Chapter 3 Flashcards
(102 cards)
1
Q
What is a 401(k) plan?
A
Qualified plans that contain elective salary deferral or cash-or-deferred arrangements; so named after the Internal Revenue Code (IRC) Sec tion that governs these arrangements. The deferral arrangement actually is a special provision added to a qualified profit sharing or stock bonus plan.
2
Q
Which retirement plans are permitted to contain a CODA?
A
- Profit sharing; * ESOP; * Stock bonus; * Pre-ERISA money purchase (and rural electric and telephone cooperative money purchase); * Simplified Employee Pensions established prior to 1997 (SARSEPs); * Tax-Sheltered Annuity 403(b)(TSA); * Nonqualified; and * Savings Incentive Match Plan for Employees of Small Employers (SIMPLE).
3
Q
How many years of service can a retirement plan require to be eligible to make elective deferrals?
A
A retirement plan cannot require more than one year of service to be eligible to make elective deferrals. The elective deferral component can however; include an entry date provision in addition to one year of service. Under no circumstances can an eligibility requirement with entry dates preclude an employee with a year of service from becoming a participant for more than 18 months from the employment date.
4
Q
Are elective deferrals considered employer contributions in a 401(k) Plan?
A
Yes. For purposes of IRC Sec 415 limits. Elective deferrals are always deductible contributions under IRC Sec 404. Elective deferrals are subject to the IRC Sec 402(g) dollar limit and satisfy nondiscrimination requirements by means of the ADP test.
5
Q
What are the rules regarding how elective deferrals in a 401(k) Plan are considered for purposes of top-heavy under IRC Sec 416?
A
For example; elective deferrals made by key employees are treated as employer contributions when determining the required amount of top-heavy minimum contribution due for non-key employees. However; elective deferrals made by non-key employees cannot be used to satisfy the top-heavy minimum contribution requirement. For this reason; careful attention must be paid to top-heavy issues when designing plans.
6
Q
What is a Roth 401(k)?
A
401(k) plans can include a provision to allow participants to make designated Roth contributions on an after-tax basis in addition to; or in place of; a traditional pre-tax elective deferral. In order to allow for designated Roth contributions; the plan must already offer pre-tax elective deferrals. Therefore; a Roth-only 401(k) plan is not allowed.
7
Q
What three basic requirements must designated Roth contributions meet?
A
- Designated irrevocably as Roth contribution at the time the contribution is made; * Included in employees wages at the time of deferral; and * Maintained in a separate account in the plan until the plan has completely distributed the account. Gains; losses and expenses must be allocated on a reasonable and consistent basis. No forfeiture allocation to the account is allowed.
8
Q
How are designated Roth contributions treated similarly as pre-tax elective deferrals?
A
They are subject to the IRC Sec 402(g) dollar limit; included as a deferral in ADP testing; subject to withdrawal restrictions; must be 100% vested; can be treated as catch-up contributions; can be borrowed against with a participant loan and are subject to minimum distribution rules under IRC Sec 401(a)(9).
9
Q
What are the advantages and disadvantages of a Roth 401(k)?
A
The primary distinction and advantage of Roth 401(k) accounts is the taxation upon distribution. If; at the time of distribution; the amount is a qualified distribution; the contributions made on an after-tax basis and the gains on such contributions are distributed tax- free. The disadvantage of the Roth 401(k) account is the Roth contribution is currently taxable to the participant; which may affect the participant’s ability to contribute to the plan.
10
Q
What are catch-up contributions and who is eligible to make them?
A
Certain elective deferrals made by catch-up eligible participants into a 401(k) plan are treated as catch-up contributions. Generally; catch-up contributions are not included in determining certain limits [e.g.; IRC Sec 402(g); IRC Sec 415] and are not included in nondiscrimination testing (although they are included for certain purposes in top-heavy determinations). Catch-up contributions are also permitted under 403(b) plans; SIMPLEs; SARSEPs and governmental 457 plans. Catch-up eligible participants are employees who are eligible to make elective deferrals under plan and who will be age 50 or older by the end of the employees taxable year (generally December 31st).
11
Q
What limits must a catch-up eligible participant exceed?
A
- Statutory limit [e.g.; IRC Sec 402(g) dollar limit; IRC Sec 415 limit];
- Employer-provided limit - any limit on elective deferrals an employee is permitted to make (without regard to allowable catch-up contributions) contained in the terms of the plan but not required under IRC; and
- ADP limit - amounts that would be distributed as excess contributions must be reclassified as catch-up contributions
12
Q
What is the effect of a catch-up eligible participant deferring a high percentage of compensation?
A
Can cause other HCEs to receive a refund.
13
Q
What requirements must plans allowing catch-up contributions meet?
A
The universal availability requirement in order to satisfy IRC Sec 401(a)(4). All catch-up eligible participants in any 401(k); 403(b); SIMPLE or SARSEP maintained by the employer must be provided with effective opportunity to make same dollar amount of catch-up contributions. The universal availability requirement is not violated if union employees are not provided the opportunity to make catch-up contributions. Special rules apply for merger and acquisition situations.
14
Q
How are top-heavy determinations made under IRC Sec 416?
A
A plan does not include catch-up contributions in the determination in the plan year made. A plan does however include catch-up contributions for prior determination years; eliminating the necessity of keeping separate accounting of historical catch-up contributions.
15
Q
What is employer matching contributions?
A
Elective deferrals may be matched by the employer. The matching contribution allocation formula must be definitely determinable under the terms of the plan; although the amount can be discretionary. A common matching formula is a percentage of the participants elective deferrals (with or without a maximum on the elective deferrals to be matched). The matching percentage can be discretionary; and so can the amount of deferrals upon which the match is based as long as the formula is applied in a uniform manner.
