Chapter 6 (SEPs, SIMPLEs, and 403(b) Plans)

What are the penalties for failure to comply with the clear and precise disclosure requirements under a SIMPLE? Why do they exist?

Trustee fined $50 a day for late distribution of participant statements or the annual summary plan description. Employer is fined $50 a day for late notification to participants of their right to make salary deferral elections. *Why* The disclosure requirements and penalty system were deemed necessary because there is no direct inventive for the employer to encourage SIMPLE participation

403(b) plan

a retirement plan similar to a 401(k) plan that is available to Sec 501(c)(3) tax-exempt organizations and to public schools also referred to as a tax-sheltered annuity (TSA) or tax-deferred annuity (TDA)

simplified employee pension (SEP)

a retirement plan that uses an individual retirement account (IRA) as the receptacle for contributions. A SEP is a simplified approach to a profit-sharing plan.

savings incentive match plan for employees (SIMPLE)

a simplified retirement plan funded with IRA accounts that allows employees to save on a pre-tax basis, with limited employer contributions. A SIMPLE is an alternative to a 401(k) plan.

In the following situation, identify whether a SEP is appropriate, and if not, what other type of plan the sponsor should consider. Candidate Growthco, Inc., has indicated that it would like to have the option to avoid contributions in certain plan years. Growthco wants to motivate employees, but it is hesitant to use stock ownership as an incentive because the owners want to control all stock.

Either a profit-sharing plan or a SEP looks like an appropriate choice. What is chosen will depend on the coverage, vesting, and withdrawal issues.

Who are candidates for the SIMPLE?

Employer looking for a plan that allows participants the right to make pre-tax contributions and who wants to develop a plan that creates a retirement planning partnership between the employer and employee. Must have 100 or fewer employees, and be looking for a plan with the lowest possible administrative hassle and cost. Will appeal over the 401(k) to the employer who has never maintained a plan before and who is looking for a low-cost plan with few administrative headaches.

T/F: A 403(b) plan is subject to the ADP test that applies to a 401(k) plan.

False 403(b) plans are not subject to this non-discrimination test, but are subject to the ACP test.

T/F: A 403(b) plan cannot be designed to permit participant loans.

False A 403(b) plan can be designed to permit participant loans.

T/F: A candidate that has a large number of part-time employees should choose a SEP because it can be designed to exclude part-time employees.

False A part-time employee with $600 (indexed for 2015) or more in earnings in 3 of the previous 5 years must be covered under a SEP.

T/F: Employers are allowed to discriminate in a SEP with regard to contributions that can be made to highly compensated employees.

False Even though a simplified employee pension plan is not a qualified plan, some of the rules that apply to qualified plans apply to SEPs, including the rule regarding nondiscriminatory actions.

T/F: All those who receive payment for services from a qualified tax-exempt organization or public school are considered eligible employees for purposes of making contributions to the organization's 403(b) plan.

False Full-time and part-time employees of a qualified employer will be eligible employees if they are so-called common-law employees. However, if they are independent contractors instead of common-law employees, they cannot be covered by the organization's 403(b) plan.

T/F: A SEP is a popular plan design choice for large corporations.

False Large corporations usually do not choose SEPs because of the rigid coverage requirements.

T/F: A SIMPLE can allow participants to borrow from the plan.

False SIMPLEs are funded with IRAs. Like SEPs, such plans cannot provide for participant loans. Other IRA rules apply as well, such as immediate vesting and no investments in life insurance or collectibles.

T/F: Today, employers can establish a salary reduction SEP.

False Salary reduction SEPs cannot be established after Dec 31, 1996. However, plans established before that date were allowed to continue under the old rules.

T/F: The employer can make both the 3 percent matching contribution and the 2 percent nonelective contribution to the SIMPLE.

False The contribution requirements for the SIMPLE are quite rigid. The employer can make either the 3% matching contribution or the 2% non-elective contribution, but not both.

T/F: An employer can sponsor both a SIMPLE and a money-purchase pension plan.

False What makes the SIMPLE different from all other types of retirement plans is that a sponsor cannot maintain any other type of tax-advantaged plan at the same time it sponsors the SIMPLE.

