CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Retirement Planning & Employee Benefits
Module 4
Fundamentals of 401(k)
Plans
©2013, College for Financial Planning, all rights reserved.
Learning Objectives
4–1 Describe the basic characteristics of a 401(k) plan.
4–2 Identify the minimum coverage rules for 401(k) plans, including the ADP
and ACP tests.
4–3 Describe the basic characteristics of the safe harbor 401(k) plan and the
qualified automatic contribution arrangements (QACAs).
4–4 Describe the basic characteristics of profit sharing 401(k) plans, 401(k)
stock ownership plans (KSOPs), solo 401(k)s, and Roth 401(k) plans.
4–5 Describe the basic characteristics of the SIMPLE 401(k) plan and how it
compares to the regular profit sharing 401(k) plan.
4–6 Identify the rules dealing with investments offered in a 401(k) plan, and
describe how qualified default investment alternatives need to be
structured.
4–7 Describe the basic types of distributions available from a 401(k) plan.
4–8 Determine the factors that employers should consider when evaluating if a
401(k) plan would be appropriate.
4-2
Questions to Get Us Warmed Up
4-3
Learning Objectives
4–1 Describe the basic characteristics of a 401(k) plan.
4–2 Identify the minimum coverage rules for 401(k) plans, including the ADP
and ACP tests.
4–3 Describe the basic characteristics of the safe harbor 401(k) plan and the
qualified automatic contribution arrangements (QACAs).
4–4 Describe the basic characteristics of profit sharing 401(k) plans, 401(k)
stock ownership plans (KSOPs), solo 401(k)s, and Roth 401(k) plans.
4–5 Describe the basic characteristics of the SIMPLE 401(k) plan and how it
compares to the regular profit sharing 401(k) plan.
4–6 Identify the rules dealing with investments offered in a 401(k) plan, and
describe how qualified default investment alternatives need to be
structured.
4–7 Describe the basic types of distributions available from a 401(k) plan.
4–8 Determine the factors that employers should consider when evaluating if a
401(k) plan would be appropriate.
4-4
401(k) Provision
• Allows pretax employee deferrals
• Must be offered as part of either a profit
•
sharing plan (including stock bonus plans)
or a SIMPLE plan
SARSEPs may offer 401(k) provisions, however
new SARSEPs cannot be
established (since 1997)
4-5
Profit Sharing 401(k) Contribution Sources
• Employee discretionary deferral of up to
•
•
$17,500 or 100% of compensation
($5,500 age 50 catch-up)
Employer discretionary contributions
Employer matching or nonelective contributions
4-6
Eligible Entities
•
•
•
•
•
Sole proprietors
Partnerships
Corporations (C & S)
Tax-exempt organizations
Indian tribal governments
Note: State and local governments can no longer establish new 401(k)
plans, but plan established under prior law can continue.
4-7
401(k)
Advantages
Motivates employees if contributions are
based on profits.
Disadvantages
Deferred funds vest 100% to participant
Employer
Employer’s tax deduction (deduction is
based on covered payroll and is not
affected by deferrals).
ADP and ACP nondiscrimination tests
Participant
CODA allows participants options on
contributions
Withdrawals of elective deferrals available
before age 59½ only under hardship
4-8
Nondiscrimination – Coverage & Discrimination Testing
Coverage tests
• Ratio percentage
• Average benefits
Discrimination testing
• ADP
• ACP
All four of these tests use highly compensated
employees
4-9
Highly Compensated Employee
• Was a “5% owner”
•
(ownership of >5%) in the
determination year or in the
preceding plan year, or
A person whose
compensation was in excess
of $115,000 in 2012
(lookback year for 2013)
o Employer has the option
to limit highly
compensated to the toppaid 20% employees.