16
Q
What is the eligibility requirements for employee matching contributions?
A
Eligibility requirements for the employer matching contribution can differ from eligibility requirements for elective deferrals. It is not uncommon for a plan to have a longer eligibility period for matching contribution than for elective deferrals; e.g.; the plan may allow immediate eligibility to make elective deferrals but require one year of service before becoming eligible for matching contribution. However; be aware of top-heavy requirements. If a plan is designed with two different eligibility requirements and is top-heavy the plan will owe top-heavy minimum contributions to everyone who is eligible for any portion of the plan.
17
Q
What are the vesting schedules for employee matching contributions?
A
Assuming no more than one year of service for eligibility purposes; matching contributions must vest according to one of the minimum vesting schedules: * Three-year cliff vesting; or * Six-year graded vesting.
18
Q
What are the rules regarding how matching contributions are considered for purposes of top-heavy under IRC 416?
A
For purposes of satisfying top-heavy minimum contribution requirements; matching contributions allocated to key employees are treated as employer contributions to determine required top-heavy minimum contributions to non-key employees. Unlike elective deferrals; matching contributions allocated to non-key employees can be used to satisfy top-heavy minimum contribution requirements.
19
Q
What is the deadline for depositing matching contributions into the plans trust?
A
The same time that other employer contributions are due (by the deadline for filing the employers tax return; including extensions). An exception exists for safe harbor matching contributions calculated per pay period which must be deposited no later than the end of the quarter following the quarter to which they apply. The definition of match for ACP testing provides that the matching contribution must be paid to the trust no later than the end of the 12- month period immediately following the year that contains that date. [Treas. Reg. Sec . 1.401(m)-2(a)(4)(iii)(C)]. Likewise the definition of safe harbor contributions provides that the safe harbor non-elective or safe harbor matching contribution must be deposited to the trust within 12-months of the end of the plan year [Treas. Reg. Sec . 1.401(k)-2(a) and 1.401(m)-2(a)]. Any safe harbor contributions that are deposited after the tax filing deadline for the year they apply to would be deducted for the year in which they are deposited in assuming it is within the deduction limit for that year. It is possible in such a scenario for an employer to have a nondeductible contribution for the year in which the contributions were deposited if they do not have enough eligible compensation for both the prior year and current year even though the contributions were required to be made to the plan based on the compensation earned during those plan years.
20
Q
Is prefunding allowed with matching contributions?
A
No. Final regulations prohibit pre-funding by plan sponsor of matching contributions on a deductible basis other than for bona fide administrative reasons. Contributions are considered deposits of matching contributions only if the matching contributions are affiliated with service performed prior to the date of contribution to plans trust.
21
Q
Is prefunding allowed with matching contributions?
A
Final regulations prohibit pre-funding by plan sponsor of matching contributions on a deductible basis other than for bona fide administrative reasons. Contributions are considered deposits of matching contributions only if the matching contributions are affiliated with service performed prior to the date of contribution to plans trust.
22
Q
What are employer nonelective contributions?
A
Employer contributions; other than matching contributions; for which participant had no election to receive cash; e.g.; employer discretionary contribution under a profit sharing plan.
23
Q
What is the eligibility requirements for employee nonelective contributions?
A
The eligibility requirements can be different from those for elective deferrals and/or matching contributions; although it is common to see the same conditions as those that apply to the matching contributions.
24
Q
What are the vesting schedules for employee nonelective contributions?
A
Assuming one year of service for eligibility purposes; nonelective contributions must vest under one of the minimum vesting schedules: * Three-year cliff vesting; or * Six-year graded vesting.
25
What are after-tax employee contributions?
Participants can be allowed to voluntarily make employee contributions on an after-tax basis to a 401(k) plan. Beginning in 2006; the ability to make designated Roth contributions makes this plan design option somewhat obsolete. However; the after-tax employee contribution option does allow an employee to contribute more to the plan than the IRC Sec 402(g) limit as after-tax employee contributions arent included in the IRC Sec 402(g) limit calculation. As a result; some plans do still contain this feature. In some plans; after-tax employee contributions are mandatory. These contributions are subject to federal income taxation (and state and local taxation; where applicable) in the year they are contributed.
26
How are after-tax employee contributions treated under IRC Sec 415(c) ?
As annual additions and satisfy nondiscrimination purposes by means of the ACP test. After-tax employee contributions made by non-key employees cannot be used to satisfy top-heavy minimum contribution requirements.
27
What contribution limitations are imposed by IRC Sec 402(g)?
The IRC Sec 402(g) limit is an individual limit and is reduced; dollar for dollar; by elective deferrals or designated Roth contributions made to any other 401(k) plan [including SIMPLE 401(k); SARSEP; IRC Sec 501(c)(18) union pension plan or 403(b) plan] in which the employee is a participant.
28
What are excess deferrals?
Elective deferrals in excess of the IRC Sec 402(g) dollar limit. Excess deferrals are included in the income of the participant for the taxable year in which deferred; but earnings allocable to excess deferrals are taxable in the year distributed. Excess deferrals may be returned during same year in which excess deferrals arose.
29
How are excess deferrals handled?
Excess deferrals plus earnings thereon must be returned to the individual or recharacterized as after-tax employee contributions no later than April 15th following calendar year in which deferred. If not timely distributed; the amount is taxable to the participant in the year of deferral and again in the year distributed (i.e.; double taxation). If all excess deferrals were made to the plan or plans of a single employer and excess deferrals were not refunded; the CODA ceases to be qualified. Qualification is not affected if some of the excess deferrals were made to a plan of an unrelated employer; including a participants 403(b) account. If timely distributed; excess deferrals are not subject to the 10% additional income tax on early distributions under IRC Sec 72(t). Excess deferrals for HCEs; whether or not timely distributed; are included in ADP test; however; all excess deferrals for NHCEs are disregarded in ADP testing. Excess deferrals are counted for purposes of IRC Sec 415 limits and IRC Sec 416 top-heavy testing.
