richard

Let's say independent contractor X works for company Y. Also, let's say and X and Y are not in the same controlled group or affiliated service group. X cannot be a participant in Y's plan as an employee of Y (since X is not an employee of Y). However, X, as a business owner, can become a participating employer in the Y's 401(k) plan. Unfortunately, this means that Y's 401(k) plan becomes a multiple employer plan, which brings with it a lot of grief. There are probably other problems I haven't thought of. However, why not have X, as a business owner, set up their own profit sharing plan (i.e. Keogh) or a SEP, covering himself. If Y would like to give the "401(k) match" that would otherwise go to X if a 401(k) plan could be set up, Y can simply pay X that dollar amount as as performance bonus or something like that. X can then contribute it into his profit sharing plan or SEP.

The IRS (or Dept of Labor, I forget) allows plan sponsors who use an hours of service eligibility (such as 1,000) hours to use an equivalency instead of actually counting hours. The equivalencies are quite generous (I think they are 10 hours per day worked, 45 hours per week worked, 180 hours--I'm not sure--- per month worked). I'm also not sure how the equivalencies are calculated for partial periods; for example, if an employee works part of a week, is he credited for 45 hours nonetheless. If you want to use the equivalency method of hours of service, the plan must specify which method you will be using [10(?) hours per day, 45(?) hours per week or 180(?) hours per month]. As long as your client knows which days and employee worked (and I hope they know that!), the equivalency method shouldn't be too bad. The problem with the elapsed time method is an employee never is truly gone unless he doesn't work for a 12 consecutive month period. If a carpet layer works very sporadically but never completely leaves the company, he keeps getting years of service. The same problem with elapsed time applies to what I call "permanent part-time workers." A part-time employee who works 1 day per week (for example) would be credited with roughly 400 hours per year if actual Hours of Service were used (500 hours per year if Hours of Service with daily equivalencies), and would never enter a plan with a 1,000 hour requirement. If elapsed time were used, he would enter the plan after one year of employment, even though that one year consisted of one day per week for 52 weeks. If you are also using elapsed time for "Year of Service" for allocation and for vesting (the reason you didn't use Hours of Service for eligibility would most likely be the same reason you wouldn't use it for allocation and vesting), he would receive an allocation and ultimately become vested. Of course, his allocation would be small because his salary would be small, but he would have to be included. So, consider Hours of Service using Equivalencies.

The IRS might have a problem if the non-profit exceeds the 15% limit dramatically; for example by contributing 50% of the payroll. I had some discussions 10+ years ago with some non-profits about this, and while they were nowhere near this level (they were thinking about contributing say 17-18%), the question did come up.

When a suspension of benefits notice is not given, at the end of each year after age 65, the employee's benefit is the greater of (1) the accrued benefit at the beginning of year plus the accrual under the regular plan formula (reflecting the additional year of service and increased earnings), and (2) the actuarial equivalent of the beginning of year benefit. (from Dept of Labor regs 1982 or 1984) In your case, you do this calculation twice to get the benefit at age 67. This (or its actuarial equivalent) is what the employee is entitled to upon retirement at age 67. Now, if you would like to separate this age-67 benefit into two pieces, the lump sum for the 2 year's worth of missed payments and whatever is left over (as long as the total actuarial value equals the age-67 benefit), you can. You might need a plan amendment to allow for this form of benefit, but as long as the age-67 value is preserved, there would be no violation of the suspension of benefits regulations. Are the DoL regulations followed in all cases? I doubt it. Also, I believe the calculation each year at the end of the plan year, so instead of doing the calculation at exact ages 66 and 67, it might be at (for example) 65.5, 66.5 and retirement date, depending on the birthday and plan yearend.

I have heard opinion on this topic that you can provide different SPDs to different groups of employees -- in effect not telling employees of Group A what you are doing for employees of Group B. I'm uncomfortable with this, I don't like it, but ... Any thoughts?

