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How to start a 401 plan for small and
emerging firms
As an entrepreneur, you're probably all too familiar with
the soaring costs of employee benefits. In many businesses,
"perks" such as health and life insurance tack on an extra 35%
to payroll.
Still, there's no getting around it: A strong benefits
program is a must. Quality employees are your company's biggest asset, and
the best way to attract, retain and motivate top-level employees is to
offer a solid savings and retirement plan.
Luckily, there's a way to provide this benefit and lower
your costs, as well. The solution: a 401k, by far the most popular savings
and retirement benefits program. Today, there are more than 100,000 401k
programs in the United States, covering 19 million people.
What makes a 401k plan so appealing is its structure.
Defined-contribution plans (named for Section 401k of the Internal Revenue
Code) let employees earmark a percentage of their wages, before taxes,
toward a retirement fund. To enhance the plan's value, most employers
match these pretax contributions - normally 50 cents of every dollar, or
up to 6% of an employee's salary.
Granted, implementing such a plan will tilt your till a
bit, since it may cost anywhere from $8 to $50 a head to administer your
401k. But the tab is well worth it. For starters, a 401k is inexpensive
compared with traditional pension plans, which are entirely
company-sponsored. Besides, the money you funnel toward a 401k is likely
to be offset anyway by lowering your staffs turnover rate.
Think you're too small to have a 401k plan? Don't let size
fool you. Anyone with more than 10 employees is a good candidate for a
401k plan, says Larry Helmke, vice president with the employee benefits
consulting firm of Towers Perrin in Dallas. In fact, about two-thirds of
all such plans are provided by firms with fewer than 100 employees.
401k
Fact:
Contributions by the company are based on the amount contributed by the employee, with XYG matching 30% of the employee's contribution. As with employee contributions, taxes on company contributions and their related earnings are deferred until distribution from the plan. Company contributions are not fully vested to the employee until after a five-year period; employee contributions are fully vested from the time of contribution. Target Labs (www.targetlab.com) makes a 30% contribution, and sees an 85% participation rate company-wide.
Gearing up a plan, of course, means you'll have plenty of
details to sort out. How will the plan work? Who will run it? How much
will you have to do? The answers to these tough questions will come from
your staff and the company you hire to handle the plan.
You'll find a host of 401k plan providers - from
commercial banks to insurance carriers to mutual fund companies. With so
many players in such a small field, you must be very selective, warns Bill
Thompson, director of marketing for Fidelity Investments in Florence, Ky.
The first step is to solicit several detailed proposals
from prospective plan administrators. Make sure you allow enough time - be
it six months or a year - to craft the right plan for your firm. But
before we go further, let's look at the basics.
How Will A 401k
Benefit Your Employees?
Everyone loves a tax break. And one of the biggest boons
to 401k participants is that they don't pay federal (and, in most cases,
state) income tax on their savings. All contributions reduce taxable
income dollar-for-dollar and compound tax-deferred until withdrawn.
In 1994, employees may contribute up to $8,994, before
taxes to a 401k account. The precise amount rises each year with
inflation. The limit for combined employer and employee contributions is
15% of the total compensation of all participants.
You can't overemphasize the importance of having employees
set aside a pre-set amount of money each month in a tax-deferred
investment that can grow to a significant amount of money over time. Be
sure to stress to your employees that for every $100 they invest before
taxes, they're getting the equivalent of a taxable investment of as much
as $145 if they're in the 31% federal tax bracket. When you consider state
and local taxes, the return may be higher for them.
With individual retirement accounts (IRAs) no longer fully
deductible, a 401k plan is a great way to get all the benefits of an IRA
but with higher contribution limits. The maximum contribution for an IRA
is $2,000 for a single individual.
Another benefit: Employees have a say about how their
money is invested. Each employee determines how much to contribute and how
to divide the money among available investment choices.
How Will A 401k Plan Benefit You?
A 401k helps promote good employer/employee relations by
showing that you're concerned about the financial future of your workers.
Such a plan also eases the burden of investing your employees' money, a
responsibility you'd have with a private pension fund. Employees bear most
of the cost of building a retirement account through their own
contributions (on average, it is about $3,000 a year per worker).
Moreover, contributions that you, as the employer, make to
the plan are tax-deductible. This alone can be a significant reason to
establish a plan for your company.
Putting A 401k Plan Into Action
Before you set up a 401k plan, assign a staff member as
plan administrator. The obvious candidate is your human resources director
or whoever coordinates employee benefits. In smaller companies, the chief
operating officer handles the duties.
It's important that you find a way to discover what your
employees want out of a plan. Do they demand a wide range of investment
options? Are they partial to mutual funds? Company, stock? Some companies
go so far as to conduct surveys. As a guideline, you'll need to address
the following in establishing your plan:
Design your plan. You will be glad to know that the IRS
has given you and your advisers - attorney, accountant, benefits director,
etc. - a head start in designing a plan. There are preapproved prototype
documents that explain clearly what a 401k plan entails (these forms are
available at any local IRS office). By filling out these government forms,
you'll save up to 90% of the cost of developing a plan document from
scratch. The prototype should offer a variety of contribution,
retirement-age and vesting options.
Find a fund
administrator. Your plan administrator (or trustee) should also help
investigate and select a pension fund administrator. This is the firm that
will help you collect data from your workforce to determine employee
eligibility, as well as handle all contributions and investment earnings.
An administrator should also take care of the recordkeeping and
accounting, prepare
employee and management statements and file all IRS
reports - keeping your plan in compliance with federal and state
regulations.
To play it safe, if your company is leaning toward an
insurance carrier to handle the plan, check such rating services as A.M.
Best Co. Inc., Moody's Investors Services Inc. or Weiss Research. If you
opt to go with an investment company, make sure you are comfortable with
the available investments. out of 35 funds, you may be privy to only five
of them.
Another word to the wise: Scrutinize closely any amendment
costs or withdrawal fees. How much is it going to cost you to change the
plan or switch funds from one company to another? Your company may get
nicked by as much as 6%.
Select a range of investment options. Some of your
employees will want their retirement money to be as safe as possible.
Others will accept some volatility in pursuit of higher returns. Your plan
should accommodate both, offering enough choices to match all employees'
needs and investment objectives.
Seek out a high-quality family, or families, of growth,
income and balanced combination of stocks and bonds) funds. Some employees
may also want a fixed-rate option, which typically can be satisfied by
including a fixed annuity product in your plan. A more sophisticated plan
offers individual stock, bonds and even real estate investment trusts (REITS).
Under the new provisions of ERISA (Section 404C),
participants must be able to choose from at least three diverse investment
alternatives, transfer money between funds at least once every three
months and receive sufficient information from their employers to make
sound investment decisions.
Certainly, pension fund managers who choose to comply with
the rule shouldn't be held liable for participants' bad picks. Still, as
manager, you have a fiduciary obligation to offer reasonable investments.
Whatever products you offer, make sure they are under solid investment
management and can be easily tracked in local newspapers,
Determine matching contributions. At a minimum, you should
plan to match at least 20 cents on the dollar, up to 4% of an employee's
pay. If you aren't going to make the plan enticing, then what's the point?