30
What are catch-up contribution limitations?
Limited on an individual basis to amounts per tax year of the participant. Permissible catch-up contributions will not count against the IRC Sec Sec 402(g); 404 and 415 limits and will not cause plan to fail ADP or ACP tests; IRC Sec 401(a)(4) nondiscrimination or IRC Sec 410(b) coverage tests.
31
What is excess amount and how is it handled; as it pertains to the annual additions limitations?
The annual additions that exceed the IRC Sec 415 limitation. The excess amount; if it derives from employer contributions is placed in an unallocated account and used (along with earnings on the unallocated amounts) in the following limitation year (and succeeding years; if necessary) to reduce employer contributions other than elective deferrals. The excess amounts are treated as annual additions in the limitation year in which they are removed from the unallocated account and used as employer contributions. No additional contributions by the employer are permitted while there are funds in the unallocated account. If an excess amount is allocated to a participants account and there have been elective deferrals or after-tax employee contributions made by the participant for the limitation year; the plan may provide for the distribution of elective deferrals and/or the return of after-tax employee contributions equal to the excess amount. Distributed elective deferrals are taxed in the year distributed. The premature distribution penalty applicable to participants who are under age 59.5 does not apply. Many; if not most; plans provide for the correction under this method first; so that an employees allocation of employer contributions is not reduced because of the employees own elective deferrals or after-tax employee contributions.
32
What are deductibility limitations and requirements?
IRC Sec 404(a)(3) limits an employers deduction under a profit sharing plan to 25% of covered payroll for each fiscal year; but the deduction limit does not include elective deferrals; which are always deductible. In order to be deductible; employer contributions must be deposited by the due date for filing the employers federal tax return; including extensions. Matching contributions may only be deducted for the taxable year in which their corresponding deferrals would have been received as compensation.
33
How are nondeductible contributions handled?
Nondeductible contributions are subject to a 10% excise tax. If employer contributions exceed the deduction limit for a tax year; the excess may be carried forward to the next tax year and be deducted in a subsequent tax year. Nondeductible contributions must generally be retained in the plan and cannot be distributed back to the employer.
34
Describe the automatic enrollment provision option available to employers after PPA.
Issues addressed in the Pension Protection Act of 2006 (PPA) and in subsequent legislation; including: * ERISA preemption of state wage garnishment laws; * Fiduciary protection for contributions deposited into a default investment; and * Addition of a 90-day period in which employees may elect to have salary deferrals returned without penalty.
35
What are advantages to adding an ACA to a 401(k) plan?
* Improved testing results due to increased plan participation; and * Greater retirement security for employees.
36
What are the disadvantages to adding an ACA to a 401(k) plan?
* Increased administrative burden; * Large number of small account balances in the plan; * Increased administration fees; and * The potential for an increased number of lost participants.
37
What are eligible automatic contribution arrangement (EACA)?
PPA created a new class of negative election plans. By meeting some specific criteria an EACA provides some additional advantages and protections beyond what is available to an ACA not meeting those criteria.
38
What are the requirements that an ACA must meet to be an EACA?
* A participant is treated as having made an elective deferral election in the amount of a uniform percentage (no minimum or maximum set by the statute) of compensation until the participant specifically elects not to have such contributions made (or to have a different percentage contributed) (i.e.; the plan has an automatic enrollment feature); this is applied to all participants not just new participants going forward; and * The notice requirements of IRC Sec 414(w)(4) are satisfied.
39
What are the notice requirements of IRC Sec 414(w)(4)?
o The required notice must be given within a reasonable period of time before each plan year to each employee to whom the EACA applies for such plan year. o It must include the following information * An explanation of the employees right under the arrangement to elect not to have elective contributions made on the employees behalf (or to elect to have such contribution made at a different percentage ); and * An explanation of how contributions made under the arrangement will be invested in the absence of any investment election by the employee. o The notice must be written in a manner that is sufficiently accurate and comprehensive to apprise the employee of his or her rights and obligations under the plan; and in a manner calculated to be understood by the average employee to whom the arrangement applies.
40
When may an automatic contribution be adopted?
The IRS has concluded that while an automatic contribution feature may be adopted at any time; an EACA cannot be established mid-year. The big benefit provided to an EACA over an ACA is the extension of the period for making corrective distributions without penalty from 2.5 months to 6 months.
41
What are qualified automatic contribution arrangement (QACA)?
Another type of automatic contribution arrangement established by PPA ; which combines features of an automatic enrollment plan with features of a safe harbor plan. Additional information on QACA is included in the Nondiscrimination Satisfied without ADP/ACP Sec tion later in this chapter.
42
What are distributable events?
Permissible distributions of elective deferrals are more restrictive than distributions of other types of contributions permitted in profit sharing or stock bonus plans. Elective deferrals; QNECs; QMACs and safe harbor contributions can be distributed as the result of the following distributable events: * Severance from employment (replaced separation from service effective January 1; 2002); * Death; * Disability; * Attainment of age 59.5; * Termination of plan without establishment of a successor plan; and * Financial hardship [does not apply to QNECs; QMACs or safe harbor 401(k) contributions].
43
What is a successor plan?
A defined contribution plan defined in IRC Sec 414(i) other than an ESOP. A plan is a successor plan if it exists at time the 401(k) plan is terminated or within the 12-month period beginning on the date the last of the plans assets are distributed. A plan is not treated as a successor plan if less than 2% of employees in the terminated 401(k) plan are eligible for another defined contribution plan of the same employer during 12-month period immediately preceding and the 12-month period immediately following termination of the 401(k) plan.
