employee benefits update february/march 2013

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1 employee benefits update february/march 2013 It s time to reap the benefits of matching contributions Can you define compensation? A review of IRS definitions that affect qualified plans Offsetting stagnant salaries with increased benefits 2012 vs retirement plan limits 5755 North Point Parkway Suite 29 Alpharetta, Georgia (678) (O) (770) (F)

2 It s time to reap the benefits of matching contributions Employees benefit from their employers offering 401(k) plans with employer-matching contributions because they re receiving additional money in their retirement fund. But how do employers benefit from matching contributions? Employer benefits Some of the benefits employers may realize by offering matching contributions include: Greater tax savings. The administrative expenses associated with a 401(k) plan including any employer contributions, such as matches and profit-sharing are tax-deductible expenses. Improved recruiting. Offering a 401(k) plan that has an employer match can help attract and retain talented and loyal employees. Employee incentive. Employers can tie employermatching contributions to meeting specific company goals. Employees may receive more through their commitment to the company s bottom line. Increased plan participation rate. Providing an employer match gives more incentive to employees to participate in the plan. Offering a 401(k) plan that has an employer match can help attract and retain talented and loyal employees. In addition, by offering a 401(k) plan for employees, an employer/owner can benefit his or her own financial future for retirement. For example, generally owners are considered highly compensated employees, and depending on plan design and demographics, a 401(k) plan could enable employees in this group to save up to the IRS maximum in a defined contribution plan. In 2013, the maximum is $51,000 (and an additional catch-up contribution of $5,500 for those who are 50 or older). Getting started Generally, employers aren t obligated to match contributions in 401(k) plans. However, if an employer provides a match, it must be noted in the plan document. In addition, employers can decide to end a discretionary match at any time. Employers should compare administrative costs and other fees associated with the several different plans to make an informed decision about which provider to choose. Then, employers must 2

3 determine what type of plan design and employer match will work best for their given situation. Matching formulas One of the most popular employer-matching contribution formulas is 50% of deferrals up to 6% of compensation. Some employers offer more generous match formulas, such as dollar for dollar. Usually, the employer-matching contribution is made at each payroll period or annually. Again, the decision on how to make the match must follow the plan document provisions. If the match is an annual match, the employer has until the due date of the plan s tax return, with extensions, to make the deposit. Vesting schedules One way to help employers retain employees and to help employees to not lose employer-matching contributions is to put a vesting schedule on the contributions. How does this help employers? It allows them to give the money to their employees, but if the employee doesn t stay in their employ long enough, they may not have to give all of the employer-match money to the employee when employment terminates. A vesting schedule requires an employee to work a certain number of years to get a percentage of the money at termination of their employment. A vesting year is earned by working one year, with at least 1,000 hours. A popular vesting schedule is known as a six-year graded. A six-year grade means that, with one vesting year or less, the employee isn t vested in any of the matching contributions. At two years, the employee is vested in 20%; at three years, 40%; at four years, 60%; at five years, 80%; and finally at six years, the employee vests in 100% of the matching contributions. For example, if an employee with two years of service terminates, he or she receives only 20% of the total employer match. The remaining 80% is forfeited, and depending on the document provisions, the employer may be able to use this money to reduce future employer contributions or to pay administrative expenses for the plan, or both. Make the match Matching contributions can boost your employee participation and provide a tax deduction. Consult your benefits specialist to review the options and determine which matching and vesting schedule is right for you. Vesting rules in safe harbor matching plans Safe harbor matching plans differ from 401(k) plan matching plans. Unlike a regular 401(k) plan, the employer must match each year to get the safe harbor status, which allows the employer to automatically pass actual deferral percentage / actual contribution percentage (ADP/ACP) testing. Employers still have the option to decide whether they ll make the safe harbor matching contribution, but by opting out, their plan is subject to ADP/ACP testing for that particular plan year. Also, keep in mind that safe harbor matching contributions are immediately 100% vested. 3

