1
DEFERRED COMPENSATION OUTLINE: National Retirement Policy: Three
Legged stool: 1. Social Securitya. Safety net to put food on the
table2. Company Pension3. Your own savings -401k or other savings
4. 4th Leg: Working after Retirement
Non-Qualified Plans: Wealthy will have Non-qualifed plans in
addition to the qualified plan. a. They will have $5M. Will
negotiate payment of $4M and then $1M after retirement ends.
Contracts: PROS & CONS EE & ER
EmployeeA. Pros: a. $ in retirementb. Lower Tax Bracket?
(maybe)i. 50-60 highest income with a peak at 70.c. Higher Yield
Company will pay higher yieldd. Tax deferral B. Cons: (Lack of
Security a. Might never be paid. i. Bankruptcy: Company may go
bankrupt-b/c EE becomes an unsecured creditorii. Hostile Mgt: Move
on Apple. Will future management honor arrangement? iii. Cash
Shortage in future: 1. Kodak-so many retires: b. No access for
emergenciesCompanyA. Pros: a. Golden Handcuffs: incentive for EE to
stay b. Forfeitures: bad boy provisionsi. Covenants not to
compete-to make it expensive for them to compete: 1. If you
compete-they forfeit their future non-qualifed plans payments. 2.
Famous Cases: Ford Mustang- Lee Iacoka (sp?) moved to Chrysler
forfeited all funds. c. Future Managements Problem.d. Less
ERISA(Employee Retirement Income Security Act of 1974) i. Little
bit of Laborii. Less IRSiii. TOP HAT plans (only for executives)B.
Cons: a. High Yield (promise high interest rate)b. Timing of Tax
Deductioni. Deductible when EE has the income ii. Cant deduct the
$100k or the interest until the EE actually gets the money
NON Qualified Plans into 3 types of Plans: A. Deferred
Compensation Agreement (tailored)a. Bill Self will have his own
plan with KU different than everyone else. B. Top Hat: Group-Tired
to Qualified Plan. Excess Benefit Plana. 30 years Pension= 50%
incomeb. Comp: 100 Pension: 50i. 200100ii. 400200iii. 800400 **most
can pay is 210K**iv. Pension plan law ERISA does not allow to go
over $210Kv. So companies will make up the difference with a
non-qualified plan. C. Yr of Employer DeductionReg. 1-404(b):
taxable yr cash-method EE reports the income. HYPO: You are lawyer
for the EE. A. Want to have income tax when I get payment.B.
Assurance that want to get paid. C. Creative ways to accomplish
this: a. Problem: The closer you get to security then the closer
you get triggering taxable income. b. EARLY TAXATION: i.
Constructive Receipt: Is the $ made available to you? (even if you
only got 400K we will tax you on all $500K)ii. 402(b)1. Sec.
1.83.3(e)-Property: Funded Trust iii. 409A (Biggest Tax Problem) So
how get rid of these 3 tax problems? A. Constructive Receipt: a.
Danger words made available b. Look at the law page 7 of handouts.
1.451-2 Constructive Receipt of Incomec. made available so that he
may draw upon it at any time. d. DEFENSE: income is not
constructively received if the taxpayers control of its receipt is
subject to substantial limitations or restrictions. e. All have to
say $100K plus 6% will be paid to you until x date (15 years) OR
will be paid to you and will not be made available to you before x
date B. 402(b)a. HYPO: Grandfather gifts $10K no income tax Sec
102-Gifts)i. Instead puts 10K in trust: Income, interest and
Dividends. 1. Deposit into trust is not ii. Company: $20,000 Bonus
to you. Yes taxable1. Instead puts in Trust: Now EE only gets
dividends and interest. a. If you have a funded Trust- you EE will
be taxed the DAY the money is put in the trust. b. Even though you
dont have access to the funds. c. Creates a big cash flow problem
when you have to pay taxes on $20K that you havent earned yet. iii.
Deposit: iv. Invested Income: Secular Trust: (funded Trust)
Creditors cannot access EE pays taxes on: ERs contributions Trust
earnings (by way of tax on trust) Distributions tax free Trust may
make distributions to EE to help w/ increased tax liability 83
Analysis: 402(b)(1): Contributions to EEs non exempt trust shall be
included in the GI of the EE in accordance with 83 transfers of
property for services; Reg. 1.83-3(e), (8): property includes a
beneficial interest in assets set aside from creditor claims of
transferor.
