401(k) Safe Harbor Options

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Information about 401(k) Safe Harbor Options
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Published on September 29, 2014

Author: pinnacleplan

Source: slideshare.net

FREE PASS! 401(k) SAFE HARBOR OPTIONS Presented by T.J. Orr, ERPA, QPA, QKA

2 The information contained in this presentation is accurate as of September 2014

Free Pass! 3 View slide

Goal: Win-Win for Employers & Employees  Cost benefit analysis makes sense for employer to provide the promised contributions.  Employees get a guaranteed contribution from their employer, and can supplement with their own contributions. 4 401(k) Plan Design Goal: A win-win for employers and employees alike View slide

Agenda 5  Challenges of Non-safe Harbor 401(k) Plans  ADP Testing  Top Heavy Minimum Contributions  Free Pass: Three Safe Harbor Options  Safe Harbor Non-elective  Safe Harbor Match  Auto-enrollment Safe Harbor  Beyond the Safe Harbor  Ideal Safe Harbor Candidates  Deadlines  PPA Restatements

Challenges of Non-SH 401(k) Plans  ADP Testing  Top Heavy Minimum Contributions to Non-Key Employees 6

7 Challenges of Non-SH 401(k) Plans ADP Testing

ADP Testing  The utilization of the 401(k) component of the plan is measured separately for the HCE group vs. the NHCE group.  NHCE utilization dictates the HCEs’ permissible utilization.  Testing impacted by:  The number of participating eligible participants, and  The rate of pay contributed 8

Testing Groups 9

The HCE Group 10

The NHCE Group 11

Example of a Failed ADP Test Pay 401(k) Catch-Up Net of Catch-Up Deferral % ADP HCE A 44,000 23,000 Maximum (5,500) Maximum 17,500 39.8% 23.25% HCE B 260,000 23,000 Maximum (5,500) Maximum 17,500 6.7% Total HCE 46.5% ÷ 2 NHCE 1 18,000 -- -- -- 0% 2.5% NHCE 2 37,000 1,480 -- 1,480 4% NHCE 3 69,000 4,140 -- 4,140 6% NHCE 4 30,000 -- -- -- 0% Total NHCE 10% ÷ 4 12

Permissible ADP Levels for HCEs  The ADP for the HCEs is limited to the lesser of:  2+ (plus), or  2x (times) the ADP of the NHCEs.  Recall that the NHCE ADP is 2.5%  HCE ADP limited to the lesser of:  4.5 % (2.5% + 2 %), or  5% (2.5% x 2)  Thus, the HCE ADP cannot exceed 4.5%  But, the HCE ADP was 23.25%  ADP Test Fails 13

Correcting the Failed ADP Test  Failure must be corrected by the last day of the following plan year (unless corrected under EPCRS, which is more expensive).  Option 1: Refunding / taxable distribution to HCE  Refund will be made to 1 or more HCEs who deferred the highest dollar amount  Must be refunded with earnings.  Taxable income to individual in year of distribution.  No penalty assessed to participant.  If distributed more than 2 ½ months (or 6-months if EACA) after plan year end, 10% penalty on employer, paid via Form 5330; 14 401(k) Plan $$$ $$$

Correcting the Failed ADP Test  Option 2: Making employer QNEC contribution to NHCEs  Qualified Non-Elective Contribution is 100% vested immediately  Cannot be used in other non-discrimination testing on non-elective contributions (to be discussed later in presentation) 15 401(k) Plan

16 Challenges of Non-SH 401(k) Plans Top Heavy Minimum Contributions to Non-Key Employees

Key & Non-Key Employees  Key Employees:  Owners of more than 5%  Owners of more than 1% and compensation exceeding $150,000  Officers with compensation exceeding $170,000  Ownership attribution rules apply  Non-Key Employees:  Those who are not Key 17

Top Heavy Minimum Contributions  A plan is top heavy if the key employees hold more than 60% of the plan’s assets.  If a plan is top heavy, the non-key employees (employed on the last day of the plan year) must receive an employer contribution of at least:  3% of annual pay, or  Greatest allocation % to any key employee, including via their elective deferral contributions 18 $$$

Example of a Top Heavy Plan YEAR 1 Key EE Pay 401(k) Total % of Total Assets HCE A Yes 44,000 23,000 HCE B Yes 260,000 23,000 46,000 89.1% NHCE 1 No 18,000 -- NHCE 2 No 37,000 1,480 NHCE 3 No 69,000 4,140 NHCE 4 No 30,000 -- Total 51,620 5,620 10.9% Key EEs have over 60% of the plan assets 19