What funding vehicles are allowed for 403(b) plans?

Funding a 403(b) annuity plan can be done either by purchasing an annuity contract from an insurance company or by purchasing shares in a mutual fund. Neither the Code nor the Regulations define what type of annuity contracts can be provided. Before September 24, 2007, a 403(b) plan could invest in life insurance as long as death benefits satisfied the same incidental death benefit requirements that apply to qualified plans.

What are the withdrawal restrictions that apply to 403(b) plans?

In a plan funded with annuity contracts, salary deferral contributions can only be withdrawn in-service if the participant has attained age 59.5 or suffers a financial hardship. When the plan is funded with mutual fund custodial account, then the in-service withdrawal restrictions apply to all types of contributions.

T/F: A simplified employee pension (SEP) plan is a retirement plan that uses an individual retirement account or an individual retirement annuity as the receptacle for contributions.

True

T/F: All amounts contributed to a SEP are immediately 100 percent vested in the participant.

True

T/F: An employer can terminate a SIMPLE quite simply without having to be concerned about making distributions from the trust.

True

T/F: Candidates for SEPs fill out the pension planning fact finder by grading as "very valuable" the items regarding the avoidance of an annual financial commitment and by instituting a plan that is administratively convenient.

True

T/F: Full-time employees willing to defer $200 or more generally have to be eligible to make salary deferrals under a 403(b).

True

T/F: If an employee participates in a 401(k) plan or a SEP, the salary reduction contributions under those plans are aggregated with 403(b) deferrals when applying the salary deferral limit to the 403(b) plan.

True

T/F: Regardless of whether a 403(b) plan is subject to ERISA, it must be maintained pursuant to a written document.

True

T/F: Salary deferral contributions to a 403(b) plan must be fully vested at all times.

True

T/F: Similar to 401(k) plan, a 403(b) plan can allow for a Roth election and provide for automatic enrollment.

True

T/F: The employer who has few rank-and-file employees interested in participating in the plan should consider the SIMPLE over the 401(k) plan.

True

T/F: The same salary deferral dollar limit that applies to 401(k) plans applies to 403(b) plans as well.

True

T/F: Under a SIMPLE there is no nondiscrimination testing, meaning that highly compensated employees can make contributions without regard to the salary deferral elections of the non-highly compensated employees.

True

T/F: Contributions to a 403(b) annuity plan can only be made on behalf of individuals who are current, former, or retired employees of an eligible employer.

True Includes employees who receive wages, bonuses, or other compensation reported on Form W-2, but does not include independent contractors.

T/F: From a design perspective, the SEP is quite similar to the profit-sharing plan.

True The maximum deductible contribution is the same as for a profit-sharing plan.

403(b) plan that are subject to ERISA are subject to what 5 additional requirements?

*Coverage requirements* The employer contribution feature has to satisfy the provisions of Code Sec 410(b) *Matching contributions* The employer contribution mast satisfy the actual contribution percentage (ACP) test that applies to 401(k) plans *Nonelective employer contributions* The allocation of employer contributions must satisfy the nondiscrimination requirements of Code Sec 401(a)(4). *Timing of contributions* Employee salary deferral contributions must be submitted by the 15th day of the month following the month when the employee would have otherwise received the contribution. Employer contributions can be made up to the due date of the employer's tax return (plus extension) for the tax year ending with or within the plan year *Joint-and-survivor requirements* The plan will be subject to the qualified joint-and-survivor rules. The plan, may, however, be eligible for the exception that applies to profit-sharing plans.

What IRA rules apply to SEPs?

*Investment Restrictions* Because contributions are hold in IRA account, the limitations that apply to individually sponsored IRAs also apply to SEPs. These rules prohibit investment in life insurance and in collectibles (except for US government gold coins). Similarly, loans cannot be made from a SEP. *Taxation of Distribution* Distributions are taxed in the same way as distributions from IRAs. Distributions are treated as ordinary income and are not eligible for special lump-sum averaging. The penalties for early withdrawals and large distributions apply (as they do with qualified plans). Most distributions can also be rolled over to either an IRA or other tax-advantaged retirement plan to avoid current taxation.