Rabbi Trusts: Creditors MAY access Irrevocable trust ER
considered owner of trust EE Pays taxes on: Actual receipt of
compensation, not contributions Substantial Restricted benefits no
constructive receipt not currently taxed Taxed when made available
83 Analysis: Reg. 1.83-3(e): property does not include an unfunded
and unsecured promise to pay money or property in the future.
Potential access to trust assets by ER creditors makes the trust
unfunded
Rabbi v. Secular(Funded)Taxation Funded-SecularRabbi
Deposit
EmployeeIncome No Income
Employer Deduction No Deduction
Investment IncomeTrustTaxed to company (all assets are listed as
co assets).
DistributionNo Effect Income and Deduction
Co gets Ded @ DepositWhenever EEMakes $$
When the trust actually distributes $ to the EE.
v. HYPO: Circuit City: and Rabbi Trust1. Bank account: a.
Executive A: $500Kb. Executive B: $220k2. Instead of a savings
account: Set up Rabbi Trust: a. Terms of the trust say this will be
paid to executive A unless company declares bankruptcy b. **This
makes it hard for the EE to lose out on Hostile management and Cash
shortage. i. Does not protect against Bankruptcy.
Rev. Ruling: 60-31: A. Individual PlanB. Group PlanC. Football
player signing agreement:
Rabbi Trusts: Triggers: A. If certain events happen, the Rabbi
Trust would become a funded trust. B. 10% HairCut: (if 1M in plan)
Executive can get the full plan balance minus 10%. So you could get
900K. Then become Funded Trust. a. Enron: Executives had this.
Executives 70% of plan was Enron stock. So all employees lost $100.
b. Executives, took the rabbi trust. c. 3 years later congress
enacted: 409A. Elminates the Haircut Triggers. i. Whats dangerous
is 409A talks about any contract not just trusts
409A Starting point: Dangerous & applies to plans. a.
Applies to simple contracts. b. Three Thing Regulation: a. When
Election can be Made: usually only in preceding year b. Assets Set
Aside: e.g., rabbi trust: i. Cannot protect from creditors; and ii.
Cannot be offshore c. Distributions i. Only permissible for six
possible events; ii. No acceleration or triggers possible iii.
Public traded company? Execs wait 6 Mo. c. Tax Results of 409A: a.
Comply: i. Employee has income upon future receipt ii. Company
deducts compensation in same year b. Fail Tests: i. EE has income
in YR earned, even if cant actually gets it ii. Treated as ordinary
income to EEso ER withholds income tax iii. Company pays 20%
penalty on all EE income iv. Fail Test after Years of deferral? ALL
accumulated income is taxes, plus interest and 20% penalty. d.
HYPO: $500K pay me $400 now and $100 later. a. If you mess up the
test: Drafted wrong. (step outside the contract)i. Executives taxed
when the $ is earned. Taxed on all $500 not just the $400. ii. Plus
a 20% penalty on amount that is deferred-co. pays the penalty on
the deferment. 1. Accelerate all penalties and interest. 2. All
just contract law. 3. Comp can deduct the taxes but not the
penalties or interest. 4. 3 years down the road..deffered 300K 5.
Exception: defer the year you are hired. Distributions allowed: 6
possible ways. Contract add all 6..but DO NOT specify anything
other than that. ADD all 6 dont add, when college goes to college,
divorce etc. . This will trigger 300k income if take 20K for e.
What is an unforeseeable emergency? a. See page 17 of notes. Enron:
Exon look at paragraph I: 6 months after for separated from
service
Problem: Nonqualified Deferred comp arrangements. P.20
Problem C: a. Constructive Receipt: was it made available Dont
have constructive receipt b/c $ not available for 5 years. b. Sec
402c. Funded:a. EE: Deposits Taxed $120b. Company: Ded $40c.
Interest: Trustd. Unfundede. 409A-distributions permits? Prob D: a.
UnFunded:a. EE: No incomeb. Company: No Ded-EE(5 years)c. Interest:
Company
Section 83: Compensation in PropertyA. GR: Taxed on labor
regardless if paid in cash or property (car dealership,
orthodontist) a. Compensation usually Cashb. Property-c. Stocki.
Restricted ii. Stock Optionsiii. Why would any company do this?
