Types of Plans

• Employee and employer contributions are allowed
• Multiple contribution types (deferrals, profit sharing, match, etc…)
• May apply eligibility requirements
• May apply vesting schedule

• Employee deferrals - $16,500 up to 100% of pay each calendar year
• Employee and employer contributions - $49,000 up to 100% of pay each plan year
• Annual employer contribution deductible is 25% of eligible plan compensation
• If Key Employees (usually 5% owners and highly paid officers) hold at least 60% of the plan assets as of the end of the plan year, then, more than likely, a 3% employer contribution will be required to all Non-Key Employees.
• Highly Compensated Employees (usually 5% owners and those making at least $110,000) may have their deferrals limited, unless the Plan is Safe Harbor (See discussion of Safe Harbor 401(k) Plans below)

• A Plan Document is required
• Government reporting is required
• Employee education is extremely important
• Restrictions on distributions
• Lots of tests must be run to ensure nondiscrimination
• The Plan must have a Fidelity Bond
• The participants must receive a Summary Plan Description upon entering the Plan and a Summary Annual Report each year

1. Employer Match – The employer must match dollar-for-dollar on the first 3% of deferred compensation and $.50 on the dollar on the next 2% of deferred compensation. In other words, if a participant defers 5%, he or she would receive a match equal to 4%. If the participant defers only 3%, then he or she would receive a match equal to 3%. An “Enhanced Match” may be offered that is equal to or greater than the match discussed above. Limitations to the “Enhanced Match” apply. Ask us what they are.
2. Employer Nonelective Contribution – The employer must make a contribution of 3% of each eligible participant’s compensation. This contribution is required even if the participant does not defer.

• 100% fully vested
• not subject to additional eligibility requirements – if the participant is eligible to defer then he or she must receive the contribution. Exceptions may be made for highly-compensated employees.
• subject to an annual election that must be provided to the eligible participants

• Automatically satisfies nondiscrimination testing
• Provides an immediate benefit to employees
• Nonelective contribution automatically satisfies Top Heavy requirement

• Plan Document must allow for it
• Annual Notice is required
• Additional restrictions on distribution of Safe Harbor money
• Must give 30 days notice before stopping match within the plan year. Plan must still pass testing.
• Nonelective contribution is required for the full plan year once Notice is provided to participants. Notice must be given between 30 – 90 days prior to the beginning of the plan year.
• A Safe Harbor “Maybe” Notice may be provided between 30 – 90 days prior to the beginning of the plan year. This allows an employer to meet the Safe Harbor requirements without fully committing. Final Notice must be given 30 – 90 days prior to the end of the plan year.

• Many employees want a vehicle provided for them to save for retirement
• However, they still want to have a certain amount of control over their retirement savings.
• Concern over complexity of required testing
• Concern over education and fiduciary liability The 401(k) feature of a profit sharing plan allows owner-participants to defer a portion of the total amount they receive, instead of sharing it in an allocation with the rest of the participants. The profit sharing formulas available are varied and offer great flexibility in designing the best plan possible. Some of the most common profit sharing formulas are listed below:
• Pro-rata – good for large employers who wish to benefit all participants equally
• Integrated – good for employers who wish to offer an additional benefit to those who make more than a certain level of compensation; usually the Taxable Wage Base or a fraction thereof.
• Age or Service-Weighted – good for employers who wish to benefit older participants or those with more years of service.
• Cross-Tested – good for employers who wish to benefit particular participants or groups of participants while providing a minimum contribution to the non-highly compensated employees (non-owner participants who make less than $110,000) Cross-Tested plans are ideal for many employers who are looking to provide certain employees (the owner, owner’s family, certain management, etc…) with the maximum qualified retirement plan benefit - $49,000 in 2010 (and 2011). Below is an example of how that’s done:

1. Definition - Converting contributions to a defined contribution plan into an actuarially equivalent life annuity payable at age 65. In other words, providing a contribution that is tested on the number of years until retirement (age 65). The idea is that the average age of highly compensated employees is generally greater than the average age of non-highly compensated employees. Therefore, you can provide a higher rate of contribution to the highly compensated employees because they have fewer years until retirement.
2. It is a hybrid of a defined contribution plan and a defined benefit plan. Some defined benefit plans are contributory. A cross-tested plan is a defined contribution plan that does not have a defined benefit. However, it is tested like a defined benefit plan.
3. Based upon the time value of money – compounding interest. For example, a Non-Highly Compensated Employee (NHCE) at age 25 receives 5% of pay with 40 years until Normal Retirement Age – 65. A Highly Compensated Employee (HCE) at age 50 receives 15% of pay, but has only 15 years until age 65. Who is really receiving the greater retirement plan benefit at normal retirement age?
4. The Plan passes the testing if the theoretical future values of the NHCE group(s) equal or exceed 70% of the HCE group(s).
5. IRC 401(a)(4) states that plans may not discriminate in favor of HCE. However, a plan can discriminate against an HCE.