No matter how popular you predict your plan will be, be very realistic
about the amount of money you can afford to match. Once you make the
commitment, it's set in stone.
Get people to enroll. It's important to get plenty of
people enrolled in your plan. Provide a simple document that makes it easy
for employees to participate. Don't forget to include effective
marketing-payroll stuffers, posters, communications in your company
newsletter, formal meetings and maybe even a videotape to help your
employees and their families understand this important benefit.
Poor enrollment may be the kiss of death for your program.
While the number of employees eligible to participate is more than 40
million today, less than half of those workers participate primarily for
this reason.
If employees aren't well educated about the plan's
features and types of investments, an employer may end up spending more
time trying to fix problems. Despite these obvious, benefits, 401k plans
can be intimidating to companies that haven't pursued this benefit for
their employees. But it doesn't have to be that way. Simply make sure to
seek the help of competent financial and legal advisers.rrp
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401(k)
Plans For Small Businesses
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Why 401(k) Plans?
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401(k) plans can be a powerful tool in promoting financial
security in retirement. They are a valuable option
for businesses considering a retirement plan, providing benefits
to employees and their employers.
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Employers start a 401(k) for a host of reasons.
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§ A well-designed 401(k) plan can help attract and keep
talented employees.
§
It allows participants to decide how much to contribute to
their accounts on a before-tax basis.
§ Employers are entitled to a tax deduction for their
contributions to employees’ accounts.
§ A 401(k) plan benefits a mix of rank-and-file employees and
owner/managers.
§ The money contributed may grow through investments in
stocks, mutual funds, money market funds, savings accounts, and
other investment vehicles.
§ Contributions and earnings generally are not taxed by the
Federal government or by most State governments until they are
distributed.
§
A 401(k) plan may allow participants to take their benefits
with them when they leave the company, easing administrative
burdens.
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This expanded version
of the printed booklet highlights some of a 401(k) plan’s
advantages, some of your options and responsibilities as an employer
operating a 401(k), and the differences among the types of 401(k)
plans. For more information, a list of resources for you and for
prospective 401(k) participants is included at the end of this
booklet.
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Establishing A 401(k)
Plan
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When you establish a
401(k) plan you must take certain basic actions. For instance, one
of your first decisions will be whether to set up the plan yourself
or consult a professional or financial institution – such as a
bank, mutual fund provider, or insurance company – to help you
establish and maintain the plan.
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Initial Actions
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Here are four basic
actions necessary to have a tax-advantaged 401(k) plan:
§
Adopt
A Written Plan
§
Arrange
A Trust Fund For The Plan’s Assets
§
Develop
A Record Keeping System
§
Provide
Plan Information To Participants
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Adopt A Written Plan
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Plans begin with a written
document that serves as the foundation for day-to-day plan
operations. If you have hired someone to help with your plan, that
person likely will provide it. If not, consider obtaining assistance
from a financial institution or retirement plan professional. In
either case, you are bound by the terms of the plan document.
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Before beginning the
plan document, however, you will need to decide on the type of
401(k) plan that is best for you – a traditional 401(k), a safe
harbor 401(k), or a SIMPLE 401(k) plan.
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A traditional 401(k)
plan offers the maximum flexibility of the three types of plans.
Employers have discretion to make contributions on behalf of all
participants, to match
employees’ deferrals, or do both. These contributions can be
subject to a vesting schedule (which provides that an employee’s
right to employer contributions becomes nonforfeitable only after a
period of time). In addition, a traditional 401(k) allows
participants to make pre-tax contributions through payroll
deductions. Annual testing ensures that benefits for rank and file
employees are proportional to benefits for owners/managers.
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A safe harbor 401(k)
plan is similar to a traditional 401(k) plan, but, among other
things, must provide for employer contributions that are fully
vested when made. However, the safe harbor 401(k) is not subject to
many of the complex tax rules that are associated with a traditional
401(k) plan, including annual nondiscrimination testing.
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Both the traditional
and safe harbor plans are for employers of any size and can be
combined with other retirement plans.
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A SIMPLE 401(k) plan
was created so that small businesses could have an effective
cost-efficient way to offer retirement benefits to their employees.
A SIMPLE 401(k) plan is not subject to the annual nondiscrimination
tests that apply to the traditional plans. Similar to a safe harbor
401(k) plan, the employer is required to make employer contributions
that are fully vested. This type of 401(k) plan is available to
employers with 100 or fewer employees who received at least $5000 in
compensation from the employer for the preceding calendar year. In
addition, employees that are covered by a SIMPLE 401(k) plan may not
receive any contributions or benefit accruals under any other plans
of the employer.
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Once your have
decided on the type of plan for your company, you will have
flexibility in choosing some of the plan’s features -- such as
which employees can contribute to the plan and how much. Other
features written into the plan are required by law. For instance,
the plan document must describe how certain key functions are
carried out, such as how contributions are deposited in the plan.
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Arrange A Trust Fund
For The Plan’s Assets
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A plan’s assets
must be held in trust to assure that assets are used solely to
benefit the participants and their beneficiaries. The trust must
have at least one trustee to handle contributions, plan investments,
and distributions to and from the 401(k) plan. Since the financial
integrity of the plan depends on the trustee, this is one of the
most important decisions you will make in establishing a 401(k)
plan. If you set up your plan through insurance contracts, the
contracts do not need to be held in trust.
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Develop A Record
Keeping System
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An accurate record
keeping system helps track the flow of money – contributions,
earnings and losses in participants’ accounts, plan investments,
expenses, and benefit distributions. If you have a contract
administrator or financial institution assist in managing the plan,
that entity typically will help in keeping the required records. In
addition, a record keeping system will help you, your plan
administrator, or financial provider prepare the plan’s annual
return/report that must be filed with the Federal government.
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Provide Plan
Information To Employees
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As you put your
401(k) plan in place, you must notify employees who are eligible to
participate in the plan about your plan’s benefits and
requirements. A summary
plan description or SPD is the primary vehicle to inform
participants and beneficiaries about the plan and how it operates.
The SPD typically is created with the plan document. You will need
to send it to all plan participants. In addition you may want to
provide your employees with information that emphasizes the
advantages of joining your 401(k) plan. Employee perks – such as
pre-tax contributions to a 401(k) plan, employer contributions (if
you choose to make them), and compounded tax-deferred earnings –
help highlight the advantages of participating in the plan.
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Operating A 401(k)
Plan
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Once you have
established a 401(k) plan, you assume certain responsibilities in
operating the plan. If you hired someone to help in setting up your
plan, that arrangement also may have included help in operating the
plan. If not, another important decision will be whether to manage
the plan yourself or hire a professional or financial institution to
take care of some or most aspects of operating the plan. Elements of
a plan that need to be handled include:
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Participation
§
Contributions
§
Vesting
§
Nondiscrimination
§
Investing
401(k) Monies
§
Fiduciary
Responsibilities
§
Disclosing
Plan Information To Participants
§
Reporting
To Government Agencies
§
Distributing
Plan Benefits
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Participation
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Typically, a plan
benefits a mix of rank-and-file employees and owner/managers.
