Case Study 1: Real Estate Syndicator
Current Situation
The real Estate Syndicator recently added 1 employee and maintains a 401(k) profit sharing plan. Objective is to increase overall contributions.
SOLUTION
Add a Cash Balance Plan and provide maximum allowable to the owner, minimum to the employee.
Case Study #2, Beneficial Non Profit Corporation
Current Situation
The Beneficial Non Profit Corporation maintains a 401(k) Plan for its employees.
There is a matching contribution of 80% of a participant’s deferred compensation up to 7% of pay (so maximum match is 5.6% of pay), as well as discretionary “profit sharing” contributions that are tiered based upon Years of Service.
There are 5 tiers, and the profit sharing contribution ranges from 4% of pay up to 10% of pay. This Plan includes 133 active employees and is not Top-Heavy.
Last year, the Plan passed the ACP test but failed the ADP test. The profit sharing portion of the Plan passed the minimum Gateway test, and the Plan passed the Average Benefits Percentage Test (using permitted disparity). Therefore, the Plan passed Code Section 401(a)(4).
Prior Year Cash Outlays
Employer Match: $274k
Employer Profit Sharing: $353k
Total Outlay: $627k
(Overall contribution is 9.97% of payroll)
Issue- Top Management receiving refunds based on unfavorable testing results.
Solution
Convert the matching portion to a Safe Harbor formula. The Safe Harbor formula is 100% of the first 4% of Compensation deferred, plus 80% of salary deferral reductions between 4% and 6% of Compensation.
NOTE: The increase in the match affected employee behavior, so the average deferral as a % of Compensation increased.
Our solution eliminates the need for ADP and ACP testing. Highly compensated employees will no longer receive refunds. No change in the profit sharing structure because this passed Code Section 401(a)(4) in the past and passes again in the current year.
Current Year Cash Outlays
Based on current deferrals of $490k, and eligible payroll of $6.414 million (overall average percent deferred = 7.640%)
Employer Match: $309k
Employer Profit Sharing: $387k
Total Outlay: $696k
(Overall contribution is 10.85% of payroll)
Case Study #3, Law Firm Partnership
Current Situation
The law firm maintains both a 401(k) Profit Sharing Plan and a tiered Cash Balance Plan. The 401(k) Plan is not a Safe Harbor Plan: the current matching formula is 50% of the first 5% of Compensation deferred. Employees are broken into 4 groups: Equity partners, non-equity partners, Associate attorneys, and staff. There are 84 eligible.
Eligibility for the 401(k) portion of the Plan was immediate with monthly entry dates. For the match and profit sharing portions it was age 21 and 1 Year of Service, with semiannual entry dates.
Equity and non-equity partners, as well as staff employees, were matched at the 50% rate; however, Associate attorneys may opt out of the DC plan.
The profit sharing portion of the Plan is tiered; with equity partners receiving a dollar amount such that their total under the Plan is $36,000. Non-equity partners receive a lower $ amount, sufficient to pass the Gateway test (3.4% of pay). Associates do not receive a profit sharing contribution. Most staff employees receive a 3.4% contribution as well; a few receive 5.5% of pay, in order for the plan to pass Code Section 401(a)(4).
The Plan as structured passed all nondiscrimination testing requirements. But in the current year when the Top Heavy testing was performed based on prior year allocations, it was discovered that the plan had become Top Heavy, primarily because of the benefits provided to the equity partners under the Cash Balance Plan.
Because of the exclusion of the Associates, and the earlier eligibility to make 401(k) deferrals, many individuals who would not otherwise be eligible to receive a profit sharing contribution are required to receive a 3% minimum Top-Heavy contribution. The additional Top-Heavy contribution was projected to be in excess of $100,000.
Cash Outlays Projected
Employer Match: $196k
Employer Profit Sharing: $516k
Top Heavy Minimum: $108k
Total Outlay: $820k
Issue- How to avoid a Top Heavy Minimum Contribution in excess of $100,000.
Solution
Change the eligibility* for 401(k) deferrals to be the same as that for the match and profit sharing contributions.
Separate the Plan into 2 Plans: a Safe Harbor 401(k) Plan with match of 100% of the first 4% deferred, and a separate Profit Sharing Plan. Now we have a Safe Harbor 401(k) Plan with no additional contributions and consistent eligibility for all contribution types, and that plan automatically satisfies Top Heavy requirements under Code Section 416(g)(4)(H).
The separate Profit Sharing Plan also automatically satisfies Top Heavy requirements.
*HCE Associates are ineligible to participate in both plans.
Cash Outlays Projected Under Redesigned Plan
Employer Safe Harbor Match: $266k
Employer Profit Sharing: $457k
Top Heavy Minimum: $0
Total Outlay: $723k
Case Study #4, Large Landowner Realty Corp.
Current Situation:
The company amended its 401(k) plan to provide a tiered discretionary match based on Years of Service. There are 5 tiers. Matching percents initially range from 20% to 100% of the amounts deferred, with no cap.
In the first year, the plan passed both the ADP and ACP tests, but in the second year, plan eligibility was expanded and the test failed. In the third year, refunds were required because the plan could not pass Code Section 401(a)(4) either.
The plan provides for a discretionary profit sharing contribution, but this feature is not utilized.
Issue - Employer wants to retain tiered match structure and liberalized eligibility, but wants to avoid refunds of any kind.
Solution
Implement an Automatic Enrollment feature. Large Landowner implemented a 2% Automatic Enrollment feature for all employees who were eligible who had not elected to make deferrals to the Plan.
Most of the newly eligible employees deferred at least 2% of Compensation to the Plan for the first year. About 25% of newly eligible employees elected to stop the 2% deferral; these were predominantly lower paid field employees.
For the next year, the regular Automatic Enrollment feature was amended to be an EACA. All those who were deferring at 2% of compensation or below were moved up to 3% and the amount of the automatic enrollment is scheduled to increase by 1% per year for each of the next several years.
Cash Outlays
Year 1 Employer Match: $610k
Year 2 Employer Match: $771k
Year 3 Employer Match: $874k
Note that the Average Deferral Percent for the NHCEs steadily increases.
Case Study #5, Painless Dentists Inc.
Current Situation
Painless Dentists, Inc. is owned by two dentists. They also employ 16 staff people, most of whom earn less than $20,000 annually, and many of whom work part time (less than 1000 hours/year).
Issue- They want to maximize contributions for the Dentists, and they know most of the staff can’t afford to defer any portion of their compensation.
Solution
Implement a Safe Harbor 401(k) Plan with an enhanced matching formula of 100% of deferrals up to 4% of Compensation. Add a discretionary matching formula, which is intended to be as follows:
200% match up to 4% of Compensation (total is limited by Code Section 415(c)).
Dental Assistants can be excluded from the Plan as long as without them it satisfies the coverage requirements of Code Section 410(b).
Projected Benefits for Owners
With this structure, the owners/dentists receive a match of 300% of deferrals up to 4% of Compensation.
Deferrals: $19,500 each (6.7% of $290,000 Compensation)
Employer Safe Harbor Match: $11,600 (100% of first 4% deferred)
Employer Discretionary Match: $23,200 each
Total for each Owner: $54,300
Note: if we increase the discretionary match above 200%, we can reach the Code Section 415 limit of $58,000 in 2021. Note that if the dentist is age 50 or over, an additional $6,500 in catch up deferrals may also be added.