4 Upcoming compliance deadlines: COMPLIANCE ALERT 2/28 Deadline for filing paper 2012 Form 1099 with IRS (electronic filing deadline is April 1) 3/15 Deadline for making corrective distribution for failed 2012 actual deferral percentage (ADP) and actual contribution percentage (ACP) tests without 10% excise tax penalty 3/15 Deadline for filing 2012 corporate tax return and making contributions eligible for deductibility without extension 4/15 Deadline for corrective distribution of (g) excess deferral failures 4/15 Deadline for filing 2012 individual and/or partnership tax returns and making contributions eligible for deductibility Can you define compensation? A REVIEW OF IRS DEFINITIONS THAT AFFECT QUALIFIED PLANS 4 Accurately defining compensation is one of the more complex areas in qualified plans. The term compensation is used in various ways, and the choices made by an employer will directly affect the administration, and ultimately the costs, of maintaining a qualified plan. For starters, the annual compensation limitation under Internal Revenue Code (IRC) Section 401(a)(17) applies to almost all qualified plans. In 2013, the annual compensation limit is $255,000. Let s take a closer look at additional definitions of compensation types. Compensation generally excludes amounts earned after termination, such as severance pay. Participant compensation Many statutory rules involving the definition of compensation require the use of IRC Sec. 415(c)(3) participant compensation. Compensation includes all amounts paid during a defined 12-month limitation year. A plan sponsor can choose from these safe-harbor definitions for participant compensation: K A simplified definition that includes only wages, fees for professional services and other amounts received for personal services to the extent these amounts are includable in gross income, K W-2 compensation, or K Compensation for income tax withholding. Under all three definitions, the IRC adds back in pretax salary deferrals to 401(k), 403(b), 457, and cafeteria plans, as well as qualified transportation fringe benefits. Qualified retirement plans use the participant compensation definition for a number of qualified plan rules, including: K Limits on contributions and benefits under IRC Sec. 415 (the 100% limit), K The highly compensated employee rule (in general, more than 5% owners and employees with compensation in the prior plan year exceeding $115,000 in 2013),

5 K Limits on 401(k) plan catch-up contributions, and K Top-heavy rules (key employees and required top-heavy contributions). Compensation generally excludes amounts earned after termination, such as severance pay. However, payment to the terminated employee within a limited time after the termination date for work already performed and for accrued sick or vacation time counts as compensation. good election to make because it generally increases the deferral percentage for nonhighly compensated employees. Also, 401(k) plans can make only salary deferrals from Sec. 415(c)(3) participant compensation. This means, for example, that an individual can t make a salary deferral on severance pay but could defer a portion of a payment for accrued sick time paid after termination of employment. Nondiscrimination rule compensation The nondiscrimination rules define compensation in IRC Sec. 414(s). Under this section, the employer can choose a safe harbor definition or an alternative. The safe harbors include any of the Sec. 415 definitions, and plans can alter the safe harbor definitions to exclude salary deferrals. An employer can elect an alternative definition that doesn t satisfy a safe harbor if it s reasonable and doesn t discriminate in favor of highly compensated employees. To satisfy this requirement, the plan must demonstrate that the average percentage of total compensation for an employer s highly compensated employees doesn t exceed by more than a de minimis amount the average percentage of total compensation for nonhighly compensated employees. For example, if an employer uses regular pay as the definition of compensation, and only nonhighly compensated employees receive additional compensation (overtime), the definition would be considered discriminatory. On the other hand, if only highly compensated salespeople were receiving additional pay (commission), the definition might not be discriminatory. Other 401(k) plan compensation issues Several additional compensation issues arise for 401(k) plans. As previously mentioned, the plan must use a definition that complies with Sec. 414(s) for testing whether salary deferrals and matching contributions satisfy the actual deferral percentage and actual contribution percentage (ADP/ACP) tests for nondiscrimination. However, the plan can disregard compensation earned before an individual becomes eligible to participate in the plan. This is a In some cases it may be useful to limit the type of compensation a participant can defer. For example, eliminating irregular pay, such as bonus and commission income, can simplify administration. However, this could make it more difficult to satisfy the ADP nondiscrimination test because this test requires a more inclusive definition of compensation. Type of entity The type of entity affects the definition of compensation, as well. For example, the definition of compensation in an S corporation is different from that of a partnership. Only wages reported on a W-2 are includable as compensation for an S corporation owner; the pass-through income reported on the owner s Schedule K-1 isn t includable as compensation. For partners in a partnership, as well as sole proprietors, compensation generally is defined as earned income derived from the business each year. Definitions matter It s important to understand the statutory definition of compensation as well as to identify the entity type in which the business operates. Once this is completed, it s easier to determine which type of qualified plan will work best in achieving the employer s retirement benefit objectives. 5