1. Maximize contributions to HCEs. These HCEs are typically
   a. Owners
   b. Physicians or dentists
   c. Executives
   d. Any other employee with wages greater than $110,000 a year
2. Minimize the total funding cost to the employer
   a. Integrated plans that maximize the contributions to the owner, typically provide benefits equal to 12%-15% of pay to the employees.
   b. Cross-tested plans typically provide a benefit of 4%-5%.
   c. That’s a lot of money that may be used to purchase health insurance, add part-time staff, buy equipment, provide bonuses, or stay in the owner’s pocket.
3. Provide an opportunity to discriminate between different HCEs or HCE groups. For example, a plan may provide an “Orthopaedic Surgeon” with a greater benefit than a “Non-Orthopaedic Surgeon”.

1. Older HCEs
2. Younger NHCEs
3. Preferably both
4. Desire to save significantly – generally good for owners who wish to save the maximum each year. However, this can work well for owners who wish to provide only a modest benefit.
5. Desire to benefit particular groups – “Practice Administrator”, “Commission Only Marketers”, “Managers” etc…
6. Desire to have additional qualified retirement plans, such as a Cash Balance plan. A Cash Balance Plan is a type of defined benefit pension plan.
   a. Cross-tested plans and cash balance plans are tested together. An actuary is required to calculate the contribution for a cash balance plan.
   b. Tremendous tax deferral opportunity for the owner – typically provides a benefit of $50,000 - $60,000 in the cash balance plan and at least $49,000 in the cross-tested plan. About $100,000 tax-deferred and held in trust.
   c. Requires a large amount of available cash to meet the funding requirements
   d. Additional benefit to employees – two plans are better than one.

1. Establish “Rate Groups”. For example,
   a. Owner Physicians and their Spouses (HCEs)
   b. Non-Owner Physicians (HCEs)
   c. All Other Employees (NHCEs)
2. Determine how much each rate group is to receive:
   a. IRC Section 415 maximum
   b. 10% of pay
   c. 5% of pay
3. Allocate a contribution based upon these groups’ percentages
4. Perform all required tests
5. If tests do not pass, then
   a. Decrease some or all of the HCE rate groups percentage
   b. Increase the NHCE rate group percentage
6. Rate groups may contain both HCEs and NHCEs

1. All NHCEs must receive a contribution that is at least 1/3 of the percentage that the highest HCE receives OR
2. All NHCEs receives at least 5% of pay

1. Either a Volume Submitter or individually designed document
2. This is an IRS requirement. A prototype document with an amendment is not sufficient. It could disqualify the Plan or cause it to be an individually designed document.
3. Submission to IRS is required for individually designed documents
4. Submission to IRS is advised for Volume Submitters
   a. Rate groups - $125 fee – this will provide assurance that the rate groups are not discriminatory and acceptable as worded.
   b. Calculation - $1,000 fee – this will provide assurance that the calculation for one specific year with specific data will satisfy the Cross-Testing requirements. If data, rate groups, or amount to rate groups change then the calculation is no longer valid.
5. Do not get fancy with Rate Groups – “Brown-eyed men over age 50” is not acceptable.
6. Do not be too general with Rate Groups – A medical practice wants to benefit the owner physicians in the highest rate group. Name the Rate Group “Owners” or “Owner Physicians”. Naming the Rate Group “Doctors” would include a receptionist who has a doctorate in Theology.
7. Stick with Rate Groups – do not change at random. Such a change would require restatement and should be resubmitted to the IRS.

