NEWSLETTERS

Do Your Plan Provisions Meet Your Retirement Needs?

Plan sponsors have many decisions in setting up and maintaining a retirement plan.  Plan design is paramount to plan success.  Each provision is important and should be carefully considered.  Plan sponsors should consider reviewing their plan provisions after reading this article.  Plan provisions can be changed by amending the plan. 

According to IRS Revenue Procedure 2002-73, the GUST remedial amendment period for pre-approved plans ends on September 30, 2003, or twelve months after the IRS issues a GUST opinion or advisory letter for the pre-approved plan. Administrative Retirement Services, Inc. (ARS) plan documents were approved on September 18, 2001, so all of our clients will be restated by September 30, 2003.  

Since ARS has recently or will soon be restating your plan, this article is devoted to explaining plan document provisions.  Whether restating your plan for current tax law changes or setting up a new plan, this newsletter will explain the various types of document and plan provisions that can be adopted, how they impact the day to day operation of the plan and how they affect the annual administration. 

Document Types
There are three types of documents plan sponsors can use: standardized prototype, non-standardized prototype and volume submitter. Document selection depends on your plan objectives.  The cost varies between these documents with standardized prototype being the least expensive and volume submitter documents being the most expensive.

Standardized and non-standardized prototypes are pre-approved by the IRS and use adoption agreements which are one to sixty page documents where specific plan provisions are selected from several different options. 

Although prototype plans are pre-approved by the IRS, users of non-standardized prototype plans can and should submit their plans to IRS for a separate IRS Letter of Determination. 

Standardized Prototypes
Standardized prototypes (SP) are used for typical retirement plans.  SP provides the plan sponsor with all of the necessary plan provisions to have a qualified plan, but limits the plan sponsor’s flexibility in defining the employer contributions and compensation. 

Non-Standardized Prototypes
Non-standardized prototypes (NSP) are used when plan sponsors want to  exclude a certain class of employee, change the definition of compensation, set up plan sponsor defined classes for employer contribution purposes or require that participants are employed on the last day of the plan year or work a certain number of hours during the year in order to receive an employer contribution. 

·     Plan sponsors can exclude a certain class of employees such as non-union employees, hourly or salaried employees, or a specific division of the company.  When excluding employees, plan sponsors must pass coverage testing under Internal Revenue Code section 410(b), which requires that 70% of non-highly compensated employees benefit under the plan or the plan pass an average benefits test.      

·     Plan sponsors can change the definition of compensation and exclude certain compensation such as overtime, bonuses, commission, etc.  Note that top heavy, safe harbor and SIMPLE plans must include all compensation for required employer contributions. 

·     Requiring that participants be employed on the last day of the plan year or work a certain number of hours during the year are the most common reasons for using a non-standardized plan document.  These provisions allow plan sponsors to exclude employees from employer contributions who either quit  or are terminated or work less than a certain number of hours during the plan year.  This provision cannot always be enforced by small plan sponsors due to the requirements of coverage testing.

Volume Submitter Document
Volume Submitter Document (VSD) is a more customized document that accomplishes all the same things as a NSP, plus it allows more entry date options and after tax contributions.  As of this restatement period, ARS is only using VSD when we cannot use a NSP.

PLAN PROVISIONS
Below and on the following pages, we discuss the most important provisions a plan sponsor should be familiar with. After reviewing, should your plan need to be amended, please contact ARS and we’ll be happy to assist you in any changes your plan may require.

Plan Name:  Plan sponsors have flexibility in choosing a plan name.  We recommend the name be as descriptive as possible.  When naming a plan which has a 401(k) plan that normally contributes profit sharing contributions, we might suggest: The Company Name 401(k) Profit Sharing Plan.

Plan Year End:  Plan sponsors can select any date as the plan year end.  We recommend that the plan year end be the same as the company year end in order to simplify contribution determination.  Calendar year plans simplify census reporting since year end payroll data provides both compensation and 401(k) contributions.

Effective Date:  The effective date of the plan is commonly the first day of the plan year in which the plan is adopted.  This allows plan sponsors to easily count compensation for employer contributions.  In some instances, companies may select a specific month to begin the plan and do not want to count full year compensation.

Trustees:  Plan trustees are individuals who are responsible for processing distributions and loans & managing and controlling plan assets.  We recommend naming more than one trustee so that trustee functions can continue in a trustee’s absence.  There are firms which exist who will act as trustee of a plan for a fee.  They purport to limit liability, but can a decision maker truly limit exposure? 

