Advanced Safe Harbor 401(K) Plan Designs (For The Financial Advisor)

Advanced Safe
Harbor 401(k) Plan
Design
(for the Financial Advisor)
Richard A. Perry, ChFC, QPA, QPFC, AIFA®
CIPC Systems, Inc.
250 Hampton Street
Auburn, MA 01501
Copyright (C) 2012 Richard A. Perry

Disclaimer
 This presentation may cause: Dizziness; drowsiness (including
daytime drowsiness); "drugged" feeling; dry mouth; headache;
nausea; nose or throat irritation; sluggishness, stomach upset,
or weakness. Seek medical attention right away if any of these
SEVERE side effects occur: Severe allergic reactions (rash;
hives; itching; difficulty breathing; tightness in the chest;
swelling of the hands, legs, mouth, face, lips, eyes, throat, or
tongue; throat closing; unusual hoarseness); abnormal
thinking; behavior changes; chest pain; confusion; decreased
coordination; difficulty swallowing or breathing; fainting; fast
or irregular heartbeat; hallucinations; memory problems (eg,
memory loss); mental or mood changes (eg, aggression,
agitation, anxiety); new or worsening depression; severe
dizziness; shortness of breath; suicidal thoughts or actions;
vision changes.

FOR FINANCIAL PROFESSIONAL USE ONLY
- NOT FOR DISTRIBUTION TO THE PUBLIC

Objectives
 Understand plan design to better advise:
 Prospects
 Clients
 Types of designs:
 Permitted Disparity (Social Security Integration)
 Age-Weighted
 Cross Tested
 Triple Stacked Match
 Not to become a TPA

Safe Harbor 401(k) Plans
 Small Business Job Protection Act of
1996 (“SBJPA”)
 Effective post-1998 plan years
 That is, plan years beginning on or after
January 1, 1999
 Small Plans
 Large Plans
 McDonald’s

401(K) Plan Issues
 Average Deferral Percentage Test
(ADP)
 IRC §401(k)
 Average Contribution Percentage Test
(ACP)
 IRC §401(m)
 Top Heavy
 IRC §416(g)(1)
 EGTRRA (Top Heavy Exemption)

401(k) Plan Limits –
IRC §402(g)(1)
 $17,000 (2012)
 Indexed for Cost of Living increases
 $5,500 Catch-Up provisions (2012)
 Age 50 or older at any time during the year


ADP & ACP Test
 Highly Compensated Employees (HCEs)
 Owns more than 5% of the voting shares of
the company stock (includes family
attribution)
 Earnings in excess of $115,000 (2012)
 Earnings indexed for Cost of Living increases
 May be limited to top 20% of employees (by
compensation)
 Look back year

ADP & ACP Test
 Non Highly Compensated Employees
(NHCEs)
 All other employees


ADP & ACP Test
 Basic Test
 Average deferral for HCEs no more than
1.25% of average deferral for NHCEs
 Alternate Test
 Average deferral for HCEs no more than
twice that of NHCEs (limit to 2% spread)


ADP & ACP Test
NHCE Average HCE Maximum
1% 2%
2% 4%
3% 5%
4% 6%
5% 7%
6% 8%
7% 9% Alternate Test

8% 10% Tests Identical

9% 11.25% Basic Test

10% 12.50%


Top Heavy Plans
 More than 60% of the benefits accrue to Key
Employees
 Owns 5% or more of the stock of the business (including
family attribution rules)
 1% owner earning in excess of $150,000 (not indexed)
 Officer and earns in excess of $165,000 (indexed) (2012)
 Minimum required contribution for non-Key
Employees:
 3% of compensation, or
 If less, the amount given to the Key Employee
with the highest allocation rate.


Safe Harbor 401(k) Plan
 Advantages  Disadvantages
 No ADP or ACP Testing  Obligates employer to a
 HCE deferral certainty contribution
 No corrective
distributions or reporting
 Can be used to satisfy
Top Heavy requirements


Top Heavy Exemption
 Contributions consist solely of:
 Elective Deferrals
 ADP Safe Harbor Contributions
 Matches that satisfy ACP safe harbor rules
 Cannot consider deferrals in excess of 6% of safe harbor
compensation.
 Rate of match cannot increase as deferrals increase.
 No HCE can have a rate of match in excess of the rate of
match of any NHCE.
 Discretionary match amount cannot exceed 4% of Safe
Harbor Compensation.


