Presented by Paystrubmakr.com By John Wolf and Tom Cullen CPA
Today Paystub maker topic is Retirement plans and how affect health.
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The plan must be a permanent and continuing program. It must not be a temporary arrangement set up in high tax years as a tax savings scheme to benefit the employer. Although the employer may reserve the right to terminate the plan and discontinue further contributions, the abandonment of a plan for any reason other than business necessity can indicate that the plan was not a bona fide program from its inception (Reg. §1.401-1(b)(2)). Thus, if a plan is discontinued after only a short period of years, the IRS may retroactively disqualify the plan.
Exclusive Benefit of Employees
The plan and trust must be for the exclusive benefit of employees and their beneficiaries. A qualified plan cannot be a subterfuge for the distribution of profits to shareholders. Thus, the plan cannot discriminate in favor of certain highly compensated employees.
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Highly Compensated Employees
Under §414(q)(1), a “highly compensated employee” is any employee who:
(1) Was a 5% owner (as defined in §416(i)), at any time during the year or the preceding year, or
(2) For the preceding year, had compensation from the employer in excess of $80,000 (indexed for inflation), and, if the employer elects this condition, was in the top 20% of employees by compensation for the preceding year (§414(q)). Reversion of Trust Assets to Employer There must ordinarily be no reversion of trust assets and contributions to the employer except for actuarial errors or an excess of plan assets upon termination of a defined benefit pension plan. The trust instrument must make it impossible, before the satisfaction of all liabilities to employees and beneficiaries, for assets to be used for, or diverted to, purposes other than for the exclusive benefit of employees or beneficiaries. This provision must be written into the trust instrument(Reg. §1.401-2).
Participation & Coverage
The plan must cover a required percentage of employees or cover a nondiscriminatory classification of employees. The plan may not discriminate in favor of highly compensated employees. Section 401(a)(3) requires that a plan meet the minimum participation standards of §410. Section 410 divides these participation standards into two general categories:
(i) Age and service requirements (that is, the rights of an employer to exclude certain employees on account of age or years of service), and
(ii) Coverage requirements, which relate to the portion of the employer’s total workforce that must participate in the plan.
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Age & Service
A qualified plan cannot exclude any employee from participation on account of his age or years of service, except for the exclusion of employees who are:
(i) Under age 21, or
(ii) have less than one “year of service.”
Note: In the case of a plan that provides for 100 percent vesting after no more than two years of service, it can require a two-year period of service for eligibility to participate. An employee who has satisfied the minimum age and service requirements of the plan (if any) must actually begin participation (i.e., enter the plan) no later than the earliest of:
(i) The first day of the first plan year beginning after he satisfied the requirements; or
(ii) Six months after he satisfied the requirements (Reg. §1.410(a)-
4(b)). A year of service is a 12-consecutive- month period (referred to as the computation period) during which the employee has at least 1,000 “hours of service.”
Hours of service include:
(i) Hours for which the employee is paid, or entitled to payment, for the performance of duties;
(ii) Hours for which the employee is paid, or entitled to payment, during periods when no duties are performed, such as vacation, illness, disability, maternity or paternity leave; and
Note: The plan does not have to credit the employee with more than 501 hours of service for this category.
(iii) Hours for which back pay is awarded or agreed to by the employer.
To ensure that lower-paid employees have the benefit of a retirement plan, tax law requires qualified plans to provide coverage for them. This is accomplished by two sets of requirements. The first set is three tests:
(i) A percentage test,
(ii) A ratio test, and
(iii) An average benefits test.
The second set requires a specific minimum number of covered participants.
Under this test, the plan must “benefit” at least 70% of all the employees who are not highly compensated employees.
Note: This is not the same as the 70% test under pre-TRA ‘86 law. This test is broader since it requires that 70% of “all non-highly compensated employees,” rather than “all employees” (which includes both highly and non-highly compensated employees).
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To satisfy this test, a plan must benefit a percentage of non-highly compensated employees that is at least 70% of the percentage of highly compensated employees benefiting under the plan.
An employer has two highly compensated employees and 20 non-highly compensated employees. If the plan covers both of the highly compensated employees (100%), it must cover at least 14 of the non-highly compensated employees (70% of 100% = 70% required coverage). If the plan covers only one
of the highly compensated employees (50%), it must cover at least seven of the non-highly compensated employees (70% of 50% = 35% required coverage).
Average Benefits Test
A plan will meet the average benefits test if:
(i) The plan meets a nondiscriminatory classification test (using the §414(q) definition of highly compensated employees); and
(ii) The average benefit percentage of non-highly compensated employees, considered as a group, is at least 70% of the average benefit percentage of the highly compensated employees, considered as a group.
The classification test is met for a plan year if the classification system is reasonable and established under objective business criteria that identify the employees who benefit under the plan. This classification must meet a safe and unsafe harbor range that compares the percentage of non-highly compensated employees to the percentage of highly compensated employees benefiting under the plan.
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The second set of requirements was added to the Code to eliminate discrimination in favor of highly compensated employees through the use of multiple plans. Section 401(a)(26) provides that a trust will not be qualified unless it benefits the least of:
(i) 50 employees; or Numerical Coverage
The second set of requirements was added to the Code to eliminate discrimination in favor of highly compensated employees through the use of multiple plans. Section 401(a)(26) provides that a trust will not be qualified unless it benefits the lesser of:
(i) 50 employees; or
(ii) 40% of “all employees.” Thus, each plan must have a minimum number of employees covered,
without regard to any designation of another plan. The additional participation rules of §401(a)(26) only apply to defined benefit plans. A defined benefit plan does not meet the §401(a)(26) rules unless it benefits the lesser of:
(i) 50 employees, or
(ii) The greatest of:
(a) 40% of all employees of the employer, or
(b) 2 employees (one employee if there is only one employee).
(ii) 40% of “all employees.”
Thus, each plan must have a minimum number of employees covered, without regard to any designation of another plan. The additional participation rules of §401(a)(26) only apply to defined
benefit plans. A defined benefit plan does not meet the §401(a)(26) rules unless it benefits the lesser of:
(i) 50 employees, or
(ii) The greatest of:
(a) 40% of all employees of the employer, or
(b) 2 employees (one employee if there is only one employee). 7-18
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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 given as legal advice. The website has readers from all US states, which all have different laws on these topics. The reader should look for legal advice before taking any action. The information presented on this website is offered as a general guide only.