401(k) Boot Camp Part 2 Getting Money Into the Plan November 12, 2014 Presenter: Nancy J. Manary, Director Benefits Consulting Verisight, Inc.
401(k) Boot Camp Part 2 Part 1 Getting People Into the Plan Eligibility rules and enrollment procedures Part 2 Getting Money Into the Plan Contribution rules and ADP/ACP tests 2
401(k) Boot Camp - Overview Key Objectives for Attendees Understand your plan s actual provisions Apply plan rules correctly to avoid common operational errors Increase your comfort level with respect to in-house plan responsibilities Improve the accuracy of your explanations of plan provisions to employees Make your plan run smoothly and effectively 3
Reminder from Part 1 Know the provisions of your plan Follow the provisions of your plan Treat all participants in a non-discriminatory manner Keep good records Call your TPA or plan consultant for assistance 4
Definitions Plan Sponsor the employer in the case of an employee benefit plan established or maintained by a single employer, the employee organization in the case of a plan established or maintained by an employee organization, or in the case of a plan established or maintained by two or more employers or jointly by one or more employers and one or more employee organizations, the association, committee, joint board of trustees, or other similar group of representatives of the parties who establish or maintain the plan. Plan Administrator person specifically so designated by the terms of the instrument under which the plan is operated; in the absence of a designation in the case of a plan maintained by a single employer, the employer. 5
Definitions Third Party Administrator (TPA) Organization that is hired by the plan sponsor (typically the employer) to run many day-to-day aspects of a retirement plan. Examples of responsibilities amending and restating plan documents; preparing employer and employee benefit statements; assisting in processing all types of distributions from the plan; preparing loan paperwork for plan participant; testing the plan each year to gauge its compliance with all IRS nondiscrimination requirements as well as plan and participant contribution limits; allocation of employer contributions and forfeitures; calculating participant vested percentages; and, preparing annual returns and reports required by IRS, DOL or other government agencies. 6
Definitions Recordkeeper Custodian of plan assets or the plan s investment platform. Examples of responsibilities value investments; provide participants with statements on their accounts; process distribution checks 7
CONTRIBUTION RULES -- OVERVIEW 8
Contribution Rules - Overview Check the plan to determine which types of contributions are permitted Possible contribution types include Employee salary deferrals (Pre-tax and Roth) Employer matching (regular, safe harbor or both) Employer non-matching (regular, safe harbor or both) Plan may have different age & service requirements and/or entry dates for different types of contributions. 9
SALARY DEFERRAL CONTRIBUTION RULES 10
Two types of deferrals Traditional and Roth Traditional 401(k) salary deferrals Deferrals not subject to income tax at the time of deferral Deferrals taxed when distributed from the plan Investment income on traditional deferrals taxed when distributed from plan Roth 401(k) salary deferrals Deferrals subject to income tax at the time of deferral Deferrals not taxed when distributed from the plan Investment income on Roth deferrals can be completely income tax free if taken as a qualified distribution 11
Two types of deferrals Traditional and Roth Roth deferrals do not increase the dollar limit on allowable salary deferral Dollar limit on deferrals applies to Roth deferrals, traditional deferrals, or a combination of both Roth deferrals do not increase the limit on salary deferrals available to highly compensated employees Non-discrimination testing applies to Roth deferrals as well as traditional deferrals made by HCEs 12
Roth conversions Small Business Jobs Act of 2010 adds a conversion option for 401(k) Plans The Plan must allow Roth Deferrals Only Participants eligible for an in-service distribution allowed by the Plan can make a conversion Plan amendment is required to add this option 13
SALARY DEFERRAL CONTRIBUTION LIMITS 14
Maximum salary deferral as a % of pay Internal Revenue Code (IRC) allows deferrals up to 100% of pay Some plan documents limit deferrals to a lower % of pay Can avoid issues with prioritization of deductions such as garnishments etc. Participant must leave enough money in a paycheck to cover his/her FICA taxes for that pay period, so 100% deferral is not actually possible Maximum $ limit usually overrides maximum % of pay limit 15