However, some employees may be excluded from a 401(k) plan if they:
§
Have not attained age 21;
§
Have not completed a year of service; or
§
Are covered by a collective bargaining agreement that does
not provide for participation in the plan, if retirement benefits
were the subject of good faith bargaining.
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Employees cannot be
excluded from a plan merely because they are older workers.
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Contributions
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Another design option
you will have in establishing and operating a 401(k) plan is
deciding on your business’s contribution (if any) to
participants’ 401(k) accounts.
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Traditional 401(k)
Plan - If you decide to contribute to your employees’ 401(k)
accounts, you have further options. You can contribute a percentage
of each employee’s compensation to the employee’s account
(called a nonelective contribution), or you can match the amount
your employees decide to contribute (within the limits of current
law) or you can do both.
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For example, you may
decide to add a percentage – say 50 percent – to an employee’s
contribution, which results in a 50-cent increase for every dollar
the employee sets aside. Using a matching contribution formula will
provide additional employer contributions only to employees who make
deferrals to the 401(k) plan. If you choose to make nonelective
contributions, the employer makes a contribution to each eligible
participant’s account, whether or not the participant decides to
make a salary deferral to his or her 401(k) account.
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Under a traditional
401(k) plan, you may have the flexibility of changing the amount of
nonelective contributions each year, according to business
conditions.
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Safe
Harbor
401(k) Plan - Under a safe-harbor plan, you can match each
eligible employee’s contribution, dollar for dollar, up to 3
percent of the employee’s compensation, and 50 cents on the dollar
for the employee’s contribution that exceeds 3 percent, but not 5
percent, of the employee’s compensation. Alternatively, you can
make a nonelective contribution equal to 3 percent of an
employee’s compensation to each eligible employee’s account.
Each year you must make either the matching contributions or the
nonelective contributions.
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SIMPLE 401(k) Plan -
Employer contributions to a SIMPLE 401(k) plan are limited to
either:
§
A dollar-for-dollar matching contribution, up to 3 percent
of pay; or
§
A nonelective contribution of 2 percent of pay for each
eligible employee.
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No other employer
contributions can be made to a SIMPLE 401(k) plan, and employees
cannot participate in any other retirement plan of the employer.
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The maximum amount
that employees can contribute to their SIMPLE 401(k) accounts is
$8,000 in 2003, with annual increases in $1,000 increments until the
limit reaches $10,000 in 2005.
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An additional
catch-up contribution is allowed for employees aged 50 and over. The
additional contribution amount is $1,000 in 2003, with annual
increases in $500 increments until the limit reaches $2,500 in 2006.
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Contribution Limits -
Total employer and employee contributions to all of an employer’s
plans are subject to an overall annual limitation - the lesser of:
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100 percent of the employee’s compensation, or
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$41,000 in 2004.
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$40,000 in 2003.
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In addition, the
amount employees can contribute (elective
deferrals) to their accounts before taxes under a traditional or
safe harbor 401(k) plan is limited to $12,000 in 2003, with annual
increases in $1,000 increments until the limit reaches $15,000 in
2006.
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Traditional and safe
harbor 401(k) plans can allow the following additional catch-up
contributions for employees aged 50 and over:
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2003 - $2,000
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2004 - $3,000
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2005 - $4,000
§
2006 - $5,000
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Vesting
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Employee salary
deferrals are immediately 100 percent vested – that is, the money
that an employee has put aside through salary deferrals cannot be
forfeited. When an employee leaves employment, he/she is entitled to
those deferrals, plus any investment gains (or losses) on their
deferrals.
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In SIMPLE 401(k)
plans and safe harbor 401(k) plans, all required employer
contributions are always 100 percent vested.
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In traditional 401(k)
plans, all employee deferrals are 100 percent vested. You can design
your plan so that employer contributions become vested over time,
according to a vesting schedule.
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Nondiscrimination
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Realizing 401(k) plan
tax benefits requires that plans provide substantive benefits for
rank-and-file employees, not only for business owners and managers.
These requirements are referred to as non-discrimination rules and
cover the level of plan benefits for rank-and-file employees
compared to owners/managers.
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Traditional 401(k)
plans are subject to annual testing to assure that the amount of
contributions made on behalf of rank-and-file employees is
proportional to contributions made on behalf of owners and managers.
Safe harbor 401(k) plans and SIMPLE 401(k) plans are not subject to
annual non-discrimination testing.
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Investing 401(k)
Monies
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After you decide on
the type of 401(k) plan, you can consider the variety of investment
options. One decision you will need to make in designing a plan is
whether to permit your employees to direct the investment of their
accounts or to manage the monies on their behalf. If you choose the
former, you also need to decide what investment options to make
available to the participants. Depending on the plan design you
choose, you may want to hire someone either to determine the
investment options to make available or to manage the plan’s
investments. Continually monitoring the investment options ensures
that your selections remain in the best interests of your plan and
its participants.
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Fiduciary
Responsibilities
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Many of the actions
needed to operate a 401(k) plan involve the use of discretion in
making decisions regarding the plan or exercising control over the
assets of the plan -- whether you hire someone to manage the plan
for you or do some or all of the plan management yourself. Using
discretion in administering and managing the plan or controlling the
plan’s assets makes you or the entity you hire a plan fiduciary to
the extent of that discretion or control. Thus, fiduciary status is
based on the functions performed for the plan, not a title. Be aware
that hiring someone to perform fiduciary functions is itself a
fiduciary act.
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There are a number of
decisions with respect to a plan that are business decisions, rather
than fiduciary decisions. For instance, the decisions to establish a
plan, to include certain features in a plan, to amend a plan and to
terminate a plan are business decisions. When making these
decisions, you are acting on behalf of your business, not the plan,
and therefore, you would not be a fiduciary. However, when you take
steps to implement these decisions, you (or those you hire) are
acting on behalf of the plan and thus, in making decisions, are
acting as fiduciaries.
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Basic
Responsibilities - Those persons or entities that are fiduciaries
are in a position of trust with respect to the participants and
beneficiaries in the plan. The fiduciary’s responsibilities
include:
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Acting for the exclusive purpose of providing benefits to
workers participating in the plan and their beneficiaries and solely
in the interest of those participants and beneficiaries;
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Carrying out duties with the care, skill, prudence, and
diligence of a prudent person familiar with such matters.
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Following the plan documents;
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Diversifying plan investments; and
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Defraying reasonable expenses of the plan.
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These are the
responsibilities that fiduciaries need to keep in mind as they carry
out their duties – whether they are managing the whole plan or
carrying out specific functions. The responsibility to be prudent
covers a wide range of functions needed to operate a plan. And,
since all these functions must be carried out in the same manner as
a prudent person would carry them out, it may be in your best
interest to consult experts in the various fields, such as
investments and accounting.
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In addition, for some
functions, there are specific rules that help guide the fiduciary.
For example, if your plan provides for salary reductions from
employees’ paychecks for contribution to the plan, then these
contributions must be timely deposited. The law states that this
must be accomplished as soon as it is reasonably possible to do so,
but no later than the 15th business day of the month following the
payday. If you can reasonably make the deposits in a shorter time
frame, you need to make the deposits at that time.
