A SIMPLE 401(k) Plan is a 401(k) plan where the employer no longer has to be concerned with discrimination testing or top heavy rules. In order to maintain a SIMPLE 401(k) plan, the employer must have 100 or fewer employees with at least $5,000 of compensation in the preceding calendar year. As a "trade off" for not having to worry about testing, employers that maintain a SIMPLE 401(k) Plan must make one of the following contributions to the accounts of their participants: (1) a dollar for dollar match on all employee deferrals up to 3% of compensation; OR (2) a 2% nonelective contribution to all eligible employees. Also, all employees are immediately 100% vested.
A safe harbor 401(k) plan is a 401(k) plan where employee deferrals and employer matching contributions are no longer subject to nondiscrimination testing. Beginning in 1999, employers were able to adopt this type of plan and it is available to new and existing plans. With a safe harbor 401(k) plan, the plan must provide for 100% vesting of the safe harbor contributions. The safe harbor contributions are equal to either (1) a dollar for dollar match on all employee deferrals up to 3% of compensation and a 50 cents per dollar match on deferrals between 3% and 5% of compensation; OR (2) A 3% nonelective contribution to all eligible employees.
A key employee is any employee who at any time during the plan year is: (1) An includible officer; (2) For plan years beginning before January 1, 2002, a top ten owner; (3) A 5% owner; or (4) A 1% owner with annual compensation greater than $160,000.
Membership in either of the following two groups will cause an employee to be considered a "highly compensated employee": (1) An employee who is a 5% owner at any time during the plan year or the 12 month period immediately preceding the plan year; or (2) An employee who receives compensation in excess of $110,000 (may be adjusted by the IRS) during the 12 month period immediately preceding the plan year and, at the election of the employer, is a member of the top-paid group during the prior plan year.
The 401(k) deferral limit for 2010 is $16,500. The deferral limit for a SIMPLE 401(k) in 2010 is $11,500. These dollar limitations apply to both Pre-Tax and Roth contributions and may be increased by the IRS for cost of living adjustments.
"Catch-Up" Contributions are a provision of EGTRRA that allow older employees to defer amounts in excess to the otherwise applicable deferral limits set by the IRS. If the plan permits, participants who are age 50 or older may make these additional contributions. The catch-up limits for 2010 are $5,500 to a traditional 401(k) plan and $2,500 to a SIMPLE 401(k) plan.
Pre-Tax contributions are deducted from an employee's compensation before Federal and State taxes are calculated. An employee's pre-tax contribution is still subject to Social Security and Medicare Taxes. Roth contributions are deducted from an employee's compensation after all payroll taxes are calculated.
The deductible limit is 25% of eligible compensation. This limit applies to Employer Contributions only (employee Pre-tax and Roth contributions are not considered in this calculation). Prior to 2002, the maximum amount that an employer could deduct for contributions to a 401(k) or profit sharing plan was 15% of total compensation of plan participants and for a money purchase plan the limit was 25% of total compensation of plan participants.
The IRS limits the events which cause a distribution to the following: Termination of Employment, Death, Disability and Retirement. Employees are also able to take a loan from the plan or a "Hardship Withdrawal" if the plan permits these types of distributions.
An employee can "roll" their money into any type of qualified retirement plan (for example, a distribution from a 401(k) plan can be rolled into a 403(b) plan).
Employees who take their distributions as cash are subject to a 20% federal tax withholding. In several cases, if your distribution is subject to federal tax withholding, your state will require state withholding as well. In addition, if the employee is less than age 59 ½, they will be subject to a 10% excise tax when they file their taxes for the year of the distribution. Employees can avoid taxes by rolling their money into another qualified plan or into an IRA.
First of all, the plan has to allow for loans. Plans are not required to offer employee loans as a provision. If the plan offers loans, generally an employee is able to take a loan of up to 50% of their vested balance. Loans have to be paid back in 5 years (unless it is for the purchase of a primary residence) at a reasonable rate of interest with at least quarterly payments. There are other factors that are specific to each plan such as the maximum number of loans an employee can have outstanding at one time or the minimum amount of loan available.
A hardship withdrawal is a distribution from the plan (which is not paid back) resulting from an employee's financial hardship. Hardship withdrawals are not required to be offered by plans and if a plan offers both hardship withdrawals and loans, the employee must exhaust all of the available loans before a hardship withdrawal is an option. Many plans use a "safe-harbor" definition of hardship to determine when an employee can take a hardship withdrawal. These "safe-harbor" reasons are as follows:
- to pay for medical expenses for the participant, his/her spouse or children;
- to purchase a primary residence;
- to prevent the eviction or foreclosure on the mortgage of the residence;
- to pay for expenses related to secondary education for the participant, his/her spouse or children;
- to pay for funeral expenses for your spouse, parent, child or tax dependent and
- to pay for repair to your primary residence for expenses that would qualify for the casualty deduction under Internal Revenue Code Section 165. These distributions are taxable distributions and are also subject to the 10% early withdrawal penalty. Employees are required to stop making their employee deferral contributions for 6 months following a hardship withdrawal.
The ADP and ACP tests ensure that Highly Compensated Employees (HCEs) are not benefiting from the plan at a rate higher than the Non Highly Compensated Employees (NHCEs). The ADP and ACP are the average of the actual deferral ratios of the eligible employees for each group (HCE & NHCE). The ADP and ACP of the eligible HCEs cannot be more than a certain percentage greater than the ADP and the ACP of the eligible NHCEs or the test fails.
When your ADP or ACP tests fail, you have a couple of options to correct the failure. (1) The Employer can make contributions to the accounts of NHCEs which will make the test pass; (2) Excess contributions are recharacterized; (3) Excess contributions and allocable income are distributed to the HCEs until the total excess contributions have been distributed.
A plan becomes top heavy if the value of all assets for key employees is more than 60% of the value of assets for all employees. When a plan becomes top heavy, non-key employees must be provided with a minimum contribution. Generally, this contribution will be equal to 3% of compensation.
GUST is an acronym for the combined legislative changes made by the following: Retirement Protection Act of 1994 adopted as part of the General Agreement on Tariffs and Trade (GATT); Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA); Small Business Job Protection Act of 1996 (SBJPA) and the Taxpayer Relief Act of 1997 (TRA '97).
EGTRRA is an acronym for Economic Growth and Tax Relief Reconciliation Act which was signed into law on 6/7/01 by President Bush. In addition to reducing marginal tax rates, the Act includes a number of changes that affect retirement plans effective in 2002 or are phased-in beginning in 2002.
A restatement is a modification of the written plan documents to incorporate the provisions needed to satisfy revised tax and pension law requirements. Periodically, the IRS approves entirely new plan documents containing the necessary amendments and each employer who sponsors an existing prototype, volume submitter or individually designed plan will need to adopt and sign the new document to retain the tax advantages of the Plan.
The IRS has made several changes to the pension laws over the past several years. The IRS requires that Plan Sponsors completely rewrite their plan documents to reflect these regulatory and legislative changes. The most recent changes were brought about by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The restatement process will become more routine and will generally be required every 6 years for Plans using prototype and volume submitter documents and every 5 years for individually designed plans.
If you did not restate your plan timely, you will no longer be in compliance with the Federal tax law's qualification requirements. This means that your plan will no longer qualify for favorable tax treatment for both the Plan Sponsor and its participants. In addition, the Plan Sponsor and the employees may be subject to additional taxes, interest and penalties. If you did not restate your plan timely, you should talk to your TPA about correcting the failure under the IRS's Voluntary Correction Program (VCP).