What ideas do you have to reduce (or eliminate) the IRS penalty. A 1994 5500C/R was filed for a 40-employee profit sharing plan indicating that there were 2 employees who terminated vested. No SSA, however, was attached, due to an oversight by their administrative firm (since fired). About a year later, the IRS sent a form letter asking for the SSA. The company sent in the SSA. This year, the IRS sent letter(s) to the company indicating a penalty of about $7,500 ($25 per day times 300 days, roughly), plus interest. Naturally, the company ignored the letter(s), until the IRS sent a Notice of Intent to Levy. Then, the company got interested. What do you think of the following issues to raise with the IRS. 1. Shouldn't the penalty should be $1 per day per participant (hence about $600 plus interest) rather than $25 per day. (I'd probably be satisfied with this result.) 2. This isn't material. The account balance for Participant Number 1 is about $50 (he still cannot be located). The account balance for Participany Number 2 is about $9,000; it was paid in 1996, and he is the brother-in-law of the owner. (I'm stretching here.) 3. There are extenuating circumstances. The Chief Financial Officer (responsible for the Plan around that time) died in early 1995. The business owner is ill (heart condition, surgery). Also, the administrative firm was incompetent and has since been fired. (I'm stretching here.) [Of course, the company could go after the prior adminstrative firms for damages, but that's another matter.] Thanks

Whether or not your profit sharing plan is continued should be a business decision. Will having a separate plan for your "division" be good or bad for the company that is acquiring you? Would it be good of bad for you? Should your division and the acquiring company have different benefits? Those are questions that you and they need to address, from a business viewpoint. The coverage testing issues are usually not a big problem unless your company or the acquiring company is very small, or if either company has a disproportionate portion of high paid employees (i.e., employees earning over $80,000 per year). Merging a profit sharing plan into a 401(k) plan is not (or should not be) a big deal. Some decisions need to be made, some care needs to be made about its timing and the communications to employees. Terminating the plan does require 100% vesting (which has a cost), but does allow the acquiring company to "lay to rest" the profit sharing plan of your company. Again, whether this is desirable is a business decision. Enjoy

What benefit options do you have to offer a terminated or retired employee who has already received (or is receiving) a benefit if the benefit amount is revised upward due to a calculation error? What is "legally required" and what is "done practically." For example, let's say an employee terminated or retired. He has elected to receive his benefit as a lump sum (over $3,500 or $5,000) and it has already been paid. It is discovered that the benefit was understated (due to erronious earnings, for example). Do we give him his additional benefit in the form of a lump sum (based on his previous election) or do we offer him the full range of benefit options as before (life annuity, J&50, etc.) based on the increased benefit? Does it make a difference if he originally elected his benefit as a life annuity or J&50? Does it make a difference if the additional benefit amount is "material" (of course, subject to the definition of "material"). Does he need to get addditional spousal consent, if applicable? Thanks.

Can you delay the mandatory distribution (age 70.5) for an owner if he is not vested in his benefit? Consider a business with a 5% owner who is an active employee and is over age 70.5. He must start his pension (or profit sharing plan) distribution by the April 1, etc. I don't see a problem with him making deductible contribution at the same time as him making a mandatory distribution. Let's say he just started the pension plan (and has never had one in the past). If we use a vesting schedule, we could generally delay his mandatory distribution until he is vested (or at least partially vested), right? However, participants automatically become fully vested upon attainment of normal retirement age. If normal retirement age in the plan is age 65, he would already be fully vested, therefore he would have to start his distribuition, right? But, if the plan's normal retirement age is the later of age 65 and 5 years of participation (thus ignoring all prior service), the full vesting wouldn't automatically occur for 5 years. So, would a age 65 / 5 years of participation together with a vesting schedule (let's say 5 year cliff vesting, assuming the plan is not top heavy) effectively delay his mandatory payout for roughtly 5 years?