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Limiting Liability -
With these responsibilities, there is also some potential liability.
However, there are actions you can take to demonstrate that you
carried out your responsibilities as well as ways to limit your
liability.
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The fiduciary
responsibilities cover the process used to carry out the plan
functions rather than simply the end results. For example, if you or
someone you hire makes the investment decisions for the plan, an
investment does not have to be a “winner” if the fiduciary can
demonstrate it was part of a prudent overall diversified investment
portfolio for the plan. Since a fiduciary needs to carry out
activities through a prudent process, you should document the
decision-making process to demonstrate the rationale behind the
decision at the time it was made.
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In addition to the
steps above, there are other ways to limit potential liability. The
plan can be set up to give participants control of the investments
in their accounts. For participants to have control, they must have
sufficient information on the specifics of their investment options.
If properly executed, this type of plan limits your liability for
the investment decisions made by participants. You can also hire a
service provider or providers to handle some or most of the
fiduciary functions, setting up the agreement so that the person or
entity then assumes liability.
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However, even if you
do hire a financial institution or retirement plan professional to
manage the whole plan, you retain some fiduciary responsibility for
the decision to select and keep that person or entity as the
plan’s service provider. Thus, you should document your selection
process and monitor the services provided to determine if a change
needs to be made.
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Some items to
consider in selecting a plan service provider:
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Information about the firm itself: affiliations, financial
condition, experience with 401(k) plans, and assets under their
control;
§
A description of business practices: how plan assets will
be invested if the firm will manage plan investments or how
participant investment directions will be handled, and proposed fee
structure;
§
Information about the quality of prospective providers: the
identity, experience, and qualifications of the professionals who
will be handling the plan’s account; any recent litigation or
enforcement action that has been taken against the firm; the
firm’s experience or performance record; the firm’s plans (if
any) to work with its affiliates in handling the plan’s account;
and whether the firm has fiduciary liability insurance.
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Once hired, these are
additional actions to take when monitoring a service provider:
§
Review the service provider’s performance;
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Read any reports they provide;
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Check actual fees charged;
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Ask about policies and practices (such as trading,
investment turnover, and proxy voting); and
§
Follow up on participant complaints.
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For more information,
see A
Look at 401(k) Fees for Employers and a sample fee
disclosure form
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Prohibited
Transactions And Exemptions - There are certain transactions that
are prohibited under the law to prevent dealings with parties that
have certain connections to the plan, self-dealing, or conflicts of
interest that could harm the plan. However, there are a number of
exceptions under the law, and additional
exemptions may be granted by the U.S. Department of Labor, where
protections for the plan are in place in conducting the
transactions.
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For example, there is
an exemption that permits you to offer loans to participants through
your plan. If you do, the loan program must be carried out in such a
way that the plan and all other participants are protected. Thus,
the decision with respect to each loan request is treated as a plan
investment and considered accordingly.
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Bonding - Finally,
persons handling plan funds or other plan property generally must be
covered by a fidelity bond to protect the plan against fraud and
dishonesty.
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Disclosing Plan
Information To Participants
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Plan disclosure
documents keep participants informed about the basics of plan
operation, alert them to changes in the plan’s structure and
operations, and provide them a chance to make decisions and take
timely action with respect to their accounts.
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The summary plan
description (SPD) – the basic descriptive document - is a
plain-language explanation of the plan and must be comprehensive
enough to apprise participants of their rights and responsibilities
under the plan. It also informs participants about the features and
what to expect of the plan. Among other things, the SPD must include
information about:
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When and how employees become eligible to participate in
the 401(k) plan;
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The contributions to the plan;
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How long it takes to become vested;
§
When employees are eligible to receive their benefits;
§
How to file a claim for those benefits; and
§
Basic rights participants have under the federal retirement
law, the Employee Retirement Income Security Act (ERISA).
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The SPD should
include an explanation about the administrative expenses that will
be paid by the plan. This document must be given to participants
when they join the plan and to beneficiaries when they first receive
benefits. SPDs must also be redistributed periodically during the
life of the plan.
|
|
A summary of material
modification (SMM) apprises participants of changes made to the plan
or to the information required to be in the SPD. The SMM or an
updated SPD must be automatically furnished to participants within a
specified number of days after the change.
|
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An individual benefit
statement (IBS) shows the total plan benefits earned by a
participant and information on their vested benefits. The IBS must
be provided when a participant submits a written request, but no
more than once in a 12-month period, and automatically to certain
participants who have terminated service with the employer. In
addition, many plans choose to provide on a quarterly basis
individual account statements that show the assets in a
participant’s account, how they are invested, and any increases
(or decreases) in investments during the period covered by the
statement.
|
|
A summary annual
report (SAR) is a narrative of the plan’s annual return/report,
the Form 5500, filed with the Federal government (see Reporting to
Government Agencies for more information). It must be furnished
annually to participants.
|
|
A blackout period
notice gives employees advance notice when a blackout period occurs,
typically when plans change record keepers or investment options, or
when plans add participants due to corporate mergers or
acquisitions. During a blackout period, participants’ rights to
direct investments, take loans, or obtain distributions are
suspended. There are strict rules that apply before and during
blackout periods.
|
|
Reporting To
Government Agencies
|
|
In addition to the
disclosure documents that provide information to participants, plans
must also report certain information to government entities.
|
|
Form 5500-Series -
Plans are required to file an annual return/report with the Federal
government. Depending on the number and type of participants
covered, most employers who have a 401(k) plan must file one of the
two following forms:
§
Form 5500,
Annual Return/Report of Employee Benefit Plan, or
§
Form
5500-EZ, Annual Return of One-Participant (Owners and Spouses)
Retirement Plan
|
|
For 401(k) plans, the
Form 5500 is designed to disclose information about the plan and its
operation to the IRS, the U.S. Department of Labor, plan
participants, and the public.
|
|
Most one-participant
plans (sole proprietor and partnership plans) with total assets of
$100,000 or less are exempt from the annual filing requirement. A
final return/report must be filed when a plan is terminated
regardless of the value of the plan’s assets.
|
|
Form 1099-R - Form
1099-R, Distributions From Pensions, Annuities, Retirement or
Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is given to
both the IRS and recipients of distributions from the plan during
the year. It is used to report distributions (including rollovers)
from a retirement plan. See Form
1099-R and the Form
1099-R and 5498 Instructions for additional information.
|
|
Distributing Plan
Benefits
|
|
Benefits in a 401(k)
plan are dependent on a participant’s account balance at the time
of distribution.
|
|
When participants are
eligible to receive a distribution, they typically can elect to:
§
Take a lump sum distribution of their account,
§
Roll over their account to an IRA or another employer’s
retirement plan, or
§
Purchase an annuity.
|
|
|
|
Terminating A 401(k)
Plan
|
|
Although 401(k) plans
must be established with the intention of being continued
indefinitely, you (as an employer) may terminate your plan when it
no longer suits your business needs. For example, you may want to
establish another type of retirement plan in lieu of the 401(k)
plan.
|
|
Typically, the
process of terminating a 401(k) plan includes amending the plan
document, distributing all assets, and filing a final Form 5500. You
must also notify your employees that the 401(k) plan will be
discontinued. Check with your plan’s financial institution or a
retirement plan professional to see what further action is necessary
to terminate your 401(k). See Form
5310 and the Form
5310 Instructions for additional information.
|
|
|
|
Compliance
|
|
Even with the best
intentions, mistakes in plan operation can still happen. The U.S.