6 Offsetting stagnant salaries with increased benefits While base pay remains a top consideration to attract and retain employees, increasingly a strong benefits package is important as well. Towers Watson, a leading global professional services company, found in a recent survey that employers indicated they may allocate more funds for employee benefits because of only moderate pay increases in the coming year. A second Towers Watson survey stated that pay is expected to increase just 2.9% for Benefits affect hiring Some employers have reported that their benefits or lack thereof have prevented them from hiring certain employees. These employers are looking to improve their employee benefit packages and may need to allocate more to make them competitive. By offering a competitive mix of salary and benefits to employees, employers may see less employee turnover. Employees are increasingly listing benefits as an essential element of their job satisfaction. According to Towers Watson, employees are more likely to prioritize retirement guarantees over pay increases by a greater than 3-1 margin. In fact, the loss of benefits is a bigger concern than the loss of a job. In Gallup s annual Work and Education poll, 40% of employees surveyed expressed concern that their benefits will be cut in the near future. That compares to 28% who fear they ll be laid off, and another 28% who worry that their pay will be reduced. What benefits matter to employers? So the studies have shown that benefits play a large role in employee satisfaction. What are some reasons to offer employee benefits that, in turn, can benefit employers? Here are a few: Tax credits. If employers offer health care plans that include dental or company paid premium life insurance plans, these expenses can help at tax time. For example, small employers (less than 25 full-time workers with average wages less than $50,000) who pay at least half of their employees health insurance premiums can use tax credits where premiums are paid for health and life insurance and dental and vision plans. Attract talented and loyal employees. Offering an employer match can help attract and retain talented and loyal employees. For example, employees or potential employees who participate in their employers qualified plan will increase whatever 6

7 they contribute by a fixed percentage, thus increasing their personal benefit. Inform employees about the cost of the benefits you offer, including the total cost incurred for the benefits and how they factor into their total compensation package. This will illustrate how much you re investing in them. Lower turnover rate. By offering a competitive mix of salary and benefits to employees, employers may see less employee turnover. Benefits equal security Employees are looking for more security in their retirement benefits. By offering a competitive benefits package, employers will have a better chance to attract and retain the key employees they need vs retirement plan limits TYPE OF LIMITATION 2012 LIMIT 2013 LIMIT Elective deferrals to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans $ 17,000 $ 17,500 Annual benefit for defined benefit plans $ 200,000 $205,000 Contributions to defined contribution plans $ 50,000 $ 51,000 Contributions to SIMPLEs $ 11,500 $ 12,000 Contributions to IRAs $ 5,000 $ 5,500 Catch-up contributions to 401(k), 403(b), 457(b)(2) and 457(c)(1) plans $ 5,500 $ 5,500 Catch-up contributions to SIMPLEs $ 2,500 $ 2,500 Catch-up contributions to IRAs $ 1,000 $ 1,000 Compensation for benefit purposes for qualified plans and SEPs $ 250,000 $255,000 Minimum compensation for SEP coverage $ 550 $ 550 Highly compensated employee threshold $ 115,000 $115,000 This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use EBUfm13 7

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