What qualified plan rules apply to SEPs?

*Maximum Contributions* - maximum employer contribution same as profit-sharing plan --- 25% of compensation of all employees eligible to participate --- applies to all profit-sharing and SEPs sponsored by the same company - Code 415(c) maximum allocation limit to each participant - compensation cap that applies to qualified plans *Top-heavy Rules* Same rules that apply to qualified plans apply to SEPs Most SEPs will be top-heavy (benefits for key employees will generally be equal to exceed 60% of total benefits) Top-heavy rules do not have much effect on the SEP because they are already required to have 100% immediate vesting, and the minimum contribution requirement for non-key employees does not have to much effect because of the special non-discrimination rules that apply.

In an SEP, there is a loss of flexibility associated with the simplicity. Describe some of the ways that SEPs are less flexible than qualified-plans?

*Under a SEP* - all employees meeting specified requirements must be covered under the plan - the allocation formula may not contain an age-weighting factor (unlike profit-sharing plans) - benefits must be fully vested at all times

In general, employers should avoid the more complex profit-sharing plan in favor of the SEP unless the employer really values what features only available in the profit-sharing plan?

- age-weighting or cross-tested allocation formulas that skew contributions to older, more highly compensated employees - investments in life insurance - limits on plan withdrawals - participant loans - deferred vesting

Describe the requirements for the SIMPLE.

- must cover any employee who earned $5,000 in any 2 previous years and is reasonably expected to earn $5,000 again in the current year. (employees subject to a collectively bargained agreement can be excluded) - eligible employees must be given the right to make the salary deferral and receive either an employer matching or non-elective contribution. - SIMPLEs can be maintained only on a calendar-year basis, and all employees become eligible to participate as of January 1

What are the plan requirements for SIMPLEs?

- participants must be fully vested in all benefits at all times - assets cannot be invested in life insurance or collectibles - no participant loans are allowed

How is a 403(b) plan similar to a 401(k) plan?

- permits an employee to defer tax on income by allowing before-tax contributions to be made to the employee's individual account - allows the employer to make matching or non-elective contributions - can be used in conjunction with, or in lieu of, most other retirement plans

Identify the market in which 403(b) plans can be used.

A 403(b) plan can be used in public school districts and 501(c)(3) nonprofit organizations.

List the two methods that can be used to fund a 403(b) plan.

A 403(b) plan can only be funded with annuity contracts or mutual fund custodial accounts.

T/F: A 403(b) plan can only be funded with an annuity contract or a mutual fund.

True

What are the major advantages and disadvantages of a SEP?

A SEP has many of the same advantages of a discretionary profit-sharing plan with less administrative hassle. If the employer has many part-time, long-service employees, or wants to limit the plan to one group of employees, then the profit-shoring eligibility rules may be preferred,. Also, many employers do not want to give participants full and immediate vesting or immediate access to the retirement account. The SEP, however, has immediate full vesting and the employer contribution can only be allocated as a level percentage of compensation or integrated with Social Security.

Describe the major characteristics of the SIMPLE plan.

A SIMPLE can only be sponsored by an employer that does not sponsor another type of retirement plan and does not have more than 100 employees. It has to be available to those employees who earn at least $5,000 in 2 calendar years, and eligible employees must be given the right to defer up to $12,500 (2015 limit) of compensation. The employer either has to make a 2% non-elective contribution for all eligible contributions or a dollar-for-dollar matching contribution up to 3% of compensation. No other contributions are allowed, and all contributions must be fully vested. SIMPLEs are funded with IRAs so that the investment restrictions, access to funds, and other considerations that apply to SEPs also apply to SIMPLEs.

What are the salary deferral contributions for SIMPLEs?

All eligible employees have the opportunity to make elective pre-tax contributions of up to $12,500 (2015). Additional $3,000 allowed for those age 50 or older.

Explain employee elections to defer salary for a 403(b) plan.