Department of Labor and IRS have correction
programs to help 401(k) plan sponsors correct plan errors,
protect participants and keep the plan’s tax benefits. These
programs are structured to encourage you to correct the errors
early. Having an ongoing review program makes it easier to spot and
correct mistakes in plan operations. See the Resources section for
further information.
|
|
|
|
A 401(k) Checklist
|
|
1.
Have you determined which type of 401(k) plan best suits
your business?
2.
Have you decided whether to make contributions to the plan,
and, if so, whether to make nonelective and/or matching
contributions? (Remember, you can may design your plan so that you
may change your rate of contributions if necessary due to business
conditions.)
3.
Have you decided to hire a financial institution or
retirement plan professional to help with setting up and running the
plan?
4.
Have you adopted a written plan that includes the features
you want to offer, such as whether participants will direct the
investment of their accounts?
5.
Have you notified eligible employees and provided them with
information to help in their decision-making?
6.
Have you arranged a trust fund for the plan assets or will
you set up the plan solely with insurance contracts?
7.
Have you developed a record keeping system?
8.
Are you familiar with the fiduciary responsibilities?
9.
Are you prepared to monitor the plan’s service providers?
10.
Are you familiar with the reporting and disclosure
requirements of a 401(k) plan?
|
Answers To Business
Organizations and 401k
_________________________________________________________
Q: If
Employer A is sold to Employer B, what happens to Employer
A's 401(k) plan?
TOP
A:
Distribution of elective contributions to all participants
is permitted upon termination of a 401(k) plan resulting
from the sale of "substantially all" (at least 85
percent) of the employer's assets. (Employer B may choose to
continue the old plan.) This is also the case if an employer
sells its interest in a subsidiary that employs the plan
participant.
Q: Can a public employer or a nonprofit entity offer a 401(k) plan? -TOP
A: A
state or local government may maintain a 401(k) plan only if
the plan was adopted before
May 7, 1986
; since
that date, state or local governments have been prohibited
from adopting 401(k) plans. Starting in 1997, a nonprofit
employer may institute a 401(k) plan. Prior to 1997,
nonprofits were prohibited from adopting 401(k) plans as of
July 2, 1986
.
Q: Are 401(k) plans appropriate for unincorporated businesses? -TOP
A: Yes.
Unincorporated businesses may use 401(k) plans as a benefit
program for employees. The calculations involved are more
difficult, since the compensation of the self-employed
individual (either a sole proprietor or partner) is reduced
by the contributions made on behalf of common-law employees.
Also, the self-employed individual's compensation must be
reduced by one half of the Social Security contribution (SECA
deduction).
Q: What are the considerations in designing a 401(k) plan for a
partnership? -TOP
A:
Complex rules govern partnerships that adopt 401(k) plans.
In fact, the final regulations under Code Section 401(k)
require that any plan that directly or indirectly permits a
partner to vary the amount of contributions on his or her
behalf will be considered a cash or deferred arrangement.
The implications for a partnership are quite significant:
1. The annual contribution for each partner is subject to
the 401(k) deferral cap of $10,500 (in 2000).
2. For plan years beginning after
December
30, 1997
, matching
contributions on behalf of each partner are no longer
treated as elective deferrals, subject to the 2000 deferral
cap of $10,500.
3. Nondiscrimination testing must be performed.
4. Each partner must be 100 percent vested.
Thus, in
designing a plan for a partnership, it is critical that the
partners decide whether contributions should be variable for
each partner. If contributions will be variable, a 401(k)
plan is the only design available, with the resulting
reduction in total contributions allocable to the partners.
Q: Qualified Separate Lines of Business (QSLOBs) -TOP
A:
Generally, all employees of corporations that are members of
the same controlled group of corporations and all employees
of trades or businesses under common control are treated as
employed by a single employer for purposes of applying
nondiscrimination and other qualification requirements.
Similarly, all employees of members of an affiliated service
group are considered employed by a single employer.
Generally, the minimum participation rules, with respect to
plan years of defined contribution plans beginning before
1997, and the minimum coverage rules (discussed in chapter
10) are applied only after the application of these
controlled group and affiliated service group provisions.
There is an exception to this general rule, however, in the
case of the controlled group rules. If an employer operates
two or more qualified separate lines of business (QSLOBs),
the minimum participation and coverage rules can be applied
separately to each QSLOB.
Q: What is a qualified separate line of business? -TOP
A: A
qualified separate line of business (QSLOB) is a line of
business that is also a separate line of business and that
meets the following requirements:
1.
The separate line of business has 50 employees. [Treas Reg
§ 1.414(r)-4(b)]
2. The
employer notifies the IRS on Form 5310-A that it is applying
the QSLOB rules. [Treas Reg § 1.414(r)-4(c)]
3. The
separate line of business passes administrative scrutiny. [Treas
Reg § 1.414(r)-1(b)(2)]
Q: What is a line of business? -TOP
A: A line
of business (LOB) is a portion of the employer identified by
the property and services sold to customers in the ordinary
course of the conduct of a trade or business. [Treas Reg
§§ 1.414(r)-2(a), 1.414 (r) -2 (b) (2)]
Q: Must
an LOB provide only on type or related types of property and
services? -TOP
A: No.
The employer may combine dissimilar types of property or
services within one LOB. [Treas Reg § 1.414(r)-2(b)(3)(ii)]
Example.
Employer A is a domestic conglomerate engaged in the
manufacture and sale of consumer food and beverage products
and the provision of data processing services to private
industry. Employer A also owns and operates a regional
commuter airline, a professional basketball team, a
pharmaceutical manufacturer, and a leather-tanning company.
Employer A apportions all the property and services it
provides to its customers among three LOBs, one providing
all its consumer food and beverage products, a second
providing all its data processing services, and a third
providing all the other property and services provided to
customers through Employer A's regional commuter airline,
professional basketball team, pharmaceutical manufacturer,
and leather-tanning company. Even though the third LOB
includes dissimilar types of property and services that are
otherwise unrelated to one another, Employer A is permitted
to combine these in a single LOB. Thus Employer A has three
LOBs.
