Chapter 3 Flashcards
What is a 401(k) plan?
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.
Which retirement plans are permitted to contain a CODA?
- 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).
How many years of service can a retirement plan require to be eligible to make elective deferrals?
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.
Are elective deferrals considered employer contributions in a 401(k) Plan?
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.
What are the rules regarding how elective deferrals in a 401(k) Plan are considered for purposes of top-heavy under IRC Sec 416?
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.
What is a Roth 401(k)?
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.
What three basic requirements must designated Roth contributions meet?
- 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.
How are designated Roth contributions treated similarly as pre-tax elective deferrals?
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).
What are the advantages and disadvantages of a Roth 401(k)?
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.
What are catch-up contributions and who is eligible to make them?
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).
What limits must a catch-up eligible participant exceed?
- 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
What is the effect of a catch-up eligible participant deferring a high percentage of compensation?
Can cause other HCEs to receive a refund.
What requirements must plans allowing catch-up contributions meet?
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.
How are top-heavy determinations made under IRC Sec 416?
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.
What is employer matching contributions?
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.
What is the eligibility requirements for employee matching contributions?
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.
What are the vesting schedules for employee matching contributions?
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.
What are the rules regarding how matching contributions are considered for purposes of top-heavy under IRC 416?
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.
What is the deadline for depositing matching contributions into the plans trust?
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.
Is prefunding allowed with matching contributions?
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.
Is prefunding allowed with matching contributions?
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.
What are employer nonelective contributions?
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.
What is the eligibility requirements for employee nonelective contributions?
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.
What are the vesting schedules for employee nonelective contributions?
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