Amounts contributed under salary reduction are excludible from gross income for federal tax purposes. - must offer the opportunity to all employees unless such employees are covered under another salary deferral type plan - employer may not require a minimum contribution level beyond a de minimis contribution of $200 *Maximum deferral limit* Same as 401(k) with addition of another special "catch-up" election: individals who have completed at least 15 years of service with most qualified sponsors are eligible. The limit is increase by the smallest of the following: - $3,000 - $15,000 reduced by increases to the regular limit the individual was allowed during earlier years because of this rule - $5,000 times the number of years of service with the organization, minus the total elective deferrals made under the plan for the individual during earlier years.

What are the contribution options that the employer has in a SIMPLE?

An employer is required to make a contribution every year. the contribution can be a 2% contribution for all eligible employees or a matching contribution. The matching contribution must be a dollar-for-dollar match, with a maximum contribution of 3% of compensation. With the matching contribution, the employer does have some flexibility. The match can be reduced as low as 1% of compensation in any 2 of 5 years.

T/F: A 403(b) plan that contains employer contributions must satisfy ERISA requirements and meet coverage and nondiscrimination requirements that apply to qualified plans.

True

T/F: A SEP cannot contain a loan provision.

True

What employers are eligible for SIMPLEs?

Any type of business entity can establish a SIMPLE; however the business cannot have more than 100 employees (only counting those employee who earned $5,000 or more of compensation). There is a 2-year grace period if the employer grows beyond the 100-employee limit. Sponsoring employer cannot maintain any other qualified plan, 403(b) or SEP at the same time it maintains the SIMPLE.

At any given time, what is the participant's benefit in a SEP?

Because contributions must be non-forfeitable, the participant's benefit at any time is simply the IRA account balance.

In the following situation, identify whether a SEP is appropriate, and if not, what other type of plan the sponsor should consider. Candidate TAMCO, Inc., would like to provide a plan that encourages participants to save for their own retirement, and that allows for discretionary employer contributions. TAMCO would like to accomplish this objective in the most tax-efficient manner possible.

Because of the employer's interest in a salary deferral option, a SEP is not a good choice. The employer should consider a 401(k) plan. A SIMPLE is not appropriate because the employer wants discretionary contributions.

In the following situation, identify whether a SEP is appropriate, and if not, what other type of plan the sponsor should consider. Candidate Smallco, Inc., has five employees and has indicated that it would like to institute a plan that is administratively convenient and allows the company to skip contributions.

Because of the interest in administrative ease, the SEP seems preferable to a profit-sharing plan in this case.

In the following situation, identify whether a SEP is appropriate, and if not, what other type of plan the sponsor should consider. The owner of candidate Transition, Inc., would like to retire and sell the company to the employees. Transition, Inc., employees do not have sufficient funds to purchase the stock outright.

Because of the interest in purchasing stock using leveraging, an ESOP is the right choice.

Describe Employee Elective Deferrals requirements under an SEP.

Before 1997, an employer could establish a SEP that allowed employees to opportunity to make pre-tax contributions in the same way as in a 401(k) plan (SARSEP). SARSEPs were banned and replaced with the SIMPLE in 1996 by the Small Business Job Protection Act, but existing plans were allowed to continue *SARSEP* - employees can elect to defer up to the same deferral amount allowed in a 401(k) plan - subject to a non-discrimination rule similar to ADP test - only an employer with 25 or fewer employees can sponsor a SARSEP - at least 50% of all eligible employees must participate in the SAPSEP - employer may not make matching contributions to encourage employees to contribute to the plan

Technology, Inc., maintains a SEP. Determine whether the following employees are eligible to participate in the plan as of January 1, 2015. a. Sally, age 45, was hired August 15, 2012, on a full-time basis. Sally earns $65,000 a year. b. Rich works part-time on an on-and-off basis. He earned $3,000 in 2011, nothing in 2012, $2,500 in 2013, and $1,500 in 2014.

Both Sally and Rich are eligible. Each earns more than $550 (indexed for 2014) in 3 of the 5 calendar years prior to the year in question. The amount increases to $600 in 2015.