Make employees think like an owner. Increase productivity.
CompanyEE
CashDeductIncome
Payroll Tax7.65%7.65%15.30%
d. Why stock: i. Incentive: EE thinks like an owner: Works to
increase stock value since feels sense of investment in business
ii. Reward EE who stay long termiii. Tax deduction by just printing
stock certificatese. Why not? i. Small business owner loses
control.
Compensation paid in Restricted stock: 83Restrictions: a. ON
transfer: i. Closely held business to avoid dilution: 1. Buy/Sell
& Right of first Refusalc. On Date that stock vestsi.
substantial risk of forfeiture1. Most common: lose stock if quit
job early. (put a time frame like if 10 years) 2. HYPO: go work for
competitor, quit job in 10 years etc. d. Amount and Year of
Incomei. Amount of Income: 1. Value of Stock @ time below less
amount paidii. Year: Earliest of: 1. No substantial risk of
forfeiture 2. Stock is transferable a. Is there a chance you might
lose your stock? i. Yes if you quit job too early.ii. Also if the
company cant meet an earnings requirement. iii. Covenant not to
compete.iv. Comitte a crime. Etc. 3. Stock is actually sold by
employee
Compensation Paid in Restricted Stock: Sec 83Amount and Year of
Income: Stock FMV$Paid
2011$10K$1K
2016$50K*forfeiture expires
2018$70KStock Sold
2011: No taxable income2016: 49K W2 Form income--$49K Witholding
taxes: social security taxes ER deductions $49K2018: $20K LT
Capital Gain
Tax Trap When Your Option Price is Same as Market Price MAKE
83(b) ELECTION!!!!!Stock FMV$Paid
2011$10K$10K
2016$50K
2018$70K
**TAX TRAP: 2016: $40K W2 Form income*withholding taxes; social
security taxes2018: $20K LT Capital gainIs there away around this
to make it as if she bought the stock on the exchange? a. Make a
section 83 b election! b. 2011: Income=0 (10-10)c. 2016: Dont use
the GR: use 83B No W2 Incomed. 2018: $60K LT Capital Gain*How make
election? There is a form, within 30 days of making the transfer of
property. *need knowledgeable people knowing this exists. *Unfair
aspect of this: What happens if she quits before 2016? And she made
the 83b election? a. the company that deducted 9K, the individual
EE cannot take a deduction for the loss in the 10K 1K example, when
the EE quits early*Want to be reasonably confident that you will be
there for 5 years, to make sure you vest.
EE STOCK OPTIONS: a. NQSO: Non-qualified employee stock option.
b. ISO: Incentive Stock OptionsWhat is a stock option? a. Grant
date:a. Stock $11b. Price $10 optionc. Exercise Date: b. NQSO:a.
Excise of option usually triggers W2 Form compensation income
(withholding taxes, SS taxes)b. Employer tax deduction for
compensation the same year employee has incomec. When Executive
excersises, they generally sell it the same day. Generally will
diversify, sell it pay taxes and diversify. c. ISO: a. Exercise of
option not trigger W2 Comp to EEi. AMT issues, thoughb. Sell Stock
> 1 year after exercise date and >2 years after grant date =
LT Cap Gainc. ER does NOT get tax deduction. d. *Tends to only
happen to cos that dont care about owners*e. Big issue with ISO is
the volatility of the stock market. i. Executives.
HYPO: EE Stock option to purchase ER stock for $10 anytime over
next 4 yrstrading @ $11. Taxed on the $1 of income on the GRANT
DATE? *Special rule for stock options: Only taxed on the Grant
Date, if they have readily ascertainable FMV a. Only if the option
(as opposed to the company stock) is traded on an established
market (oversimplified)b. Reg. 1.83-7(b)StockOption
2011Grant$11 $1
201250%$16 $6 < 600%
2013100%$22 $12 < 1200%
HYPO: When taxed? Taxed on Exercise date. Exercised in 2013 @
$10 Exercise Price 2013: W2 Form Compensation=$12/shareWithholding
taxes, social security, etcER: tax deduction=$12/share2015 Sell
Stock for $26LT Capital Gain $4/share (Income/Sale proceeds FMV @
Exercise Date) (26-22)Same Facts: ISOExercise in 2013 @ $10
Exercise Price2013: no income, but AMT preference =$12/share)2015:
LT Capital Gain=$16/share($26 sale price - $10 cost)ER : No income
tax deductionsStockOption
2011Grant$11 $1
201250%$22 $12 < 600%
2013100%$26 $ < 1200%
2014$9Worthless
**Point: Restricted Stock can still have value even when stock
options are underwater**
Timeline: 1930a. Social security 1935/1938 (kicks in at
65)1940a. WWIIb. Labor unionsa. Pensions from companiesb. Life
expect: 63-681960a. Major bankruptciesa. Studebakerb. White Motor
corporations1974-100,00 a. Labor Day 1974a. ERISA law signed into
acti. Provided security-required a trust to exist.ii. Corp paid $
into a trust then paid to employees.iii. 100K Defined Benefit
Plans: 1981-1986a. Regan elected/starts terma. Introduced IRA to
everyoneb. If you work $2,000 (now $5500 with inflation)b.