Can K-1 income be the basis for a pension plan. If not, can K-1 income be converted into W-2 income, and therefore be the basis for a pension plan? Currently, an LLC exists (call it A"). It has two limited liability members, B and C, which are each S-Corporations. Individual X is the sole owner of Corporations B and C. "A" makes money by buying things and either selling them or renting them out. Currently, the net profit of A is shown on K-1's for B and C. The K-1 amounts are then transferred to X's 1040. My understanding is that these amounts cannot be used for a pension plan for Individual X. However, Individual X performs services for "A" that enables A to show a profit. (X knows the customers, arranges the deals, etc.) X is currently not drawing any income from A, except via the K-1 distribution through B and C. If X becomes an employee of A, then couldn't A set up a pension plan and cover X based on X's W-2 income paid by A? Now, this income would be subject to FICA (and FUTA, etc.), but other than that, it would seem that all other moneys would be taxable in the same manner to X. So, a pension plan would make sense if the value of the pension benefit for X (based on his W-2 income from A) would significantly exceed the FICA taxes that A (as the employer) and X (as the employee) would have to pay. Is this analysis correct? Have I missed something? (I assume that X does perform legitimate services for A and that any W-2 income could be justified. Clearly, the accountant involved would have to be comfortable with this.) Would there be any rationale (or advantage or disadvantage) for X to be the employee of either B or C, instead of A? (I don't think there would be any advantage or disadvantage. In this situation, X owns B and C.)

I would define the benefit at NRD (ignoring the 25 year minimum) to be 50% multiplied by years of credited service at NRD divided by potential years of credited service at NRD. I believe that takes care of the problem at NRD of two different employees hired at different ages but have the the same total service at NRD due to missing intervening years. If this rationale isn't satisfactory, you can define the benefit formula using a unit credit approach rather than the fractional approach, with different unit credit accrual rates based on original hire age. For example, the benefit formula for employees hired at age 40 or later would be 2% X years of service; the benefit formula for employees hired at age 39 would be 1.92% X years of service (1.92% = 50% / 26), etc. While the "standard" fractional accrual formula is cleaner to meet the IRS safe harbor tests, the "unit credit approach" is equivalent, so it should meet the safe harbor as well (of course, it might have to be explained to the IRS reviewer). Regardless, the 401(a)(4) general test is easy to pass anyway. (By the way, what I don't like about defining the benefit using the unit credit approach is that it is explicitly clear to young hires that they are accruing their benefit more slowly than old hires; at least with the fractional rule, that is "hidden." Some HR folks don't mind hiding these things.)

David, there is no more discrimination than any other fractional accrual situation. Employee A (the 30 year old hire) is accruing his 50% projected pension at the rate of 1.43% (50/35) per year; Employee B (the 35 year old hire) is accuring his 50% projected pension at the rate of 1.667% (50/30) per year. After 5 "Years of Credited Service (at whatever ages these "Years of Credited Service"), Employee A has a 7.15% benefit (50%x5/35 or 5 x 1.43%); Employee B has a 8.33% benefit (50%x5/30 or 5 x 1.667%). If the rehire issue concerns you, let's ignore rehires completely. Compare the age 40 benefit of Employee B (hired at age 35) to the age 35 benefit of Employee C (hired at age 30). Both have 5 years of service, but Employee B's accrued benefit is 8.33% (50%x5/30) and Employee C's accrued benefit is 7.15% (50%x 5/35). They are different, even with the same service. It makes sense (I think), but it gets tricky.

I ran into this situation a number of years ago, and it is very tricky. By the way, this approach can also apply to rehired employees (rhe period of time between initial termination of employment and date of rehire is analogous to the period of time working between 500 and 1000 hours per year), time an employee workes for a noncovered division, or time an employee worked for the employer as a member of a union. The situation was resolved as follows: An employee who has 25 or more POTENTIAL years of service at NRD will receive a 50% benefit multiplied by his "actual years of service" at NRD and divided by his "potential years of service" at NRD. Actual years of service were years in which the employee worked at least 1000 hours. Potential years of service were measured from his original hire date. So, in MWYATT's example of an employee hired at age 30, terminated at age 40, rehired at age 50 and retired at age 65 would have an accrued benefit of 10/35 x 50% at age 40, 10/35 x 50% at age 50, 24/35 x 50% at age 64, and 25/35 x 50% at age 65. This reduction factor at age 65 is because he did not work for the company between ages 40 and 50 (or equivalently, if he had worked between 500 and 1000 hours between ages 40 and 50). Stated another way, for an employee ORIGINALLY HIRED at age 30, his benefit is (50/35)% per year of service (where year of service is based on 1000 hours). For employees (with at least 25 years of potential service at NRD) who terminate before NRD, their benefit is 50% multiplied by his "actual years of service" at termination of employment and divided by his "potential years of service" at NRD. Finally, for employees with less than 25 years of potential service at NRD, the 50% described above is proportunately reduced. The way this mess was written in the plan document was actually quite succinct. Accrued Benefit = 50% x [min(potential credited service at NRD, 25) / 25] x min [actual credited service at termination / potential credited service at NRD , 1 ]. I'll not go into the details of how employee who worked past NRD were treated; it's ugly.