44
What are qualified distributions?
Designated Roth contributions are after-tax contributions; and earnings on those contributions may be withdrawn tax-free if the distribution is a qualified distribution. A qualified distribution is one paid as result of attainment of age 59 .5; death or disability and occurs no earlier than five years after the first designated Roth contribution is made (often called the five year holding period). If a distribution from a Roth 401(k) account is not a qualified distribution; it is treated as a distribution or withdrawal from an after-tax employee account. In other words; the amount of the distribution is pro-rated between basis and earnings under the specific rules applicable to after-tax contributions. This is in contrast to a Roth IRA where basis in the account is distributed prior to earnings.
45
What type of distributions are not qualified?
These include corrective distributions of excess amounts; deemed distributions; dividends on employer Sec urities and imputed income from life insurance policies. Distributions of employer Sec urities from Roth 401(k) accounts are subject to special rules depending on whether or not the distributions were qualified distributions.
46
What type of matching can no longer be included in ACP testing?
Under final regulations for 401(k) plans issued in December 2004; certain matching; know as targeted QMACS; allocated to NHCEs; known as targeted QMACs; can no longer be included in ACP testing if they are considered to be disproportionate matching contributions. Rules regarding disproportionate matching contributions for NHCEs are effective generally for plan years beginning on or after January 1st 2006.
47
When are matching contributions for NHCEs disproportionate ?
If they exceed the greatest of three limits: * 5% of compensation; * 100% of employees elective deferrals; or * Two times the plans representative matching rate.
48
What is the representative matching rate and how is it determined; as it relates to determining if the matching contributions for NHCEs are disproportionate?
The representative matching rate is calculated by dividing matching contributions by elective deferrals (and after-tax employee contributions; if matched). If plans matching formula is not uniform; the rate of match is calculated by assuming a 6% deferral and applying plans matching formula. Representative matching rate is determined by taking greater of: * Lowest matching rate of any NHCE employed as of the last day of the plan year who made elective deferrals for the year (or who made an employee contribution if plan provides matching contribution for after-tax employee contributions); or * Lowest matching rate for any NHCE who made elective deferrals for the year (or who made an employee contribution for the year if the plan provides matching contribution for after-tax employee contributions); taking into consideration at least 50% of total eligible (deferring or contributing) NHCEs.
49
Who is included in the ADP and ACP test?
All employees eligible to make elective deferrals at any time during the plan year. The ACP test includes all employees satisfying eligibility requirements for matching contributions or after-tax employee contributions. Employees making a one-time irrevocable election not to participate in the 401(k) plan by their date of plan eligibility are excluded from both tests. Employees suspended from deferring because of hardship withdrawal safe harbor requirements are included in both tests. Participants not receiving matching contribution due to allocation requirements (e.g.; 1,000 hours during plan year or last day employment) may be excluded from ACP test provided coverage rules under IRC Sec 410(b) are satisfied. Employees who are eligible for a matching contribution but did not receive one because no deferrals were made are included in the ACP test. Classes of employees excluded from participating are not included in either test provided coverage rules under IRC Sec 410(b) are satisfied. Examples of this are the exclusion of members of a controlled group; employees excluded from eligibility due to classification; leased employees; independent contractors; new employees resulting from mergers and acquisitions; etc. For testing purposes; a single 401(k) plan covering both union and nonunion employees is treated as if it were two separate plans: one plan covering only union employees and the other covering nonunion employees. Separate ADP tests are required for the union and nonunion portions of plan. The union portion of plan is deemed to pass the ACP test whether or not there are union after-tax employee contributions. The nonunion portion of plan is subject to the ACP test.
50
What contributions are included in the ADP test?
All elective deferrals and designated Roth contributions unless they have been recharacterized as catch-up contributions by exceeding a statutory or plan limit. Elective deferrals and designated Roth contributions in excess of the IRC Sec 402(g) limit are included in the test for HCEs and excluded for NHCEs
51
What contributions are included in the ADP test?
All elective deferrals and designated Roth contributions unless they have been recharacterized as catch-up contributions by exceeding a statutory or plan limit. Elective deferrals and designated Roth contributions in excess of the IRC Sec 402(g) limit are included in the test for HCEs and excluded for NHCEs
52
What contributions are included in the ACP test?
The ACP test includes all after-tax employee contributions and all matching contributions unless they are QMACs that have been shifted to the ADP test as described below or they are disproportionate matching contributions as described above.
53
How are the ADP and ACP tests calculated?
To start; calculate actual deferral ratio (ADR) and/or actual contribution ratio (ACR) for each employee included in the testing. Next; calculate the average of the ADRs (or ACRs) for the HCE group; the HCE ADP (or HCE ACP); and the average for the NHCE group; the NHCE ADP (or NHCE ACP).
54
What is ADR?
The ADR equals total amount of elective deferrals and designated Roth contributions (excluding permissible catch-up contributions) made by the participant during a plan year divided by the participants compensation.
55
What is ACR?
The ACR equals total amount of employer matching contributions allocated to the participant for plan year plus any after-tax employee contributions made by participant during plan year divided by participants compensation.
56
What are the HCE ADP (or ACP) limitations?
The NHCE ADP (or ACP). The HCE ADP (or ACP) cannot exceed greater of: * 1.25 times NHCE ADP (or ACP); or * Lesser of o 2 times NHCE ADP (or ACP); or o 2 percentage points plus NHCE ADP (or ACP)
57
What is the default testing method for ADP and/or ACP testing?
The prior year testing method: comparing current year HCE ADP (or ACP) to prior year NHCE ADP (or ACP). The IRS has interpreted this to mean the plan document must still specify the testing method.
58
What is the alternative method to the default testing method for ADP and/or ACP testing?
