Pamela Noble

1
Employer Matches Profit Sharing Contributions
Its Not So Easy Anymore

• Presented by
• Pamela Noble
• Noble Davis Consulting , Inc.
• 30275 Bainbridge Road
• Solon, Ohio 44139
• 440-498-8408

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CURRENT IRS CLIMATE

• IRS to issue 1200 401(k) questionnaires in the
  month of May
• Initial step in maximizing guidance and
  enforcement efforts
• There are nearly half a million 401(k) plans in
  America covering over 50 million participants
• Per IRS 401(k) plans are by far the most
  non-compliant plan type in the retirement plan
  universe

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COMPLIANCE

• and limitations set by law
• Subject to annual cost of living increases
• Non-discrimination testing
• Comparison of HCE benefits to NHCE benefits
• Operational compliance with your plan document

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COMPLIANCE AND NON-DISCRIMINATION TESTING

• 1. Annual additions
• 2. Deferral limits
• 3. Compensation limits
• 4. Deduction Limits
• 5. Average deferral percentage test (ADP test)
• 6. Average contribution percentage test (ACP
  test)
• 7. Top Heavy
• 8. 401(a)(4) - allocation of profit sharing
  contribution
• 9. Coverage

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COMPENSATION

• TWO BASIC APPLICATIONS
• Testing Compensation
• Allocation Compensation

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TESTING COMPENSAION

• TWO BASIC DEFINITIONS
• 415 Compensation as defined in an amendment to
  your plan that was effective for the plan year
  beginning on or after July 1, 2007
• 414(s) Compensation starts with 415
  Compensation and allows non-discriminatory
  modifications, such as
• Limiting compensation to date of participation
• Exclusion of elective deferrals
• Exclusion of taxable fringe benefits

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APPLICATION OF 415 COMPENSATION

• Determination of HCEs and Keys
• Determination of top heavy minimums
• Application of annual additions
• Determination of post-severance pay eligible for
  elective deferral contributions

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APPLICATION OF 414(s) COMPENSATION

• Non-Discrimination Testing
• ADP/ACP Testing
• 401(a)(4) Amount of profit sharing contribution

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ALLOCATION COMPENSATION

• Must be stated in the plan document
• Sample permitted modifications
• Recognition of date of participation compensation
• Inclusion or exclusion of elective deferrals
• Exclusion of taxable fringe benefits
• Exclusion of bonus/overtime/commission pay (if
  non-discriminatory)

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SURPRISE RESULTS

• Employer allocates a 4 profit sharing
  contribution on date of participant compensation
• Allocation is in compliance with the plan
  document
• Allocation satisfies 414(s) testing compensation
  so is not discriminatory
• Plan is top heavy
• Non-key employees must receive 3 of total year
  compensation
• So affected non-key employees need to receive an
  additional top heavy contribution

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SURPRISE RESULTS

• Employer allocates a match based on compensation
  that does not include overtime pay
• Allocation is in compliance with the plan
  document
• Allocation does not violate 415 requirements
• Only NHCEs receive overtime so the definition of
  compensation is discriminatory and does not
  satisfy 414(s).
• Allocation compensation may not be used for ACP
  test

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MATCHING CONTRIBUTIONS

• Formula should be discretionary in plan document
  (unless plan is a safe harbor)
• May change formula from year to year (without
  cost of plan amendment)
• May change formula mid-year (without cost of plan
  amendment)
• May decide after the end of the plan year to make
  a contribution
• Still need to comply with verbal commitments made
  to employees
• Hard coded safe harbor match formula
• Modifications require a plan amendment and 30
  day advance participant notice
• Plan then becomes subject to non-discrimination
  testing

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SURPRISE RESULTS

• Plan has allocated a safe harbor match for 6
  years. In the middle of the 7th year the plan
  eliminates the safe harbor match due to economic
  conditions. Proper amendments and notifications
  are processed.
• Allocation is in compliance with plan document
• Plan is now subject to ACP testing which passes
• Owner elected a 5 deferral and the plan is top
  heavy
• Employer is now obligated to make a top heavy
  contribution equal to 3 of non-key compensation
• Safe harbor match does count toward 3 obligation
• Plan document may require a 3 contribution to
  all employees

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MATCHING CONTRIBUTIONS continued

• Should your document require a per pay
  calculation or an annualized calculation?
• Depends on what you are trying to accomplish
• Budgeting your match obligation
• Maximizing the allocation
• Always use a per pay calculation if a payroll
  company is computing your match and you do not
  want to make true-up contributions

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TRUE-UP MATCH CONTRIBUTION

• Payroll company computes the match contribution
  each pay period.
• The match formula is 50 on the first 6 of
  deferrals
• The owner receives a 50,000 bonus on December
  15th and elects to defer 16,500 in one pay
• The owners annual salary is 200.000
• Owners match if a per pay calculation - 1,500
• 50,000 times 6 3,000
• 50 of 3,000 1,500
• Owners match if an annual calculation - 6,000
• 200,000 times 6 12,000
• 50 of 12,000 6,000

