1. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning for Retirement Needs Coverage, Eligibility, and Participation Rules Chapter 7

2. Copyright © 2007, The American College. All rights reserved. Used with permission. Overview Coverage –410(b) –401(a)(26) –Aggregation Participation –21-and-one rule –2-year/100 percent Rules for SEP, SIMPLE, 403(b)

3. Copyright © 2007, The American College. All rights reserved. Used with permission. Highly Compensated Employee 5-percent owners in current or previous year Earn over indexed limit in previous year –$100,000 (2006 limit) –$100,000 (2007 limit) –Election to limit to top 20 percent

4. Copyright © 2007, The American College. All rights reserved. Used with permission. 410(b) Perform test once a year Perform not counting “excludibles” Excludibles –Less than 1,000 hours –Age 21 –Less than 1 year –Collectively bargained

5. Copyright © 2007, The American College. All rights reserved. Used with permission. Percentage test Cover at least 70 percent of all NHCEs Block, Meyers and Andrews –24 employees, 4 are part-time –Plan covers all 12 HCE’s and 6 of 8 non- HCEs –Plan covers 75% of the non-HCEs

6. Copyright © 2007, The American College. All rights reserved. Used with permission. Ratio Test NHCE percentage must be at least 70 percent of the of HCE percentage Thunder Company –100 eligible employees –15 of 30 HCEs are covered (50%) –40 of 70 non-HCEs are covered (57%) –Minimum coverage is 50% x 70% ((35%)

7. Copyright © 2007, The American College. All rights reserved. Used with permission. Average Benefits Test Must satisfy three tests –Reasonable job classification –Percentage test –Average benefits test—average benefits of NHCEs are at least 70 percent of the benefits of the HCEs (looking at all qualified plans)

8. Copyright © 2007, The American College. All rights reserved. Used with permission. 401(a)(26) Only applies to defined benefit plans Covers the lesser of –50 employees –40 percent of the employees –If two employees, must cover both

9. Copyright © 2007, The American College. All rights reserved. Used with permission. 401(a)(26) If the company has 50 employees, how many have to be covered? If the company has 1,000 employees, how many have to be covered?

10. Copyright © 2007, The American College. All rights reserved. Used with permission. Excluding Employees Excludibles –Age 21 –Less than one year –Less than 1,000 hours –Collectively bargained Any HCE At least 30 percent of the NHCEs

11. Copyright © 2007, The American College. All rights reserved. Used with permission. Separate Lines of Business Separate operating units –A unit must have 50 employees to be treated separately –Separate lines of business can be tested separately

12. Copyright © 2007, The American College. All rights reserved. Used with permission. Aggregation Controlled groups –All members of the controlled group are treated as one employer –Parent subsidiary (80 percent ownership) –Brother-sister (80 percent/50 percent test)

13. Copyright © 2007, The American College. All rights reserved. Used with permission. Brother-Sister One person owns 100% of both companies 10 people each own 10 percent of two companies Husband-wife each own 100% of their won companies

14. Copyright © 2007, The American College. All rights reserved. Used with permission. Brother-Sister Example Joe 20% of X and 12% of Y = 12% Sally 60% of X and 14% of Y = 14% Ralph 20% of X and 74% of Y = 20%

15. Copyright © 2007, The American College. All rights reserved. Used with permission. Affiliated Service Groups All members of the affiliated service group are treated as one employer A org-B org affiliation –Work together to produce a product –One is a service organization –Some common ownership Management services

16. Copyright © 2007, The American College. All rights reserved. Used with permission. Leased Employees Agreement with third party Substantially full-time basis (1,500 hours) for at least one year Services are performed under primary direction or control of recipient If less than 20 percent leasing company can maintain safe harbor –10 percent fully vested money purchase

17. Copyright © 2007, The American College. All rights reserved. Used with permission. Practical Considerations Identify the issue Ask lots of general questions If any common ownership send issue to lawyer or accountant Be concerned if client actively seeks to avoid the coverage rules

18. Copyright © 2007, The American College. All rights reserved. Used with permission. Why Cover NHCEs Even though the plan can exclude many, consider covering the rank and file.

