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Retirement Planning and
Employee Benefits for
Financial Planners
Chapter 5: Profit Sharing
Plans
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Seven Types of Profit Sharing Plans
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Profit Sharing Plans
Stock Bonus Plans
Employee Stock Ownership Plans
401(k) Plans
Thrift Plans
Age Based Profit Sharing Plans
New Comparability Plans
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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.
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Contributions and Deductions
 Contributions must be made by the due date of the
company’s income tax return (including extensions)
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Plan must be established by end of year, however
 Contributions are discretionary, but must be “substantial
and recurring.”
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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.
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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.
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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
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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.
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Establishing a 401(k)
 May be established by:
 Any legal form of business
 Cannot be established by
governmental entities.
 457 plans
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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.
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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
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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.
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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.
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Negative Elections
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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
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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)
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Actual Deferral Percentage Test (ADP
Test)
 Limits the employee elective deferrals
for the HC based on the elective
deferrals of the NHC.
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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%
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Failing the ADP Test
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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
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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
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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.
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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.