective • This rule applies to amendments to change testing methods

  22. Case Study • XYZ Corp maintains a 401(k) plan for its EEs. The plan defines comp for deferral purposes as gross comp for full plan year. • Joe, the CEO of XYZ makes $500,000 per year and defers $15,500 into the plan for 2008. The remaining 4 HCEs make over $125,000 and defer between $10,000 and $15,500 into the plan. • Sally, an NHCE, first becomes a participant in the plan in July of 2008 and defers $2,000 (5% of her $40,000 annual compensation). • XYZ declares a bonus twice a year (in June and December). Generally, bonuses are only paid to NHCEs • The ADP of the HCE group for 2008 is 7.5%. The ADP of the 10 NHCEs for 2008 is 4.3% and for 2007 is 4.9%. The plan is tested using current year testing.

  23. Compensation Definitions • Code §415 = gross • Top-heavy = gross • Highly compensated employees = gross • Deductions = gross • Allocations or benefits = as defined in plan • Testing compensation = any Code §414(s) definition of compensation

  24. 414(s) Compensation • Start with Code §415 compensation and may exclude any of the following: • Elective deferrals • Fringe benefits • Amounts payable only to HCE • Other exclusions = “compensation ratio test” • Earned income of self-employed EEs must be modified in same fashion • Example: if NHCE compensation percentage is 90%, then must multiply each self-employed EE's earned income by 90% to get 414(s) comp

  25. Compensation Ratio Test • Determine compensation percentage for each employee plan comp • Compensation % = -------------- total comp • Both numerator and denominator of comp ratio is limited to $245,000 comp limit • Compare average for HCEs and NHCEs • HCE average cannot exceed NHCE average by more than a “de minimis” amount

  26. Case Study • XYZ Corp maintains a 401(k) plan for its EEs. The plan defines comp for deferral purposes as gross comp for full plan year. • Joe, the CEO of XYZ makes $500,000 per year and defers $15,500 into the plan for 2008. The remaining 4 HCEs make over $125,000 and defer between $10,000 and $15,500 into the plan. • Sally, an NHCE, first becomes a participant in the plan in July of 2008 and defers $2,000 (5% of her $40,000 annual compensation). • XYZ declares a bonus twice a year (in June and December). Generally, bonuses are only paid to NHCEs. • The ADP of the HCE group for 2008 is 7.5%. The ADP of the 10 NHCEs for 2008 is 4.3% and for 2007 is 4.9%. The plan is tested using current year testing.

  27. Compensation Definition • Net vs. gross compensation • Exclude compensation elements – such as bonus or overtime • Compensation while a participation • Post-severance compensation • Can plan exclude elements of compensation (such as overtime or bonuses) under a SH 401(k) plan?

  28. Determining HCE Status • 5% owners at any time during current or lookback year • EE's compensation for the lookback year exceeds HCE dollar limit • $100,000 for 2007 • $105,000 for 2008 • $110,000 for 2009 • May be able to use top-paid group test to limit number of HCEs 

  29. Top-Paid Group Test • EE must have compensation > dollar amount and must be in top-paid group = top 20% of EEs ranked by compensation • Election must be made in plan • Excluded employees • EEs who have not completed 6 months of service • EEs who normally work < 17½ hours per week • EEs who normally work < 6 months per year • EEs younger than age 21

  30. Determining HCE Status • May be able to use top-paid group test to limit number of HCEs  • 5 HCEs and 10 NHCEs • Top-paid group test • 15 EEs * 20% = 3 EEs • Only top 3 highly paid HCES are considered HCEs for ADP test • Remaining 2 HCEs are treated as NHCEs • Requires plan amendment before end of year for which amendment is effective • May want to consider making amendment to plan during year if think will help ADP/ACP test

  31. Targeted QNECs • Targeted QNEC = can only use QNEC in ADP or ACP test to extent does not exceed greater of: • 5% of compensation • 2x plan’s “representative contribution rate” • The lowest QNEC rate of any NHCE, taking into account at least 50% of total eligible NHCEs • The lowest QNEC rate of any NHCE employed as of the last day of the plan year • Plan can be designed to provide for targeted QNECs

  32. Charles Lockwood ASC Institute, LLC Littleton, CO New Comparability and Cash Balance Plans Presented by:

  33. Have become very popular = based on concept of “cross-testing” Permits substantial disparity in contribution for older employees Must be tested for discrimination using general nondiscrimination test IRS has issued regulations requiring a minimum 5% contribution for NHCEs in a “cross-tested” plan New Comparability Plan

  34. New Comparability Plan

  35. New Comparability Plan

  36. New Comparability Plan

  37. Factor used to convert contribution to equivalent benefit rate (EBR) at NRA Conversion factor: Project contribution to NRA at applicable interest rate (e.g., 8.5%) = Contribution * 1.085^N where N is years to NRA Convert projected benefit to life annuity at age 65 based on applicable interest rate and mortality table (e.g., 8.5% and UP 1984 table) = 7.9486 annuity factor Example = Dr. Rott (age 45) has a conversion factor of 0.643138 (1.085^20 / 7.9486) Conversion Factor

  38. New Comparability Plan

  39. New Comparability Plan

  40. New Comparability Plan

  41. New Comparability Plan

  42. General Nondiscrimination Applies if plan fails to satisfy safe harbor nondiscrimination test Each HCE rate group must satisfy a minimum coverage test under Code §410(b) Rate group includes all equal or higher allocation or equivalent benefit rates Rate groups may be expressed as allocation rates or equivalent benefit rates (cross-testing) allocation Allocation rate = --------------- 414(s) comp

  43. Ratio test NHC benefiting % ------------------- > 70% HCE benefiting % Average benefits test Nondiscriminatory classification test Average benefit ratio test (ABR test) Coverage Tests

  44. Nondiscriminatory Classification Test

  45. New Comparability Plan

  46. How many NHCEs must benefit under Dr. DeKay’s rate group to satisfy the nondiscriminatory classification test? NHCE %/HCE% > Midpoint % NHCE concentration percentage = 8/11 = 72.72% What is Magic # of NHCEs?

  47. Nondiscriminatory Classification Test

  48. How many NHCEs must benefit under Dr. DeKay’s rate group to satisfy the nondiscriminatory classification test? NHCE %/HCE% > Midpoint % NHCE concentration percentage = 8/11 = 72.72% Midpoint safe harbor = 36% NHCE%/33.3% > 36% NHCE % > 36% * 33.33% NHCE % > 12% 1/8 = 12.5% Only need to bring one NHCE into Dr. DeKay’s rate group What is Magic # of NHCEs?

  49. New Comparability Plan

  50. New Comparability Plan

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