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MATCHING CONTRIBUTIONS continued

• Prior year testing versus Current Year Testing
• Prior year testing
• HCE deferrals and match limitations are
  determined based on the NHCE averages from the
  prior year.
• Current year testing
• HCE deferrals and match limitations are
  determined based on the NHCE averages for the
  current year.
• Prior year testing popular with employers because
  it limits end of the year surprises

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SURPRISE RESULTS

• Employer match is discretionary
• Plan document requires prior year testing for
  both the ADP/ACP test
• Employer does not make a match in 2008 due to
  economic conditions
• Employer declares a match for 2009
• Allocation is in compliance with the plan
  document
• ACP prior year testing would completely eliminate
  any 2009 match for the HCEs
• Suggestion modify plan document so ADP is
  tested on prior year data and ACP is tested on
  current year data (if document permits)

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MATCHING CONTRIBUTIONS continued

• Allocation of forfeitures
• Law permits
• Reduce future contributions
• Use to pay administration expenses
• Allocate in the same manner as profit sharing
  contribution
• Document specific
• Forfeitures must be allocated per the document

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SURPRISE RESULTS

• Plan has 25 eligible participants
• Document allocates forfeitures pro rata based on
  compensation
• Currently the plan only has deferral and match
  accounts
• One participant terminates and forfeits 250
• Plan document now requires that the forfeiture be
  allocated between all 25 eligible participants
• Allocation to some participants may be under 5.
• New accounts need to be established for
  participants who never completed an investment
  election form
• Administration fees may be effected

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PROFIT SHARING CONTRIBUTIONS

• Allocation Conditions
• Last day of the plan year and/or 1000 hour
  requirement subject to coverage testing
• If plan document does not contain fail safe
  language must retroactively amend your plan to
  increase participation in allocation

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PROFIT SHARING CONTRIBUTIONS continued

• Definition of allocation compensation
• Taxable fringe benefits to exclude or not
• Examples Personal use of auto or term life
  insurance coverage exceeding 50,000
• Depends on who receives fringe benefits
• If the owners are the only employees receiving
  taxable fringes then including them in
  compensation will only enhance testing and
  provide potentially increased contributions.
• If the employer has ten sales persons whose
  compensation includes personal use of auto, then
  you might want to exclude taxable fringes.

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PROFIT SHARING CONTRIBUTIONS continued

• Determination of allocation compensation
• Who is responsible for determining allocation
  compensation?
• Ultimately the employer
• IRS audits always require copies of W-2 forms
• Important to furnish a year-end payroll report to
  your TPA

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SURPRISE RESULTS

• Employer sends a payroll file every two weeks to
  their TPA. The payroll file does not include YTD
  totals. The TPA computes the 3 safe harbor
  contribution and transmits all contributions to
  the custodian every pay. The payroll provider
  processed multiple corrections during the year.
  The TPA does not request a year-end payroll
  report.
• Most payroll corrections are recorded in YTD
  totals not in current pay totals.
• Consequently, the 3 safe harbor was not
  calculated on total compensation plan
  disqualification if not corrected.
• Employee elective deferrals not paid timely .
  Imputed interest due the plan and employer pays
  excise tax.

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PROFIT SHARING CONTRIBUTIONS continued

• Cross-tested allocations
• Contributions allocated to groups
• Complex testing
• Age sensitive
• Suggestion
• Make everyone their own group (if volume
  submitter document)
• Limit safe harbor contributions to NHCEs

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SURPRISE RESULTS

• 3 safe harbor allocated to all participants
• Cross-tested profit sharing allocation.
• Employer hires twenty-two year old daughter
• Daughter earns 30,000 and defers 1,200.
• Daughter turns out to be the youngest
  participant.
• Allocations are in compliance with the plan
  document
• Elective deferral contributions pass
  non-discrimination testing
• Cross-tested profit sharing allocation is
  seriously impacted because the daughter is an HCE

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PROFIT SHARING CONTRIBUTIONS continued

• When to prefund employer profit sharing
  contributions?
• When the contribution is mandatory
• If allocation is cross-tested, when everyone is
  in their own group

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SURPRISE RESULTS

• Employer sponsors a profit sharing plan
• The participant accounts are participant directed
  on a daily valuation platform
• Employer contributes a discretionary 3 of
  compensation each pay for budgetary reasons
• Employer stops the contribution in the middle of
  2008 for economic reasons
• Plan document requires a pro-rata allocation of
  contribution
• If one terminated employee received 3 of
  compensation, then all employees must receive 3
  of compensation for the entire year

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CONCLUSIONS

• Hire a competent TPA
• Ask questions and have a basic understanding of
  your plan, for example, how many of you know .
• Definition of allocation compensation
• Is the plan top heavy
• Which employees drive the cross-testing

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QUESTIONS?

• Pamela S. Noble
• psn_at_noblepension.com
• 440-498-8408