Chapter 8: Installation, administration, and termination of qualified plans

Outline: - Selection of Qualified Plans

- Broad things to consider when selecting a qualified plan - Business objectives and selection of a qualified plan - What an employee census is used for in relation to selection of qualified plans - Cash flow conisderations and selection of qualified plans - Administrative Cost and Selection of Qualified plans - Small business owners and selection of qualified plans - Adopting a Written Plan: 1. Master and Prototype plans 2. Individually designed plans 3. Volume Submitter Plan - Determination Letters - Giving Notice to Employees - Summary Plan Description - Qualified Trust - Investing Plan Assets - Operating the Plan 1. Covering eligible employees 2. Minium funding requirements for defined benefit plans 3. Contribtuions 4. Deductions for contributoins 5. Contribution deductions for the self-emplyoed 6. Forfeitures 7. Prohibited Transactions 8. ERISA and Filing Requirements - Amending and Terminating a plan - Reaons to amend or termainte - Requirements for amending - Requirements for terminating - Permenancy Requirement and Termination - Defeined benefit plan terminations: 1. Standard termination 2. Distress TErmination 3. Involuntary Termination - Defined contirbution terminations - Partial Terminations - Plan Freezes - Tax on Reversion of qualified Plan Assets to Employer

Operating the Plan: Covering eligible employees

- Covering eligible employees: Have to follow the IRC's eligibility requirements at minimum (21 years old and 1 year of service). Annual coverage testing is required

Operating the plan: Minimum funding requirements for defined benefit plans

- Defined benefit/Pension plans have to contribute enough money into the plans to satisfy the minimum funding requirements determined by the actuary. The actuary will take into account factors like the life expectancy, inflation rates, investment return rates, and expected rates of forfeiture. They must make quaterly installment payments on the amount the actuary determines for each year, otherwise they'll owe interest if they underpay. Installments paymnets due dates are 15 days after the end of each quater (April 15th, July 15th, Ocotber 15th, January 15th). Each payment is 25% of what actuary determines is needed for the annual payment

ERISA and Filing Requiremnts

- ERISA: ERISA imposes fiduary responsibility on those indivduals with the authoirty over the plan's management, administration, or dispositoin of assets. The duty is also imposed on individauls that render investment advice on the plan's assets for a fee. - things a fiduary must do: Follow prudent man rule, diversify plan assets to reduce risk, must follow the document and the law. - What they cannot do: Cannot be paid for their services if they are already recieving full-time pay from an employer or union whose members are participants. Cannot act in any transaction involving the plan on behalf of a party whose interests are adverse to those of the plan, its partiicpants, or beneficares. May not self-deal with their own account. Cannot cause plan to engae in certain transactions with parties in interest. No more than 10% of plan assets to be invested in employer securites.

Business Objectives and selection of qualified plans

- Establishing the business objectives that you want the plan to take care of is the first step in establishing a qualified plan - Examples of such business objectives include: helping the company be more competive in the labor market and assistiing small business owners with tax-deferred savings

Operating the plan: Contributions (continued)

- Self-employed individuals can make contributions on behalf of themselves only if they have positive net earnings from their business. These net earnings must be from the business itself and not from investments. In a year in which there's a loss, they can't make contirbutions for themselves, but they can make them for other emplyoees, based on their compensation - Of course, defined benefit and defined contribution plans have different limits as to how much can be contributed (as a refresher, annual benefit for a defined benefit plan cannot exceed the lesser of 100% of the participant's average compensation for their highest 3 consecutive years or 225,000; annual contributions to a defined contribution are the lesser of 100% of compensatoin or 56,000). Catch-up contirbutions can add to this a little bit - What if more money is contributed to a defined contribution plan than is allowed? If this is the case, the excess amount is called the Excess Annual Addition, and a plan can correct this if it was caused by a reasonable error in estaming a participant's compensation, determining elective defferals commited, or because of forfeitures alloced to participant's accounts. To correct an Excess Annual Addition, the excess amount can be allocated to other participants in the plan or they can hold onto it and reduce the amount they have to contribute in later years or they can return employee after-tax contributions or elective deferrals (corrective distributions)