Top Heavy Exemption
 Top Heavy Exemption does not apply
if:
 Forfeitures are allocated to accounts
 Nonelective discretionary contributions
are allocated
 Longer eligibility is required for the Safe
Harbor contribution that elective deferrals


 Non-elective contribution
 QNEC
 Flexible Safe Harbor Plan
 Plan document states plan may be amended
during the year (at least 30 days prior to plan
year end) to become safe harbor
 Supplemental notice required

 Eligible matching contribution


 Non-elective contribution equal to 3%
of compensation
 All employees eligible by age and service
 Employee need not make elective deferral
contribution


 Matching contribution equal to at least:
 Basic Safe Harbor Match
 100% of the first 3% of an employee’s elective
deferrals, plus
 50% of the next 2% of an employee’s elective
deferrals
 Enhanced Safe Harbor Match
 100% of the first 4% of an employee’s elective
deferrals


Employee Elective “Basic” Safe “Enhanced” Safe
Deferral Harbor Match Harbor Match
1% 1% 1%
2% 2% 2%
3% 3% 3%
4% 3.5% 4%
5% 4% 4%
6% 4% 4%
7% 4% 4%
8% 4% 4%
9% 4% 4%
10% 4% 4%

Match vs. Non-Elective
 Match  Non-Elective
 No employer contribution  Possible higher costs –
if employee does not all employees get at least
3%
defer
 Costs more predictable
 Possible lower employer
 May use rate group
costs testing
 Higher employer cost if  Minimum gateway in
most employees defer at cross tested plans
maximum
 HCE contribution
flexibility
 “Stacking” match may
allow greater HCE
deferrals at lower costs

Safe Harbor Plan Designs
 Increase contributions for owners and
key employees:
 Permitted Disparity (Social Security
integration)
 Age-Weighted Plans
 Cross Tested Plans
 Triple Stacked Match


Annual Additions Limit –
IRC §415(c)(1)(A)
 2012 Limits
 Lesser of:
 $50,000 ($55,500 if age 50 or older*)
 100% of compensation

 * Using $5,500 “catch-up” amount


Deferral & Match (Only)
Gross Safe Harbor Total
Name Compensation Deferrals Match Allocation
Owner 1 $250,000 $22,500 $10,000 $32,500*
Owner 2 $250,000 $17,000 $10,000 $27,000*
Employee A $50,000 $2,500 $2,000 $4,500
Employee B $45,000 $2,000 $1,675 $3,675
Employee C $40,000 $1,500 $1,350 $2,850
Employee D $35,000 $0 $0 $0
Totals $670,000 $45,500 $25,025 $70,525

*Each HCE $23,000 less than allowed under IRC §415(c)


Safe Harbor 401(k) with
Integrated Profit Sharing
Integrated
Gross Safe Harbor Profit Total
Name Comp. Deferrals Match Sharing Allocation

Owner 1 $250,000 $22,500 $10,000 $23,000 $55,500

Owner 2 $250,000 $17,000 $10,000 $23,000 $50,000

Employee A $50,000 $2,500 $2,000 $2,895 $7,395

Employee B $45,000 $2,000 $1,675 $2,606 $6,281

Employee C $40,000 $1,500 $1,350 $2,316 $5,166

Employee D $35,000 $0 $0 $2,027 $2,027

Totals $670,000 $45,500 $25,025 $55,844 $126,369

 Total employee cost of $14,869


Safe Harbor 401(k) with
Integrated Profit Sharing
 Using safe harbor match
 Could use non-elective (QNEC) to satisfy
safe harbor
 Need to allocate QNEC before integrated profit
sharing


Cross Tested Profit Sharing
Formulas
 Cross Tested Plan Formulas:
 Age-Weighted
 Cross-Tested
 Classification Formulas
 New Comparability
 “Super” Integrated


Formulas
 Allowed under IRC §401(a)(4)
 Precursor was Rev. Ruling 81-202
 In many instances replace integrated
formulas
 Since EGTRRA they are allowed in
prototype plan documents
 Typical designs are:
 Age weighted formulas
 Classification formulas