The current year testing method which compares the current year HCE ADP (or ACP) with the current year NHCE ADP (or ACP). Subject to provisions of the plan document and IRS restrictions; the current year testing method may be used instead of the prior year testing method. It is permissible to switch from prior year to current year at any time. However; a plan must use current year for at least five years before switching back to prior year unless the plan has used current year since its inception. If switching from current year to prior year testing; the plan is prohibited from double-counting QNECs included in either ADP or ACP test.
59
How are new plans ADP tested?
For a new plan, or the first year a CODA is effective, if the prior year testing method is used; the NHCE ADP and/or ACP is deemed to be 3%.
60
Is the same testing method required for both ADP and ACP tests?
Plans are not required to use same testing method for both ADP and ACP tests unless shifting of contributions is performed.
61
Is an amendment to change testing methods for ADP and/or ACP tests an option?
Yes. The amendment must be adopted by the end of the plan year for which the change will apply.
62
How can disaggregation be used and favorable for ADP tests?
Disaggregation allows participants who have not met the statutory age and service requirements (otherwise excludable employees) to be excluded from the ADP and/or ACP tests (if NHCEs); or to be tested separately as a group (NHCEs and HCEs). Disaggregation of otherwise excludable employees can only be done for ADP/ACP purposes if it is also done when testing coverage under IRC Sec 410(b).There are two ways to disaggregate otherwise excludable employees: * Under Treas. Reg. Sec 1.401(k)-1(b)(4); and * Under IRC Sec 401(k)(3)(F)
63
What does disaggregation under Treas. Reg. Sec 1.401(k)-1(b)(4) involve?
Performing two separate ADP (or ACP) tests. The first test includes all HCEs and NHCEs who meet statutory minimum age and service requirements. The Sec ond test includes all HCEs and NHCEs who are otherwise excludable employees. Both testing groups must pass coverage under IRC Sec 410(b).
64
What does disaggregation under IRC Sec 401(k)(3)(F) involve?
Only one ADP (or ACP) test. The test includes all HCEs and NHCEs who meet statutory minimum age and service requirements (which age 21 and 1 year of service); and includes HCEs who are otherwise excludable employees. Disaggregate only the NHCEs who are otherwise excludable employees and disregard them from testing. Note that disaggregation in this manner; which essentially ignores the presence of otherwise excludable NHCEs; applies only to ADP and/or ACP testing and not to IRC Sec 410(b) testing. If disaggregating under IRC Sec 401(k)(3)(F); coverage tests are performed in same manner as if disaggregating under Treas. Reg. Sec 1.401(k)-1(b)(4).
65
When can an amount of the matching contributions be shifted?
If matching contributions are fully vested and subject to the same withdrawal restrictions as elective deferrals; Treas. Reg. Sec 1.401(k)-1(b)(5) permits that all; or any amount; of the matching contributions may be shifted and included in ADP test. If a plan does not include after-tax employee contributions; the plan sponsor might wish to shift all of the matching contributions into the ADP test to eliminate need for ACP testing altogether. While this may be administratively simpler to run a single test; the testing results may be adversely impacted
66
When is shifting of elective deferrals into ACP test permitted?
If the ADP test is passing but ACP test is failing; Treas. Reg. Sec 1.401(m)-1(e)(1)(i) permits shifting of elective deferrals into ACP test. ACP test results will be improved; and may even pass; by shifting the greatest amount of elective deferrals possible from ADP test to the ACP test without making the ADP test fail. Both HCE and NHCE deferrals may be shifted. If deferrals are shifted to the ACP test; the plan must be able to pass the ADP test taking into account all deferrals (including those that are being shifted) and also must pass taking into account only salary deferrals that are not being shifted to the ACP test. That is; the ADP test must be passed both before and after shifting deferrals to the ACP test. How the ADP percentages are manipulated is not regulated as long the ADP test is passed before and after the percentages are manipulated. In other words; adjusting the HCEs ADP as well as the NHCEs is permissible.
67
When must corrections occur for failed ADP/ACP tests?
Failed ADP and/or ACP tests must be corrected no later than last day of the 12-month period following the plan year end. Disqualification of the CODA may result if corrective action is not timely taken; but note that EPCRS may be available.
68
What corrections methods may be considered for failed ADP/ACP tests?
* RECHARACTERIZING EXCESS CONTRIBUTIONS * CORRECTIVE DISTRIBUTIONS * ORPHAN MATCH * QNECS AND QMACS
69
When may excess contributions be recharacterized as after-tax employee contributions?
This correction method is only available if the plan allows for after-tax employee contributions. Recharacterized excess contributions become taxable to the affected HCEs and must retain the same withdrawal restrictions they had as elective deferrals. Since recharacterized contributions must be included in ACP test; this option usually results in adverse consequences and is consequently rarely a practical solution.
70
What is the most common correction method for a failed ADP and/or ACP test and how is it implemented?
Corrective distributions to HCEs. Failure to satisfy the ADP test results in HCEs receiving excess contributions. Failure to satisfy the ACP test results in HCEs receiving excess aggregate contributions. Note that only the vested portion of any excess aggregate contributions would only be refunded to participants; any unvested portion would be forfeited.
71
What is the most common correction method for a failed ADP and/or ACP test and how is it implemented?
Corrective distributions to HCEs. Failure to satisfy the ADP test results in HCEs receiving excess contributions. Failure to satisfy the ACP test results in HCEs receiving excess aggregate contributions. Note that only the vested portion of any excess aggregate contributions would only be refunded to participants; any unvested portion would be forfeited. The leveling method is a two step process where the first step is used to determine total amount of excess contributions and/or excess aggregate contributions; and then the Sec ond step determines which HCEs will be refunded what amount.
72
When must contributions be forfeited?
