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By John Wolf and Tom Cullen CPA
PAYSTUB MAKER.Your payroll mate keeps informing you about retirement and your best options.
Related Employers
An employer could attempt to circumvent the coverage requirements of §410(b) by operating its business through multiple entities. Because of this potential abuse, certain related employers are treated as a single employer for purposes of the coverage tests. That is, all employees of each entity in the group are used in computing the percentage of classification tests.
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The related employers that fall into this classification are:
(i) Trades or businesses under a common control (both parent-subsidiary and brother-sister forms),
(ii) Affiliated service groups, and
(iii) Leased employee arrangements.
Vesting
Vesting refers to the percentage of accrued benefit to which an employee would be entitled if they left employment before attaining the usual retirement age under the plan. Vesting represents that portion of the employee’s benefit that is non-forfeit-able. Section 401(a)(7) requires a plan to meet the rules under §411, regarding vesting standards. These vesting standards contain three classes of vesting:
(i) Full and immediate vesting;
(ii) Minimum vesting under §411(a)(2); and
(iii) To comply with §401(a)(4) nondiscrimination requirements.
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Full & Immediate Vesting employers are treated as a single employers are treated as a single
Under §411(a), a participant’s regular retirement benefit derived from employer contributions must be nonprofitable upon the attainment of average retirement age, regardless of where the employee happens to fall on the plan’s vesting schedule at regular retirement age. Section 411(a)(1) requires that a participant must be vested fully at all times in the accrued benefit derived from the employee’s self-contributions to the plan. This requirement applies regardless of whether the employee contributions are voluntary or mandatory. Section 411(d)(3) requires that a qualified plan provide that accrued benefits become nonprofitable for participants who are affected by a complete or partial termination of, or a discontinuance of contributions to, a plan.
Minimum Vesting
For employer contributions, plans have historically had to meet the employers are treated as a single requirement of two minimum vesting schedules:
1. Five-Year Cliff Vesting. Under this schedule, participants who have completed five years of service with the employer must receive a 100% nonprofitable claim to employer-derived benefits. Thus, the timetable is as follows:
Completed Years of Service Nonprofitable Percentage
1-4 0%
5 100%
2. Three-to-Seven Year Graded Vesting. This schedule is graded similarly to the old five-to-15 year graded schedule, except, of course, that it provides a more rapid rate of vesting. The schedule is:
Completed Years of service Nonprofitable Percentage
1-2 20%
3 40%
4 60%
5 80%
6 100%
However, for plan years beginning after December 31, 2006, the expedited vesting schedule that applied to employer matching contributions was extended to all employer contributions to defined contribution plans by the Pension Protection Act of 2006 (§411(a)(2)). As a result, for plan years beginning after 2006, a defined contribution plan (e.g. Profit-sharing and §401(k) plans) must vest all employer contributions according to the schedule that, before 2007, applied only to employer matching contributions. For example, if a defined contribution plan used cliff vesting, accrued benefits derived from all employer contributions must now vest with the participant after three years of service. Likewise, if a defined contribution plan used graduated vesting, all employer contributions must now vest with the participant at the rate of 20% per year, beginning with the second year of service.
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Nondiscrimination Compliance
Even if a plant adopts one of the statutory vesting schedules, it may still discriminate in favor of highly compensated employees in practice. If the IRS determines either that there has been a “pattern of abuse” under the plan or that there is reason to believe that there will be an accrual of benefits or forfeitures tending to discriminate in favor of highly compensated employees, it can require a more accelerated vesting schedule under §411(d)(1).
Benefit Limits
Section 401(a)(16) requires a plan to comply with §415 limitations for contributions and benefits. These limitations set the maximum amounts that the employer may provide under the plan. A plan must include provisions to ensure that these limitations are never exceeded for any participant; otherwise, the entire plan will become disqualified for the year. The limitations imposed on both defined contribution and defined benefit plans are based on the participant’s compensation. However, there is a maximum dollar amount of compensation that may be considered. Initially set at $200,000, for 2017, it is $270,000.
Defined Benefit Plans (Annual Benefits Limitation) – §415
A defined benefit plan may not provide “annual benefits” more than the lesser of:
(i) A dollar limit of $160,000 (subject to COLAS) ((§415(b)(1)(A)); or
(ii) 100% of the participant’s average annual compensation for the three consecutive years in which their compensation was the highest (§415(b)(1)(B)). The $160,000 limit is subject to cost of living adjustments. In the 2017 plan years, this amount is $215,000. The annual benefit means a benefit payable annually at the participant’s social security retirement age in the form of a straight-life annuity, with no ancillary benefits, under a plan to which employees do not contribute and under which the employee makes no rollover contributions.
Note: Employee contributions, whether mandatory or voluntary, are considered to be a separate defined contribution plan to which the limitations thereon apply.
Defined Contribution Plans (Annual Addition Limitation) – §415
A defined contribution plan’s “annual additions” to a participant’s account for any limitation year may not exceed the lesser of:
(i) $54,000 in 2017 (or, if greater, one-fourth of the defined benefit dollar limitation) (§415(c)(1)(A)).; or
(ii) 100% of the participant’s compensation (§415(c)(1)(B)). Annual additions include employer contributions, including contributions made at the election of the employee (i.e., employee elective deferrals), after-tax employee contributions, and any forfeitures allocated to the employee (§415(c)(2)).
Limits on Deductible Contributions – §404
A contribution that can be allowable to a qualified plan must be an ordinary and necessary expense of carrying on a trade, business, or other activity engaged in for the production of income. Also, a contribution may not be deducted unless it is paid into the plan.
1. Defined contribution plans: For profit-sharing, stock bonus, simplified employee pension, and money purchase pension plans, deductible contributions are limited to 25% of the compensation otherwise paid or accrued during the taxable year to plan beneficiaries (§404(a)(3)(A)).
2. Defined benefit plans: An employer is permitted to use either one of two methods for determining the minimum deductible annual contribution to a defined benefit pension plan:
a. The level funding method (§404(a)(1)(A)(ii)), or
b. The standard cost method (§404(a)(1)(A)(iii)).
Note: However, if the annual contribution necessary to satisfy the minimum funding standard provided by §412(a) is greater than the amount determined under either of the above two, the limit may be increased to that amount.
As to the maximum deductible annual contribution (subject to a special rule for plans with more than 100 participants), the employer may not deduct an amount that exceeds the full funding limitation determined under the minimum funding rules (§412). 7-223. Combination plans: Where each employee is the beneficiary under both a defined benefit and a defined contribution plan of the employer, deductible contributions are limited to 25% of the compensation otherwise paid or accrued during the taxable year to plan beneficiaries (§404(a)(9)).
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Disclaimer: John Wolf and paystubmakr.com are making a total effort to offer accurate, competent, ethical HR management, employer, and workplace advice. We do not use the words of an attorney, and the content on the site is not legal advice. The website has readers from all US states with different laws on these topics. The reader should look for legal advice before taking any action. The information presented on this website is a general guide only.