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Regulations may be boon to plan sponsors who are experiencing economic hardships. |
Generally, plans that have 401(k) features must satisfy testing that restricts highly compensated
employees from getting greater than a certain percentage of contributions from deferrals than
non-highly compensated employees. One common way to avoid testing is to institute a “Safe
Harbor” contribution that will allow the plan to automatically pass these deferral tests. Typically, a
safe harbor contribution is either a required 1) matching contribution of 100% up to 3% of
compensation and 50% on the next 2% of compensation, or 2) a straight 3% of compensation to
all eligible employees.
Generally, plans that opted for the safe harbor matching formulas have been permitted to cease
making their required contributions prospectively after making an amendment to the plan. Now,
thanks to the new IRS regulations, it appears that plan sponsors who have a straight 3% of
compensation safe harbor formula could now suspend their contributions prospectively as well.
The new regulations state that if a plan sponsor wants to stop making the 3% safe harbor
contribution, the sponsor must provide adequate notice to the plan participants, adopt an
amendment removing the safe harbor contribution, and meet certain business requirements. If
the plan sponsor chooses to cease contributing, the plan will then have to undergo the testing
from which it is normally exempt. Additionally, the plan sponsor will have to contribute the 3% up
until the date the amendment removing the contribution is adopted.
There are still several outstanding questions relating to the suspension of the safe harbor
contributions, but the Matthews Benefit Group will follow up on any further IRS guidance on the
issues. If you have any questions, feel free to Contact Martin Burke in our offices at 727 577-
7000.
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Fee Disclosure Will Make Comparing Fees Associated With Plans Easier. |
Probably the most prominent critic of the current investment structure of 401(k) plans is
Congressman George Miller, the chairman of the House Education and Labor Committee. The
San Francisco Chronicle recently published an interview with Rep. Miller that reveals his
antipathy for the current system and discusses his ideas for fee disclosure reform. The entire
interview is available at http://www.sfgate.com/cgibin/article.cgi?f=/c/a/2009/05/16/BUTO17EB6V.DTL. He was also included in a 60 Minutes
report on 401(k) plans, and the website for Rep. Miller’s committee has an article about the
segment and a link to the entire 60 Minutes report at
http://edlabor.house.gov/blog/2009/04/chairman-millers-interview-wit.shtml.
In the Chronicle interview, Rep. Miller first explained the reasoning for his push for legislation on
fee disclosure. In his view, congressional hearings revealed that the people managing funds for
401(k) plan participants are “dipping into those funds for fees that are really not in the best
interest of those savers. So, you have elite financial managers getting rich off the back of middleclass
working people.” He feels that the current problems with the economy have drawn renewed
attention to the issue of 401(k) plan performance, including the loss of savings in part due to fees
“that cannot be justified and are excessive.” For the time being, however, his current legislative
proposal focuses on disclosure issues and does not place limits on the amount of fees that can
be charged. That proposal does mandate inclusion of an index fund in the investment choices
available to participants.
Rep. Miller has joined with Rep. Rob Andrews of New Jersey to introduce a bill to deal with fee
disclosure. Senator Tom Harkin of Iowa has introduced similar legislation in the Senate.
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Form 5558 procedures change |
Plan sponsors have been receiving return correspondence in the form of an acknowledgment
letter from the IRS when a Form 5558 is properly filed to extend the due date for filing Form 5500
or Form 5500-EZ. This correspondence indicates that you must save the letter and include a copy
with the 5500.
The IRS is working to have the language in the acknowledgement letter modified to advise plan
sponsors that they do NOT need to attach the acknowledgement letter to their Form 5500 or
Form 5500-EZ filings. The language instructing filers to do so is an error and will be removed
soon. As has been the practice in the past, only a copy of the Form 5558 must be attached to the
Form 5500 or Form 5500-EZ filing.
A recent “ASAP” from the American Society of Pension Professionals and Actuaries (ASPPA)
confirmed that the IRS is working to have the language in the acknowledgement letter modified to
advise plan sponsors that they do not need to attach to their Form 5500 or Form 5500-EZ filings.
It will take some time for this re-programming to be accomplished, but rest assured that both the
IRS and the DOL are working on it! |
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Avoiding the 3% Required Top-Heavy Contribution is Key for Some Employers |
It comes as no surprise that plan sponsors are often upset when their plans become “top heavy”
and thus require a three percent of compensation contribution for “non-key” employees that they
haven’t previously been making. As a result, almost all TPAs have in place tools to help predict
this possibility. With many companies downsizing in a sluggish economy, distributions to
terminated participants may have accelerated this event. This is a serious problem in plans that
have been flirting with being top heavy. For those plans that are not top heavy, the decreased
asset values may offer some opportunity for TPAs to do some “top heavy” planning with clients
this year.