Maximum salary deferral as a dollar amount Basic $ limit set by IRC (adjusted annually for cost of living) $18,000 in 2015 Additional catch-up amount if age 50 or older $6,000 in 2015 Dollar limit on deferrals applies on a calendar year basis, even if the plan year is not the calendar year 16
Maximum salary deferral as a dollar amount $ limit on an individual is cumulative for deferrals made to all 401(k)-type plans that year on combined basis: 401(k), 403(b), SAR-SEP, SIMPLE-IRA, or SIMPLE-401(k) Roth deferrals are not subject to a separate $ limit, but are included in the $ limit with all pre-tax deferrals $18,000/$24,000 (2015) limit applies to salary deferrals only Matching and/or profit sharing contributions do not apply toward the $ limit available for salary deferrals 17
Salary deferral contribution limits Additional limits may apply to deferrals by highly compensated employees (HCEs) due to non-discrimination testing (ADP test) HCEs may not be able to contribute maximum $ amount 18
Age 50 catch-up deferral contributions increase $ limit if: Participant is at least age 50 by 12/31 of that year, and Participant s deferrals are exceeding some other limit Basic dollar limit ($18,000) $ limit from a failed ADP test on HCEs deferrals IRC Sec. 415 dollar limit on employee deferrals and employer contributions combined ($53,000 in 2015) % of pay limit (if one is stated in plan document) 19
Audience Question John, age 50, worked for Tax-Exempt Organization A for the first four months of 2015. He deferred $5,500 into Org A s 403(b) plan during that time. John then went to work for Corporation B, which sponsors a 401(k) plan. John wants to save as much as possible for his retirement this year. 20
Audience Question Since John (age 50) had already contributed $5,500 to Org A s 403(b) plan, what is the maximum amount he can contribute to Company B s 401(k) plan this year(2015)? a) $12,500 b) $18,000 c) $18,500 d) $24,000 21
SALARY DEFERRAL OPERATIONAL ISSUES 22
Employer s responsibility for enforcing the $ limit Is the employer responsible for limiting an employee s salary deferrals to the maximum $ amount? Yes but only for deferrals made from its own payroll Not expected to have knowledge of deferrals made by one of its employee to another employer s plan in the same calendar year 23
Employer s responsibility for enforcing the $ limit An employee is responsible for requesting a refund of excess deferrals if he/she exceeds the maximum $ limit through multiple employers plans Deadline for request of refunds March 1st following end of year in which excess deferrals were made by the employee Deadline for employer to refund excess April 15th following end of year in which excess deferrals were made by employee 24
Employer s responsibility for enforcing the $ limit The employee can choose which plan to treat as holding the excess deferrals Last money in does not have to be the source of the refund Matching contributions attributable to refunded deferral amounts in excess of the annual dollar limit are often forfeited to avoid discrimination issues. Check your plan document and discuss with your TPA 25
Compensation from which deferrals are withheld Deferrals can only be made from plan compensation Some plans exclude certain types of compensation Bonuses Commissions Overtime Check your plan s definition of plan compensation You cannot allow employees to make deferrals out of any compensation that is excluded under the plan. 26
Compensation from which deferrals are withheld Note: Most plans define plan compensation as the employee s gross pay for the year, without excluding any items such as bonuses, overtime, commissions, etc. Why? Excluding of any part of compensation may be discriminatory in practice, if the exclusion affects non-highly compensated employees (NHCEs) more than it affects highly compensated employees (HCEs). 27
Compensation from which deferrals are withheld Flip side of this issue: Employer cannot prevent an employee from making deferrals from any part of their plan compensation If plan compensation includes overtime, you must withhold salary deferrals from overtime pay If plan compensation includes commissions you must withhold salary deferrals from commissions Even if commissions are paid in a separate check outside of the regular payroll cycle 28
Compensation from which deferrals are withheld If plan compensation includes bonuses, you must follow the employee s salary deferral instructions and withhold deferrals from bonuses Unless the employee gives separate deferral instructions for his/her bonus Separate deferral instructions allow employee to defer a different amount (or nothing) out of a bonus than from regular pay Allowing separate deferral instructions from bonuses may be administratively difficult for the payroll department 29