Plan Number:  Retirement plan numbering begins with 001 and each new successive plan is assigned the next number, such as 002, 003, etc.

Eligible Employees:  Plan sponsors can select who is considered an eligible employee.  Typically, plan sponsors exclude union members and nonresident aliens.  Plan sponsors that employ union members normally set up a separate plan for union members.  This allows different contribution formulas for non-union and union employees and avoids nondiscrimination test failures in situations where union employee contributions are low.

Eligibility Requirements:  Eligibility requirements are paramount in plan design and should be based on the company’s benefits objectives.  Plan sponsors have discretion in determining the eligibility requirements.  Some age and service requirements are often defined.  The most restrictive, and most common, eligibility requirements for 401(k) plans are attainment of age 21 and 1,000 hours of service during a 12-month eligibility computation period.

Date of Entry: Once a participant meets the eligibility requirements, plan sponsors can select date of satisfaction, monthly, quarterly or semiannually as the date of entry into the plan.  Entry dates are also frequently used for 401(k) election changes.  401(k) plans that have eligibility of age 21 and one year of service must have at least semiannual entry dates.

Compensation:   Most plans use Wages, Tips and Other Compensation Box (Box 1) on Form W-2 or Code Section 415(c)(3) compensation.  If defined as W-2 wages, cafeteria plan, transportation and 401(k) deferrals should be added to the definition.  Code Section 415 compensation is basically gross compensation for most small companies

If a non-standardized document is used, compensation can also exclude any or all of the following: overtime, commissions, bonuses. 

Compensation for the year an employee becomes eligible for the plan can be for the entire 12 month plan year or for only the part of the year from the participant’s entry date. 

Compensation from the entry date can improve the discrimination testing percentages and can mean lower employer contributions for the year.  The disadvantage is that the compensation from the entry date must be calculated and provided to ARS for testing purposes. 

If a plan is top heavy, code section 415 compensation for the entire plan year must be used to allocated top heavy contributions.  Generally, code section 415 compensation is used for safe harbor and SIMPLE plans.

Profit Sharing Contribution:  Typically a percentage of each participant’s compensation as defined in the plan.  We recommend that plan sponsors make this contribution discretionary so that it can be determined each year.  This contribution can be allocated proportionate to salary, integrated with social security or a flat dollar amount. 

Integrated with social security means that participants who earn more than social security wage base can receive an extra contribution based on the wages above the base.  The contribution can also be a certain dollar amount per hour of service or a flat dollar amount per participant. 

Cross Testing: Allows plan sponsors to set up plan sponsor defined classes of employees and contribute a specific percentage per class subject to an average benefits test.

Plan sponsors must pass an IRS gateway which requires that a plan satisfy a minimum allocation gateway where either:

·     each NHCE (Non-highly Compensated Employee) in the plan has an allocation rate that is at least one third of the allocation rate of the HCE (Highly Compensated Employee) with the highest allocation rate.

OR

·     each NHCE receives an allocation of at least 5% of the NHCE's compensation (within the meaning of section 415(c)(3).

If a non-standardized document is used, the plan sponsor can limit the contribution to participants who complete a certain number of hours during the year (not to exceed 1,000 hours) or can limit it to participants employed at the end of the year.  However, certain tests must be passed to use these limiting requirements.

Match Contribution:  Allocated to participants who make a salary deferral contribution.  The formula can be stated in the plan or it can be discretionary each year.  We recommend making the match discretionary so that it can be changed each year based on business conditions. 

The match is usually a percentage of each employee’s salary deferrals. The salary deferrals which are matched may be limited to a percentage of the participant’s compensation.

The same allocation requirements and limitations which apply to the profit sharing contributions (see profit sharing contribution definition) may also be used for match contributions.  Match contributions may be calculated and deposited each payroll period or at the end of the year.

Discrimination Testing Method:  Current year percentages or prior year percentages may be used for the discrimination testing.  Once a method is chosen, it can only be changed under certain circumstances. 

The current year method uses the contributions and compensation from the plan year being tested for all eligible employees. 

The prior year method uses the contributions and compensation for the NHCEs from the year prior to the year being tested. 

The contributions and compensation from the current year are still used for the HCEs.  Plan sponsors use either of these methods based on different factors.  If the plan has problems passing the discrimination testing and wants to avoid refunds to HCEs, the plan sponsor may consider using the prior year method.  This method allows the plan sponsor to predict the contributions which the highly compensated employees may make as a group in order to pass the discrimination testing.