Top Heavy Minimum Contribution 20 YEAR 1 Status Key EE Pay 401(k) Top Heavy Contribution (3% to non-keys) HCE A Active Yes 44,000 23,000 -- HCE B Active Yes 260,000 23,000 -- NHCE 1 Terminated No 18,000 -- -- NHCE 2 Active No 37,000 1,480 1,110 NHCE 3 Active No 69,000 4,140 2,070 NHCE 4 Active No 30,000 -- 900 Total 4,080

21 Free Pass! 401(k) Safe Harbor Options

Free Pass!  Safe harbor 401(k) plans provide free passage of ADP Testing and Top Heavy Minimum Contribution Requirements! Safe Harbor 401(k) Plan 22

Three Safe Harbor Options Auto-enroll ADP/ACP Safe Harbor ADP/ACP Safe Harbor Match ADP Safe Harbor Non-elective 23

Auto-enroll ADP/ACP Safe Harbor Safe Harbor Non-elective ADP/ACP Safe Harbor Match ADP Safe Harbor Non-elective 24

Safe Harbor Non-Elective  No less than 3% of participation compensation  Not a matching contribution  Contribution generally must be provided to all NHCEs, regardless of their rate of deferral (including 0%).  Pairs well with additional non-elective contributions (i.e. profit sharing) for non-discrimination testing purposes. 25 3% 401(k) Plan

Safe Harbor Non-Elective Salaries 401(k) SH NE (3%) Total 26 HCE A 44,000 23,000 Maximum -- 23,000 HCE B 260,000 23,000 Maximum -- 23,000 HCE Total 46,000 -- 46,000 NHCE 1 18,000 -- 540 540 NHCE 2 37,000 2,200 1,110 3,310 NHCE 3 69,000 4,140 2,070 6,210 NHCE 4 30,000 -- 900 900 NHCE Total 6,340 4,620 10,960

Safe Harbor Non-Elective Salaries 401(k) SH NE (3%) Total 27 HCE A 44,000 23,000 Maximum 1,320* 24,320 HCE B 260,000 23,000 Maximum 7,800* 30,800 HCE Total 46,000 9,120 55,120 NHCE 1 18,000 -- 540 540 NHCE 2 37,000 2,200 1,110 3,310 NHCE 3 69,000 4,140 2,070 6,210 NHCE 4 30,000 -- 900 900 NHCE Total 6,340 4,620 10,960 *Optional

Auto-enroll ADP/ACP Safe Harbor Safe Harbor Match ADP/ACP Safe Harbor Match ADP Safe Harbor Non-elective 28

Safe Harbor Match  Basic Match  100% match on first 3% deferred, plus 50% match on next 2%, or  Enhanced Match  Commonly set at 100% match on first 4% deferred (must be at least as great as basic match at each rate of deferral) 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Basic vs. Enhanced Safe Harbor Match Deferral Basic Enhanced 6% Deferral 5% Deferral 4% Deferral 29

Safe Harbor Match Salaries 401(k) Deferral % Enhanced SH Match (4%) Total 30 HCE A 44,000 23,000 Maximum 52.3% 1,760 24,760 HCE B 260,000 23,000 Maximum 8.8% 10,400 33,400 HCE Total 46,000 12,160 58,160 NHCE 1 18,000 -- 0% -- -- NHCE 2 37,000 1,480 4% 1,480 2,960 NHCE 3 69,000 4,140 6% 2,760 6,900 NHCE 4 30,000 -- 0% -- -- NHCE Total 5,620 4,240 9,860

Allocation Periods 31 Per Pay Period Allocation Per Year Allocation Deferrals and Pay Considered For the pay period only For the entire plan year Matching deposits due Last day of the following quarter Last day of the following plan year Employer benefits from routine cash flow Yes Deposits still permissible each pay period, and may be based on per pay period allocation with true up at year end, or based on year-to-date data Can TPA accurately confirm computations/ deposits? Less likely to do so More likely to do so If participant delays contribution May miss out on matching contributions Retain ability to maximize matching contributions

Allocation Period Example 32 Jan-June Deferral % July-Dec Deferral % Deferrals as % of Annual Pay Enhanced SH Match as % of Annual Pay Per Pay Period Allocation 0% 8% 4% 2% Per Year Allocation 0% 8% 4% 4% Therefore, per year allocations are typically a better choice.

