Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning for Retirement Needs Profit-Sharing Plans, 401(k) Plans, Stock Bonus Plans, and ESOPs Chapter 5

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Chapter 5: Profit Sharing Profit sharing 401(k) Stock bonus ESOP

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Why Profit Sharing? Discretionary contributions Or state as percentage of profits Or state as percentage of pay Withdrawal flexibility Tie contributions into profits Cross-tested allocation formula

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Allocation Formula “Employer contributions made for the year will be allocated, as of the last day of each plan year, to each participant’s account in the proportion which that participant’s compensation bears to the total compensation of all eligible participants for the plan year.”

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Disadvantages of Profit Sharing Can not provide benefits based on past service Can not provide specified replacement ratio

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. 401(k) Plans Employee salary deferrals Employer matching contributions Employer profit-sharing contributions Employee after-tax contributions

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Special Requirements Employee deferrals 100 percent vested Withdrawals –Termination of employment –Attainment of age 59 1/2 –Financial hardship General rule Safe harbor

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Safe Harbor Hardship Hardship events –Medical expenses –Purchase principal residence –College education for family member –Forclosure –Burial expenses for family member –Repair of damage to principal residence “Reasonably available” requirement –Receive all distributions and loans available first –Suspend deferrals for 6 months

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. ADP Test Average deferral percentage test Compare the contributions made by HCEs in relation to the contributions made by non-HCEs Mathematical test Plan has to satisfy one of two alternative tests

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Highly Compensated Employees 5-percent owners in current or prior year Earn more than dollar limit in prior year –$100,000 in 2006 –$100,000 in 2007 Election to limit group earning more than the dollar limit to only the highest paid employees (in the top 20 percent)

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Performing the Test Calculate deferral percentage in prior year for each non-HCE Calculate average deferral of entire group Determine maximum deferral for HCE group

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. ADP Test –1.25 Average ADP of the HCEs for the current year can not exceed 125 percent of the average ADP for the nonhighly compensated for the prior year. Example: 6% deferral for non-HCEs means 7.5% for HCEs

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. ADP Test—2.0 The average of the ADP for the HCEs for the current year can not exceed more than 200 percent of the average ADP for the nonhighly compensated for the prior year. In addition, the difference between the averages for each group cannot exceed 2 percentage points. Example: 6% for non HCEs means 8% for HCEs

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Questions If the average ADP of the NHCE group is 2 percent, what is the maximum for the HCE group? (4%) How about 8 percent? (10%) How about 10 percent? (11.25%)

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Satisfying the ADP Test Current or prior-year testing Safe harbor provision –Nonelective option-3% for all participants –Matching option-100% match on first 3% and 50% on next 2% deferred (4% contribution) Correcting excess

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. 401(k) Contribution Limits $15,500 salary deferral (for 2007) $5,000 additional for those over 50 Total allocations can not exceed Code Sec. 415 dollar limits ($45,000 in 2007) ADP and ACP (test) can limit the contributions for HCEs

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Roth 401(k) Employees elect “Roth” tax treatment on salary deferrals Establish separate account for Roth Election does not effect tax treatment of employer contributions Roth salary deferrals are counted under maximum deferral limits and ADP testing Qualified Roth distributions are tax free Roth account can be rolled to a Roth IRA Several tax differences between Roth 401(k) and Roth IRA.

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Stock versus Profit Sharing Assets invested primarily in stock Market for company stock Distributions in stock

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Bank Company Loa n ESOP Repayments Suspense account Contributions Loan guarantee accounts Leveraged ESOP Stock

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. Qualified Plan Scorecard Defined benefit Cash balance Target benefit Money purchase Profit sharing Stock bonus ESOP 401(k)

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions Distributions from a profit-sharing plan may be made only after termination of employment resulting from death, retirement, or disability. An allocation formula in a profit-sharing plan determines how much the employer must contribute on behalf of each participant. Stock bonus plans and ESOPs are categorized as profit-sharing plans. If a participant elects to defer cash compensation to a 401(k) plan, the amount deferred is taxed in the following year.

Copyright © 2006, The American College. All rights reserved. Used with permission. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions An individual can defer a larger amount on a tax-preferential basis to a 401(k) plan than can be deferred to an individual retirement account (IRA). Contributions attributable to 401(k) salary reduction elections are always 100- percent vested. One of the 401(k) safe-harbor “ financial hardship ” events is payment of college tuition for a family member.