1. The owner’s deferral reduces the amount of the profit sharing contribution necessary to get him to the maximum. In other words, the owner gets a deferral of $16,500 in 2010 (and 2011) without having to share it in a an allocation with the other employees.
2. Most such 401(k) plans ADP/ACP testing. Therefore, plan should use the 3% Safe Harbor Nonelective Contribution (SHNEC).
3. The SHNEC is used to help satisfy the Gateway requirement.
4. Safe Harbor Match may not be used to help satisfy Gateway.
5. Examples of possible plan types used with cross-testing:
   a. Profit Sharing only
   1) Besides cross-testing, there are no testing issues, except possibly Top Heavy if employees do not receive at least 3% of full year compensation.
   2) However, 100% of owners’ allocation is shared with NHCEs
   b. Profit Sharing with 401(k)
   1) Must still pass ADP non-discrimination testing
   2) Match adds to cost
   3) Portion of owners’ allocation not shared with NHCE
   c. Profit Sharing with 401(k) SHNEC
   1) Portion of profit sharing contribution is fully vested
   2) Match adds to cost
   3) Satisfies all testing
   4) The least expensive option
   5) The most effective at benefiting the owners, while providing a good benefit to the NHCEs.
   6) One drawback – if a participant receives the SHNEC, then he must also receive the full Gateway required minimum contribution.
6. Keep it simple. The more elaborate the design, the greater the chance for error. Trying to skirt the requirements could be detrimental to the Plan’s qualified status.

1. Why a DB Plan?
   a. A cash balance plan is a DB plan that looks like a DC plan. Legally it is a DB plan. Therefore the DB limits apply – i.e. the annual contribution on behalf of any participant is not limited to $46,000. Instead, the ultimate retirement benefit cannot exceed the DB limit indicated above (i.e., the lump sum amount cannot exceed approximately $2.0 million at age 62).
   b. In a cash balance plan a “theoretical” account balance (or “TAB”) is maintained on behalf of each participant. On an annual basis the TAB is credited with a “pay credit” and an “earnings credit.” The pay credit can be a flat dollar amount or a percentage of pay and can vary by employee (again, the pay credit is not limited to the annual DC limit). The earnings credit is normally based on an index of 30-year U.S. Treasuries (or other rate prescribed by the IRS – the 30 year Treasury rate is the currently prescribed rate).
   c. The plan is a DB plan because the pay credit and the earnings credit are guaranteed to the employee. That is, the amount that the employee will receive at retirement is defined. As the sum of the pay credits and earnings credits to the employee’s TAB while participating in the plan. If the plan earns more or less than the earnings credit, future contributions are either increased or decreased to reflect the positive or negative, but the participants’ account balances are not affected by favorable or unfavorable investment of plan assets. Only the amount required to be contributed by the employer is affected.
   
   Earnings Credit Rate: Why We Use the IRS Rate.
   a. It is dangerous to use an earnings credit rate other than the IRS-prescribed rate (again, currently the 30-year U.S. Treasury rate). This is due to what is referred to as a “whipsaw” effect that would grant to employees a bigger lump sum benefit than what shows as their TAB.
   b. As indicated above, a cash balance plan is a defined benefit plan. The law says that when cashing out defined benefit plan participants, the lump sum cash out at any age must be the “present value” of the amount payable at retirement age (generally age 65).
   c. When determining the amount payable at retirement age, the benefit earned to date (i.e., the current hypothetical account balance) must be projected out to the retirement age based on the plan’s interest crediting rate. When determining the present value of this projected retirement benefit we must discount the projected benefit by using the rate prescribed by the IRS.
   