Audience Question Michelle, age 40, made a 10% of pay salary deferral election for 2015. Her base salary is $160,000. She will be receiving a $50,000 bonus in a separate check on 12/31/2015. The plan s definition of compensation has no exclusions. How much, if anything, must be withheld from Michelle s bonus? a) $2,000 b) $5,000 c) $8,000 d) $-0-, We do not withhold salary deferrals on bonuses. 30
DEADLINE FOR DEPOSITING EMPLOYEE DEFERRALS 31
Deadline for depositing employee withholdings As soon a salary deferrals (and/or loan payments) are withheld from an employee s paycheck, that money is classified by the DOL as a plan asset IRC and ERISA prohibit the employer from having use of plan assets Keeping deferrals in the employer s checking account longer than necessary is seen by DOL as borrowing money from the 401(k) plan. Use of plan assets by the employer is a prohibited transaction subject to penalty taxes and other corrective measures 32
Deadline for depositing employee withholdings DOL regulations require employers to deposit salary deferrals (and loan payments) into a plan account as soon as administratively possible after the date the amounts were withheld from pay. Failure to make the deposits as soon as administratively possible will subject the employer to penalty taxes for late deposits and make-whole contributions to participants for lost earnings. 33
Deadline for depositing employee withholdings How soon is as soon as administratively possible after the date the amounts were withheld from pay? It depends on each employer s facts and circumstances. Since payroll taxes have to be deposited within a few days of payroll, DOL assumes employers should be able to deposit 401(k) deferrals within a similarly short time period Safe harbor period for small plans is 7 business days after it is withheld from payroll DOL audits plans on this point and aggressively enforces the as soon as administratively possible timing rule. 34
Deadline for depositing employee withholdings Can you deposit deferrals up to 15 business days after the end of the month during which deferrals were withheld? DOL regulations state that the latest date for depositing these contributions is 15 business days after the end of the month only if it was administratively impossible for the employer to make the deposits sooner. There are very few reasons the DOL will accept to justify taking more than a week--for small plans, possibly less for large plans--, to deposit deferrals into the plan. 35
Deadline for depositing employee withholdings Are there similar deadlines for depositing employer contributions? No The deadline for depositing matching and/or profit sharing contributions into the plan is the due date of the employer s tax return for that year, including extensions (as much as 8 ½ months after the end of the year). Exception: Safe harbor matching contributions that are calculated on a pay period basis must be deposited at least quarterly. 36
Deadline for depositing employee withholdings Timing of deposit of employer contributions must be non-discriminatory. Do not deposit employer contributions earlier for some participants than for others. 37
MATCHING CONTRIBUTION BASIC RULES 38
Matching contribution basic rules Not all 401(k) plans have a matching contribution Salary deferral only plans Plans with salary deferrals and non-matching (profit sharing) contributions Eligibility rules for the match may differ from eligibility rules for salary deferrals Different minimum age and/or minimum service requirements Different excluded categories of employees 39
Matching contribution basic rules Types of match formulas Fixed formula stated in plan document Discretionary formula determined by the employer annually Both There may be allocation conditions applicable to the match Still employed on last day of plan year At least 1,000 hours of service during the year Check the plan document for all details about your plan s matching provisions (if any) 40
Many match formulas have two components: Matching rate (25% match, 50% match, 100% match, etc.) Cap on salary deferrals to which the match applies Match may apply only to salary deferrals of up to X% of pay Match may apply only to salary deferrals of up to $Y 41
Matching contribution basic rules Examples of match formula with two components: 50% match, applicable to salary deferrals of up to 6% of pay 25% match, applicable to salary deferrals of up to $2,000 Describe your match formula carefully when discussing it Avoid misleading employees about the match they can receive Avoid confusing the people who calculate the match 42