Q: What is a separate line of business? -TOP
A: A
separate line of business (SLOB) is an LOB that is organized
and operated separately from the remaining businesses of the
employer. [Treas Reg § 1.414(r)-3(a)] A SLOB must meet all
four of the following requirements:
1. The
LOB must be formally organized as a separate organizational
unit or group of separate organizational units. An
organizational unit is a corporation, partnership, division,
or other unit having a similar degree of organizational
formality. [Treas Reg § 1.414 (r) -3 (b) (2)
2. The
LOB must be a separate profit center or group of separate
profit centers. [Treas Reg § 1.414(r)-3(b)(3)]
3. The
LOB must have its own, separate workforce. [Treas Reg §
1.414(r)-3(b)(4)]
4. The
LOB must have its own, separate management. [Treas Reg §
1.414(r)-3(b)(5)]
Q: Must
business entities under common control be aggregated as a
single employer when applying the nondiscrimination and
other qualification requirements? -TOP
A: Yes,
provided the entities meet the definition of a controlled
group as set forth in Code Sections 414(b) and 414(c).
Q:
How many kinds of controlled groups are there? -TOP
A: In
general, there are two kinds of controlled groups:
1. A
parent-subsidiary controlled group; and
2. A brother-sister controlled group.
[Treas
Reg §§ 1.414(c)-2(a), 1.1563-1(a)]
Q:
What is a controlling interest? -TOP
A: For a
corporation, a controlling interest means ownership of stock
possessing at least 80 percent of the total combined voting
power of all classes of stock entitled to vote, or at least
80 percent of the total value of shares of all classes of
stock. In the case of a trust or estate, it means ownership
of an actuarial interest of at least 80 percent of the trust
or estate. Finally, in the case of a partnership, a
controlling interest means ownership of at least 80 percent
of the profits or capital interest of the partnership. [Treas
Reg §§ 1.414(c)-2(b)(2), 1.1563-1(a)(2)(i)]
Example.
The ABC Partnership owns stock possessing 80 percent of the
total combined voting power of all the classes of stock of S
Corporation entitled to vote. S Corporation owns 80 percent
of the profits interest in the DEF Partnership. The ABC
Partnership is the common parent of a controlled group
consisting of the ABC Partnership, S Corporation, and the
DEF Partnership. The result would be the same if the ABC
Partnership, rather than S Corporation, owned 80 percent of
the profits interest in the DEF Partnership.
Q:
What
exactly is meant by "non-profits do not deduct their
401(k)contributions"? -TOP
A: The
conventional "for-profit" company pays income tax
based on it's taxable income (the money it takes in, minus
the expenses incurred in conducting it's business).
Contributions to a qualified plan are deductible from the
company's income, meaning that the income subject to
taxation is lowered by the amount contributed to the
qualified retirement plan.
Non-profit
organizations do not pay a tax on their income, because
non-profits are barred from making profits. As a result,
401(k) contributions cannot, de facto, be deducted from a
profit, because the is never a profit to deduct the
contribution expense from.
Q: What
is a successor plan? -TOP
A: For
401(k) plan purposes, a successor plan is any other defined
contribution plan (other than an employee stock ownership
plan or a simplified employee pension plan),
maintained by the same employer, existing when the plan in
question was terminated or within 12 months of the
distribution of all assets from that plan. However, a plan
is not a successor plan if fewer than 2 percent of the
employees eligible to participate in the terminated plan are
(or were) eligible to participate in another defined
contribution plan at any time during the 12 months before or
the 12 months after the termination.
Q: What is the purpose of the controlled group rules? -TOP
A: The
controlled group rules were designed under ERISA to prevent
employers from passing the coverage nondiscrimination test
by hiring highly paid employees to work for only one entity
of a group, placing rank-and-file employees in other
entities, and maintaining pension plans only for the highly
paid employees in the first entity. The nondiscrimination
coverage tests must be applied based on all employees
employed by all entities within a controlled group.
Q: What is an affiliated service group? -TOP
A: An
affiliated service group consists of a combination of an
organization whose principal purpose is to perform
professional services (for example, doctors, dentists or
engineers) and at least one other related organization.
Q: What
is a Related Employer? -TOP
A: This
is an employer that is part of a group of companies under
common control and is a member of a controlled group or an
affiliated service group. You should discuss the
determination of Related Employers with your tax advisor or
legal counsel.
Q: Can a non profit company have a 401(k) plan with profit sharing? -TOP
A: YES
Q: Are there any special ERISA requirements (filings, reports, special
amendments, etc.) for a tax-exempt organization? -TOP
A: NO
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|
401(k)
The 401(k) plan is a type of retirement plan available in the
United States
.
Named after a section of the 1978 Internal Revenue Code, a 401(k) is an
employer-sponsored qualified retirement savings plan. It allows you to
save for your retirement while deferring any immediate income taxes on the
money you save or their respective earnings until withdrawn. Comparable
types of salary-deferral retirement plans include 403(b) plans covering
workers in educational institutions, churches, public hospitals, and
non-profit organizations and 457 plans which cover employees of state and
local governments and certain tax-exempt entities.
401(k) plans must be sponsored by an employer, typically a
private sector corporation, but self employed individuals can set them up
also, and previously government entities could too. The employer acts as a
plan fiduciary and is responsible for creating and designing the plan as
well as selecting and monitoring plan investments. (In practice, nearly
all employers outsource all of this work to a financial services company,
such as a bank, mutual fund, or insurance company.)
The employee elects to have a portion of his salary paid
directly, or "deferred", into his 401(k) account. In
trustee-directed 401(k) plans, the employer appoints trustees who decide
how the plan's assets will be invested. In participant-directed plans (the
most common option), the employee can select from a number of investment
options, usually an assortment of mutual funds that emphasize stocks,
bonds, money market investments, or some mix of the above. Many companies'
401(k) plans also offer the option to purchase the company's stock. The
employee can generally re-allocate his money among these investment
choices at any time.
Some companies match employee contributions to some extent,
paying extra money into the employee's 401(k) account as an incentive for
the employee to save more money for retirement. Alternatively the employer
may make profit sharing contributions into the 401(k) plan. These
contributions may vest over several years as an inducement to the employee
to stay with the employer.
When an employee leaves a job, he can generally keep that
401(k) account active for the rest of his life, if desired, though the
accounts must begin to be drawn out beginning at age 70-1/2. In 2004 some
companies started charging a fee to ex-employees who maintained their
401(k) account with that company. Alternatively, if the employee takes a
new job at a company that also has a 401(k) or other eligible retirement
plan, the employee can "roll over" his account into a new 401(k)
account hosted by the new employer, or into an IRA.
History
The first 401(k) was created in 1980. Originally intended for
executives, during the decade of the 1990s the plan proved popular with
workers at all levels because it offers greater flexibility than
Individual Retirement Accounts (IRAs), with higher yearly contribution
limits than IRAs, and the ability to "roll over" the account
from job to job. Also, 401(k) plans are tax-qualified plans covered by the
Employee Retirement Income Security Act of 1974 (ERISA), so assets held by
the plans are generally protected from creditors. That protection does not
apply to IRA accounts in some states.
Much of the reason for the explosion of 401(k) plans was
because they are cheaper for employers than maintaining a pension for
every retired worker. In most cases, defined contribution plans are less
expensive than defined benefit plans for employers. 401(k) plans also
create a predictable cost for employers while the cost of defined benefit
plans can vary unpredictably from year-to-year.