1986-401K Plansa. These plans IRAs ad 401Ks were designed to
supplement defined benefit plans. Now they are actually replacing
the defined benefit plans. 2005: only 30,000 defined benefit
plansa. Life Expectancy: 78
Fortune 1000 Companies: 2004 :59% DB Frozen 9%2008: 45% DB
Frozen 25%Risk shifting.
Spending time in this class to planning without the defined
benefit plans.
Employer-Sponsored Tax-Favored Retirement Plans1. Overview: a.
401(a) Qualified Retirement Plan is Most Favored: Two Types i.
Defined Contribution Plan: including 1. 401(k): Cash or deferred
Arrangement 2. 403(a): Qualified annuity Plan 3. 408(p): SIMPLE IRA
4. 408(k): Simplified Employee Pension (SEP) 5. Profit sharing
plans 6. Stock Bonus plans 7. Money Purchase Pension Plansii.
Defined Benefit Plan1. 2. Qualified Retirement Plans and Annuities
a. In General i. Taxable Distribution: employer contributions,
earnings on contribs, or benefits not in GI until amount are
distributed even if funded and vested. ii. Employer Deduction-404:
current deduction w/I limits even though not in EEs GI. iii. FICA
Tax: contribs to a QRP (other than elective deferrals and after-tax
contributions) are exempt from FICA along w/ distributions. iv.
Minimum Participation Rules: 1. 410(a) Rule: Cannot delay EEs
participation in plan beyond the later of: a. Service: one yr of
service (i.e., 21 mo period w/ 1K of service); or i. Exception: a
plan providing 100% vesting to ER contribs after two years of
service may impose 2 yr requirement. 1. But: cannot apply if plans
contains a 401Kb. Age: attaintment of age 21. 2. Cant Exclude
Participation: on the basis of attainment of a specified age 3. May
Exclude Participation: a. Job classification b. Other basis so long
as not an age proxy4. Defined Benefit Plan--401(a)(26): must cover
the lesser of: a. 50 employees; or b. The greater of of: i. 40% of
the workforce; or ii. 2 people. v. Vesting Rules--411:1. General
Rule: Accrued benefits must become nonnforfeitable after a
specified period of service or, if earlier, at attainment of normal
retirement age under the plan.a. Age Limit: Plan may not specific
an age later than age 65 or, if later, the 5th anniversary of
participation. 2. Amendments: May not reduce previously accrued
benefits or eliminate optional forms of benefits. 3. Involuntary
Distributions: w/o consent of EE are not allowed before the later
of the time the participant has attained normal retirement age
under the plan or attained age 62. a. Exception: if present value
of accrued benefits @ time of distrib is no more than $5kmandatory
cashout. vi. Income Limit401(a)(16), 17, 404, 415: 260K b. Minimum
Coverage and Nondiscrimination Requirements i. In General: 1.
Policy: ensure QRP provides meaningful benefits to an ERs
rank-and-file EEs and highly compensated EEs so the goal of
retirement security for both is achieved. 2. Two Requirements: a.
Minimum Coverage Requirements; and i. 401(a)(3)ii. 410(b)b.
