1. Copyright © 2007, The American College. All rights reserved. Used with permission. Planning for Retirement Needs Designing Benefit Formulas and Employee Contributions Chapter 8

2. Copyright © 2007, The American College. All rights reserved. Used with permission. Chapter 8: Benefit Formulas Nondiscrimination rules Defined-contribution plans Defined-benefit plans Employee contributions

3. Copyright © 2007, The American College. All rights reserved. Used with permission. Nondiscrimination 401(a)(4) –Plan can not discriminate in favor of HCEs with regard to benefits or contributions –OK to give participants a level percent of pay –OK to integrate with Social Security –However, can you give one group of employees one rate of contribution and another a different rate?

4. Copyright © 2007, The American College. All rights reserved. Used with permission. Nondiscrimination Regulations Established objective tests –Either satisfy a safe-harbor design –Or test for nondiscrimination annually –Allows for cross-testing

5. Copyright © 2007, The American College. All rights reserved. Used with permission. Ground Rules Accrued benefits –Under regulations, test accruals for the year –Cannot backload Calculating service –Must credit partial year for 1,000 hours –Full year at 2,000 –Can use past service –Can eliminate pre-participation service Total compensation to satisfy design safe harbors Benefit formulas—can change prospectively

6. Copyright © 2007, The American College. All rights reserved. Used with permission. Example 2 percent of FAC x years of participation plus 1 percent of FAC for years of service prior to plan –Compensation is W2 plus salary deferrals –FAC is high 3 years –Year of service for 1,000 during plan year Joe has $100,000 FAC, 5 years of preplan service, 10 years of participation, and 10 years until normal retirement. –Benefit accrual for current year is 2 percent of FAC –Current accrued benefit is $25,000 –Projected benefit at normal retirement age is $45,000

7. Copyright © 2007, The American College. All rights reserved. Used with permission. Defined Contribution Plans Level-percentage safe harbor Integration safe harbor Target-benefit safe harbor Age weighting (tested annually) Cross testing (tested annually)

8. Copyright © 2007, The American College. All rights reserved. Used with permission. Integration Contribute 5.7 percent of total compensation—can contribute an additional 5.7 percent of compensation in excess of the current year’s taxable wage base (see text) Contribute more than 5.7 percent of total compensation —still limited to 5.7 percent on excess Contribute 3 percent of total compensation— can contribute 3 percent of excess compensation

9. Copyright © 2007, The American College. All rights reserved. Used with permission. Integration Level If you integrate at lower than taxable wage base the maximum disparity is reduced See table in text

10. Copyright © 2007, The American College. All rights reserved. Used with permission. Integrated Profit-Sharing Allocation Step 1: Allocate first 3 percent on a comp/comp basis to all participants Step 2: Allocate next 3 percent of excess compensation to those earning more than TWB Step 3: Allocate next 2.7 percent of total compensation plus 2.7 percent of excess compensation Step 4: Allocate remaining on a comp/comp basis to all participants

11. Copyright © 2007, The American College. All rights reserved. Used with permission. Choosing an Integrated Plan With compensation cap, integration does not result in tremendous disparity Generally appropriate when HCEs earn more than the compensation cap

12. Copyright © 2007, The American College. All rights reserved. Used with permission. Cross-testing Larger contribution to “buy” the same benefit for an older worker than a younger worker Basic elements –Mathematical test –Retroactive compliance –Costs more to administer

13. Copyright © 2007, The American College. All rights reserved. Used with permission. Age-weighted vs Cross-tested Age-weighted means contributions result in level benefit accrual for each participant. Cross-tested — choose an allocation formula and test. It is not unusual to be able to contribute $45,000 for older owners and 5 percent for NHCEs. Cross-tested also referred to as “new comparability

14. Copyright © 2007, The American College. All rights reserved. Used with permission. Specific Plans Profit sharing –Level percentage and integrated –Age weighted and cross tested 401(k) –ADP –ACP –401(a)(4)

15. Copyright © 2007, The American College. All rights reserved. Used with permission. Specific Plans (continued) Money purchase Target benefit SEP SIMPLE

16. Copyright © 2007, The American College. All rights reserved. Used with permission. Defined-Benefit Pension Plans Uniform percentage Integrated (see example in text) Other

17. Copyright © 2007, The American College. All rights reserved. Used with permission. Employee Contributions Voluntary after-tax contributions –Allowed in all qualified plans –Common prior to 1987 No nondiscrimination requirements 10% in addition to other limitations Rule changes in 1987 –Nondiscrimination—now contributions are subject to ACP test (with matching contributions) –Contributions counted under Code Sec. 415 –Generally only find in large company 401(k) plans

18. Copyright © 2007, The American College. All rights reserved. Used with permission. True/False Questions A plan integrated with Social Security will provide disproportionately higher contributions or benefits to the rank-and- file employees. A defined-contribution plan with a formula of 4 percent of total compensation and 2 percent of compensation earned in excess of $60,000 satisfies the integration requirements. 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 age weighted allocation formula is quite flexible and will generally work regardless of the employee census. If the integration level in a defined-contribution plan is the taxable wage base and 3% of compensation is contributed for each participant an additional contribution of 5.7% of compensation in excess of the taxable wage base is allowed.