Tax
benefits and considerations
The employee does not pay federal income taxes on the amount
of current income that he defers to his 401(k) account. For example, a
worker who earns $50,000 in a particular year and defers $3,000 into his
401(k) account that year is federally taxed as though he had earned only
$47,000 in that year, ignoring other deductions. In 2004, this would
represent a near term $750 savings in taxes for a single worker, assuming
he remained in the 25% marginal tax bracket when taking into account other
deductions and adjustments.
Furthermore, all earnings from the investments in a 401(k)
account are not taxed until withdrawn. The resulting compound interest
without taxation can be a major benefit of the 401(k) plan over the years.
The employee finally pays taxes on the money as he withdraws
it, generally after retirement. The taxes are at the "ordinary
income" rate, falling into whatever tax bracket the employee is in at
the time he withdraws the money. The assumption is often made that the
employee will be in a lower tax bracket in retirement, but this assumption
is not always realistic or guaranteed to be correct.
The IRS allows the tax advantage for income deferred into a
401(k), but places the restriction that unless an exception applies, money
must be kept in the plan or an equivalent tax deferred plan until the
employee reaches 59 1/2 years of age. Money that is withdrawn prior to 59
1/2 is typically assessed with a 10% penalty tax immediately unless a
further exception applies.[1] (http://www.irs.gov/publications/p575/ar02.html#d0e3742)
This penalty is of course on top of the "ordinary income" tax
that has to be paid on such a withdrawal. The exceptions to the 10%
penalty include: the employee's death, the employee being totally and
permanently disabled, separation from service in or after the year the
employee reached age 55, substantially equal periodic payments under
section 72(t), a qualified domestic relations order, and for deductible
medical expenses (exceeding the 7.5% floor).
One option for withdrawal from a 401(k) while currently
employed (and before reaching age 59-1/2) is a hardship distribution with
specific hardship rules applying. Hardship withdrawals are subject to the
10% penalty if made before age 59 1/2.
Though the Law may permit it, some plans do not offer many of
the above withdrawal options. For example, some plans do not allow
withdrawals for hardship.
Many plans also allow employees to take loans from their
401(k) to be repaid with after-tax funds at pre-defined interest rates.
The interest proceeds then become part of the 401(k) balance. The loan
itself is not taxable income nor subject to the 10% penalty as long as it
is paid back either before separation from service or immediately upon
separation.
Technical
details
There is a maximum yearly employee salary deferral
contribution. The limit in 2004 is $13,000 for employees under the age of
50. Employees over the age of 50 are now allowed an additional "catch
up" provision of up to $3,000 in 2004. If the employee somehow
contributes more than the maximum to his 401(k) account, she must withdraw
the excess; if this is noticed too late, the employee may have to pay
taxes and penalties on the excess and move it to another type of account.
Plans set up under section 401(k) can also have employer
contributions that (when added to the employee contributions) can exceed
the above limits. The total amount that can be contributed between
employee and employer contributions is the section 415 limit, or the
lesser of the employees compensation or $41,000 for 2004.
Governmental employers in the
US
(that is, federal, state, county, and city governments) are currently
barred from offering 401(k) plans unless they were established before May
1986. Governmental organizations instead can set up a section 457(g).
To help ensure that companies extend their 401(k) plans to
low-paid employees, an IRS rule limits the maximum deferral by the
company's "highly compensated" employees, based on the average
deferral by the company's non highly compensated employees. If the rank
and file saves more for retirement, then the executives are allowed to
save more for retirement. This provision is known as discrimination
testing.
There are a number of "safe harbor" provisions that
can allow a company to avoid the 401(k) discrimination testing. This
includes making a "safe harbor" employer contribution to
employees accounts. Safe harbor contributions can take the form of a match
(generally totalling 4% of Pay) or a non-elective profit sharing (totalling
3% of Pay).
Safe
Harbor
401(k) contributions must be 100% vested at all times.
Additional non-profit websites
that include relevant unbiased information about 401k plans
include: www.internet-401k.com
401(k) plans for certain small businesses or sole
proprietorships
Many self-employed persons felt (and financial advisors
agreed) that 401(k) plans weren't in tune with their needs due to the high
costs, difficult administration, and low contribution limits. But the
Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made
401(k) plans more beneficial to the self-employed. The two key changes
enacted related to the allowable "Employer" deductible
contribution, and the "Individual" IRC-415 contribution limit.
Prior to EGTRRA, the maximum tax-deductible contribution to a
401(k) plan was 15% of eligible pay (reduced by the amount of Salary
Deferrals). Without EGTRRA, an incorporated businessman taking $100,000 in
Compensation would have been limited in Y2004 to a maximum contribution of
$15,000.
EGTRAA raised the deductible limit to 25% of eligible Pay
without reduction for Salary Deferrals. Therefore, that same businessman
in Y2004 can defer $13,000, make a profit sharing contribution of $25,000
(i.e 25%), and - if he's over age 50 - make a catch-up contribution of
$3,000 for a total of $41,000 - the maximum allowed under now higher
IRC-415 limit.
Economic Growth and Tax Reconciliation Act of 2001 (EGTRA)
Issue
|
Current Law
|
EGTRA
|
|
Tax
Credits for New Small Employer Plans
|
An
employer's costs related to the establishment and
maintenance of a retirement plan generally are deductible as
business expenses. However, there is no tax credit for such
expenses.
|
Beginning
in 2002, small businesses with 100 employees or less will be
eligible for an annual tax credit of 50 percent on up to
$1000 of administrative costs for the first three years of a
new plan. The credit is available only if at least one
non-highly compensated employee is participating..
|
|
Participant
Loans for Small Business Owners
|
Generally,
plans may make loans to participants. But, prohibited
transaction rules prevent sole proprietors, partners, and
Subchapter S corporation shareholders from taking
participant loans.
|
The
prohibited transaction rules are modified to allow for
participant loans to sole proprietors, partners, and
Subchapter S corporation shareholders. The provision also
applies prospectively to pre-existing loans.
|
|
Repeal
of the Multiple Use Test
|
In
addition to two nondiscrimination tests (the ADP and ACP
tests), some 401(k) plans must also satisfy the complicated
multiple use test.
|
The
multiple test is repealed.
|
|
Tax
Credits for Lower Income Savers
|
Currently
there is no tax credit for low and moderate income savers.
|
Eligible persons will receive a non-refundable tax credit
of up to 50 percent on up to $2000 in contributions to an
IRA, 401(k), 403(b), SIMPLE, SEP or 457 plan. This credit is
in addition to the tax deduction already associated with
these contributions.
In the case of joint filers, individuals whose adjustable
gross income is less than $30,000 are eligible for a 50
percent credit. Joint filers with adjusted gross income
between $30,000 and 32,500 are eligible for a 20 percent
credit. Joint filers with income between $32,500 and $50,000
are eligible for a 10 percent credit. The income threshold
for single filers is one-half the threshold for joint
filers.
|
|
Catch-up
contributions for Older Workers
|
The
Code limits the amount that can be contributed to a defined
contribution plan on behalf of an employee for any year. In
the case of elective deferrals, the limit is $10,500 per
year. There are no separate limits for older workers.
|
Beginning in 2002, individuals who are age 50 or older
will be allowed to make an additional contribution to a
401(k), 403(b), 457 plan equal to $1,000 in 2002, then
increased by $1,000 each year until $5,000 in 2006, and then
indexed in $500 increments. The catch-up amount for SIMPLE
plans will be one-half of these amounts.
