Chapter 3: Profit sharing & 401(k) plans Flashcards
Difference between profit sharing and a pension plan?
3.1
Contributions are not mandatory
Who contributes to a traditional profit-sharing plan?
3.1
Employers only
What is a traditional profit-sharing plan?
3.1
Qualified defined contribution plan Nondiscriminatory Contributions are not mandatory—but there needs to be “substantial” and recurring contributions
What are the limits of profit-sharing contribution plans?
3.1
$58k or 100% of income
What are in-service distributions in profit-sharing plans?
3.1
Only allowed to take from profit-sharing defined controbution plans
Two tests must be satisfied to take distributions:
- Hardship (immediate and heavy need)
- Approved reason like
- Unreimbursed med expenses
- Buy a primary residence
- Prevent foreclosure
- College expenses
How are hardship withdrawals from profit-sharing plans taxed?
3.1
- taxed as ordinary income
- If it’s for education—10% penalty
- If it’s for a home—10% penalty
- Medical expenses don’t have a penalty above 10% of AGI
When do you use a profit-sharing plan?
3.1
- When you want to motivate employees.
- When profits fluctuate.
What is an age-based profit-sharing plan?
3.2
Allocations adjusted based on age
What is an age-based profit-sharing plan?
3.2
Allocations adjusted based on age
What is a new comparability plan?
3.2
Employees are divided into classes like job category, age, years of service. Each class recieves a different employer contribution
Great for when there is a young owner and an older owner. Owners get equal contributions.
These plans must satisfy these rules:
- At least 5% allocation to non-HCEs
- Minimum allocation for non-HCEs must be 1/3rd of the highest allocation rate
What are Stock bonus plans?
3.3
Profit-sharing plan
Employer is contributing stock rather than cash
What is Net Unrealized Appreciation? 3.3
NUA is always taxed as LTCG
What are ESOP Plans?
3.3
Type of stock bonus plan NUA advantages
Best when:
- Employer wants to make the employees owners of the business through tax-advantaged and low cost
- Employer wants to create a way for the company to borrow money
- owner wants to engage in estate and financial planning that creates a market for the stock
- employer doesn’t mind having additional shareholders
What is a LESOP?
3.3
Leveraged Employer Stock Ownership Plan– An ESOP with a loan
What are the types of 401K plans?
3.3
Traditional 401(k)
Safe Harbor 401(k)
SIMPLE 401(k)
Roth 401(k)
One participant (solo) 401(k)
What are the features of a traditional 401(k)?
3.3
- CODA
- Contributions are limited to $19.5k
- Salary deferral
- Must pass general non discrimination test
- Must also pass ADP and ACP tests
When are 401(k) plans chosen?
When the employer wants to encourage employees to save for themselves. Works best for younger people
How is the ADP test calculated?
3.3
Actual Deferral Percentage
Looks at what the employees put into the 401(k)
How is the ACP test calculated?
3.3
Includes the employee contributions and employer contributions.
What happens if the ADP or ACP test fail?
3.3
Two options:
- HCEs get their contributions back
- Company can make additional matching contributions to non-HCEs to meet the ADP/ACP rules (QMAC or QNECs)
What is automatic enrollment in traditional section 401(k) plans?
3.3
The employer is allowed to automatically enroll their employees.
You must agree to provide prescribed
Must have the opt-out notice
What is a Safe Harbor 401(k)?
3.3
More simple than a traditional
Don’t have to do non-discrimination testing (deemed to have already met ADP and ACP test)
Still subject to top heavy rules
Has a mandatory employer contribution that is either:
- 3% for all employees
- Matching contribution 100% on first 3% of non-HCE comp AND 50% match on next 2%
Government orgs can’t use it
Who can setup a SIMPLE 401(k)?
3.3
Employers with 100 or fewer employees that are earning at least $5k per year.
What are benefits of SIMPLE 401(k)?
3.3
Easier/cheaper to setup
No nondiscrimination test
No ADP test
What are SIMPLE 401(k) employee contribution limits?
3.3
$13500
What are employer requirements in a SIMPLE 401(k)?
3.3
Must match elective deferrals up to 3% of the employee comp OR
make nonelective contributions of 2% of comp for all employees, even if the employee chooses not to make an elective deferral
No vesting—all employees are immediately 100% vested.
What is a Roth 401(k)?
3.3
A 401(k) that allows for Roth deferrals
What are the requirements for a stock bonus plan?
3.3
- taxation on LTCG may be deferred past distribution date
- Allows for flexible employer contributions
- Allows social security integration
- If the stock is not tradable, a participant who separates from service must be provided a put option
What are cross-tested plans?
Designed to slant employer contributions in favor of older, higher-paid employees.
- New comparability plans
- Age-based profit sharing plans
What is a keogh (self employed) plan?
Employer sponsored that covers one or more self employed individuals
Can be a DB, DC or tax advantaged
Typically a profit sharing, money purchase, or target benefit
How is the net contribution rate for a Keogh determined?
Divide the contribution percentage by 1+ the contribution percentage.
ex: If company contribution is 25%–.25/1.25 = 20%
if company contribution is 15% –.15/1.15 = 13.04
How do you calculate a Keogh deduction?
- Determine net income
- Subtract deductible amount of SE tax paid
- Multiple by net contribution rate