4-10
ADP & ACP Tests
• ADP (actual deferral percentage) – employee
•
deferrals (does not include age 50 catch-up
contributions)
ACP (actual contribution percentage) –
employer contributions and employee after-tax
contributions must pass
both tests, unless plan
is a safe harbor plan
4-11
Summary of ADP & ACP Tests
If the actual deferral percentage for
the Non-highly compensated
employees (NHCE) is:
Then the maximum actual deferral
percentage for the highly
compensated employees (HCE) is:
Between 0% and 2%
2 times the actual deferral
percentage for NHCE
Between 2% and 8%
2 plus the actual deferral
percentage for the NCHE
Greater than 8%
1.25 times the actual deferral
percentage for the NCHE
4-12
Compliance Options if Plan Fails Either Test
•
•
•
•
Corrective distribution
Recharacterization
Qualified Matching Contributions (QMACs)
Qualified Nonelective Contributions (QNECs)
4-13
Qualified Plan Vesting Schedules
Completed Service
Years
Defined benefit
plans (non-top
heavy)
Defined
contribution
plans, and all
top-heavy plans
1-2
3
4
5
6
7
1
2
3
4
5
6
Cliff Vesting
% Vested
Graded Vesting
% Vested
5-Year Cliff
3-to-7-Year Graded
0%
0%
0%
100%
100%
100%
0%
20%
40%
60%
80%
100%
3-Year Cliff
2-to-6-Year Graded
0%
0%
100%
100%
100%
100%
0%
20%
40%
60%
80%
100%
4-14
Key Employee – Top Heavy Testing
A “key employee” is an employee who, at any time
during the plan year containing the determination
date for the plan year to be tested, met either of
the following criteria:
• was a “5% owner” (ownership of >5%), or
• owned >1% of the company and
received compensation >$150,000,
or
• was an officer of the company
and received compensation
>$165,000 (2013)
4-15
Testing – HCE & Key Employees
Test
HCE
Key Employee
50/40
(DB plans only)
All ERISA
eligible
employees
All ERISA
eligible
employees
Ratio %
(DB & DC plans)

Average benefits
(DB & DC plans)

ADP
(401(k) plans)

ACP
(401(k) plans)

Top heavy
(DB & DC plans)

4-16
Learning Objectives
4–1 Describe the basic characteristics of a 401(k) plan.
4–2 Identify the minimum coverage rules for 401(k) plans, including the ADP
and ACP tests.
4–3 Describe the basic characteristics of the safe harbor 401(k) plan and the
qualified automatic contribution arrangements (QACAs).
4–4 Describe the basic characteristics of profit sharing 401(k) plans, 401(k)
stock ownership plans (KSOPs), solo 401(k)s, and Roth 401(k) plans.
4–5 Describe the basic characteristics of the SIMPLE 401(k) plan and how it
compares to the regular profit sharing 401(k) plan.
4–6 Identify the rules dealing with investments offered in a 401(k) plan, and
describe how qualified default investment alternatives need to be
structured.
4–7 Describe the basic types of distributions available from a 401(k) plan.
4–8 Determine the factors that employers should consider when evaluating if a
401(k) plan would be appropriate.
4-17
401(k) Safe Harbor Provisions
A plan may be a safe harbor plan if:
• Notice is given, and
• the employer makes a contribution:
o Deferrals are matched as follows:
• 100% match on the first 3% of compensation and
• 50% match on between 3% and 5% of
compensation
• (or 100% match on the first 4% of compensation)
•
o or a non-elective contribution of 3% is made
for all non-highly compensated employees
and all employer contributions are 100%
immediately vested.
4-18
Automatic Deferral Arrangements
Created under the PPA of 2006
• Participants must make a negative election to
“opt out” – meant to encourage participation
• ACA – Automatic Contribution Arrangement
• EACA – Eligible Automatic Contribution
Arrangement
• QACA – Qualified Automatic Contribution
Arrangement
• QACA is a safe harbor plan
• maximum vesting schedule is two-year cliff
4-19
Learning Objectives
4–1 Describe the basic characteristics of a 401(k) plan.
4–2 Identify the minimum coverage rules for 401(k) plans, including the ADP
and ACP tests.
4–3 Describe the basic characteristics of the safe harbor 401(k) plan and the
qualified automatic contribution arrangements (QACAs).
4–4 Describe the basic characteristics of profit sharing 401(k) plans, 401(k)
stock ownership plans (KSOPs), solo 401(k)s, and Roth 401(k) plans.
4–5 Describe the basic characteristics of the SIMPLE 401(k) plan and how it
compares to the regular profit sharing 401(k) plan.
4–6 Identify the rules dealing with investments offered in a 401(k) plan, and
describe how qualified default investment alternatives need to be
structured.
