1. 1 Retirement Planning and Employee Benefits for Financial Planners Chapter 5: Profit Sharing Plans

2. 2 Seven Types of Profit Sharing Plans  Profit Sharing Plans  Stock Bonus Plans  Employee Stock Ownership Plans  401(k) Plans  Thrift Plans  Age Based Profit Sharing Plans  New Comparability Plans

3. 3 Characteristics  Defined contribution plan.  Established and maintained by an employer.  Provides for employee participation in profits.  Utilizes a definite predetermined formula for allocating the contributions to the plan. Must be nondiscriminatory.  Either noncontributory or contributory. Noncontributory: Employee does not contribute to the plan and all contributions to the plan are from the employer. Contributory: Employee contributes to the plan.

4. 4 Contributions and Deductions  Contributions must be made by the due date of the company’s income tax return (including extensions) Plan must be established by end of year, however  Contributions are discretionary, but must be “substantial and recurring.” No requirement of company profit for contribution.  Limited to 25% of total employer covered compensation.  Limited to the lesser of 100% of compensation, or $52,000 for 2014 per employee per year.

5. 5 Allocation of Contributions  Standard Allocation Equal percentage of comp to all participants.  Social Security Integration Provides higher allocations to employees whose earnings are greater than the Social Security Wage base.  Excess rate: < of double base rate or 5.7% if integration is at Social Security wage base ($117,000 in 2014)  Everyone: 5%; top dogs 10% on salary above $117,000 up to $260,000  Everyone: 7%; top dogs 12.7% on salary above $117,000 up to $260,000 Profit sharing plans can only use the excess method.

6. 6 Allocation of Contributions  Age-Based Profit Sharing Plans Use a combination of age and compensation to allocate the plan contribution. Take comp x PV of $1 from age 65 based on  Current age  Discount rate of 7.5% to 8.5% What rate would you select?  This equals age-weighted comp which is used to allocate contribution Example: Flintstone Quarry  Fred: age 55, comp $100,000  Barney: age 25, comp $80,000  Company contributes $50,000

7. 7 Cash or Deferred Arrangements (CODA) – 401(k)  Most prevalent type of plan established today. Predominantly funded by employee deferral contributions.  Attaches to a profit sharing plan or stock bonus plan.  Permits employees to defer compensation to a qualified plan. Limited to $17,500 for 2014 per year, or $23,000 for 2014 for those age 50 and over ($5,500 additional contribution). Employers may (buy are not required to) match the employee’s deferral.

8. 8 Establishing a 401(k)  May be established by: Any legal form of business  Cannot be established by governmental entities. 457 plans

9. 9 Qualification Requirements  Eligibility – Same as Chapter 3  Vesting Employee deferral contributions  100% at all times Employer matching contributions  Must vest at least as rapidly as 2 to 6 graduated or 3-year cliff  See Example 5.8 on pages 199.

10. 10 Contributions to CODAs (1 of 2)  Employee Contributions Elective deferral contributions  Limited to $17,500 for 2014 per year. Additional $5,500 for 2014 for age 50 and older.  Subject to payroll taxes. After-tax contributions available. Roth contributions allowed after 2005.  Employer contributions: not Roth

11. 11 Contributions to CODAs (2 of 2)  Employer Contributions Matching contributions Profit sharing contributions Contributions to meet ADP/ACP  CODAs are not permitted to use Social Security integration.

12. 12 Tax Impact  Contributions are not currently subject to income tax.  Employee deferral contributions are subject to payroll taxes.  Employer contributions are not subject to payroll taxes.

13. 13 Negative Elections Negative Elections: the employee is deemed to have elected a specific employee deferral unless the employee elects out.  In 2008, 20% of eligible employees don’t participate 40% of plans now include automatic enrollment for new hires 15% also auto-enroll non-participating employees Does this cause employees to contribute less than if not auto enrolled?  Employee contribution: 3% in year 1 increasing 1% a year to 6%  Match: 100% of 1% + 50% above 1% And top dog match = peon match  Investment: default investment 53% now use target-date fund; in 2007 35% used money market funds as default 70% of negative elections stay in default  Annual notices/Ability for employee to get funds back

14. 14 Nondiscrimination Testing  Benefits must be provided to a certain percentage of rank-and-file employees. Two tests for 401(k) in addition to qualified plan tests  Actual Deferral Percentage Test (ADP Test)  Actual Contribution Percentage Test (ACP Test)

15. 15 Actual Deferral Percentage Test (ADP Test)  Limits the employee elective deferrals for the HC based on the elective deferrals of the NHC. Top Dogs: >5% owner; or comp>$115K Peons < 2%; Top Dogs= 2 x Peon% Peons 2 – 8%; Top Dogs= 2 + Peon% Peons >8%; Top Dogs= 1.25 x Peon%

16. 16 Failing the ADP Test  Corrective Distributions: Give Them Back Decreases ADP of HC  Recharacterization: After-Tax Decreases ADP of HC  Impact ACP test  Qualified Non-elective contributions (QNEC): to everyone Increases ADP of NHC 100% vested  Qualified matching contributions (QMC) To those who participated IBM in 2012 started making 401(k) contributions once a year at end of year Increases ADP of NHC 100% vested

17. 17 Actual Contribution Percentage (ACP)  Like ADP, but determined utilizing: Employee after-tax contributions, and Employer matching contributions  Uses same scale as ADP  Uses same corrective procedures as ADP

18. 18 Safe Harbor 401(k) Plans  Not required to pass ADP or ACP tests.  Employer must provide any one of the following: 3% nonelective contribution  To all eligible employees Matching contribution  100% up to 3%, and  50% from 3% to 5%  Employer contributions are 100% vested at all times.

19. 19 Distributions  Hardship Distributions Distribution for immediate and extreme financial need:  Medical Expenses  Funeral Expenses  Purchase of principal residence No other sources of funds are available. May be subject to income tax and early withdrawal penalties.