Cross Tested Profit Sharing Plans

 IRC §401(a)(4)
 An employee benefit plan shall not
discriminate on the basis of benefits,
rights or features.
 Treasury Regulation 1-401(a)(4)-1
 300+ pages


Cross Tested Profit Sharing Plans

 IRC §401(a)(4)
 “A trust created or organized in the United States and
forming part of a stock bonus, pension, or profit sharing
plan of an employer for the exclusive benefits of its
employees or their beneficiaries shall constitute a qualified
trust under this section if the contributions or benefits
provided under the plan do not discriminate in favor of
highly compensated employees (within the meaning of
§414(q)). For purposes of this paragraph, there shall be
excluded from consideration employees described in
§410(b)(3)(A) and (C).”
 Treasury Regulation 1-401(a)(4)-1
 300+ pages

Formulas
 Gateways
 Broadly Available Allocation Rates
 Gradual Age/Service Schedules


Formulas
 Gateways
 Treasury Regulation 1.401(a)(4)-2(c)(2)
 Allocation rate for each benefiting NHCE must be
greater than or equal to the lessor of:
 1/3 the highest allocation rate of any HCE benefiting
under the plan
 5% of IRC §415(c)(3) pay
 Can use any IRC §414(s) definition of compensation
 Most commonly use W-2 wages


Formulas
 Broadly Available Allocation Rates
 Each allocation rate must meet the Ratio
Percentage Test or both parts of the
nondiscriminatory classification test
 Assuming plan’s testing group meets Average
Benefits Percentage Test (ABPT) this design
would pass the general test on a contribution
basis
 Therefore, no need to cross-test
 Very limited applicability


Formulas
 Each band not greater than the prior band by more than 5%
nor twice that prior band
 Ratio of band to preceding band cannot exceed ration of the
two immediately preceding bands
 Minimum allocations (for example Top Heavy) generally
permitted as long as contribution to lowest band is at least 1%
 Each band (other than the highest) must be the same length
 If lowest band starts at age 25 it can be deemed to start at any
prior age and still satisfy the same length requirement


Formulas
Gradual Age/Service Schedule

Age Contribution % Difference Ratio
< 28 1.25% N/A N/A
28 – 35 2.50% 1.25% 200%
36 – 43 5.00% 2.50% 200%
44 – 51 10.00% 5.00% 200%
52 – 59 15.00% 5.00% 150%
≥ 60 20.00% 5.00% 133%


Formulas
 Works well for:
 Transient populations
 Small groups
 Can reduce staff contributions to:
 Nearly 3% if Top Heavy
 Below 3% if not Top Heavy
 Schedule must be specified in plan
document

Safe Harbor 401(k) with Age
Weighted Profit Sharing
Age
Gross Safe Harbor Weighted Total
Name Comp. Deferrals Match Profit Allocation
Sharing
Owner 1 $250,000 $22,500 $10,000 $23,000 $55,500

Owner 2 $250,000 $17,000 $10,000 $6,770 $33,700

Employee A $50,000 $2,500 $2,000 $6,921 $11,421

Employee B $45,000 $2,000 $1,675 $1,832 $5,507

Employee C $40,000 $1,500 $1,350 $479 $3,329

Employee D $35,000 $0 $0 $948 $948

Totals $670,000 $45,500 $25,025 $39,950 $110,405



Safe Harbor 401(k) with Cross
Tested Profit Sharing
Cross
Gross Safe Harbor Tested Total
Name Comp. Deferrals Match Profit Allocation
Sharing
Owner 1 $250,000 $22,500 $10,000 $23,000 $55,500

Owner 2 $250,000 $17,000 $10,000 $23,000 $50,000

Employee A $50,000 $2,500 $2,000 $1,750 $6,250

Employee B $45,000 $2,000 $1,675 $1,575 $5,250

Employee C $40,000 $1,500 $1,350 $1,400 $4,250

Employee D $35,000 $0 $0 $1,225 $1,225

Totals $670,000 $45,500 $25,025 $51,950 $122,475



Stacked Match Formulas -
Objectives
 Provide HCEs with contributions totaling the Annual
Additions Limit – IRC §415(c)(1)(A)
 Limit the plan contributions to elective deferrals and
matching contributions which satisfy ADP and ACP
safe harbors
 Qualify the plan for the Top Heavy exemption
 Impose a 6-year graded vesting schedule to the
greatest extent possible
 Maximize employer contribution flexibility as much
as possible
 Minimize employer contribution to NHCEs as much
as possible