Nondiscrimination Requirements. i. 401(a)(4)ii. 401(a)(5) 3. Highly
Compensated Employee--414(q)a. Compensated more than $120,000 AND
is top 20% of the payroll (all EEs)b. OR 5% owner of the business
own more than 5% so if exactly 5% then not 5% owner4. Election for
HCE: at election of ER, EEs who are HCE based on compensation may
be limited to the top 20% of highest paid employees. 5. Operation
of the Requirements: a. Applied annualy b. Disregarded Employees:
i. not satisfied min age and service conditions, ii. non resident
aliens; and iii. employees covered by a collective bargaining
agreement c. Aggregation with others plans allowed (b/c
collectively bargained plans are deemed to satisfy the
discrimination requirements)ii. Minimum Coverage Requirement: plans
coverage of employees must be nondiscrim1. Plans Ratio Percentage:
percentage of non-HCE covered over percentage of HCEs covered. 2.
Satisfaction of Minimum Coverage Requirement: 70% or higher ratio
%3. Fail Minimum Coverage Requirement: Less than 70% ration % than
multi part test:a. Plan must cover a group (or Classification) of
EEs that is reasonably and established under objective biz
criteria, such as hourly or salaried EEs; and b. Plans ration
percentage must be at or above a specific level specified in the
regs. 4. Average Benefit Percentage Test: must also be satisfied:
a. Requirement: the average rate of contributions or benefit
accruals for all nonhighly compensated employees in the workforce
(taking into account all plans of the employer) must be at least 70
percent of the average contribution or accrual rate of all highly
compensated employees.iii. Overview of Coverage RulesIRC 410(b)1.
Three Basic Tests: Try to satisfy the first, then keep moving
downa. 70% Test: 410(b)(1)(A)b. Ratio Percentage Test:
410(b)(1)(B)i. Ratio Percentage: NHCE Benefiting %/HCE Benefiting
%ii. Benefiting Percentage: # of HCE Benefitting/Total
nonexcludable HCEsiii. Excludable HCE: 1. Not met minimum
age/service2. Nonresident alien 3. Collectively bargained employees
4. Employees of QSLOBs; and 5. Certain terminated Employees c.
Average Benefit Test: 410(b)(1)(C): Two Parts i. Nondiscriminatory
Classification Test: Two Tests 1. Reasonable Classification: Reg.
1.410(B)-4(b): classification must be reasonable and established
under objective business criteria a. job categoriesb. Salary v.
hourly 2. Nondiscriminatory Classification: a. Determine NHCE
Concentration Percentage: i. Total nonexcludable NHCE/Total
nonexcludable EEsb. Refer to chart in Reg. 1.401(b)-4(c)(4)(iv) to
determine safe harbor and unsafe harbor percentages c. Compare the
plans ration percentage with the above. i. Ratio % = or above safe
harbor, plan satisfies nondiscrim classification test. ii. Ration %
below SH but above unsafe harbor, the prong must be satisfied w/
facts and circumstances and factors in Reg. 1.410(b)-4(c)(3). iii.
Ratio % = or below unsafe harbor, plan fails coverage ii. Average
Benefits Percentage Test: Average benefit % must be equal to or
greater than 70%1. Average Ben %: iv. General Nondiscrimination
Requirements1. Three General Approaches: a. General Rule: i. Three
Steps: 1. Determine the: a. Allocation Rate: DC Plans: amount of
employer contribution allocated to an EEs account for the plan year
as a % of the Ees compensations for the plan yr. b. Accrual Rate:
DB Plans: amount of annual payments under the Es accrued benefit
payable at normal retirement age in the form of a straight life
annuity divided by # yrs of service. 2. Form Rate Groups of EEs w/
same or higher rate 3. Each group must satisfy the 410(b) minimum
coverage tests. a. If ratio % of rate groups is less than 70%: then
i. Minimum ration % of 45% if NHCE % is 60% or less ii. Minimum
ratio % 20.375% if the NHCE % is 99 %. b. Design Based
Safe-Harbors: i. Generally: 1. DC Safe Harbor1.401(a)(4)-2(b)(2):
allocates contribs pursuant to thae formula in the reg2. DB Safe
Harbor1.401(a)(4)-3(b)(2): same as above ii. DC Safe Harbor Design:
requires a uniform allocation formula that allocates to each EE: 1.
Same % of plan yr compensation; 2. Same dollar amount; or 3. Same
dollar amount for each uniform unit of service (not to exceed one
week). iii. DB Safe Harbor: Must satisfy each:1. Uniformity
Requirements of Reg. 1.401(a)(4)-3(b)(2); and a. Uniform Normal
retirement formula b. Uniform post normal retirement benefit c.
