The Tools & Techniques of Employee Benefit & Retirement Planning, 14th Edition

Stephan R. Leimberg , John J. McFadden, C. Frederick Reish

• Verlag: The National Underwriter Company
• Jahr: 2015
• ISBN:
  9781941627501
• Thema: Commerce
• Thema: Assurance

The Tools & Techniques of Employee Benefit and Retirement Planning, 14th Edition, applies the trusted "Tools and Techniques" approach to this complex area, making it simple for you to confidently guide your clients through even the most complex employee benefit and retirement planning processes.

SECTION 401(K) PLAN

CHAPTER 19

INTRODUCTION

A Section 401(k) plan (also known as a “cash or deferred arrangement” or CODA) is a qualified profit sharing or stock bonus plan under which plan participants have an option to put money in the plan or receive the same amount as taxable cash compensation. Contributions are permitted of up to $18,000 annually for years beginning in 2015 plus “catch-up contributions” (see below).¹ Amounts contributed to the plan under these options are not taxable to the participants until withdrawn. Aside from features related to the cash or deferred option, a traditional Section 401(k) plan is much like a regular qualified profit sharing plan described in Chapter 22. SIMPLE 401(k) plans and safe harbor 401(k) plans (see the Frequently Asked Questions at the end of this chapter) vary from the traditional arrangements in that each has a funding requirement; however, such plans are exempt from the special ADP nondiscrimination testing that applies to traditional 401(k) plans.

WHEN IS USE OF SUCH A DEVICE INDICATED?

1. When an employer wants to provide a qualified retirement plan for employees but can afford only minimal extra expense beyond existing salary and benefit costs. Traditional 401(k) plans can be funded entirely from employee salary reductions, except for installation and administration costs. In most plans, however, additional direct employer contributions to the plan will enhance its effectiveness. The plan can be adopted for even a single owner-employee (see the Frequently Asked Questions section at the end of this chapter).

2. When an employer is willing to meet a minimal funding requirement for nonhighly compensated employees and wants to maximize the contributions available to highly compensated employees without annual ADP testing. A SIMPLE 401(k) plan or a safe harbor plan (see the Frequently Asked Questions at the end of this chapter) can offer many of the advantages of a traditional plan, without the nondiscrimination testing.

3. When the employee group has one or more of the following characteristics:

• Many would like some choice as to the level of savings—that is, a choice between various levels of current cash compensation and tax deferred savings. A younger, more mobile work force often prefers this option.

• Many employees are relatively young and have substantial time to accumulate retirement savings.

• Many employees are willing to accept a degree of investment risk in their plan accounts in return for the potential benefits of good investment results.

4. When an employer wants an attractive, “savings-type” supplement to its existing defined benefit or other qualified retirement plan. Such a supplement can make the employer’s retirement benefit program attractive to both younger and older employees by providing both security of retirement benefits and the opportunity to increase savings and investment on a tax-deferred basis.

5. When the organization is a private taxpaying or tax-exempt organization. Governmental employers may not adopt Section 401(k) plans.

Advantages

1. As with all qualified plans, a Section 401(k) plan provides a tax-deferred retirement savings medium for employees. Employers can also offer a Roth 401(k) feature, which allows after-tax contributions, with tax-free distributions if certain requirements are met (see the Frequently Asked Questions section at the end of this chapter).

2. A Section 401(k) plan allows employees a degree of choice in the amount they wish to save under the plan. The amounts—both as dollar amounts and as percentages of payroll—that can be contributed to 401(k) plans by employees and employers are scheduled for substantial increases (see the Design Features section further in this chapter).

3. The employer’s deduction for plan contributions is 25 percent of the total payroll of employees covered under the plan. Furthermore, “total payroll” for purposes of the 25 percent limit includes elective deferral amounts. However, the limit itself does not apply to elective deferral amounts. In other words, an employer may contribute and deduct up to 25 percent in addition to elective deferrals.² A higher deduction limit applies to SIMPLE 401(k) plans.

4. Traditional Section 401(k) plans can be funded entirely through salary reductions by employees. As a result, an employer can adopt the plan with no additional cost for employee compensation; the only extra cost is plan installation and administration. The plan may actually result in some savings as a result of lower state or local (but not federal) payroll taxes.

5. In-service withdrawals by employees for certain “hardships” may be permitted; these are not available in qualified pension plans.

Disadvantages

1. As with all defined contribution plans (except target plans), account balances at retirement age may not provide adequate retirement savings for employees who entered the plan at later ages.

2. The annual employee salary reduction under the plan is limited to $18,000 in 2015. (However, employees over age fifty as of the end of the plan year may supplement this amount with “catch-up” contributions of up to $6,000 in 2015, as explained below.) In addition, employers may make matching or nonelective contributions to provide additional tax-deferred savings. For details and scheduled increases of these limits, see “Design Features,” below.

3. Because of the “actual deferral percentage” (ADP) nondiscrimination test described below, a Section 401(k) plan can be relatively costly and complex to administer. Safe harbor 401(k) plans and SIMPLE 401(k) plans are not subject to this test; however, both require that certain funding requirements be met. (See the Frequently Asked Questions section at the end of this chapter for the requirements of each of these plans.)

4. Employees bear investment risk under the plan, both before and after retirement. (However, they can also potentially benefit from good investment results.)

DESIGN FEATURES

Salary Reductions

Section 401(k) plans are generally built around salary reduction contributions elected by employees. Automatic enrollment (formerly called “negative election”) provisions are also permitted; these are plan provisions whereby the employer contributes a specified portion of each employee’s salary to the 401(k) plan unless the employee specifically requests to receive the amount in cash.³

Salary reductions must be elected by employees before compensation is earned—that is, before they render the services for which compensation is paid. Salary reductions elected after compensation is earned are ineffective as a result of the tax doctrine of “constructive receipt.”

The usual practice is to provide plan participants with a salary reduction election form that they must complete before the end of each calendar year. The election specifies how much will be contributed to the plan from each paycheck received for the forthcoming year. Usually the plan will permit the employee to reduce or entirely withdraw the election for pay not yet earned, if circumstances dictate. The plan must restrict each participant’s salary reductions to no more than the annual limits set forth in the Code (see below).

The participant is always 100 percent vested in any salary reductions contributed to the plan and any plan earnings on those salary reductions. Even if a participant leaves employment after a short time, his portion of his plan account attributable to salary reductions cannot be forfeited. Usually plan account balances are distributed in a lump sum when a participant terminates employment.

Salary reductions, as well as any other plan contribution which the employee has the option to receive in cash (referred to as “elective deferrals”), are subject to an annual limit. The limit is a “per employee” rather than a “per plan” limit, and one limit applies to both pre-tax elective contributions and Roth contributions. The employee must add together each year all of his or her elective deferrals from:

• Section 401(k) plans;

• salary reduction SEP...