Cash Flow Considerations and selection of qualified plans

- The company's cash flows dictate how committed the company can be with regard to mandantory contributions, such as those required for pension plans; - ex. if cash flows fluctuate from year to year....its probably not a good idea to adopt a pension plan because of their mandantory funding requirement; it would be better to adopt a profit-sharing plan where contributions are discretionary

Reasons to Amend or Terminate a Plan (elaborated)

.- Plans are often changed to maximize the provision of benefits to key employees. For example, if a plan designates that forfeitures are to be distirbuted to other employees and the owners contribution limit of 56,000 has been reached, they might want to change the plan to benefit the owner by amending it to have forfeitures go towards reducing future plan costs. - Plan might also be amended because, as I mentioned earlier, a new law may make it no longer favored. - As also mentioned earlier, a qualified plan may also be termianted when the employer finds that its no longer financially viable. The employer may decide this on their own or the PBGC may make the decision for them. The PBGC has the right to step in to terminate a plan if the plan is underfunded and they feel that there is a good chance the plan will go under. - A plan may also be termianted because the employer no longer feels that it meets the needs of the employees or the company.

Contribution limit for Self-Employed Individuals Example: "Jack has Schedule C net income of 200,000 and wants to know the maximum amount he can contribute to a Keogh Profit sharing plan. In this instance, Jack can contribute 37,816 to the plan for 2019. How was this calculated???

1. Calculate the self-employed individual's contribution rate: - Contribution rate to other participants/1+contribution rate to other participants= 25%/1+25%=20% 2. Calculate Self-Employment Tax: - Net self-employment income X 92.35%= net earnings subject to employment tax X 15.3% (up to 132,900) + 2.95% over 132,900= self employment tax - 200,000 x 92.35%= 184,700= (15.3% X 132,900) + (51,800 X 2.9%) = 21,836 3. Caulcate the self-employed individual's contribution: - Net self-employment income- 1/2 of self-employment taxes= Adjusted Net Self-employment income X self-employed contribution rate= contirbution for self-employed indivdiaul - 200,000 - 10,918 (0.5 X 21,836) X 0.2=37,816

Termainating a Defined Benefit Plan: Distress Termination

2. A Distress Termination is voluntary and occurs when the employer is in financial difficulty and is unable to continue with the plan finanically.....usally because they're liquidating or filing for bankrupcy. -Adminsitrtor still must notify affected partities and PBGC

Volume Submitter Plan

A Volume Submitter plan falls in between a prototype plan and an individually designed plan. - Its a plan that is designed by a professional, like an attorney, and it contains language thats been pre-approved by the IRS - This allows for more customization than a standard prototype plan but is generally less costly than an individually designed plan.

Prohibited Transactions

A prohuted transaction are transactions between the plan and a disqualified person that are prohibited by law. If a disqualified person takes part in a prohibted transaction, that disqualified person will be subject to a tax. - Prohibited transactions generally inlcude actions by a disqualified person that potentially could have adverse consequences to the plan or participatns, including trnasfer of plan income or assets to, use of them by, or fr the benefit of a disqualified person. - Prohibted transaction is also any act of a fiduary that uses plan income or assets in their own interst. - Certain transactions are exemept from being treated as prohibited transactoins....a prohibited transaction does not take place if a disqualified person receives any benefit that they are entitled as a plan participant or beneficary.

Small Business owners and conideration of their Personal Objectives when establishing a qualified plan.

A side-note section. Consideration of the owner's business and personal objectives is more important for smaller companies; this is because these type of owners are wanting the plan to benefit them in order to help fufill their objectives of reducing their current taxes and saving for their future.

Permanency Requirement for Qualified Plans

Although qualified plans are required to be permenant, permancy does not necessiarly require that the plan continue to exsist forever. - In this context, permenancy is meant to stop owners from creating plans that only benefit themselves and key employees and then dissolving them before rank and file employees get to touch them. - The abadonment of the plan for any reason other than business necessity within the first few years after its establishment will be evidence that it was not a bona fide plan. This is espeically true for a pension plan.

Terminating a Defined Beneit Plan: Involuntary Termination

An Involuntary termination may be initiated by the PBGC for a plan that is unable to pay benefits from the plan in order to limit the amount of exposure to the PBGC. - Reaons why the PBGC might terminate a plan: 1. Plan cannot meet minimum funding requirements 2. Plan cannot pay current benefits when due 3. Lump-sum payment has been made to a partiicpant who is a substanital onwer of the sponsoring company 4. the loss of PBGC is expected to increase unreasonably if the plan is not terminated. - PBGC must termainte a plan if assets are unavaliable to pay benefits currently due.