Uniform subsidiesd. No contributory DB plans allowed; and e. The
period of accrual must be uniform and uniformly applied. 2. One of
the Accrual Requirements of Reg. 1.401(a)(4)-3(b)(3),(4) or (5). c.
Cross-Testing: 3. Types of QRPs a. Defined Benefit Plan: benefits
determined under plan formula i. Formula Example: 2% x (Averaged
compensation) x years of service = Annual retirement benefit ii.
Individual Accounts: not maintained for each participant iii.
Minimum Funding Requirements--4121. Risk: of investment loss/gain
born by Er through increases/decreases in required contributions to
fund promised benfits 2. Excise Taxes--4971: for a failure to make
required contributions, unless there is a funding waiver. iv.
Guaranteed: benefits under the PBGC. b. Defined Contribution Plan:
Separate account maintained for each participant, to which contribs
are allocated and investment earnings (and losses!) are credited.
i. Benefits Based on: account balance only ii. Risk: bore by the
EE4. Rollovers:a. General Rule: distribs from QRP that is an
eligible rollover distrib may be rolled over to another such plan
or IRA. b. Two Types of Rollovers: i. Direct Rollover: direct
payment from the distributing plan to the recipient plan; and ii.
60-Day Rollover: contribution of the distribution to the eligible
retirement plan w/I 60 days of receipt. c. Taxed: not included in
GId. NonSpouse Beneficiaries: are not able to use 60 day rollover
under 402(c)(11). e. See Page 27 of Committee Report
Pension Plans: Legal Definitions of QRP Section 401A. Pension
Plan (Section 412 must pay every year regardless of profits)a.
General Rules:i. Cannot provide in-service distributions 1.
Exceptions: a. Age of 62 still working 401(a)(36)b. Reach normal
retirement age ii. May provide death and disability benefits b.
Defined Benefit (D/B) Actuaries involved (not with the Money
purchase and Target plans) i. Provide retirement income (concept)
to replace your paycheck. c. Money Purchase Pension Plani. Defined
Contribution Plans (D/C) will fund annually ii. Some formula: 6% or
5%-we will add this amount to your account for every year you work,
this amount.d. Target Benefit (Type of money purchase pension
plan)i. Defined Contribution Plans (D/C)-not income
replacement-just deferred compensationii. Issues of
Discriminations: D/B plans $ favor older workers. iii. Set up as a
Defined benefit plan, instead we have a target benefit plan. iv.
Rule: Plan cannot discriminate with contributions or Benefits. v.
HYPO: DB plan pay 50% $40,000/yr need: $300,000 to buy this annuity
1. Worker age 55 80K have 12 years to save - $27,0002. Worker age
40 80K have 27 years to save - $10,000 3. Even though the
contributions discriminate- the benefits dont discriminate because
they are the same for both employees. 4. Then you set up the plan
as a DC plan. This is how you 5. Practical TIP: you dont want a
target benefit plan with 10 or more EEs a. HYPO: EEs that do the
same work for the same pay then the EEs fight and there becomes
issues with younger and older employees. vi. Age Weighted P/S plan-
set up as a target benefit plan-same rule though, B. Profit Sharing
Plans (discretion) (becoming more popular than the pension plans)
a. No requirement for profits Reg. 1.401-1(b)(1)(ii)b. Has to be a
Fixed # of yearsc. Stated Age (60)d. Separate from Servicee. This
type is a LONG TERM retirement Plan. f. Discretionary contribution
by ER, but plan formula must be set in plan document. C. Stock
Bonus (ESOP) (Employee Stock Ownership Plan)a. Defined: similar to
a profit sharing plan except benefits are distributable in stock of
the ER, and that the contributions by the ER are not necessarily
dependent upon profits. All the allocation and discriminating
plans. b. KC has 5 of the top ESOP companies-Article in readingc.
Leveraged ESOP-most likely to see
Stock Bonus PlansESOP
1.Pass Through of voting rights (merger/Sale) 409(e)(1)xx
2.Right to Demand Stockxx
a. Co is EE Owned (in bylaws of the co)
b.
3.EE Put Option Xx
4.When quit how soon can you get stockxx
a.One year rule
5.Age 55 Retire at 50% of stockxx
6.Prohibited transactions (where diff is)a. Buying stock &
loans-Can borrow $$b. Waiver of Duty to diversify c. **These are
what make the ESOP more attractive**
N/AOkMake them a little better because of these are OK.