The amount of the catch-up contribution will not be
subject to nondiscrimination testing, provided all
participating employees over age 50 are eligible to make a
catch-up contribution. Also the catch-up contribution will
not count against the employers deduction limit under
section 404, or against the individual's overall 415(c)
dollar limit.
|
|
Modifications
of Top Heavy Rules
|
A plan is generally considered "top heavy" if
more than 60 percent of plan assets are held on behalf of
"key employees." Due to the design of this test,
top heavy rules essentially affect only small business. Key
employees generally include officers earning over half the
Section 415 defined benefit plan dollar limit ($70,000 in
2001), 5 percent owners, 1 percent owners earning over
$150,000, and the 10 employees with the larges ownership
interest in the business (as long as they earn more than
$30,000). Further, family members of 5 percent owners are
deemed to be key employees under family attribution rules.
Top heavy plans must meet a special vesting schedule and
make minimum contributions to all non-key employees to the
extent contributions are made on behalf of key employees.
|
A number of changes have been made here:
·
The definition of "key employee" is modified to delete the
"top 10 owner" rule, provided that an employee
will not be treated as a key employee based on his/her
officer status unless the employee earns more that $130,000,
and to eliminate the 4-year look-back rule for identifying
"key employees."
·
Matching contributions will now count toward satisfying the top heavy
minimums.
·
The matching contributions 401(k) plan safe harbor will be deemed to
satisfy the top heavy rules. This does not mean that an
accompanying profit sharing contribution automatically
satisfies the top heavy rules, although the matching
contributions will count toward otherwise satisfying the
minimum.
·
The 5-year look-back rule applicable to distributions will be
shortened to one year. However, the 5-year look-back rule
will continue to apply to in-service distributions.
·
A frozen top heavy defined benefit plan will no longer be required to
make minimum accruals on behalf of non-key employees.
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Modification
of
Safe
Harbor
Relief for
401(k) Plan Hardship Withdrawals
|
401(k)
plans generally must restrict distributions of amounts
attributable to elective contributions. An exception to this
restriction applies in the case of certain hardship
distributions. Treasury regulations provide a safe harbor
for determining whether a distribution qualifies as a
hardship distribution. To qualify for this safe harbor, a
participant receiving a hardship distribution must be
prohibited from making elective contributions to the plan
for the 12 months following the date of distribution.
|
Treasury
is directed to revise its safe harbor hardship distribution
rules to reduce to 6 months the period of time participants
must be prohibited from making additional elective
contributions. Also, hardship withdrawals under the terms of
the pan will not be treated as eligible rollover
distributions.
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Modifications
to Limits on Retirement Plan Contributions and Benefits
|
Current law limits:
·
401(a)(17): annual compensation taken into account limited to
$170,000.
·
402(g): elective deferrals limited to $10,500 per year.
·
415(b): maximum annual benefits are the lesser of 100 percent of
three-year high salary or $140,000 (or less for pre-65
retirees).
·
415(c): maximum defined contribution plan contribution is the lesser
of $35,000 or 25 percent of compensation.
·
457(b): contribution limit is generally $8,500 per year.
·
SIMPLE: maximum elective deferral is $6,500 per year.
|
Beginning in 2002, the Act raises all of the significant
dollar limits as follows:
·
401(a)(17) compensation limit to $200,000; and then indexed in $5,000
increments.
·
402(g) elective deferral limit to $11,000 in 2002; then increased
$1,000 each year until $15,000 in 2006; and then indexed in
$500 increments.
·
415(b) annual benefit limit to $160,000; and then indexed in $5,000
increments. Note that this provision applies to years ending
after
December 31, 2001
.
·
415(b) annual benefit limit will no longer have to be reduced for
retirements ages 62 through 65. Note that this provision
applies to years ending after
December
31, 2001
.
·
415(c) contribution limit to $40,000, and then indexed in $1,000
increments.
·
457 elective deferral limit to $11,000 in 2000, then increased $1,000
each year until $15,000 in 2006; and then indexed in $500
increments.
·
SIMPLE elective deferral limit to $7,000 in 2002, then increased
$1,000 each year until $10,000 in 2005; and then indexed in
$500 increments.
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Deduction
Limits
|
A
sponsor of a profit sharing plan cannot deduct contributions
to the plan in excess of 15 percent of aggregate employees'
compensation. In the case of a stand-alone money purchase
plan, the deduction limit is the minimum funding requirement
for the plan.
|
The
deduction limit for profit sharing plans is increased to 25
percent of aggregate employees' compensation. Money purchase
plans will be treated as profit sharing plans for purpose of
the 404 deduction limit and thus will be subject to the 25
percent limit.
|
|
Increase
in 25 Percent of Compensation Limitation
|
Under
Section 415(c), total annual contributions to a defined
contribution plan may not exceed the lesser of 25 percent of
compensation or $35,000.
|
The
25 percent of compensation limitation has been increased to
100 percent of compensation. The dollar limitation will
still apply. The provision also repeals the maximum
exclusion allowance applicable to 403(b) plans.
|
|
Repeal
of "Same Desk Rule"
|
Under
the "same desk rule," a distribution to a
terminated employee is not allowed if the employee continues
performing the same functions for a successor employer. The
same desk rule applies to 401(k), 403(b) or 457 plans.
|
The
same desk rule is eliminated by replacing "separation
from service" under Section 401(k)(2)(B) with
"severance from employment." Conforming changes
are also made for 403(b) and 457 plans. The provision
applies to distributions are after
December 31, 2001
, regardless of when the severance from employment
occurred.
|
|
Employers
May Disregard Rollovers for purposes of Cash-Out Amounts
|
Terminated
participants' benefits may be cashed out if the
non-forfeitable present value of such benefits does not
exceed $5,000.
|
A
plan is permitted to ignore amounts attributable to rollover
contributions when determining the cash-out amount.
|
Q-1: Do all states maintain 401(k) and other pension regulations and laws in
synch with federal pension laws?
A: No, not necessarily.
See the following important notice:
IMPORTANT TAX NOTICE
Some states maintain
401(k) and other pension regulations and laws that are not in
synch with federal pension laws. As a result, residents of these
states face the possibility of over-contributing to their 401(k)
plans or making pre-tax distributions that may conform to federal
law, but run afoul of state law.
As of January, 2002
residents of the following states should check with their tax
advisors concerning their state's treatment 401(k) contributions,
IRA rollovers, pre-tax distributions, and the like. This listing
is provided for informational purposes only and is subject to
change without notice; It is important for all 401(k) participants
to be aware of their state's conformity with federal 401(k)
regulations: rrp
Arizona
Arkansas
California
Georgia
Hawaii
Idaho
Indiana
Iowa
Kentucky
Maine
New Jersey
North Carolina
Pennsylvania
South Carolina
West Virginia
Wisconsin
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