Audience Question HR rep tells employees We match 50% up to 3% of pay. What is the plan s match formula? a) 50% match, applicable to salary deferrals of up to 3% of pay (maximum match amount = 1.5% of pay) b) 50% match, applicable to salary deferrals of up to 6% of pay (maximum match amount = 3.0% of pay) c) You cannot tell from this verbal description 43
MATCHING CONTRIBUTION OPERATIONAL RULES 44
Compensation used to calculate match Match amount must be calculated on plan compensation Cannot exclude certain types of pay [bonuses, commissions, overtime, etc.] when calculating match amount Unless that type of pay is excluded from plan compensation Check your plan s definition of plan compensation May be different for match purposes than for deferral purposes May exclude compensation earned prior to entry date in first year of eligibility 45
Compensation used to calculate match Match formula applies only to compensation up to the maximum that can be taken into consideration under a 401(k) plan Capped compensation = $265,000 in 2015 Compensation in excess of the cap must be ignored when applying the match formula Definition of Compensation for Safe Harbor Match must be safe harbor definition 46
Compensation used to calculate match Example: Employee A defers $15,000 out of his/her $300,000 salary. The plan has a dollar for dollar match, which applies to salary deferrals of up to 5% of pay. $300,000 x 5% = $15,000 $265,000 x 5% = $13,250 A s matching contribution is $13,250, not $15,000 47
Catch-up deferrals and match calculations Catch-up salary deferrals are eligible for the match unless: Catch-up amounts exceed the % of pay or $ cap on salary deferrals to which the match applies, or Plan document specifically excludes catch-up deferrals from the match calculation Note: A safe harbor 401(k) plan is not allowed to exclude catch-up deferrals from the match calculation 48
CALCULATING MATCHING CONTRIBUTIONS 49
Calculating matching contributions Methods used to calculate the matching contribution: Pay-period method (cap on salary deferrals applied each pay period) Annualized method (cap on salary deferrals applied on an annual basis) Pay-period method with a true-up at year end to annualize the calculation Caution: Prefunding match contribution to participants accounts by payroll period when match contribution eligibility requires last day of employment and/or 1,000 Hours of Service. 50
Calculating matching contributions Check your plan document to see which match calculation method is specified If the plan has a discretionary match, the match calculation method may also be discretionary and not stated in the plan document You must calculate the match using a consistent method for all participants. 51
Summary Inform employees of the match calculation method Different match calculation methods can result in very different dollar amounts, depending on how an employee s deferrals are spread throughout the year Follow the match calculation method specified in the plan Or follow the method communicated to participants, if one is not stated in the plan document Treat all participants the same when calculating the match 52
Audience Question Arnold prefers to defer out of his bonus instead of deferring by regular payroll deduction all year. Arnold receives $90,000 in salary plus a $10,000 bonus in a separate check, for a total of $100,000 in pay this year. Arnold s 401(k) plan has a 50% match, which applies to salary deferrals up to 4% of pay. The match is calculated on a pay-period basis. Bonuses are included in the definition of plan compensation. 53
Audience Question Arnold defers $4,000 out of his $10,000 bonus check. How much will Arnold receive as a match this year? a) $2,000 b) $200 c) Cannot determine from the facts provided 54
NON-DISCRIMINATION TESTING ON SALARY DEFERRALS BY HIGHLY COMPENSATED EMPLOYEES 55
Non-discrimination testing on HCEs Non-discrimination testing applies to salary deferrals made by highly compensated employees (HCEs) The average % of pay deferred by HCEs is limited, based on the average % of pay deferred by non-hces Similar non-discrimination testing applies to matching contributions made for HCEs (not covered in this webcast due to time constraints) The average % of pay received as a match by HCEs is limited, based on the average % of pay received as a match by non-hces 56
Who is classified as an HCE? Any employee owning more than 5% of the business in the current year or prior year, regardless of compensation Family members of > 5% owners, regardless of compensation [Family members = owner-employee s lineal ascendants, descendants, and spouse] Non-owner employees with compensation about a specified level in the prior year [regardless of compensation in current year] 57