Put option: at any time can put the stock to someone at a
certain price.
HYPO: Leveraged ESOP (debit)
408-IRAs (EP/Simple) (next weeks class)
a. D/B Plan: Need definitely determinable benefits b. Flat
Dollar plan: everyone gets a benefit of $10,000 no one does thisc.
Flat Percentage plan-everyone gets 20% no one does thisd. UNIT
Benefit Plan:**most common** Number of years of service x % (picked
by company) x average compensation of high 5 years20x1% x
100,000=$20,000*have to be definitely determinable cant have
contingent payments cant jigger with the numbers. If have lots of
forfeitures you can change the percent given.
Conceptual Problem: When does the D/B liability kick in for the
employer? A: when the EE quits
incidental benefit rule retirement trust account. What does the
IRS allow us to put into this trust? A limited amount. Disability,
death benefits-funeral expense s to the family,
Defined Contribution DC Plans: BalanceGrows from 4 sources: a.
Employer Contributionsa. How allocate? % of Total compensation of
total payrollb. -basic compensation: if hired at $50K yearc. -Total
Compensation: hired plus bonus amount etc. b. Investment Income a.
Allocated: % of Total Assetsc. Forfeitures: a. Rewarding long term
employeesb. Vesting Schedules: c. What formula do we use for
allocations? A. Cant discriminate: cant say basic comp plus
bonuses, not overtime. But could say basic comp plus OT but not
bonuses, because wouldnt discriminate against the average
employees)B. Safe Harbor-just allocate as % of Compensationd. EEs
own contributions (100% to your own account)
REV Ruling: 84-155: *have to give credit for past service-past
service cost*
**Moving towards the general plans (like Paychex has) where a
business can pick and choose their certain options of the plan.
Prototype plans-not having lawyers draft these individually
anymore.
Recurring and substantial-for profit sharing plans. Dont have to
put in every year.
Jurisdiction: (3 players)a. Labor: Employee Securitya. Sep
Trustb. Pay according to planc. Diversify investmenti. Adequate
Cashd. Prohibit self-deal-owners prohibited from looking at
employees accounts as personal piggy bank.b. IRS-Limit Benefits to
Rich **this class is aimed at learning at this IRS**a. Cap on
Contrib/Benifb. No Discriminate HCE (highly compensated
employees)c. PBGC: (pension benefit guarantee corporation) a.
Insure D/B Plans (one that plans the monthly benefit to
employees)b. *no insurance of defined contribution plans**c. Max of
$40k per year.
ERISA is the compromise 1974 of multiple legislation: 26 USC
40129 USC 1302ERISA Section 1251-this was the section of the bill
that became the same statute. Will find in the Tax Volume and the
Labor Volume. **All of these are the same code.
IRA: governed by section 408 (individual retirement account)a.
No part can be invested in life insuranceb. Interest is
nonforfeitablec. Assets cant be commingled with other property.
U has an IRA in 2013/2014? a. Earned Income b. Max : is Lesser
of $5,500 or 100a. Married: spousalc. Can I deduct? Under 96,000
married, or less than $60K single
Trust vs. Custodial account? Custodial account: mutual funds,
operates like a trust: Look at 5305:
Best plan with least administrative costs? *SEP & SIMPLE
Look at: No trust, no DOL reports, No 5500 forms etc.
How set up an SEP? a. 5305-SEP Simplified EE Pension-Individual
Retirement Accounts Contribution Agreement b. Requirements: a. ER
agrees to contributions made on behalf of each eligible ee will
bei. Based only on the first $260,000 of compensationii. Same
percentage of comp for every EEiii. Limited annually to the smaller
of $41,000 or 25% of compensationiv. Paid to the employees IRA
Trustee, custodia, or insurance company. c. What wrong with SEP?
its only like a profit sharing plana. Only employer
contributions-not EE contributions. b. This is where the 401K plan
comes into play.