Employee Census

Another early step in establishing a qualified plan. This is essential if the the qualified plan is intended to help not only employees but the small business owner as well. - This census identifies the age, number of years of employment, compensation, and any owership interest of all employees. - With this information in mind, you can identify which employees would benefit and which would not in various types of plans.

Notifying Eligible Employees

As mentioned earlier, information about the plan must be distributed to eligible employees and even to ineligible employees who work in that same office. - Notice to "interested parties" (elidigble and inelidgble employees who work in that same office) is required BEFORE the IRS is willing to send out a satisfactory determination letter. - Example: "Wallace Corp wants to establish a qualified plan that requires one year of service to participate. Wallace Corp has two offices: one in Chicago and one in Dunn NC. The Chicago office has 10 employees and the office in Dunn has 32 employees. Half of the employees in the Dunn office are eligible to participate. The Chicago office has very recently opened and none of the employees have met the 1 year service requirement to be elidgible under ERISA. All of the employees, but elidgible and inelidgble will be notified in the Dunn office, and nobody will be notified in the Chicago office. - Notice can be given in-person, over email, or by posting in a place for employees to see.

Master and Prototype Plans

As we just mentioned, qualified plans must be detailed in a written plan thats adopted the company. These plans follow a "standard form" called master or prototype plans. These plans have been preapproved by the IRS and are avaliable for employers to easily adopt. The difference between the two: - Master plans: Provide a single trust or custodial account that is jointly used by all adopting employers - Prototype plans: allow employers to establish their own seperate trust or custodial account. - Where are these plans obtained? IRS approved master or prototype plans can often be obtained banks, trade organizations, insruance companines, or mutual fund companines. These type of organizations offer employers a basic plan and trust document.

Qualified Trust

Assets in a qualfied plan can be placed in a qualified trust or a custodial account. - Generally, a qualified trust is a trust established or organized in the US that is maintained by an employer for the exclusive benefit of their employees. - Trust must distribute assets (In Witherspoon's class we would call this a Simple Trust) to employees and not discriminate

Qualified Plan Selection:

Broadly speaking, selection of a qualified plan depends on consideration of business, personal and financial goals, as well as a number of other considerations.

Terminations for Defined Benefit Plans

ERISA requires that a Defined Benefit Plan terminate under a standard, distress, or involuntary termination. 1. Standard Termination: This is voluntary and may occur has sufficent assets to pay all benefits at the time of the final distribution. All effected parties must be notified between 60-90 days before the proposed termination date. An affected party is: A) A plan participant B) A beneficary of a deceased participant or an alternate payee under a qualified domestic relations order C) Any employee organization representing plan partiicpants - Termaintion date can be any date selected by the adminsitrtor, including a weekend or holiday. - Administrator must notify PBGC, and they must approve it

Employer Deduction (elaborated)

Employer can usually deduct contributions to a qualified plan, even those made for their own benefit. The deduction limit depends on the type of plan - Deduction for contirbutions to a defined contirbution plan cannot exceed 25% of the covered compensation paid or accrued during the year to eligible employees participating in the plan. (covered compensation limit=280,000). - Deduction for contributions to defined benefit plans is based on what actuary determines

Summary Plan Description

Employer is required to provide a, free of charge summary of the details of the qualifed retirement plan to employees, participants, and beneficaries who are recieving benefits. - This must be furnished within 90 days of a person becoming a participant or first receives benefits as a beneficiary or within 120 days after the plan is established under ERISA - Summary Plan description explains what the plan provides and how it operates. It also provides info on when an employee can begin to participate, how service and benefits are calculated, when benefits become vested, when and in what form benefits are paid, and how to file a claim to benefits. - Why is the Summary Plan Description helpful? It takes the meat and potatos of the plan document and puts it in plain langauge for employees to understand. - Since employers are required to give notice to employees of any changes to a plan, a revissed summary plan description can be sent out or a new document called Summary of Material Modifications (must be given out within 210 days of the end of the plan year in which a modification was made) - Summary plan document must be reissued every 10 years