Compensation threshold for determining non-owner HCEs Dollar threshold for 2015 HCEs: Earned more than $120,000 in 2015 The non-owner HCE group can be limited to the top 20% of employees when ranked by pay, using prior year data 58
Non-discrimination testing on HCEs In-house staff handling the 401(k) plan can generally determine who is an HCE at the beginning of a plan year HCE status is based on prior year s compensation for non-owners HCE status is based on prior year or current year ownership status Therefore, newly hired owners or family members of owners are immediately classified as HCEs in the year hired Current non-owner employee who becomes an owner during the year will immediately become an HCE 59
Why do you need to know who is an HCE for the current plan year? So you can tell HCEs that their salary deferral contributions may be limited [based on the average level of salary deferral participation by non-hces] So you can gather information about the amounts each HCE would like to defer this year to see if their desired deferral levels are likely to pass or fail non-discrimination testing 60
NON-DISCRIMINATION TESTING - SALARY DEFERRALS CONTRIBUTIONS 61
Non-discrimination testing on salary deferrals Non-discrimination testing applies to salary deferral contributions made by HCEs Unless the plan is a Safe Harbor 401(k) plan The average % of pay that can be deferred by HCEs is determined by the average % of pay deferred by non-hces Low levels of deferral participation by non-hces will result in low limits on the amounts HCEs can defer 62
Two testing methods available for limits on deferrals by HCEs Prior year testing Compare the average deferral % (ADP) of non-hces in the prior plan year to the ADP of HCEs in the current plan year Current year testing Compare the average deferral % (ADP) of non-hces in the current plan year to the ADP of HCEs in the current plan year HCE deferral percentages always based upon current year. 63
Non-discrimination testing on salary deferrals Check the plan document so you know whether your plan uses prior year or current year testing Prior year or current year ADP testing does not change which non-owners are classified as HCEs in the current year. Determining which non-owners are HCEs is always based on employees prior year compensation. 64
How is the limit on salary deferrals by HCEs calculated? Calculate the average deferral % (ADP) of the non-hce group (current year or prior year, depending on plan provisions) Calculate the average deferral % (ADP) of the HCE group for the current year Compare the ADP of the HCE group to the ADP of the non-hce group. If the HCE group average is too much higher than the non-hce average, the plan failed the ADP test on salary deferrals 65
Non-discrimination testing methods Example: Compensation Sal.Deferral Deferral % HCE 1 $200,000 $12,000 6.0% HCE 2 $50,000 $5,000 10.0% 8.0% HCE avg. NHCE 3 $75,000 $7,500 10.0% NHCE 4 $50,000 $2,500 5.0% NHCE 5 $35,000-0- 0.0% 5.0% NHCE avg. 66
Compare ADP of HCEs to ADP of non-hces Test I: ADP of HCEs cannot exceed ADP of non-hces multiplied by 1.25 5.0% (non-hce avg) x 1.25 = 6.25% max for HCE avg. Test II: ADP of HCEs cannot exceed the lesser of (a) ADP of non-hces multiplied by 2.0 or (b) ADP of non-hces plus 2.0% (a) 5.0% x 2 = 10.0%, or (b) 5.0% + 2.0% = 7.0% Lesser result must be used In this example, the HCE average of 8.00% fails both Test I and Test II 67
CORRECTING FAILED NON-DISCRIMINATION TESTS ON SALARY DEFERRALS 68
Correcting failed test on salary deferrals Option A: Refund excess salary deferral amounts to HCEs Option B: Make an extra fully vested employer contribution for non-hces only (QNEC qualified non-elective employer contribution) Most employers use Option A unless the cost of a QNEC under Option B is a very low dollar amount. 69
Correcting failed test on salary deferrals Which HCEs make the ADP test fail? HCEs with the largest % of pay salary deferrals Which HCEs have to get refunds to correct a failed ADP test? HCEs with the largest dollar amount deferred Lower paid HCEs may be unaware that their large deferral amounts will make the plan fail non-discrimination testing. They might not even be among the HCEs who have to get a refund of excess deferrals due to a failed ADP test. 70
Correcting failed test on salary deferrals Comp. Salary Deferral Deferral % HCE 1 $245,000 $16,500 6.73% HCE 2 $110,000 $11,000 10.0% 8.36% Average ADP of the non-hce group was 5.5%, so plan failed the ADP test because the ADP of HCEs exceeded 7.5% of pay. Required refund amount = $1,903 71