The next-to-last sentence in Dawn Hafner's reply is particularly useful -- "the answer may be to go on a document that has more flexibility if they want this to be a part of their plan design." This is usually my preference for several reasons. (1) It clarifies any qualification issues, because all of the questions in this thread would be moot. (2) It would save the consultant time/client money if this discussion doesn't have to happen. (3) It would save the consultant time/client money since the consultant wouldn't have to revisit this issue each year ("What did we conclude last year?" Is there anything that would change this for the current year?") There are two negatives: (1) the cost of changing the plan (although this is less than the cost/time in (2) and (3) above or the risk in (1) above. (2) the politics of the situation (you may be using a document that cannot be changed due to a relationship with a broker, insurance company, etc.) You have to decide on this one.

I've been wrong before, but, despite the hype, I think the new safe harbor 401k will have limited appeal. From a cost standpoint, the employer will measure the additional cost of the 3% match over his current level of match, as well as the cost of full and immediate vesting. Offsetting this will be the consulting (or internal) cost saving of not having to perform ADP/ACP testing and post-year-end corrections; however, this is probably a small administrative cost compared to the cost of the match. (Also, the post-year-end corrections will become easier now that we can use the prior year's nonHCE ADP/ACP levels to determine the current year's maximum HCE ADP/ACPs.) From an HR standpoint, they will have to decise if the removal of a vesting schedule circumvents the appeal of "the longer you stay with us, the more vested you will become," which HR typically likes. One key element in the safe harbor's favor is not the cost elimination of the ADP/ACP testing, but rather freeing up the HCEs from any ADP/ACP testing. This can have important HR implications, since HCEs are an important group within the company. Bottom line -- my best guess is .. probably not tremendous appeal, but it's another design that we ought to analyze for our clients. (Side note. LCARISI's comment about it being unfair to not be able to take into account the DB cost is correct. Unfortunately, there are many instances where a combination of 401k and DB plans are not "integrated" in the IRS's rules -- in particular, the mandatory disaggregation in the 401(a)(4) rules.)

You may actually not have a coverage problem; it depends on your employee data. You may be able to use the general test under 401(a)(4) to meet the coverage and non-discriminiaton requirements. It depends on what retirement benefits you are providing your salaried employees, how many of them are highly compensated employees, how old are the employees, etc. Based on your raw numbers (10 salaried employees covered by a plan and 30 hourly employees not covered by a plan), it could be difficult for this approach to work. But it depends on the numbers and is not as bad as VCR/CAP, etc. Good luck.

The reduction to take a joint and survivor annuity could be set up as a "lower-than-actuarial" reduction, thus effectively subsidizing the joint and survivor annuity. For example, if the "correct actuarial reduction" was 10% based on the age of the employee and spouse, the plan could use a 7% reduction factor. All of this must be spelled out in the plan document. There is no limit on how much the actuarial reduction can be with an old employee and a young spouse. For example, a 65 year old with a 21 year old spouse might have his benefit reduced by (let's say)70% to provide a joint and 100% survivor benefit. However, if the plan wants to allow a non-spouse beneficiary (e.g., his daughter), he cannot name a non-spousae beneficiary such that the reduction would be greater than 50%. (The reason for this is that the pension plan must provide primarily retirement benefits for him. With such a young daughter, the pension plan would actually be providing primarily death benefits for him, not retirement benefits.)

The previous message should have read "adult son Jim owns 0% of the company," not "adjust son Jim owns 0% of the company."

Dad owns 60% of a company. Adult son "Fred" owns 40% of the company. Adjust son "Jim" owns 0% of the company. All three are employees of the company. Ignoring the $80,000 pay rule, is Jim an HCE because he is either (a) the son of a 60% owner, or (B) the brother of a 40% owner? I believe the answer is "yes" because, Section 318(a)(1)(A)(ii) indicates that an individual is considered as owning the stock of his ... parents. Also, Section 318(a)(5)(B) doesn't help (I think it would have helped is the employer were Jim's wife, not Jim). Am I correct or all wet?

