Every October, the IRS comes out with the annual retirement
plan limits. Some of these limits provide in part; the maximum
individual contribution to Solo 401k, 401(k), 403(b) or 457
plans; the maximum compensation taken into consideration for
retirement plan allocations and deductions; and the social
security limits.
Investment representatives and retirement service providers
will be hailing the new limits as an opportunity for employees
to save more money in their retirement plans on a tax deferred
basis. Following that advice may be a mistake for highly paid
employees and could cost their employer additional fees.
Following the advice, highly compensated employees, with higher
discretionary income levels, would increase their contributions.
The non-highly compensated employees, with little discretionary
income, will maintain their contributions at the current levels.
The net result is a failed Average Deferral Percentage test
with the subsequent refunds to the highly compensated and
additional employer fees.
Instead of touting the new plan contribution limits alone,
investment representatives need to include the Safe Harbor
plan design benefits with them. Adopting a safe-harbor 401(k)
plan design permits an employer to avoid discrimination testing
of the rates of employee elective deferrals and/or employer
matching contributions(ADP /ACP testing). The benefit for
avoiding testing is maximized contributions for the highly
compensated.
Generally, there are two types of safe-harbor designs.
One type is the safe-harbor non-elective design of 3% of
compensation. Generally, a 3% contribution is provided to
all employees eligible to make elective deferrals to the plan.
The guaranteed contribution requires that a 3% employer contribution
be made each plan year, unless the employer amends the plan
and removes the provision before the start of the new plan
year. The 3% is 100%
employee vested.
The other type of safe-harbor design is a matching contribution.
There are two options from which to choose, the basic or the
enhanced match. The basic safe-harbor matching contribution
is defined as a 100% match on the first 3% deferred and a
50% match on deferrals between 3% and 5%. Alternatively, the
employer may choose an enhanced matching formula equal to
at least the amount of the basic match; for example, 100%
of the first 4% deferred. Safe-harbor 401(k) plan provisions
may not be added to anexisting 401(k) plan in the middle of
a plan year. Instead, the plan must be timely amended to add
the safe-harbor 401(k) provisions for the next plan year.
In an exception to the timing requirements for giving the
safe harbor notice, a new 401(k) may adopt a safe-harbor design
atthe same time that the plan is established, assuming the
notice is provided simultaneously. There must be at least
3 months remaining in the plan year to make elective deferrals
for a plan to use this provision. An existing profit-sharing
plan that is amended to add a 401(k) feature is eligible to
use this rule.
Further, a totally new business entity establishing a new
401 (k) plan may have as short as a one-month initial plan
year (assuming that the initial year is then followed by the
normal 12 month year).
The sponsor of a plan using a guaranteed 3% must make that
contribution regardless of its subsequent financial condition
during that plan year. However, an employer may stop making
safe-harbor matching contributions by providing a notice to
the employees. This notice must be given at least 30 days
before the contributions are to be stopped. If an employer
stops safe-harbor matching contributions before the plan year
is completed, the ADP and ACP tests must be preformed for
the entire plan year.
Investment representatives hooking the annual plan limits
with a Safe Harbor plan design will end up providing their
clients with three benefits-higher contribution levels for
the highly compensated, no ADP/ACP testing issues, and satisfaction
of any top heavy issues.- That's a triple play.
Lawrence Groves is the Small Business Retirement Services
Director for The Retirement Group. He has helped thousands
of small businesses set up retirement plans. For more information
visit Lawrence at http://www.solo-k.com
