• Defined Benefit Plans

• Defined Contribution Plans

• The employer is able to contribute to the plan on a pre-tax basis.
• The funds in the trust compound tax free until removed from the trust.
• The image of the company is enhanced by the installation of a qualified plan.
• The Employer is able to apply the "golden handcuffs" through the use of a vesting schedule on the Employee's account balance
• The contribution may be deposited up to 8 ½ months after the plan year end, and the tax deduction will still apply to the previous year.
• The funds are self-Trusted. You may invest the funds of the plan as you choose, within certain limitations set by the Department of Labor.

This retirement plan has been the most popular over the years and is the basis for all 401(k) plans.  The allowable contribution is calculated on 25% of eligible compensation  ($40,000 maximum per individual) and the Employer may contribute all, none, or a part of the calculated contributions.  It is no longer necessary that the contribution be attributed to profits in the company to be tax deductible.  The document must state which of the benefit formulas you are using in your plan.

The benefit formula options available for these plans include:

Compensation to Compensation  Under this formula, the contribution is allocated according to the compensation of each individual.  This formula is usually used in SEPS and basic Profit Sharing plans.

ntegrated with Social Security   This formula allocates a slightly higher percentage of the contribution to the employees making in excess of the social security wage base. This wage base is $87,000 in 2003.

Cross Tested  or Tiered  This formula combines the best of the Defined Benefit Plan and the Profit Sharing Plan. Each year the contribution is calculated actuarially, taking into consideration the age of the Employee and the compensation of the Employee.  Certain classes or tiers of employees by title, as defined by the Employer are set up. The contribution is then allocated to the account of each of the Participants based on the calculation which includes age, compensation and class and the numbers must pass several tests set up by the IRS.  This type of plan typically enables the older, more highly compensated Employee to receive a substantially higher percentage of the contribution.   This formula is very demographic sensitive, and the hiring of an older employee may skew the numbers substantially.

On each of these formulas, the contribution is discretionary each year.  There is no mandatory contribution.

Each of these Profit Sharing formulas may form the basis for the 401(k) Plan.

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The 401(k) Plan adds several accounts to the Profit Sharing Plan. IRS Code 401(k) allows the addition of the Employee Deferral Account (salary contributed by the Employee from his/her pay) and/or the Match account (Employer money contributed to the plan to encourage the Employee to defer).  The composition of the 401(k) Plan may be illustrated as:

ACCOUNTS IN THE 401 (K) PLAN:

Many tests apply to the 401(k) Plan but at the heart of the plan is the

Average Deferral Percentage Test.

Essentially, the Department of the Treasury wanted the Management of the company to encourage the average employee to defer part of his/her salary into the plan.  This test provides that dynamic.  All the employees are divided into two groups, Highly Compensated (any Owner or family member of an Owner, or any Employee who earned more than $90,000 in the previous year) and Non-Highly Compensated.  The Highly Compensated employees are then set aside and the deferral percentage for each of the Non-Highly Compensated is calculated.  The deferral percentages for all Non-Highly Compensated are added together and the total is divided by the total number of Non-Highly Compensated who are eligible to get the Average Deferral Percentage of the Non-Highly Compensated.  Generally speaking the Highly Compensated may only defer 2% more than the Average Deferral Percentage of the Non-Highly Compensated.

The IRS has now allowed the Employer to disregard the Average Deferral Percentage Test, if they install a Safe Harbor 401(k) Plan – see below

Employee Deferral Account:

As discussed above, this account is subject to the ADP test for all Highly Compensated employees and they may be limited by the percentage allowable.  The other limits for the Deferral and Catch Up Contribution are:

                  Employee Deferral Maximum            Catch Up Contribution
2003                        $12,000                                         $2,000
2004                        $13,000                                         $3,000
2005                        $14,000                                         $4,000
2006                        $15,000                                         $5,000

Catch Up Contribution:

In an effort to encourage more retirement savings, the IRS now allows any employee age 50 for any part of the year to deposit a Catch Up Contribution; the limits are shown above.   The Employer will deposit the Catch Up Contribution to the Employee Deferral Account and it will only be declared as “Catch Up” at the end of the year.  This contribution is over an above the allowable deposit for the plan year.  To be denoted as “Catch Up”, the contribution must be in excess of a legally allowable limit.  For example, the $12,000 is the limit of Employee Deferral allowed in 2003, and the $2,000. is automatically Catch Up in this case if the Employee defers $14,000.