   Example: Assume that the plan credits a participant’s account with an earnings credit of 8%. Further presume that the rate prescribed by the IRS is 5.5%, and the retirement age under the plan is 65. Take a 35-year-old participant who has a hypothetical account balance of $2,500. At 8%, $2,500 will grow to $25,157 at age 65 (this assumes no further contributions, just the interest at 8% on the $2,500). To cash this person out at age 35, the plan must pay the present value of this amount. However, when determining the present value, the law says we must discount back at the rate prescribed by the IRS (i.e., currently the 30-year U.S. Treasury rate at 5.5% in this example). $25,157 discounted back 30 years at 5.5% is $5,048. The difference in the interest rate effectively doubled this person’s payout amount from $2,500 to $5,048 (this is the “whipsaw” effect).
   1.) Contrast this to a plan that credits interest at the IRS-prescribed interest rate. At 5.5% the $2,500 will be worth $12,460 in 30 years. Discounting this amount back at 5.5% yields a present value of $2,500, which exactly equals the participant’s TAB. This works because we are projecting forward and discounting back at the same rate. Accordingly, to avoid the possibility of having to pay any amount greater than a participant’s TAB, we use the IRS prescribed rate (the 30-year Treasury rate).
   2.) Note also that the benefit to be paid from a DB plan comes from a single pool of assets. Therefore, the investments in a defined benefit plan may not be tracked separately for any one participant. That is, you may not have a separate investment account for each participant where the participant is entitled to the results of that account.
   3.) Note also that we are permitted under IRS nondiscrimination regulations to provide for greater levels of cash balance benefit and employer DC plan contributions on behalf of the principals, compared to what are provided for the other employees. Basically, we treat the two plans (i.e. the DC plan and the DB plan) as single plan to demonstrate to IRS that we meet the nondiscrimination rules. We then show that the benefit levels that the principals will receive at retirement are similar to those that the non-principals will receive. There are very complex formulas that we go through to prove this lack of discrimination, and this is another factor that dictates just how large a benefit (and, therefore, how large a tax deductible contribution) can be provided.

• Administratively complex – Don’t worry. That’s why you call on us.
• Expensive – no more expensive than the benefits it provides
• Erratic funded requirements – this is because some of the funding is based upon the investment returns of the plan assets.

• Opportunity for some to receive annual benefits of greater than $46,000
• Provides a stable and definite benefit – no stock market fluctuations
• Unlike 401(k) plans, they are insured by the Pension Benefit Guarantee Corporation
• May be combined with a 401(k) Plan to offer total benefits much greater than the $46,000 maximum in a 401(k) Profit Sharing Plan.

• Only for use by educational institutions and certain not-for-profits
• Investment options are usually more limited
• A Special “Catch-Up” Contribution allows participants to increase their annual deferral by $3,000 to $16,000. To qualify, participants must have completed at least 15 years of service with the same employer. Usually, contributions may not exceed $3,000 per year, up to a $15,000 lifetime maximum.

• May be used in conjunction with a 401(k) or 457 Plan. This depends upon how the employer is organized. Consult an attorney to see if this option is available for you.
• Do not have as many testing requirements to satisfy
• Rollovers are allowed to 401(k) and 457 plans

• Only for use by certain governmental or private tax-exempt organizations
• State law governs eligibility
• Employer contributions are not allowed. However, they may be made in another qualified plan known as a 401(a) Plan.
• Just like a 403(b), a Special “Catch-Up” Contribution allows participants to increase their annual deferral by $3,000 to $16,000. To qualify, participants must have completed at least 15 years of service with the same employer. Usually, contributions may not exceed $3,000 per year, up to a $15,000 lifetime maximum.
• Nondiscrimination rules do not apply
• 457 Plans for tax-exempt entities are covered by ERISA
• Tax-exempt entities may establish a 457 Plan to benefit only certain highly paid employees. This is known as a “Top Hat” Plan. Such a plan is exempt from certain ERISA requirements, such as funding.
• Trustee is not required. However, plan assets for governmental plans must be held in trust for the exclusive benefit of plan participants.

• May be used in conjunction with a 401(k) or 403(b) Plan. This depends upon how the employer is organized. Consult an attorney to see if this option is available for you.
• Rollovers are allowed to 401(k) and 403(b) plans
• No loans are available
• If plan assets are not held in trust, then the participant does not have the same guarantees that a participant in a qualified plan – 401(k) or 403(b) – has.

• Deferred Compensation Plans
• Supplemental Employee Retirement Plans
• Supplemental Executive Retirement Plans
• Supplemental Excess Retirement Plans
• Top Hat Plans

• To induce a particularly valuable employee to remain for a specific number of years.
• The principals of an employer may want to defer compensation above the limits allowed under a qualified retirement plan. Such plan is usually referred to as an “Excess” or “Top Hat” Plan.

• A “nonqualified" plan does not get as many tax breaks as regular pension plans
• They are primarily beneficial only to C-corporations
• Most importantly, under a nonqualified plan the employer's business income tax deduction is also deferred. The business is not entitled to a deduction for the deferred compensation until the funds are available to the recipient, which could be years away.
• Participants are considered general creditors of the corporation. If the corporation declares bankruptcy, then the participant may not receive all, if any, of the benefit promised.