By top heavy planning, we mean looking for things that can be done to help avoid crossing the
60 percent key employee threshold. A plan becomes top heavy when the total value of benefits
for the “key employees” divided by the value of all of the participant’s accounts, as of the
determination date, is more than 60 percent. Key employees include five percent owners (and
certain family members who are participants), officers who earn over $140,000 in 2009 for the
2009 determination date, and one percent owners who earn more than $150,000. It may seem
that the calculation to determine whether a plan is top heavy is quite straightforward and there is
little that could be done from a planning standpoint, but that initial observation may be wrong.
Remember, nothing in pension law is really as simple as it first appears.
Here is an idea that may help keep a plan from being top heavy if it is almost at the 60 percent
threshold: Deposit all employer contributions for the non-key employees before the end of the
plan year, but delay the employer contributions for the key employees until after the end of the
plan year. This helps because the top heavy determination is made on a cash basis –
contributions that are accrued but not contributed at year-end will be excluded in the calculation.
If the plan’s profit sharing contribution is based on a category allocation, and the employer is
permitted to make additional profit sharing contributions for a selected non-key employee or
designated (in the plan) group of non-key employees, then making some additional contribution
to those participants’ accounts before year-end can sometimes avoid the 60 percent threshold.
This may get the plan sponsor a year or two reprieve. Note, however, this cash basis calculation
is not permitted for the plan’s first year when it must base the top heavy determination on the
accrued contribution for the plan year.
Unfortunately, the rules for counting distributions don’t work the same way. If you thought you
could reduce the account values of a key employee by making an in-service distribution
(if permitted by the plan) just before the close of the plan year, that won’t work. Distributions
made in the one-year period before the determination date are added back in making the
top heavy calculation. If a distribution was made for a reason other than severance from
employment, death, or disability, then the add-back period increases to five years. Thus, hardship
distributions, loans in default treated as distributions, and other in-service distributions made in
the last five years are added back as if they were still in the plan. Keeping that in mind, looking for
prior hardship distributions to non-key employees may help in the determination. This can be an
overlooked element in a plan’s top heavy calculations where the TPA has changed and did not
collect the full plan records. Couple that with the fact that these distributions tend to occur
more among the non-key employees, a careful look at prior distributions might just give
additional values to help avoid the 60 percent threshold.
However, from a planning standpoint it may be worthwhile to make an in-service distribution for a
key employee while asset values are low. Distributing the accounts of a key employee now will
keep the increased value attributed to the hoped-for market rally out of future calculations. And
a final thought as to other types of distributions: You will need to include the accounts of
participants who have received a distribution on account of an individual’s death, disability, and
termination of employment, only if the distribution occurred within the last year. The accounts of
any individual not employed in the year ending on the determination date are disregarded from
the top heavy calculations.
Lastly, changing the status of a key employee to be a non-key employee won’t help, and may
actually put the plan over the 60 percent threshold. The accounts of a participant who was
previously classified as a key employee and now is a non-key employee are excluded from the
top heavy calculation. That is, the value of their accounts are excluded from both the numerator
and the denominator of the calculation. If that individual is changed back to key, then the value of
his or her accrued benefit is included in the numerator and denominator of the top heavy ratio. |
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Note: Occasionally, articles we feel would be of interest to our E-newsletter readers will be presented that previously appeared in other compilations of writings by Greg Matthews who is the Editor for the 401(k) Advisor, a monthly newsletter from Aspen Law & Business. The newsletter may be ordered at www.aspenpublishers.com or by calling 1-800-638-8437. |
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IRS CIRCULAR 230 DISCLOSURE: To ensure
compliance with the requirements imposed on us by IRS
Circular 230 (31 C.F.R. 10.33 - 10.37, et. seq.), we
inform you that to the extent this communication, including
attachments, mentions any federal tax matter it is not
intended or written and cannot be used, for the purpose
of avoiding Federal Tax penalties. In addition, this
communication may not be used by anyone in promoting,
marketing or recommending the transaction or matter
addressed herein. Anyone other than the recipient who
reads this communication should seek the advice based
on their particular circumstances from an independent
tax advisor. |
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