1. In determining the denominator of my ADP/ACP test, do I use: W2 earnings, W2 earnings plus 401k deferrals, W2 earnings plus 401k deferrals plus Section 125 deferrals, or other? 2. To determine whether or not an employee is an HCE, do I use: W2 earnings, W2 earnings plus 401k deferrals, W2 earnings plus 401k deferrals plus Section 125 deferrals, or other?

Consider an individual that owns, let's say, 5 businesses, and earns about $200,000 from each business. Each business has several employees. The 5 businesses are NOT in the same controlled group, because he owns 50% of each business, and there are no common owners among the businesses. An attorney has advised him to this fact. Also, assume that the businesses are completely separate. So, it appears that he can have multiple defined benefit plans (or multiple defined contribution plans) covering each business. And a separate 415 limit would apply for each business. Therefore, he will be able to contribute either $150,000 (5 x $30,000) to defined contribution plans, or probably around $250,000 to five defined benefit plans. Have I missed something? I suspect that he has (either by design or by fortune) structured his ownership very favorably! Again, have I missed something? (By the way, he be be forwarned that ANY changes in the ownership could jeopardize this nice arrangement.)

I've only seen volume submitter documents that require extra language. Does anyone know whether the IRS will consider the extra language to be material (and thus require a higher user fee) or to be immaterial (and the lower user fee).

I agree with ezollars that putting insurance inside a qualified plan to "take advantage of the tax-deferral" because of insurance is not cost-effective. (In other words, it wastes money.) I've seen it make sense outside of a qualified plan, through COLI or individually purchased by the owner. I understand COLI is still being used to fund executive benefits. It was used extensively about 15 years ago, where tax loopholes allowed borrowing to create extremely high internal rates of return -- usually in the 20-25% range. Of course, that was in the large corporate environment, where 30-50 year time horizons could be used. (At that time, I was on the analysis side doing actuarial analysis and the numbers were legitimate -- had I been on the sales side, I would have retired by now.) Finally, I was unaware that the use of the term "private pension plan" is illegal in some states. Good! (By the way, do you know which states?)

Since clients don't like to pay in cash what they could "pay for" in soft dollars, I wonder what firms that consult in other areas are doing. For example, accounting firms, general management consulting firms, operations consulting firms, software and Y2K firms, etc.

It seems to me that structuring and testing retirement plans for employers that contract with leasing organizations is similar to testing for employers in the same controlled group - as long as the owners are also considered as leased employees. Is this correct? The following illustrates my rationale. I'd appreciate your comments. A leasing organization contracts with 3 employers, A, B and C. All of the "employees" of A, B and C, INCLUDING THE RESPECTIVE OWNERS, become "employees" of the leasing organization. The leasing organization sets up a safe-harbor profit sharing plan for "employees" of A (including its owner who is now an employee of the leasing organization). (I put "employees" in quotes, since these individuals were former employees of A and are now employees of the leasing organization.) The leasing organization sets up a safe harbor defined benefit plan for "employees" of B (including its owner who is now an employee of the leasing organization). No retirement plan covers "employees" of C. 1. Since "A" is a safe harbor plan, we perform 410(B) coverage testing for "employees" of A by doing a ratio percentage test with employees of A in the numerator and all employees of A, B and C in the denominator. 2. Similarly, since "B" is a safe harbor plan, we perform 410(B) coverage testing for "employees" of B by doing a ratio percentage test with employees of B in the numerator and all employees of A, B and C in the denominator. 3. Let's assume the above two steps fail. We then do a 401(a) general test based on the entire group (A, B and C) converting contributions to benefits, or vice versa. 4. Finally, in determining whether or not the entire group (A, B, and C) is Top Heavy, we can exclude C because they are not participants. 5. Is there any difference in the above reasoning if A and B were both separate defined contribution plans? 6. Is there any difference in the above reasoning if A and B were one single defined contribution plan with different contribution structures for A and B (e.g., employees of A receive 3% of pay and employees of B receive 5% of pay). 7. Is there any difference in the above if instead of instead of A, B and C contracting with a leasing organization which maintains the plan, A, B and C were companies within a controlled group (e.g., owned by a holding company).