Correcting failed test on salary deferrals HCE 1 (deferred $16,500, 6.73% of pay) HCE 2 (deferred $11,000, 10.0% of pay) Which HCE made the ADP test fail? HCE 2 deferred the largest % Which HCE will get the $1,903 refund? HCE 1 deferred the largest $ amount 72
Deadline for refunding excess salary deferrals to correct a failed ADP test 2 ½ months after end of plan year in which excess contributions occurred, to avoid a 10% penalty tax on employer for late refunds 3/15/2015 for plan year ending 12/31/2014 By end of plan year following year in which excess contributions occurred, to avoid plan disqualification 12/31/2015 for plan year ending 12/31/2014 73
Tax treatment of refunded salary deferrals to HCEs Taxable to employee for the calendar year in which it is refunded If refunded to HCE within 2 ½ months following end of plan year (March 15 for calendar year end plan). Refunded amount not subject to 10% penalty tax on distributions prior to 59 ½ Refunded amount not eligible for rollover to an IRA 74
COMMON IN-HOUSE OPERATIONAL ERRORS TO AVOID 75
Common error #1 Late deposit of salary deferral and/or loan payments into the plan. 76
Required corrections for error #1: Make employees whole through employer contribution for lost earnings Lost earnings Calculator available on DOL website (www.dol.gov/ebsa/calculator/main.html) Caution use Calculator when submitting under the DOL s Voluntary Fiduciary Correction Program. Calculation based on the greater of: Plan s investment rate of return, or the IRS Underpayment Rate (currently at 3%) Employer pays excise tax for the prohibited transaction due to use of plan assets (borrowing from the plan) Excise tax is 15% of amount employer would have paid in loan interest on the amount borrowed from the plan Excise tax reported on IRS Form 5330 77
Best practices to avoid error #1 Make sure all in-house staff understand the financial consequences to the company if deferrals are not deposited ASAP after every pay period. Give salary deferral deposits the same importance and timeliness as the deposit of payroll tax withholdings. Have a back-up person available if the primary person who handles this task is on vacation, out sick, or is being replaced due to a job change. 78
Common error #2 Not following the match calculation method specified in the plan document Typical errors of this type include: Calculating match on an annualized basis when plan document specifies payperiod match calculation Calculating match on a pay-period basis without a year-end true-up when plan document specifies an annualized calculation of the match 79
Required corrections to error #2 Recalculate the match using method specified in plan document Deposit additional match amounts for participants who did not receive the full amount of match to which they were entitled Remove the excess match amounts from accounts of participants who received too high a match, and transfer the excess to the forfeiture account. 80
Best practices to avoid common error #2 Train in-house staff to refer to plan document for exact specifications on the way the match is to be calculated. Have the third party administrator check the in-house staff s calculation of the match. Amend the plan document to change the match calculation to an alternate method, if the alternate method is preferable to the company. 81
Common error #3 Not applying the same match calculation method to all participants. Typical error Calculating the match on a pay-period basis (as specified in the plan) for most participants, but doing an annualized match calculation for those who capped at the $18,000 limit (2015) 82
Required correction for error #3 Recalculate the match for those participants capping at $18,000 (2015 limit) in deferrals using the method specified in the plan and transfer the excess match amount from their accounts to the forfeiture account. 83
Best practices to prevent error #3 Communicate clearly to all employees the method used to calculate the match, so they can plan the timing of their salary deferrals accordingly. Train in-house staff to follow the plan s provisions uniformly for all plan participants. Consider amending the plan document to use a different method of calculating the match, if that would better fit the company s objectives. 84
Summary Understand your plan s actual provisions for contributions: deferrals and match Type of contributions Limits on contributions Understand your plan s operational issues for contributions Timing of deposits Nondiscrimination testing Understand common operational errors and how to avoid them 85
Thank You! 401(k) Boot Camp Webinars: November 19, 2014 Part 3 Getting Money Out Of The Plan 86