Chapter 5: Profit-sharing Plans
Can CODA's use Social Security Integration?
CODAs are not permitted to use Social Security integration; however the profit sharing portion of a 401(k) plan may use integration - just the deferral arrangement portion cannot.
What does CODA stand for?
Cash or Deferred Arrangements (CODA) - 401(k)
Are employee and employer contributions to CODA's subject to tax?
Contributions are not subject to income tax Employee contributions; however, are subject to payroll tax Employer contributions are not subject to payroll tax
Who can and cannot establish a 401(k)?
Corporations Partnerships LLCs Sole Proprietorships Tax-exempt entities They cannot be established by governmental entities.
What does the contribution to a new comparability plan depend on?
Designed to skew benefits towards owner classification. IRC states that "either contributions or benefits must not be discriminatory..." Owner Long time employee (10 years) Rank-and-File
What are the advantages of a 401(k) plan?
Employees: Shelter current income from taxation in a qualified plan. Self-directed investment Earnings grow tax deferred Employers: Minimal expense No annual contribution commitment required Owner employees may participate
What is the purpose of the ADP test?
Limits the employee elective deferrals for the HC based on the elective deferrals of the NHC. ADP test is designed to ensure that others besides the HC are utilizing the 401(k) plan. This limits the HC from deferring too much more than NHC.
Illustrate the impact of an age-based formula on the allocation of contributions to a profit sharing plan
Owners and those that are older and highly compensated can have a much higher contribution to their own account compared to other allocation methods.
What are the 7 types of profit sharing plans
Profit Sharing Plans Stock Bonus Plans Employee Stock Ownership Plans (ESOP/LESOP) 401(k) Plans with either Profit Sharing or Stock Bonus Thrift Plans Age Based Profit Sharing Plans New Comparability Plans
Describe a 401(k) plan and determine when it would be an appropriate retirement plan for a business
otherwise known as a cash or deferred arrangement These are employee self reliant plans and establish and qualified retirement plan without mandatory funding.
Explain the 401(k) deferral limits and how the impact the limits under IRC section 415c
$19,500 + $6,500 catch up Max funding $58,000 or $64,500 for 50+ individuals Arch up contributions are only employee funded.
What are the limits to contributions for profit sharing plans?
Contributions must be made by the due date of the company's income tax return including any extensions. Contributions are discretionary, but must be "substantial and recurring." No requirement of company profit for a contribution to be made. Contributions are limited to 25% of total employer covered compensation. Contributions are limited to the lesser of 100% of compensation, or $58,000 for 2021 per employee, per year.
What is the ADP schedule?
0-2% = 2x ADP for NHC 2-8% = 2% plus ADP for NHC 8% + = 1.25x ADP for NHC
What are the main characteristics of profit sharing plans?
All profit sharing plans are defined contribution plans. All profit sharing plans are established and maintained by an employer. All profit sharing plans provide for employee participation in profits. All profit sharing plans utilize a definite predetermined formula for allocating the contributions to the plan. Contributions must be nondiscriminatory. All profit sharing plans are either noncontributory or contributory. Noncontributory: Employee does not contribute to the plan and all contributions to the plan are from the employer. Contributory: Employee contributes to the plan (CODA (Cash or Deferred Arrangement) plan).
Describe the basic elements of a new comparability plan
Allows contributions to be discriminatory Each NHCE has an allocation rate those at least 1/3 of the allocation rate of the HCE with the highest allocation rate Or if each NHCE receive now Quetion of at least 5% of compensation.
Understand the primary differences between pension plans and profit sharing plans.
Profit-sharing: Legal promise: to defer compensation and this tax deferral In-service withdrawals: after two years Mandatory funding: No Employer securities in plan: Up to 100% Annual contribution limit of covered compensation: 25% Pension: Legal promise: To pay pension at retirement In-service withdrawals: No Mandatory funding: Yes Employer securities in plan: Up to 10% Annual contribution limit of covered compensation: 25%
What are the options to employers who fail the ADP test?
Recharacterization - change from pre tax to after tax contributions. This decreases the ADP of HC employees. Qualified Non-elective Contributions (QNEC) - make a contribution to NHC for the purposes of passing the ADP test. This increases the ADP of NHC employees. QNECs are 100% vested. QNECs are made to all eligible NHC employees. Qualified Matching Contributions (QMC) - make an additional matching contribution only to NHC employees that elected to defer. This increases the ADP of NHC employees. The contribution is 100% vested. It is made only to employees who elected to defer in the current year.
Explain why Social Security integration is permitted and how to apply it to a profit sharing plan
Revenue act of 1942: let pension plans provide increased benefits to highly compensated individuals because their social security won't meet their wage replacement in retirement (max $137,500) For profit sharing plans: they apply the excess method using the formulas on pg 211
Describe the differences between Roth accounts and Roth Ira's
Roth IRA - Participation: Must have earned income under limit Contribution Limits: $6,000 + $1,000 catch up Rollover/Conversion recharacterization:No longer permitted after 2017 Min. Distributions: Only after death of participant Requirements for Qualified Distribution: 5 years & on account of death, disability, age 59.5 or first time home purchase up to $10,000 Tax for nonqualified distributions (early distributions): Distributed in order: Basis 1st, Conversion basis, then earnings (Taxable). Roth Account- Participation: Must be a participant in a qualified plan that permits Roth Contribution Limits: $19,500 + $6,500 catch up Rollover/Conversion characterization: Not permitted Min. Distributions: 5 yrs & on death/disability or age 59.5 Requirements for Qualified Distribution: Tax for nonqualified distributions (early distributions):Prorated distributions between basis and earnings
Discuss the various methods of allocating profit sharing contributions to employee accounts including advantages and disadvantages of each method
Standard allocation: benefits the highly compensated as they will get a higher $ amount.
What is the deferral limit for CODA's?
The deferral limit is a per person per year limit which aggregates deferrals from 401(k), 403(b), SIMPLEs, and SARSEPs. 457 plans have a separate deferral limit.
Explain the basic purpose of profit sharing plans
The purpose of the plan is to provide for participation by employees and beneficiaries The plan must have a predetermined formula for contributions and distributions, and the plan cannot be discriminatory