Triple Stacked Match
 Four part contribution
 Employee Elective Deferrals
 Safe Harbor Match
 Basic Safe Harbor Match or Enhanced Safe Harbor Match
 Must be 100% vested
 Discretionary Match
 Can be subject to vesting
 Match up to 4% of first 6% of elective deferrals
 Cannot match deferrals beyond 6%
 Cannot have a discretionary match greater than 4%
 Fixed Match
 Can be subject to vesting
 Based on first 6% of deferrals
 Specified in plan document

Matching Contribution
Requirements
 All matches must meet ADP/ACP Safe Harbor
requirements
 Discretionary match limited to 4% of pay
 Cannot match deferrals in excess of 6%
 Match % cannot increase as deferrals increase
 Match rate for any HCE cannot exceed rate for
NHCE
 No last day of plan year or hours of service
requirements


Triple Stacked Match – Step A
Gross Basic
Name Comp. Deferrals Match
Owner 1 $250,000 $22,500 $10,000
Owner 2 $250,000 $17,000 $10,000
Employee A $50,000 $2,500 $2,000
Employee B $45,000 $2,000 $1,675
Employee C $40,000 $1,500 $1,350
Employee D $35,000 $0 $0
Totals $670,000 $45,500 $25,025

 Basic match equals 100% of the first 3% the employee defers, plus 50% of the
next 2% the employee defers.


Triple Stacked Match – Step B
Gross Basic Discretion.
Name Comp. Deferrals Match Match
Owner 1 $250,000 $22,500 $10,000 $10,000
Owner 2 $250,000 $17,000 $10,000 $10,000
Employee A $50,000 $2,500 $2,000 $1,667
Employee B $45,000 $2,000 $1,675 $1,333
Employee C $40,000 $1,500 $1,350 $1,000
Employee D $35,000 $0 $0 $0
Totals $670,000 $45,500 $25,025 $24,000

 Add Discretionary Match equal to 2/3 of deferrals up to 6% of compensation.
 Discretionary Match cannot exceed 4% of compensation
 Discretionary Match is flexible
 Discretionary Match can be subject to a vesting schedule


Triple Stacked Match – Step C
Gross Basic Discretion. Fixed Total
Name Comp. Deferrals Match Match Match Allocation
Owner 1 $250,000 $22,500 $10,000 $10,000 $13,000 $55,500
Owner 2 $250,000 $17,000 $10,000 $10,000 $13,000 $50,000
Employee A $50,000 $2,500 $2,000 $1,667
Employee B $45,000 $2,000 $1,675 $1,333
Employee C $40,000 $1,500 $1,350 $1,000
Employee D $35,000 $0 $0 $0
Totals $670,000 $45,500 $25,025 $24,000

 Owners (HCEs) need an additional allocation of $13,000 each to reach
maximum account Annual Additional Limits under IRC §415(c)(1)(A).
 Use an additional Fixed Match.


Triple Stacked Match – Step C
Owner 1 $250,000 $22,500 $10,000 $10,000 $13,000 $55,500
Owner 2 $250,000 $17,000 $10,000 $10,000 $13,000 $50,000
Employee A $50,000 $2,500 $2,000 $1,667 $2,167 $8,334
Employee B $45,000 $2,000 $1,675 $1,333 $1,733 $6,741
Employee C $40,000 $1,500 $1,350 $1,000 $1,300 $5,150
Employee D $35,000 $0 $0 $0 $0 $0
Totals $670,000 $45,500 $25,025 $24,000 $31,200 $125,725

 Cannot consider deferrals in excess of 6% of Safe Harbor Compensation.
 Fixed match equals 86.67% of deferrals up to 6% of compensation
($13,000/$15,000 = 86.67%).
 Employee Cost = $14,225.