19. Copyright © 2007, The American College. All rights reserved. Used with permission. Participation 21 and 1 rule 2 year / 100 percent vesting Enter within 6 months after eligibility Defining service –1,000 hours –Numerous equivalencies –Choose counting method that works with payroll records

20. Copyright © 2007, The American College. All rights reserved. Used with permission. Defining Service 1000 hours worked or entitled to pay 870 actual hours 750 regularly scheduled hours Elapsed time Time-period method –10 hours for each day –45 per week –95 semimonthly –190 hours

21. Copyright © 2007, The American College. All rights reserved. Used with permission. Coverage—Other Plans SEP –Exclude for 3 years –Must cover part-timers earning $500 (counting affiliated companies) SIMPLE –Exclude for 2 years –Must cover part-timers earning $5,000 403(b) –Same rule as qualified plans –Deferral election to those working 20 hours per week

22. Copyright © 2007, The American College. All rights reserved. Used with permission. Coverage Case Study #1 Given the following eligibility provisions, does the Small Corporation profit-sharing plan have coverage problems? “All non-union employees who have attained age 21 and have earned one year of service will be eligible to participate on the January 1 or July 1 following completion of one year of service.”

23. Copyright © 2007, The American College. All rights reserved. Used with permission. Case Study #1 Answer As long as there are no other companies that must be aggregated under the control group rules and affiliated service group rules and there are no “leased employees,” this plan covers 100 percent of the nonexcludible employees.

24. Copyright © 2007, The American College. All rights reserved. Used with permission. Coverage Case Study #2 Are there any additional coverage problems if the Small Corporation’s plan is a 401(k) plan with salary deferrals and matching contributions and only 40 percent of the employees make salary deferral contributions?

25. Copyright © 2007, The American College. All rights reserved. Used with permission. Case Study #2 Answer There are no additional coverage problems because eligibility to make salary deferrals in a 401(k) plan is considered eligibility to participate.

26. Copyright © 2007, The American College. All rights reserved. Used with permission. Coverage Case Study #3 Mega Corp. has 10,000 employees and about 20 different defined-benefit and defined-contribution plans covering different groups of employees. Describe some of the steps necessary in determining whether or not the plans satisfy the coverage requirements.

27. Copyright © 2007, The American College. All rights reserved. Used with permission. Case Study #3 Answer Determine who is the employer. Identify any leased employees. Eliminate excludible employees. Test 410(b) coverage using the ratio test. If any plan fails, look to average benefits test. If failure, refer to separate line of business rules. Test defined-benefit plans under 401(a) 26.

28. Copyright © 2007, The American College. All rights reserved. Used with permission. Coverage Case Study #4 Joe owns ABC and DEF companies. He is considering a SEP or SIMPLE for ABC company. Explain to Joe the coverage rules for each type of plan.

29. Copyright © 2007, The American College. All rights reserved. Used with permission. Case Study #4 Answer A SEP plan will have to cover all employees of both companies who have earned at least $500 (indexed for 2007) in 3 of the 5 preceding years. A SIMPLE plan will have to cover all employees of both companies who have earned at least $5,000 in any 2 previous years.

30. Copyright © 2007, The American College. All rights reserved. Used with permission. Additional Coverage Problems Review question 7-2 Review question 7-12

31. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions An adoption agreement contains all the requirements necessary for a plan to be a qualified plan. An employer wanting to elect a large number of customized design features can generally use an adoption agreement. An individual who is a 5-percent owner in the current year earning $35,000 a year is considered a highly compensated employee for the current year. An individual who is a new employee earning $150,000 in 2007 will be a highly compensated employee for 2007.

32. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions Sorry Corp. has 20 employees meeting the minimum age and service requirements, and four are HCEs. The Sorry Corp. pension plan covers two HCEs and eight non-HCEs. The plan satisfies the minimum-coverage-ratio test. Each plan of a large corporation operating separate lines of business must satisfy the 410(b) coverage test, taking into consideration all employees of the corporation.

33. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions Divided Corporation has two plants, each with 100 employees. Because Divided Corporation’s profit-sharing plan only covers the employees of one plant, the plan does not satisfy the requirements of 401(a)(26). If the integration level in a defined contribution plan is $85,000 the maximum contribution based on compensation in excess of the integration level is 5.7%. An eligibility provision in a qualified plan can provide that employees earn 3 years of service before participation as long as the plan satisfies the coverage requirements of Code Sec. 410(b). The percentage test requires a plan to benefit at least 70 percent of employees who are not highly compensated.

34. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions Long-term full-time leased employees must be covered under a qualified plan. A defined-contribution plan that covers no highly compensated employees can cover any number of non-highly compensated employees. A qualified plan can exclude all employees who do not complete a 1,000 hours of service in a year.