Match Account:

The Match Account is the “selling tool” to get the Non-Highly Compensated employees interested in deferring.  The Match offered may be a formula based on percentages such as:

Employer will contribute a Match of $.50 for each $1. deferred by the employee from his/her pay.  The Match is usually set up in the document as discretionary so that the Employer has the option of changing the match from year to year.  The new Match should always be announced to the employees at the beginning of the plan year to be an effective sales tool.  Since the Match account is only contributed to those Employees who save for themselves, the Employer is able to maximize the benefit dollar.  The Match is usually lower than a Profit Sharing contribution which must be contributed to all employees who are eligible, and the Match is contributed to the employees who are concerned about their own retirement.

Profit Sharing Account:

If the Employer does not wish to contribute to this account, it is usually not necessary to do so. (If the plan is Top Heavy, a 3% minimum contribution will be necessary to the Profit Sharing Account)  If the Profit Sharing account is not utilized, it is not shown on the Employee Statements.  The Profit Sharing contribution is usually decided upon at the end of the plan year, and must be deposited by the deadline for the Employer tax returns.

Many plans are designed with a Cross-Tested Profit Sharing Formula, and the contribution to the Profit Sharing is decided upon at the end of the plan year, when the Employer is in a position to know his desired contribution amount and CAI is able to compute the actual allocation of the Profit Sharing to each Participant.

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The Safe Harbor 401(k) Plan is a fairly recent addition to the available plans.  If the various rules of this plan are followed, the Highly Compensated employees may ignore the Average Deferral Percentage Test and each of the Highly Compensated may defer the maximum allowable ie. $12,000 for 2003 plus the “Catch-up Contribution” of $2,000 if applicable.

The Employer must offer one of the two following options to the employees in his/her plan:

Option 1

Match Contribution to the Employees who defer from their own pay during the year:

The Match promised is usually $1. in the match account for each $1. you defer from your compensation up to 3% of your annual compensation and $.50 on the $l. you defer from your compensation for the next 2% of your annual compensation.

Sample:  If you earn $30,000. per year and you defer $3,000. or 10% of your compensation into the plan.

Your employer will match $1. for $1. on the first 3% or $900. (3% of $30,000.) and $.50 on the $1. for the next 2% or $300. (2% of $30,000 divided by 2).  Your total match for a 10% employee deferral from your salary would be $1,200.   If your employee deferral is less than 5%, the match would be reduced according to the formula.

The Employer has the further option of making a Match contribution equal to this formula, for instance $1. for $1. up to 4% of the Employee’s salary deferred.

Option 2

Profit Sharing Contribution to each and every Employee eligible.

Your Employer may make a contribution equal to 3% of your compensation for the year to the Profit Sharing account, whether or not you defer any money into the plan.

Sample:  You earn $30,000. - from your Employer you will receive the following:

An Employer contribution of 3% of your compensation or $900. for the plan year.

Additional Rules for Safe Harbor Plan:

-          The Safe Harbor contribution must be 100% vested

-          The Notice to Employees must be posted 30 days prior to the beginning of the year

-          A 401(k) Plan may only change to a Safe Harbor Plan at the beginning of the Plan Year

Other formulas may be added to the Safe Harbor plan that are able to benefit the Highly Compensated, such as the Cross-Tested Profit Sharing Plan.  As your Plan Administrator to explain the benefits of these plans. At CAI we are happy to give you a detailed proposal free of charge, if you send us your census of Date of Birth, Date of Hire, Annual Compensation.

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The Money Purchase Plan was useful in the past to increase the total deductible contribution to 25% of salary.  However, since the Profit Sharing Plans are now permitted 25% of salary (from 15%), the use of the Money Purchase Plan has become very limited.

If a Plan Sponsor wishes to stop all contributions to his/her plan, but wishes to hold the assets in a qualified plan trust, the IRS has suggested the use of 0% Money Purchase Plan.  In the past, the term “Wasting Trust” was used to describe this plan.  The advantages of the Money Purchase Plan are:

- If the trust was commingled with other employee plan money, it is protected in case of bankruptcy etc.

- The cost of holding the assets in the trust is the administration fee for the year, and may be much lower than the cost of a custodial account.

- The trust can hold such assets as land, trust deeds, partnerships etc. with ease.

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