Triple Stacked Match – Worst Case
Scenario
Owner 1 $250,000 $22,500 $10,000 $10,000 $13,000 $55,500
Owner 2 $250,000 $17,000 $10,000 $10,000 $13,000 $50,000
Employee A $50,000 $2,500 $2,000 $1,667 $2,167 $8,334
Employee B $45,000 $2,000 $1,675 $1,333 $1,733 $6,741
Employee C $40,000 $1,500 $1,350 $1,000 $1,300 $5,150
Employee D $35,000 $1,400 $1,225 $933 $1,213 $4,771
Totals $670,000 $46,900 $26,250 $24,933 $32,413 $130,496

 Employee Cost = $17,596


Triple Stacked Match – “True” Worst
Case Scenario
Owner 1 $250,000 $22,500 $10,000 $10,000 $13,000 $55,500
Owner 2 $250,000 $17,000 $10,000 $10,000 $13,000 $50,000
Employee A $50,000 $3,000 $2,000 $2,000 $2,600 $9,600
Employee B $45,000 $2,700 $1,800 $1,800 $2,340 $8,640
Employee C $40,000 $2,400 $1,600 $1,600 $2,080 $7,680
Employee D $35,000 $2,100 $1,400 $1,400 $1,820 $6,720
Totals $670,000 $49,700 $26,800 $26,800 $34,840 $138,140

 Each employee deferring minimum of 6% of compensation


Triple Stacked Match – Flexible
Formula
90%
Name Gross Deferrals Basic Discretion. Fixed Total
Comp. Match Match Match Allocation
Owner 1 $250,000 $22,500 $10,000 $9,500 $13,500 $55,500
Owner 2 $250,000 $17,000 $10,000 $9,500 $13,500 $50,000
Employee A $50,000 $3,000 $2,000 $1,900 $2,700 $9,600
Employee B $45,000 $2,700 $1,800 $1,710 $2,430 $8,640
Employee C $40,000 $2,400 $1,600 $1,520 $2,160 $7,680
Employee D $35,000 $2,100 $1,400 $1,330 $1,890 $6,720
Totals $670,000 $49,700 $26,800 $25,460 $36,180 $138,140

 Each employee deferring minimum of 6% of compensation


Stacked Match Formulas -
Objectives
 Design achieves all objectives:
 Not subject to ADP and ACP testing
 No non-elective contributions to test under IRC
§401(a)(4)
 Not Top Heavy because of the “safe harbor”
exemption
 Designed to comply with IRC §415(c)(1)(A)
 Only testing needed is coverage under IRC
§410(b) – design is “bullet proof” from a testing
standpoint
 A true “players only” design
 If an employee defers nothing, the employee gets
nothing


Stacked Match Formulas
 Advantages  Disadvantages
 HCE flexibility  Fixed matching
 Increased disparity costs
 Potential to reach  Employer costs
IRC §415(c) limits dependent on
with lower costs actions of NHCEs
 Not age sensitive  Match at 200+% of
 Top Heavy exempt deferrals on first 6%
of compensation
 No ADP/ACP tests
 No allocation
conditions

Stacked Match Formulas
 Attractive for:  Less Attractive for:
 Smaller employers  Larger employers
 Less sophisticated  Sophisticated
work force employees
 Need for owner  Employer wants to
flexibility provide a minimum
benefit for all
employees


Summary
Plan Design NHCE Employee Cost
Integrated Profit
$14,869
Sharing
Age Weighted Profit
$15,205
Sharing
Cross-Tested Profit
$10,975
Sharing
Stacked Match 401(k) $14,225/$17,596/$22,440

* Problem of disparate allocations for the two HCEs


Design Summary
 Don’t ignore Social Security Integration as a
plan design.
 May still be a viable design alternative
 Cross-Tested and Stacked Match designs
very dependent on:
 Employee demographics
 Levels of employee elective deferrals
 Look at all options
 Need for good plan design studies
 Understand plan design basics
 Partner with a good local TPA


Richard A. Perry, ChFC, QPA, QPFC, AIFA®

CIPC Systems, Inc.
250 Hampton Street
Auburn, MA 01501
Tel: (508) 832-2299 Fax: (508) 832-9885
rperry@cipcsystems.com

Advanced Safe Harbor 401(K) Plan Designs (For The Financial Advisor)

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