Describe the coverage requirements under an SEP

Contributions must be made for all employees who meet all three of the following: - attained age 21 - performed services for the employer for at least 3 of the immediately preceding 5 years (includes part-time workers) - earned the required minimum compensation ($550 in 2013/14; $600 in 2015)

Describe the disclosure requirements under a SIMPLE.

Must notify participants that they have the 60-day election period just prior to the calendar year to make a salary deferral election or modify a previous election for the following year. Every year, prior to the 60-day election period, the trustee must prepare and the employer must distribute a summary plan description that includes employer-identifying data, a description of eligibility under the plan, benefits provided, terms of salary election, and description of the procedures for and effect of making a withdrawal. 30 days after the calendar year ends, the trustee must give participants a statement of the year's activity and the closing account balance.

Describe the *Timing of Distribution* requirements under an SEP.

Participants must be given the opportunity to withdraw the account balance at any time.

What are the three types of tax-advantaged retirement plans that are not qualified plans under Code Sec 401(a)?

SEP SIMPLE 403(b)

Describe the allocation formula requirements under an SEP.

SEP allocation formula is more limited than a profit-sharing plan. The allocation formula must either allocate contributions as a level percentage of compensation or be integrated with Social Security using the same method as for other defined-contribution plans. Cannot use age-weighting or cross-testing to skew contributions to older, more highly compensated employees

What are the vesting provisions for 403(b) plans?

Salary deferral contributions must be fully vested at all times. Employer contributions can be subject to the vesting scheduled available for defined-contribution plans.

What employers are most likely to choose the SIMPLE?

The SIMPLE is especially effective for employers looking for their first retirement plan that offers participants the option to make pre-tax salary deferrals. The plan can work much better than a 401(k) plan if only a small percentage of the workforce intends to make salary deferral contributions.

Describe the special tax rule to discourage participants from spending their SIMPLE accounts?

The plan cannot put any limitations on participant withdrawals. To discourage participants from spending their SIMPLE accounts, a special tax rule assesses a 25% penalty tax (in addition to ordinary income tax) for amounts withdrawn within 2 years of the date of participation. Other early withdraws may be subject to the special 10% excise tax.

Describe the *Documentation and Reporting" requirements under an SEP.

The supporting plan document is much simpler than with a qualified plan. IRS supplies Form 5305(SEP) and service providers (bank/insurance companies) may also sponsor a SEP prototype document and receive IRS approval. If the IRS form or prototype document is used, the plan does not have to file Form 5500 annually as long as participants receive (1) either a copy of the plan or a summary of the plan (2) some general information about SEPs, and (3) annual notice of contributions made on their behalf

T/F: 403(b) plans are not subject to the ADP test that applies to 401(k) plans.

True

The benefits administrator of Mercy Hospital has asked you to determine which of the following employees could be allowed to participate in the hospital's 403(b) plan. a. Dr Smith, who heads up the hospital's radiology department and is a full-time employee of the hospital. b. Dr Jones, who has admitting privileges at the hospital and is considered an independent contractor. c. Gary Green, who is called in by the hospital every summer to clean out the boilers d. Joy Cheerful, who works part-time (500 hours per year) distributing magazines to patient.

a. Dr. Smith is eligible because he would be considered a hospital employee and not an independent contractor. b. Dr Jones is an independent contractor and as such is not an employee of the hospital; therefore, he is not eligible for the plan. c. Gary Green would also be considered ineligible because of independent contractor status. d. Joy Cheerful could be made eligible because she is an employee.

Explain employer contributions under a 403(b) plan.

employer contributions can be made as matching contributions based on employee elections to defer compensation (subject to ACP test) - or - sponsor can make contributions on a nonelective basis, as in a profit-sharing plan or money-purchase pension plan Code Sec 415 limitations apply. - the annual amount that can be credited to a participant's account, including employer contributions, employee contributions, and forfeitures, cannot exceed the lesser of 100% of the employee's compensation from the employer or $53,000.

Sec 501(c)(3) organizations

employers that are exempt from tax under Code Sec 501(c)(3) or educational institutions of a state or political subdivision of a state