Contribution Deduction Limit for the Self-Employed

For sole proprietors, partners, or LLC owners who are taxed as a partnership, they are considered "employed" for this purpose. - A "self-employed" individual can adopt basically any qualified plan, but whatever plan they choose to adopt is going to be called a "Keogh Plan " (name for a qualified plan of a self-employed person). - Keogh plans are distinct in the sense that contributions made on behalf of the self-employed individual are reduced. The rest of the employees will be treated like normal as far as contributions. - The formula the IRS uses for the max contribution the self-employed individual can make to their Keogh plan is: 1. Calculate the self-employed individual's contribution rate: Self-employed contribution rate= (contribution rate to other participants/1+ contribution rate to other participants) 2. Calculate Self-employment Tax: - Net self-employment income X 92.35%= net earnings subject to employment tax X 15.3% up to 132,900 + 2.95 over 132,900= Self-employment tax 3. Calculate the self-employed individaul's contribution: - Net self-employment income - 1/2 of self-employment taxes= Earned income X self-employment contribution rate=self-employmed individual's qualified plan contribution

Forfeitures

Generally forfieutes occur when employees terminate employment. In the event that there are forfeitures from a defined contribution plan, the forfeited amount can be used to either reduce the employer's contributoins or be reallocated among the remaining plan partiicpants. Employers often anticipate the effect of forfeitures on remaining plan particiapnts in determing the costs of a qualified plan - Hopper Corp recently established a profit sharing plan that requires 3 years of service before obtaining a vested right to benefits under the plan. Eleven, one of the employees resigned from her positoin after two years of service and has an unvested account balance of 8,000. She missed the 3 year cliff, so they reduce their next contribution by 8,000 or reallocate the 8,000 to the remaining participants - Defined beneift plans are required to use forfeitures to reduce plan costs. Forfeitures cannot be allocated to paritipant's accounts becuase there are not inidivdual accounts with defined benefit plans.

Carryover of excess Contributions

If the employer contributes more to the qualified plan than the permitted deduction for the year, the excess contribution can be carried over and deducted in future years, combined with, or in lieu of contributions for those years. - Amount that can be carried over and deducted may be subject to excise tax. Usally when an employer contributes more than whats permissible, they're gonna be hit with a 10% excise tax on that amount. - 10% excise tax does not apply to any contribution made to a self-employed indvidiaul to meet minimum funding requirements in a defined benefit plan. - Certain expections avoid the 10% penealty for certain nondeductible contributoins to defined benefit plans

Plan Freezes

In some cases, an employer may find that they no longer want to contirbute to a plan but do not want to fully terminate it. this can be accomplished by freezing teh plan. - For defined contirbution plans, a freeze simply means that the employer will no longer make any contributions - For a defined benfit plan, participants will no longer accrue addtional benefits but the plan sponsor must maintain the previously accrued benfits. Tax deferral will continue to distribution.

Partial Termiantions

In some instances, by operation of law, a plan will experince a partial termination. This can occur when the employer changes the plan so that it is very adverse to the employees or there is a signfnciant severance of employee coverage by the plan (ex. layoff). - A partial terminaiton is decided on a facts and circumstances test; therefore, companines who plan to make decisions that will affect a large number of employees should consider how their actions will affect their qualified plans. - Similar to a full termaintion, the benfits of the plan participants will be 100% vested in the event of a partial termination

Perodic Pension Benefit Statement

PPA of 06 says the administraotr of a defined contirbution plan is required to provide a benefit statement: 1. To a participants or beneficary who has the right to direct the investment of assets in his account, at least quaterly 2. To any other partiipcant or other beneficary who has his own account under the plan, at least anually 3. To other beneficaries upon written request but limited to one request within a 12 month period

Administration costs and selection of qualified plans

Plans can entail numerous cost. Depending on how large the plan is and how many employees it covers, the sponsor may need to hire employees to administer the plan or hire a 3rd party to administer it. A company's ability to pay for such cost impacts the type of plan they can take-on. - Profit sharing plans are relatively inexpensive to maintain. Adding a CODA feature can slightly increase cost because of ADP/ACP testing (assuming they didn't choose the safe harbor route) - Stock bonus plans and ESOPs are more expensive to administer than the typical profit sharing plan because of the periodic stock valuations. - Defined benefit plans are usually the most expensive type of plan to adopt because of the required PBGC premiums that must be paid and the cost of paying actuaries to determine the plan contributions.