Auto-enrollment Safe Harbor Auto-enroll ADP/ACP Safe Harbor ADP/ACP Safe Harbor Match 33 ADP Safe Harbor Non-elective

Auto-enrollment Safe Harbor 34 Safe Harbor Match for Plans 6% With Auto-enrollment 50% match on next 5% 100% match on first 1% 7% 6% 5% 4% 3% 2% 1% 0% Sample Employee Deferral Auto-enroll Safe Harbor

Auto-enrollment Safe Harbor For this Qualified Automatic Contribution Arrangement (QACA):  Minimum and maximum rates of auto deferral and auto escalation apply to plan years as follows:  1-2 – not less than 3%  3 – not less than 4%  4 – not less than 5%  5 – not less than 6% and no more than 10%  6 and thereafter – same  May wish to start at 6% without escalation for ease of administration 35

Auto-enrollment Safe Harbor For this Qualified Automatic Contribution Arrangement (QACA):  100% vesting after 2 Years of Service rather than immediate for non-QACA safe harbors 36

Add Auto-enrollment Safe Harbor Salaries 401(k) Deferral % Auto-enroll SH Match Total HCE A 44,000 23,000 Maximum 52.3% 1,540 24,540 HCE B 260,000 23,000 Maximum 8.8% 9,100 32,100 HCE Total 46,000 10,640 56,640 NHCE 1 18,000 -- 0% -- -- NHCE 2 37,000 1,480 4% 925 2,405 NHCE 3 69,000 4,140 6% 2,415 6,555 NHCE 4 30,000 -- 0% -- -- NHCE Total 5,620 3,340 8,960 37

Additional Safe Harbor Requirements  Notice: Participants must be notified within a reasonable period of time prior to the plan year beginning. This drives the year-end deadline to amend for next year’s provisions.  30-days notification deemed to be reasonable.  Documentation: Plan document must specify safe harbor formula  Vesting: Contribution 100% vested immediately (other than auto-enrollment safe harbor, which vests over 2 years)  Recipients of Contribution: Generally, all NHCEs must receive contribution  Cannot condition contribution on anything, such as employment on last day nor minimum hours worked 38

Summary  At least 3% contribution to all NHCEs 39  Basic - 100% match on first 3% plus 50% match on next 2%, or  Enhanced - Commonly 100% match on first 4%; not less than basic; ACP if more than 6% 100% match on first 1% plus 50% match on next 5% 100% Immediate Vesting 100% Immediate Vesting YOS<2 = 0% YOS≥2 = 100% YOS = Years of Service = generally 1,000 Hours of Svc in Plan Year

Other Methods to Increase Owner Allocations Additional Non-elective Contributions 40

Additional Non-Elective Contributions  On top of these safe harbor options, the employer has the option to add a non-elective contribution (aka “profit sharing”)  Subject to non-discrimination testing, unless uniform allocation  ADP test is still satisfied by safe harbor contribution  Top Heavy testing is no longer bypassed  A vesting schedule can apply  Contribution is discretionary 41

Additional Non-Elective Contribution Salaries 401(k) SH NE (3%) 42 HCE A 44,000 23,000 Maximum -- HCE B 260,000 23,000 Maximum -- HCE Total 46,000 NHCE 1 18,000 -- 540 NHCE 2 37,000 2,200 1,110 NHCE 3 69,000 4,140 2,070 NHCE 4 30,000 -- 900 NHCE Total 6,340 4,620 NE (i.e. PS at 9%) Total 3,960 26,960 23,400 46,400 27,360 73,360 -- 540 -- 3,310 -- 6,210 -- 900 10,960 The non-elective contributions as a whole are not uniform, so non-discrimination testing is required. Illustration results may vary based on demographics, including age.