Safe Harbor 401(k) Plan: Plan sponsors contribute either 3% of compensation to all eligible participants or match 100% of the first 3% and 50% of the next 2% of employee contributions. Both contributions are 100% vested immediately. Safe Harbor plans automatically pass nondiscrimination testing.  Many Safe Harbor plans are also considered not to be top heavy.

Vesting:  Percentage of profit sharing and match accounts which the participant receives when requesting a distribution based on years of service with the plan sponsor. 

A year of service is usually defined as 1,000 hours of service within a plan year.  Many different vesting schedules can be used.  The most common ones are: (1)  20% vested after two years of service and then 20% each year thereafter until 100% vesting after six years or (2) 100% vested after three years of service and 0% vested for prior years.  The plan sponsor can also choose to exclude years of service before age 18 or years before the effective date of the plan.

Loans:  Participants may be allowed to receive loans from their account balances.  In most cases, the maximum loan which can be requested is the lesser of  50% of the participant’s vested balance or $50,000.  The minimum loan which can be requested is usually $1,000, but a lower minimum can be used. 

The interest rate must be reasonable in relation to the rate that a local financial institution would charge for a similar loan.  The prime rate plus one percent is commonly used. 

The plan sponsor may also limit the number of loans which may be outstanding at one time to each participant.  We recommend a minimum loan amount of $1,000 and a limit of one or two outstanding loans at a time to ease the administrative burden and the cost to the plan sponsor. 

Loans are repaid by withholding after-tax amounts from the participant’s wages each payroll period.

Forfeitures:  Non-vested amounts from terminated participants accounts.  Forfeitures are usually determined at the earlier of the last day of the year a participant receives a distribution or the last day of the 5^th consecutive year after termination from employment.  Forfeitures can be used to pay expenses of the plan, to reduce the plan sponsor contributions or to be reallocated to participants. 

We recommend that the plan sponsor use forfeitures to pay plan expenses and to reduce the cost of the plan sponsor contributions.

Distribution Types:  Withdrawals from plans may be paid as one lump sum, in installments or as different types of annuities. 

We recommend that plan sponsors use only lump sums for administrative ease and to lower administrative costs.  If a participant wants an annuity or installments, the participant can rollover the lump sum to an IRA and withdraw their money from the IRA using these methods.

In-Service Distributions: The plan sponsor can allow participants to withdraw all or a portion of their accounts before termination from employment if certain requirements are met.  Salary deferral accounts can not be withdrawn, except for Hardship distributions (see Hardship Distribution definition), before the participant has attained the age of 59 ½. 

If allowed by the plan sponsor, certain employer contribution accounts can be withdrawn if the amounts have been allocated to the participant for two years, if the employee has been a participant for at least five years, if the participant has attained a certain age, and lastly, on account of Hardship.  Many plans do not allow In Service distributions until the participant reaches Normal Retirement Age (see Normal Retirement Age definition) in order to simplify these requirements.

Hardship Distributions: Hardship distributions allow employees to receive an in-service distribution for the following reasons:

·     For the payment of expenses for medical care previously incurred or necessary to obtain medical care for a     participant’s family.

·     The purchase of a principal residence (excluding mortgage payments).

·     The payment of tuition and related education fees, including room and board, for the next 12 months of post secondary education for a participant’s family.

·     The prevention of foreclosure on or eviction from a principal residence.

Most 401(k) plans only allow hardship distribution from an employee’s aggregate amount of elective deferrals.  Some plans allow hardship distribution from other accounts.  The other accounts are subject to various rules.

To receive the hardship distribution the following requirements must be satisfied:

·     The distribution is not in excess of the immediate financial need plus the amount necessary to pay any related federal, state, or local taxes or penalties.

·     The participant has previously obtained all distributions and nontaxable loans available under all retirement plans maintained by the plan sponsor.

·     The participant is not allowed to make any salary reduction contributions [or voluntary contributions] to any qualified or non-qualified plans maintained by the company (other than a health or welfare benefit plan or defined benefit plan requiring mandatory employee contributions) for at least six months after the participant receives the hardship withdrawal.

Normal Retirement Age: A participant becomes 100% vested upon attainment of normal retirement age and can begin taking normal distributions if allowed by the plan.  A common retirement age is age 65.  

Early Retirement Age: The date participants can elect an early retirement, which would provide many of the same advantages as the normal retirement plan provision.  This feature is seldom used.

Rollover Contribution: Plan sponsors can elect to provide new employees the option to rollover funds from a prior plan sponsor plan or IRA into the company’s qualified plan, even if the employee is not eligible for the plan.

Now is a great time to review your plan provisions and contact ARS to discuss or change them.

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