Establishing a qualified plan: Adopting a written plan and when it must be adopted by to receive an income tax deduction for contributions for that year

Qualified plan must be detailed in a written plan thats adopted by the company. - If the employer wants to take an income tax deduction for contributions for a particular tax year, the plan must be adopted by the last day of that particular day year. - Ex. If a company is on a calendar year basis, then the plan must be adopted by December 31st of the year in which the deduction is desired. But if they're own a fiscal year ending some other time (ex. August 31st) then it must be adopted by then in order to get the income tax deduction for contributions for that year.

Establishing a qualified plan

Several steps are involved in establishing a qualified plan, including communicating the plan to employees and establish a procedure for for funding and adminsitering the plan.

Defined Contribution Termaintions

Terminating a defined contirbution plan is much easier than terminating a defined benfit plan, since defined contirbution plans are already funded and not subject to PBGC. Employer will simply pass a corporate resolutin to do so and disitbute plan assets

Investing Plan Assets

The assets within plans will either be managed by the plan sponsor or by the plan participants, depending on the type of plan. - For a defined benefit plan, the investing will be handled by the employer. These emplyoers will usally hire a 3rd party to invest in such a way as to fund the pension liability they've incurred. - For a defined Contribution plan, participants are responsible for investment risk, even if employers are actually managing the assets or have hired a 3rd party firm to. - A plan sponsor is usally classified as a fiduary when it comes to handling the investment of qualified plans. - Even if employees are mainly responsible for investing sponsors still retain some responsiblity for investment choices that are avalibale to them. They must offer at least 3 broad investment alternatives (genrally one stock invesmtnt, one fixed income, and one money-market type investment); this helps employees achieve diversification.

Individually designed plans

The company can draft their own plan if they have special needs or want to for some other reason. BUT, if they do this, to make it be considered a qualified plan they'll need to consider the plan permanent and for the exclusive benefit of the employees and their beneficiary. - Approval from the IRS is not required for an individually designed plan, but approval is usually sought anyways.

Amending and Terminating a Qualified Plan

There are many reasons for changing provisions of a qualified plan. Changes are often used to solve defects in the original plan document, maximize benefits to key employees, or comply with a new tax law requirement. - There are also many reasons for terminating a plan, such as when the law changes so that the plan type is no longer advantageous, the company can no longer financially maintain the plan, or the company realizes the plan no longer meets the needs of the employees or the company.

Determination Letters

These may be used when a retirement plan is adopted, amended, or terminated. They aren't required in any of these circumstances but are useful to the plan sponsor because they allow the sponsor to get a quick response from the IRS about any issues they might need to fix (saving them from heartache later) - There's usually a fee with a determination letter - Just because a plan receives a favorable determination letter from the IRS does not mean that it can't lose its qualified status if it does not continue to comply with the provisions in the plan document, IRC, ERISA.

Requirements for amending a Qualified Plan

To amend a qualified plan, an employer must provide the plan participants notices of any plan amendments or changes. They are also required to revise the summary plan description or to create a seperate document called the summary of material modificaitons. This document must be provided to partiicpants within 210 days after the end of the plan year in which the modification was made.

Requirements for terminating a qualified plan

When a qualified plan is termianted, assuming sufficent funds are avaliable, all of the participants in the plan become fully vested in their benefits as of the date of termination. - Sponsors must stop all contributions and benefit accurals and distirbute plan assets within a reasonable period of time.

Tax on Reversion of Qualified Plan Assets to Employer

While plan sponsors are prohibited under ERISA from withdrawing assets from a qualified plan, they can recop assets in the plan that exeed the liabilites and obligtions provided for under the plan upon plan termiantion. There is a 20% excise tax on any amount of assets that revert back to the employer from a qualified plan. If certain requirements are not met, then the excise tax is increased to 50%** of the reviosnary amount....such requirements include the employer establishing a qualified replacement plan or providing for specific benefit increaes - **50% excise tax does not apply in the event that the plan sponsor is in bankrupcy.