4–7 Describe the basic types of distributions available from a 401(k) plan.
4–8 Determine the factors that employers should consider when evaluating if a
401(k) plan would be appropriate.
4-20
401(k) Plan Types
•
•
•
•
•
•
profit sharing plans
solo 401(k)
KSOPs
Roth 401(k)
SIMPLE 401(k)
SARSEPs
4-21
Profit Sharing 401(k)
• Employee deferrals ($17,500/$5,500)
• Employer contribution maximum is 25% of
•
covered payroll (employee deferrals do not
count against the 25%)
Employer contributions may be discretionary,
matching, or nonelective
4-22
The Solo 401(k) Plan for Sole Employee Companies
Appropriate candidates
Any business that employs only owners
spouses and partners
Set-up deadline
Business tax year-end
Elective employee deferral
contributions (subject to FICA tax)
Up to $17,500 (2013)
Employee catch-up contributions
$5,500 (2013)
Employer contributions
Up to 25% of compensation (20%
for self-employed), maximum
including employee deferral is
$51,000 (2013)
Rollovers and
transfers
Allowed from most programs
Loans
Available to all participants,
including sole proprietorships
4-23
401(k) Stock Ownership Plans (KSOPs)
• Stock bonus plan with
•
•
•
401(k) provisions
Must be a corporation
since stock involved
Employee deferrals and
employer contributions,
including matching
contributions, are
invested in employer stock
Since company stock –
eligible for NUA treatment
4-24
Roth 401(k)
• Same employee deferral limits as profit sharing
•
•
401(k)
No income phaseouts as with Roth IRAs
Roth 401(k):
o has its own five-year “clock”
o has required minimum distributions (RMDs)
starting at age 70½
o if rolled into a Roth IRA then the Roth IRA
clock applies, and there are no RMDs
4-25
SIMPLE 401(k)
• 100 or fewer employees paid at least $5,000 in the
•
•
•
•
•
•
preceding year
Must be only plan offered by the employer
Employees with less than 1,000 hours of service in
the past year can be left out of the plan
Permits employee elective deferrals
($12,000/$2,500)
100% immediate vesting
No discrimination testing
Mandatory employer
contribution
4-26
SIMPLE Plan Employer Contributions
SIMPLE IRA
SIMPLE 401(k)
(covered in next module)
Match 100% first 3%—
can reduce to 1% 2 out
of 5 years—$255,000
limit on compensation
applies only to nonelective contributions
Match 100% first 3% —
$255,000 on
compensation applies
to all contributions
OR
OR
Non-elective 2%
contribution
Non-elective 2%
contribution
4-27
SARSEP
•
•
•
•
•
•
•
SEP with employee deferrals through 401(k) provisions
May not be established after 12/31/96
May have up to 25 employees, 50% of whom must participate
No matching contributions allowed
Contribution limit, lesser of 25% of compensation
or $17,500 ($5,500 catch-up)
Special ADP test
o HC ADP less than 125% of NHC, or
o ADP for each HC not greater than double
the NHC ADP and the difference is
less than 2%
IRA rules generally apply
to distributions
4-28
Investments in 401(k) Accounts
• Must offer a broad range of investment alternatives –
•
•
defined as at least three alternatives, each of which is
diversified with materially different risk and return
characteristics
Plan fiduciary responsibilities
Qualified default investment alternatives (QDIAs):
o life-cycle or target retirement funds
o balanced funds
o professionally managed fund
o variable annuity that offers
any of the above
o capital preservation product
4-29
Distributions from 401(k) Plans
• In-service (after 2 years)
• Loans (allowed but not required) –
•
maximum is 50% or $50,000, whichever is
less
Hardship withdrawals (allowed but not
required) – can only withdraw deferral
amounts, generally subject to 10% early
withdrawal penalty tax
4-30
Multiple Choice Question 1
“Annual additions” consist of which of the
following in a defined contribution plan
account?
I. employer contributions
II. employee contributions
III. investment earnings
IV. forfeiture reallocations
a. I only
b. I and II only
c. I, II, and III only
d. I, II, and IV only
4-31
Multiple Choice Question 2
Which of the following types of retirement plans
are currently permitted to offer 401(k)
provisions?