```
Final regulations for IRC Sec 401(a)(4) generally require that employer matching contributions attributable to elective deferrals that were refunded to HCEs in order to satisfy the ADP test (and the ACP was passed) be forfeited and treated as forfeitures in accordance with plan document. If these extra matching contributions were not forfeited; HCEs would be receiving a rate of matching contributions that NHCEs were not able to receive; even though elective deferrals were refunded and taxable. This would cause the matching contribution to be discriminatory. Forfeitures are not required in all refund situations as many plans only match elective deferrals up to a certain percentage of compensation; such as 50% up to a maximum match of 3% of compensation. When both the ADP test and ACP test fail; a plan may have to refund matching contributions as excess aggregate contributions in order to satisfy the ACP test. This refund is done prior to evaluating whether or not orphan match exists based on deferrals refunded as excess contributions. Any remaining excess matching contribution over the amount that would otherwise be allocated based on plans matching formula is then forfeited in order to satisfy IRC
Sec 401(a)(4).
```
73
Describe the first step in the leveling method.
The leveling method starts with the HCE with the highest ADR (or ACR) in order to determine the total dollar amount of excess contributions (or excess aggregate contributions). The HCE with the highest ADR (or ACR) reduced until: * ADP (or ACP) test passed; or * ADR (or ACR) of the HCE with highest ADR (or ACR) equals ADR (or ACR) of the HCE with next highest ADR (or ACR). This process is repeated until the ADP (or ACP) test is passed.
74
Describe the Sec ond step in the leveling method.
After the ADP (or ACP) test is passed; the total amount of excess contributions (or excess aggregate contributions) is calculated. The Sec ond step of the leveling method then looks at the HCE with highest dollar amount deferred (or employer matching plus after-tax employee contributions for the ACP test) in order to determine which HCEs will receive refunds of excess contributions (or excess aggregate contributions). The HCE with the highest dollar amount deferred (or amount of matching plus after-tax employee contributions) is reduced until: * The total amount of excess contributions (or excess aggregate contributions) has been refunded; or * The remaining amount of elective deferrals (or matching plus after-tax employee contributions) of the HCE with highest dollar amount deferred (or amount of matching plus after-tax employee contributions) equals the HCE with the next highest dollar amount deferred (or amount of matching plus after-tax employee contributions)
This process is repeated until the total amount of excess contributions (or excess aggregate contributions) is refunded. The plan may not satisfy the ADP (or ACP) test if it is performed on the contributions remaining after the returns have been made; but as long as the correct dollar amount is returned there is no retesting required
75
How are excess contributions or excess aggregate contributions under IRC Sec 4979 handled?
Included as taxable income in the year in which the corrections were made. There is no employer excise tax on excess contributions or excess aggregate contributions under IRC Sec 4979(f) if the corrections are made within 2.5 months after the plan year end. The employer must pay a 10% excise tax under IRC Sec 4979 on amount of excess contributions or excess aggregate contributions (excluding earnings) if the corrections are made after 2.5 months after the plan year end. For plan years beginning after December 31; 2007; plans with an Eligible Automatic Contribution Arrangement (EACA) have 6 months (rather than 2 .5 months) to make corrective distributions. Corrective distributions are not subject to the 10% additional income tax on early distributions under IRC Sec 72(t). No employee or spousal consent is required for an excess distribution; except to waive 10% withholding; if applicable. Distributions of excess contributions or excess aggregate contributions (and earnings thereon) are not eligible for rollover. Therefore; an HCE may elect an amount or a percentage to be withheld for federal income taxes. In the absence of an election; 10% of the distribution amount must be withheld.
76
When must contributions be forfeited?
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Final regulations for IRC Sec 401(a)(4) generally require that employer matching contributions attributable to elective deferrals that were refunded to HCEs in order to satisfy the ADP test (and the ACP was passed) be forfeited and treated as forfeitures in accordance with plan document. If these extra matching contributions were not forfeited; HCEs would be receiving a rate of matching contributions that NHCEs were not able to receive; even though elective deferrals were refunded and taxable. This would cause the matching contribution to be discriminatory. Forfeitures are not required in all refund situations as many plans only match elective deferrals up to a certain percentage of compensation; such as 50% up to a maximum match of 3% of compensation. If refunds of elective deferrals include only those elective deferrals over 6% of compensation; no matching contributions were made on the refunded amounts; so no forfeitures are required. When both the ADP test and ACP test fail; a plan may have to refund matching contributions as excess aggregate contributions in order to satisfy the ACP test. This refund is done prior to evaluating whether or not orphan match exists based on deferrals refunded as excess contributions. Any remaining excess matching contribution over the amount that would otherwise be allocated based on plans matching formula is then forfeited in order to satisfy IRC
Sec 401(a)(4).
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77
How can a qualified nonelective contribution (QNEC) or a qualified matching contribution (QMAC) be used to correct failed ADP and/or ACP tests?
The employer may deposit additional funds as a QNEC and/or a QMAC subject to the limits on the amount of QNECs and QMACs that can be considered in ADP and/or ACP testing. The employer may designate all or part of its discretionary contribution as a QNEC; subject to limits on the amount of QNECs that can be considered in ADP and ACP testing. The employer may designate all or part of its matching contribution as a QMAC; subject to limits on the amount of QMACs that can be considered in ADP and ACP testing. Note that calculation of disproportionate matching contributions for NHCEs does consider QMACs as part of an NHCEs matching contribution; whether or not those QMACs were shifted to the ADP test. QNECs and QMACs may be used in either the ADP or ACP test but the same dollars may not be used for both tests. QNECs and/or QMACs are treated like elective deferrals and combined with actual elective deferrals in the ADP test and/or treated as matching contributions and combined with actual matching contributions in ACP test. QNECs and QMACs must be fully vested and subject to same withdrawal restrictions as 401(k) elective deferrals; however; they are not eligible for hardship withdrawal under any circumstances.
