Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright ©...

Copyright © 2006, The American College. All rights reserved. Used with permission.


Planning for Retirement Needs

Profit-Sharing Plans, 401(k) Plans,

Stock Bonus Plans, and ESOPs Chapter 5



Chapter 5: Profit Sharing

• Profit sharing • 401(k)• Stock bonus• ESOP



Why Profit Sharing?• Discretionary contributions

• Or state as percentage of profits• Or state as percentage of pay

• Withdrawal flexibility• Tie contributions into profits• Cross-tested allocation formula



Allocation Formula “Employer contributions made for

the year will be allocated, as of the last day of each plan year, to each participant’s account in the proportion which that participant’s compensation bears to the total compensation of all eligible participants for the plan year.”



Disadvantages of Profit Sharing

• Can not provide benefits based on past service

• Can not provide specified replacement ratio



401(k) Plans

• Employee salary deferrals• Employer matching contributions• Employer profit-sharing contributions• Employee after-tax contributions



Special Requirements

• Employee deferrals 100 percent vested

• Withdrawals – Termination of employment– Attainment of age 59 1/2– Financial hardship

• General rule• Safe harbor



Safe Harbor Hardship

• Hardship events– Medical expenses– Purchase principal residence– College education for family member– Forclosure– Burial expenses for family member– Repair of damage to principal residence

• “Reasonably available” requirement – Receive all distributions and loans available

first– Suspend deferrals for 6 months



ADP Test

• Average deferral percentage test• Compare the contributions made by

HCEs in relation to the contributions made by non-HCEs

• Mathematical test• Plan has to satisfy one of two

alternative tests



Highly Compensated Employees

• 5-percent owners in current or prior year• Earn more than dollar limit in prior year

– $100,000 in 2006– $100,000 in 2007

• Election to limit group earning more than the dollar limit to only the highest paid employees (in the top 20 percent)



Performing the Test

• Calculate deferral percentage in prior year for each non-HCE

• Calculate average deferral of entire group

• Determine maximum deferral for HCE group



ADP Test –1.25

• Average ADP of the HCEs for the current year can not exceed 125 percent of the average ADP for the nonhighly compensated for the prior year.

• Example: 6% deferral for non-HCEs means 7.5% for HCEs



ADP Test—2.0 • The average of the ADP for the HCEs

for the current year can not exceed more than 200 percent of the average ADP for the nonhighly compensated for the prior year. In addition, the difference between the averages for each group cannot exceed 2 percentage points.

• Example: 6% for non HCEs means 8% for HCEs



Questions• If the average ADP of the NHCE

group is 2 percent, what is the maximum for the HCE group? (4%)

• How about 8 percent? (10%)• How about 10 percent? (11.25%)



Satisfying the ADP Test

• Current or prior-year testing• Safe harbor provision

– Nonelective option-3% for all participants

– Matching option-100% match on first 3% and 50% on next 2% deferred (4% contribution)

• Correcting excess



401(k) Contribution Limits

• $15,500 salary deferral (for 2007)• $5,000 additional for those over 50• Total allocations can not exceed

Code Sec. 415 dollar limits ($45,000 in 2007)

• ADP and ACP (test) can limit the contributions for HCEs



Roth 401(k)• Employees elect “Roth” tax treatment on

salary deferrals• Establish separate account for Roth• Election does not effect tax treatment of

employer contributions• Roth salary deferrals are counted under

maximum deferral limits and ADP testing• Qualified Roth distributions are tax free• Roth account can be rolled to a Roth IRA• Several tax differences between Roth

401(k) and Roth IRA.



Stock versus Profit Sharing

• Assets invested primarily in stock• Market for company stock• Distributions in stock



Bank

Company

Loan

ESOP

RepaymentsSuspenseaccount

Contributions

Loan guarantee

accounts

Leveraged ESOP

Stock



Qualified Plan Scorecard• Defined benefit• Cash balance• Target benefit• Money purchase• Profit sharing• Stock bonus • ESOP• 401(k)



True/False Questions

• Distributions from a profit-sharing plan may be made only after termination of employment resulting from death, retirement, or disability.

• An allocation formula in a profit-sharing plan determines how much the employer must contribute on behalf of each participant.

• Stock bonus plans and ESOPs are categorized as profit-sharing plans.

• If a participant elects to defer cash compensation to a 401(k) plan, the amount deferred is taxed in the following year.



True/False Questions

• An individual can defer a larger amount on a tax-preferential basis to a 401(k) plan than can be deferred to an individual retirement account (IRA).

• Contributions attributable to 401(k) salary reduction elections are always 100-percent vested.

• One of the 401(k) safe-harbor “financial hardship” events is payment of college tuition for a family member.

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright ©...

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