Getting HCEs to $57,500 via Non-Elective Contributions Salaries 401(k) SH NE (3%) 43 HCE A 44,000 23,000 Maximum -- HCE B 260,000 23,000 Maximum -- HCE Total 46,000 NHCE 1 18,000 -- 540 NHCE 2 37,000 2,200 1,110 NHCE 3 69,000 4,140 2,070 NHCE 4 30,000 -- 900 NHCE Total 6,340 4,620 Illustration results may vary based on demographics, including age. NE (2% for NHCEs) Total 26,500 Maximum 49,500 34,500 Maximum 57,500 61,000 107,000 360 900 740 4,050 1,380 7,590 600 1,500 3,080 14,040

Three Years Later 44 401(k) SH NE (3%) NE (2% for NHCEs) Total 3 Years Later HCE Total 46,000 -- 61,000 107,000 $363,120* NHCE Total 6,340 4,620 3,080 14,040 Grand Total 52,340 4,620 64,080 121,040 * Total flow of dollars contributed to the plan over three years, unadjusted for investment performance

Other Methods to Increase Owner Allocations Discretionary Matching Contributions 45

Discretionary Match  Matching contributions are typically subject to Average Contribution % Test (ACP Test)  Similar to ADP testing  Contribution Percentage = Match ÷ Pay  Failed testing results in distribution of vested portion of match and forfeiture of non-vested match.  Less likely to fail when formula provides for caps on % of deferrals subject to match.  May be subject to vesting schedule  May be declared and funded after close of plan year. 46

Discretionary Match  When combined with SHM or SHNE, receives automatic passage of ACP testing, and bypass of top heavy minimums, provided:  Salary deferral contributions in excess 6% of pay are disregarded;  Match does not exceed 4% of pay;  Rate of match does not increase as rate of deferral increases; and  There is not a requirement for employment on last day nor minimum hours worked. 47

Add Discretionary Match to Safe Harbor Match 48 Salaries 401(k) Deferral % Enhanced SH Match Disc. Match (4%) Total HCE A 44,000 23,000 Maximum 52.3% 1,760 1,760 26,520 HCE B 260,000 23,000 Maximum 8.8% 10,400 10,400 43,800 HCE Total 46,000 12,160 12,160 70,320 NHCE 1 18,000 -- 0% -- -- -- NHCE 2 37,000 1,480 4% 1,480 1,480 4,440 NHCE 3 69,000 4,140 6% 2,760 2,760 9,660 NHCE 4 30,000 -- 0% -- -- -- NHCE Total 5,620 4,240 4,240 14,100

Other Methods to Increase Owner Allocations Yet Another Matching Contribution 49

Yet Another Matching Contribution 50 SH Match + Discretionary Match + Fixed Match Salary $260,000 401(k) 23,000 Maximum SH Match (4%) $10,400 100% vested immediately Disc. Match (4%) $10,400 Deferrals in excess 6% of pay disregarded; Match cannot exceed 4% of pay; Vesting schedule applies. Fixed Match (6%) $15,600 Cannot match deferrals in excess of 6% of pay, but 4% cap does not apply. Vesting schedule applies. Total $59,400 Over Max. Annual Addition Limitation $57,500 Maximum Discretionary match would be reduced so as not to exceed the limit.

Ideal Candidates for a Safe Harbor 401(k) Plan 51

Ideal Safe Harbor Candidates  Owners interested in maximizing contributions  They’re simply fully vesting a portion of what they were going to contribute anyway  Top heavy 401(k) Plans  Budget conscious employers seeking predictable contributions  Employers dedicated to providing generous, guaranteed contributions to employees 52

Ideal Safe Harbor Candidates (cont.) 53  Demographics and circumstances for each employer are unique.  It is important to customize the type of safe harbor that works best.

54 Deadlines – 2014 Effective SH Newly Implemented SH 401(k) Plans Month Profit Sharing Only Plans Adding a SH 401(k) 1 2 3 4 5 6 7 8 9 10 11 12

PPA Restatements  Pre-approved plans (non-403(b)): Amendment and Restatements (A&R) on a 6-year cycle  A&R for EGTRRA closed 4/30/2010  A&R for PPA opened 5/1/2014; closes 4/30/2016  Existing 401(k) plans must add safe harbor provisions prior to beginning of next plan year  Restrictions apply to amending safe harbor plans during plan year 55

PPA Restatements Evaluate before you restate! 56

Win-Win  Good plan design starts with careful evaluation of the client’s goals.  Good plan design requires an understanding of the nuances of the safe harbor alternatives.  Safe harbors mandate certain minimum contributions, yet provide benefits and opportunities to maximize contributions. 57

Retirement Plan Design▲Administration▲Consulting▲Actuarial Services www.pinnacle-plan.com 58 Beth A. Cooper, CRPS® Strategic Development Consultant bcooper@pinnacle-plan.com (520) 906-4821

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