78
What is the difference between a QNEC and QMAC?
The method of allocation. QMACs are allocated only to participants who make elective deferrals for plan year. QNECs are allocated to participants whether or not they make elective deferrals for plan year. QNECs and QMACs may be allocated to both HCEs and NHCEs but are usually only allocated to NHCEs in order to pass ADP and/or ACP test with the least cost to the employer. QNECs and QMACs are subject to IRC Sec 410(b) coverage rules. A plan may require that participants satisfy allocation requirements (i.e.; be credited with at least 1;000 hours during plan year and/or be employed by plan sponsor at end of plan year) in order to be allocated a QNEC and/or QMAC.
79
ADP and ACP tests may only include QNECs that are within what limitation?
Do not exceed the greater of the following two limits: * 5% of compensation; or * Two times plans representative contribution rate expressed as a percentage of compensation. For determining the allowable amount of QNECs for inclusion in ADP testing; an individuals contribution rate is calculated by dividing compensation by the sum of all QNECs other than those included in the ACP test and all QMACs included in the ADP test. For determining the allowable amount of QNECs for inclusion in ACP testing; an individuals contribution rate is calculated by dividing compensation by the sum of all QNECs other than those included in the ADP test and all QMACs included in the ACP test. The representative contribution rate is determined by taking the greater of: * Lowest contribution rate of any NHCE employed as of the last day of plan year; or * Lowest contribution rate for any NHCE; taking into consideration at least 50% of total eligible NHCEs.
80
When may 401(k) plans be deemed to satisfy the ADP and/or ACP tests?
During any plan year because of: * Employee demographics (e.g.; if all participants for plan year are NHCEs the plan is deemed to pass or if all participants for plan year are HCEs the plan is deemed to pass); or * Plan design [e.g.; if no HCEs benefit; (i.e.; they are not allowed to make elective deferral contributions and/or are not eligible for matching contributions) the plan will automatically pass].
81
What plans are deemed to pass the ADP and/or ACP testing?
* Governmental plans; * Plans that satisfy SIMPLE-401(k) requirements; and * Plans that satisfy traditional or qualified automatic contribution arrangement (QACA) safe harbor 401(k) requirements.
82
What must a CODA satisfy to be treated as satisfying the ADP test?
* Contribution; and * Notice requirements
83
What are the requirements of the safe harbor contribution?
* Be allocated to all eligible NHCEs and may or may not be allocated to HCEs (e.g.; could be limited only to employees who meet statutory requirements); * Not have allocation requirements (i.e.; 1,000 hours or employment on last day of the plan year) imposed to receive a contribution; * Be immediately 100% vested; * Be subject to 401(k) withdrawal restrictions except that they are never available for hardship withdrawal; and * Not be used in the determination of the base contribution and allowable excess contribution in permitted disparity under IRC Sec 401(l).
84
What are ADP safe harbor contributions?
The types of safe harbor contributions that satisfy the ADP test. ADP safe harbor contributions can be either a safe harbor nonelective contribution or a safe harbor matching contribution. Safe harbor nonelective contributions must be at least 3% of employees compensation. This type of contribution can be decided upon as late as 30 days prior to last day of plan year if a maybe notice was provided at least 30 days prior to the start of the plan year and a final notice and plan amendment are made at least 30 days prior to the end of the plan year.
85
What is the timing of the annual written notice of the safe harbor 401(k) plan?
The timing requirements are satisfied if the notice is provided within a reasonable period before the beginning of the plan year. A reasonable period has been defined as between 30 and 90 days before beginning of plan year. Employees who become eligible later than 90th day before beginning of plan year may be given notice between their date of eligibility and 90 days prior to eligibility. The notice can be given to eligible employees up to first day of first plan year for a newly established 401(k) plan.
86
ADP safe harbor contributions fall into one of what two categories?
Either a basic matching formula or an enhanced matching formula.
87
What is the basic matching formula for ADP safe harbor contributions?
* 100% match on first 3% of compensation deferred; plus * 50% match on next 2% of compensation deferred. The basic matching formula results in a maximum match of 4% of compensation for employees who defer at least 5% of compensation.
88
What is the enhanced matching formula for ADP safe harbor contributions?
Any formula that meets all of the following requirements: * Matching contributions provided under formula that; at any rate of elective deferrals; is at least as great as matching contributions provided under basic formula; * Rate of match cannot increase as rate of deferral increases; and * Matching formula may not provide a higher level of match for HCEs than for NHCEs who contribute at same level. A common enhanced matching formula is 100% up to 4% of compensation or 100% up to 6% of compensation.
89
Describe the safe harbor 401(k) plan annual written notice requirement.
Each eligible employee must receive an annual written notice that meets content and timing requirements put forth by IRS that must contain certain information including; the safe harbor contribution formula; any other fixed or discretionary employer contributions (including match); the plan to which the safe harbor contribution will be made; the amount and type of compensation the participant may defer under the plan; the procedure for making the deferral; the periods available for making the election; and the contact information to obtain additional information (i.e.; plan contact; phone number and address).
90
What is the timing of the annual written notice of the safte harbor 401(k) plan?
The timing requirements are satisfied if the notice is provided within a reasonable period before the beginning of the plan year. A reasonable period has been defined as between 30 and 90 days before beginning of plan year. Employees who become eligible later than 90th day before beginning of plan year may be given notice between their date of eligibility and 90 days prior to eligibility. The notice can be given to eligible employees up to first day of first plan year for a newly established 401(k) plan.
91
Are discretionary nonelective contributions allowable in safe harbor plans?