I. money purchase plans
II. SEPs
III. profit sharing plans
IV. stock bonus plans
a. I and II only
b. I and IV only
c. II and III only
d. III and IV only
e. I, II, III, and IV
4-32
Multiple Choice Question 3
If the nonhighly compensated employees’
average deferral percentage (ADP) is 4%, what
is the maximum allowable ADP for highly
compensated participants?
a. 4%
b. 5% (4% × 125%)
c. 6% (4% + 2%)
d. 7% (4% + (75% × 4%))
e. 8% (4% × 2)
4-33
Multiple Choice Question 4
Which of the following accurately describe provisions under
the hardship withdrawals from a profit sharing 401(k) plan?
I. A withdrawal may be made from employee elective
deferrals and associated earnings.
II. A participant must establish an “immediate and heavy
financial need.”
III. A withdrawal is exempt from the 10% early withdrawal
penalty.
IV. A participant must exhaust other available resources.
a. I and II only
b. II and III only
c. II and IV only
d. I, III, and IV only
e. II, III, and IV only
4-34
Multiple Choice Question 5
LMN Corporation provides a profit sharing 401(k) plan
that covers 10 participants. The participants’ total
compensation is $300,000, and their elective deferrals
for the year total $20,000.
What is the maximum additional amount the employer
can contribute and deduct as a plan contribution for the
year?
a. $50,000 (25% of $280,000, minus $20,000 of
elective deferrals)
b. $55,000 (25% of $300,000, minus $20,000 of
elective deferrals)
c. $70,000 (25% of $280,000)
d. $75,000 (25% of $300,000)
4-35
Multiple Choice Question 6
Which one of the following is a characteristic of
a SARSEP?
a. Employees who are age 21 with one year of
service must be allowed to participate in the
plan.
b. Only employers with up to 25 eligible
employees may offer the plan if established
prior to 1997.
c. Participants are 100% vested and may
withdraw account balances without penalty.
d. No discrimination tests are required.
4-36
Multiple Choice Question 7
Which of the following are correct statements regarding
requirements an employer must satisfy in order to offer a
SIMPLE plan?
I. The employer cannot have more than 25 employees who
earn $300 (indexed) or more.
II. The employer cannot have more than 100 employees
who earn $5,000 or more.
III. An employer can combine a SIMPLE plan with either a
profit sharing plan or an ESOP.
IV. To offer a SIMPLE plan, the employer cannot sponsor
another qualified plan, a 403(b) plan, or a SEP.
a. I only
b. II and IV only
c. III and IV only
d. I, III, and IV only
4-37
Multiple Choice Question 8
Employee elective deferrals cannot exceed
which one of the following under a SIMPLE
plan in 2013?
a. 25% of compensation
b. $5,500
c. $11,000
d. $12,000
e. $17,500
4-38
Multiple Choice Question 9
Joan Smith works for XYZ Corp. and earns
$268,000. XYZ Corp. provides a matching
contribution under a SIMPLE 401(k) plan.
What would be the maximum amount
that could go into Joan’s account? (The
Section 401(a)(17) limit on includible
compensation is $255,000 in 2013.)
a. $8,040
b. $12,000
c. $14,300
d. $19,650
e. $19,800
4-39
Multiple Choice Question 10
LMN Corp. made the 3% matching contribution under its
SIMPLE 401(k) plan in the prior three years. Due to extensive
capital expenses anticipated for this year, the company is
considering options on cutting back other expenses. Last year,
the 3% matching contribution was actually 2.7% of the total
aggregate salary. The company wants you to discuss its options
for this year regarding the SIMPLE plan. Which one of the
following would you recommend?
a. Since the company has satisfied the 3% matching
contribution for three years, it could reduce the contribution
to 1%.
b. By providing adequate notice, the company could move to
the 2% nonelective contribution for this year.
c. Employer contributions under a SIMPLE plan are
“discretionary,” and the company could provide notice that it
will not provide any contributions for this year.
4-40
CERTIFIED FINANCIAL PLANNER CERTIFICATION
PROFESSIONAL EDUCATION PROGRAM
Retirement Planning & Employee Benefits
Module 4
End of Slides
©2013, College for Financial Planning, all rights reserved.