Some Frequently Asked Questions

This is in no way a complete list of questions, but it represents many of the topics that concern clients, brokers and employees

What are ADP/ACP Tests?
A test designed to prevent discrimination in 401(k) plans. It compares the amount deferred by highly compensated employees to the deferrals of non-highly compensated employees. The object is to ensure highly compensated employees do not contribute at a disproportionately higher rate than rank and file employees. This encourages owners to promote plan participation among the non-highly compensated employees. See also ‘safe harbor plan’.

What is the top-heavy Plan?
A plan in which 60% of account balances (both vested and non-vested) are held by “key” employees will be considered ‘top heavy’. Such a plan will require that to the extent any key-person gets or makes a deposit in the following year, an amount equal to the key-persons deposit, as a percentage of pay, must be contributed on behalf of all other non-key employees, up to 3%.

What are minimum coverage tests?
A plan, to be qualified, must cover a reasonable portion of the employees of the company. The basic rule is that a plan must cover 70% of the employees. Thus a plan could exclude all employees at a specific job site, but only if they were a small minority of the total. Most plans cover all employees (minimum age/service, union and non-resident alien exclusions aside), thus this is not a consideration. However, care must be taken in designing eligibility requirements beyond the standard.

What is a controlled group?
If the owner of a business owns some or all of a second or more business, the separate businesses may be considered a ‘controlled group’. Any qualified plan put in for one business in a controlled group of businesses must cover the employees of the other business. The actual rules as to ownership, family members, partnerships etc. are complex. Failure to abide by them, however, can result in covering many more employees than planned for and dramatic cost increases. Buying new companies and other acquisition activity must be carefully reviewed to properly plan in the event of controlled group conditions.

Do I need a Fidelity Bond?
Yes, the IRS required that all fiduciaries and others that handle plan money be bonded for 10% of the assets, with the maximum bond $500,000. Note that plans covering only 1 participant are exempt.

When is the Form 5500 due?
7 months after the close of the plan year, with the ability for one automatic extension for 2 & 1/2 months.

What is a “TPA”?
A TPA is a Third Party Administrator. Qualified plans must be operated in compliance with the plan document, IRS and DOL rules and regulations, and provide the benefits promised. When a business establishes a qualified plan such as a 401(k) plan, it is the duty of the Plan Administrator and Trustees to keep the plan in compliance. This requires skills and knowledge not often in the hands of the owner, HR people and CFO etc. It is then appropriate to retain a responsible, trained and qualified party to assist in the duties of plan compliance. That is what a Third Party Administrator does.

Are Matching Contributions mandatory?
No. A 401(k) may consist only of employee elective deferrals. It may, however, elect to match those deferrals. Matching may be done on a payroll to payroll basis, or determined after the plan/fiscal year ends. This also applies to Profit Sharing contributions.

What is a safe harbor plan?
In order to avoid the 401(k) ADP discrimination testing, a plan can choose to be treated as a ‘safe harbor plan’. To get this treatment the employer must contribute either; (1) 3% for all employees, or, (2) a matching contribution to those employees who contribute, the match being dollar for dollar up to 4% (with variations). These contributions must be 100% vested. In small plans this can greatly help the owners to optimize the plan.

What is a Prototype Plan?
There are three formats available when preparing the plan document for a pension, profit sharing or other qualified plan. The most expensive, but most flexible, is an individually drafted plan, generally prepared by an attorney well versed in this area. This type requires the document be submitted to the IRS for review and approval.

At the other end of the spectrum are Prototype plans. These are pre-drafted and pre-approved documents with limited options that can be elected. These do not require submission to the IRS.

In the middle are Volume Submitter plans. These offer much greater flexibility than prototype, and if the elections made by the employer do not stray too far from acceptable limits, the plan can rely on the determination letter granted to the sponsor of the Volume Submitter document.

What is a Volume Submitter Plan?
See answer to “What is a Prototype Plan”

What is Fiduciary Liability Insurance?
Anyone with discretionary control over a plan or its investments is a fiduciary. There is a requirement that fiduciaries act in a manner tantamount to that of a prudent expert in matters of funding etc. It is conceivable that a plan’s investment policy may not be followed, or it is flawed, or some disgruntled employee simply wants to make up for bad investment judgment. In any event, a suit could be brought, and the cost of defending will be borne by the fiduciary in question. Defense costs and more can be insured against by using Fiduciary Liability Insurance.

Why am I the Plan Administrator?
Although technically possible to name someone other than the employer as plan administrator, the duties and activities of plan maintenance are properly the responsibility of the employer. Note that is the Employer, not an individual, who is considered the plan administrator. See also “What is a TPA”.

What is vesting?
Vesting is the participant’s ownership right to a percentage of their account balance. Typically a year of vesting is calculated based upon a twelve month period as defined in your plan’s document, in which a participant works 1,000 hours or more.

What are the plan’s eligibility and entry requirements?
Eligibility is the determination of when an employee is eligible to become a participant in the plan. The entry date is when the participant can enter the plan. The plan document will state the age and service and entry date requirements to join the plan such as first of the month following the attainment of age 21 and one year of service from the employee’s hire date.

For more frequently asked questions, CLICK HERE.


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