Yes; safe harbor plans may be designed to allow for discretionary nonelective contributions which can be subject to accrual requirements like a 1,000 hour requirement and employment on the last day of the plan year. The nonelective contribution must pass the coverage requirement of IRC Sec 410(b) or; if permissible under the plan; the general nondiscrimination requirements of IRC Sec 401(a)(4). This contribution may be subject to a vesting schedule at least as favorable as a 2/20 vesting schedule or 3-year cliff. A common plan design is a safe harbor 401(k) plan using the 3% safe harbor nonelective contribution and an additional cross-tested discretionary nonelective contribution. Including these contributions would eliminate the automatic pass for top-heavy that the safe harbor 401(k) plan can provide.
92
When is a safe harbor 401(k) plan treated as satisfying the ACP test?
If contribution and notice requirements are met. The safe harbor matching contributions which satisfy the ACP test (commonly called ACP safe harbor contributions) must: * Be made under the basic match formula to satisfy the ADP test and no other matching contributions are made (100% up to 3 % and 50% up to the next 2%); * Be made under enhanced formula to satisfy the ADP test but; cannot match deferrals exceeding 6% of compensation (for example 100% up to 4% or 200% up to 5%); or * Be a matching formula in which: o The match does not take into consideration deferrals of more than 6% of compensation; o The rate of match does not increase as rate of employee contributions or elective deferrals increases; and o The rate of matching contributions for any HCE is not greater than any NHCE with same rate of elective deferrals.
93
Are additional discretionary matching contributions are permitted in addition to the ACP safe harbor matching contributions?
Yes; however any discretionary matching contributions must not exceed 4% of employees compensation.
94
How can safe harbor matching contributions be discontinued?
The plan sponsor can reduce or discontinue safe harbor matching contributions during plan year and instead perform ADP and/or ACP testing if a 30-day advance notice to employees is provided and the necessary amendments are timely signed. Contributions through the end of the notice period must still be made. Discontinuing safe harbor matching mid-year should be carefully considered before it is done because the corrections required when the ADP and ACP are run may not be worth the money saved on the safe harbor match; particularly if it is already late in the plan year.
95
Are safe harbor plans top-heavy?
Safe harbor 401(k) plans are deemed not to be top-heavy for the plan year; if the only employer contributions made to plan are matching contributions or nonelective contributions meeting the safe harbor requirements described in IRC Sec 401(k)(12) (the ADP safe harbor).
96
How can a triple stacked match arrangement be provided for in a safe harbor plan?
This plan design provides a safe harbor match that satisfies the ADP requirements (basic or enhanced) then a fixed match (that does not match amounts in excess of 6% of compensation) and discretionary match (that does not match amounts more than 6% of compensation and is not more than 4% of compensation) that would satisfy the ACP requirements. The rate of match cannot increase as deferrals increase. This type of match would allow the employer to focus contributions only on participants who defer while still meeting the top heavy minimum exemption [assuming all participants who defer are eligible for the employer matching contributions and there are no additional employer contributions (including forfeiture reallocations)].
97
Are discretionary nonelective contributions allowable in safe harbor 401(k) plans?
Yes. Safe harbor plans may be designed to allow for discretionary nonelective contributions which can be subject to accrual requirements like a 1,000 hour requirement and employment on the last day of the plan year. The nonelective contribution must pass the coverage requirement of IRC Sec 410(b) or; if permissible under the plan; the general nondiscrimination requirements of IRC Sec 401(a)(4). This contribution may be subject to a vesting schedule at least as favorable as a 2/20 vesting schedule or 3-year cliff. A common plan design is a safe harbor 401(k) plan using the 3% safe harbor nonelective contribution and an additional cross-tested discretionary nonelective contribution. Including these contributions would eliminate the automatic pass for top-heavy that the safe harbor 401(k) plan can provide.
98
Are discretionary nonelective contributions allowable in safe harbor plans?
Yes; safe harbor plans may be designed to allow for discretionary nonelective contributions which can be subject to accrual requirements like a 1;000 hour requirement and employment on the last day of the plan year. The nonelective contribution must pass the coverage requirement of IRC Sec 410(b) or; if permissible under the plan; the general nondiscrimination requirements of IRC Sec 401(a)(4). This contribution may be subject to a vesting schedule at least as favorable as a 2/20 vesting schedule or 3-year cliff. A common plan design is a safe harbor 401(k) plan using the 3% safe harbor nonelective contribution and an additional cross-tested discretionary nonelective contribution. Including these contributions would eliminate the automatic pass for top-heavy that the safe harbor 401(k) plan can provide.
99
What is the qualified automatic contribution arrangement (QACA) and what provisions must it make?
A safe harbor plan (first available in 2008) that provides employer relief from ADP and/or ACP testing. A QACA must have the following provisions: * An automatic enrollment arrangement that meets the minimum requirements of a minimum contribution percentage. The automatic arrangement must stay in effect until the participant makes an affirmative election to defer any amount including 0%; * The employer must provide a specific employer contribution which meets the requirements; and * The employer must provide a notice geared to be understood by the average plan participant.
100
How must the employers contribution be allocated in a QACA?
At least to all of the eligible NHCEs. It can either be a nonelective contribution or an employer match. If the employer nonelective contribution is used it must be at least 3%. The employer match can be a basic match of 100% of deferrals up to 1% of compensation plus 50% of deferrals that exceed 1% compensation but not 6% of compensation or an enhanced match. If the employer wishes to contribute an enhanced match; it must meet the basic match requirements; and cannot be designed to increase as the percentages of deferral increases.
101
When must a QACA provide 100% vesting?
A QACA must provide for 100% vesting after two years.
102
When must a QACA provide 100% vesting?
Unlike the vesting of traditional safe harbor plans which must provide for 100% vesting immediately; a QACA must provide for 100% vesting after two years. So; the vesting schedule could be a 2 year cliff or 50% after year 1 and 100% after year 2.