W-210%
me$300K (only up to $260k)$26K
EE 1$260K$26K
EE 2$26K$2,600
SIMPLE: Savings Incentive Match Plan for Employees of Small
Employers: (where EEs can contribute unlike the SEP) a. *General
rule ER has to match 3% -under extraordinary circumstances can go
lower but should plan on contributing 3%b. Non-elective
contribution: c. Notice to EEs for the SIMPLE IRA Plan: d. Salary
Reduction Agreement: for payroll deductions
Things to think about when deciding plan type: a. Age of
employeesb. 50 or less EEs to have a SIMPLE planc. Turnover of
employees-vesting of SIMPLE vs. SEP
Max Contribution 260K
ElectCatch up(over 50)
IRA$5,500 1,000=$6500
SIMPLE12,0002500: $14,500
401K17,5005500= $23,000
403(b)17,5005500= $23,000
S.E.P (solo)(no ee's)*ideal candidate for SEP-no EEs**52,000
(25% x 260,000)
D/BNO LIMIT (only what actuaries say)NO LIMIT
DB plans-national shifts are away from DB to now DC plans. WHY?
A: DC Plans: The investment risk is all on the employee. B: DB: The
risk for DB plan is all on the company.
DCDB
Deferred CompensationRetirement Income
Investment RiskEECompany
Administor
ActuatriesNO yes
PBGCNO Yes
FASBNO Yes
Monster Tax Deduction Possible?
Monster Tax Deduction Possible: HYPO: NO discrimination in
contribution or benefit for HCE. -DB plan **big issue for
AGE**Doctors AGE: W-2PensionAnnual ContributionD/CTrick (older and
owner of business Can set up the DB plan-D/B
55$500K$200K$200,00050,00055 Dr. 500k
25$500K$200K$20,00050,00025 Nurse50K
Contrib$220,000 DB plan to contribute100,000
*For each Doc have to have a pot of money of $2,500,000 to pay
for the annuity
When do you want it? Only when you want more than $52,000-the
solo defined benefit plan is the way to go.
Plan our own company retirement Plan: How much $ do you want?
SOLO (no ee's)1-50 EE'sMore than 50 EE's
Pail SEP (up to 25% of pay)SIMPLE (cheap 401K plan)3% of
payroll(2% of payroll-nonelective contribution401K Safe Harbor-less
admin costs (cant have IRA plans with more than 50EEs)
BucketSolo Safe Harbor 401K plan (25% of pay plus $12,000 401K
contribution)Safe Harbor 401K4% payroll *have to match*401K Safe
Harbor
BarrelSolo DB Plan (if over 50)Combo D/C & D/B (have 401K
and defined benefit plan)D/C & D/B Combo
Edward Jones #s Plans Set up each year: Solo CompaniesWith
EEs
300 Solo D/B15,000 SIMPLE
3,000-Solo 401K4,000 401(k)
20,000 SEP
SECTION 415: Limitations on Benefits and Contributions under
Qualified Plans401(a)(16): Trust is is not a qualified trust if the
plan provides for benefits or contribution that exceed the limits
of 415 Limits of Contributions D/B Max: Lesser of415(b)(1): maximum
benefit that can accrue under a defined benefit plan is, when the
benefit is converted to an annual life annuity, the lesser of:a.
Max Annual: $210,000 (2012 $200,000) ORb. 100% of the average three
years which the employee had the greatest aggregate compensation.
(415(b)(2)(3) states its not just preceding 3 yrs)a. 99, 100, 101-
average is 100 so thats most can put in. b. Exception: Does not
apply to collectively bargained for plans 415(b)(7)c. EXCEPTIONS
(limits-special but no one ever does these)a. 10,000 for anyone
ruleb. Early retirementc. Highly Comp Executives: Worked less than
10 years. i. Cant get 210 limit if less than 10 years. Shrink to
ratio to number of years actually worked at the company. 1. HYPO
Executive makes 10M. for 3 yearsa. 21, 21, 21 = 63K is this exc.
415 limit because less than 10 years workedd. Age Adjustments: a.
Benefits Begin Before 62415(b)(2)(C); Reg. 1.415(b)-1(d)(1): dollar
limit reduced to annual benefit that is the actuarial equivalent of
an annual benefit equal to the regular dollar limit beginning at
age 62. b. Benefits Begin After 65415(b)(2)(D); Reg.
1.415(b)-1(e)(1): the dollar limit is increased to an annual
benefit (beginning when benefit payments begin) that is the
actuarial equivalent to the regular dollar limit beginning at age
65.e. Plan Participation Adjustment415(b)(5): If ee has less than
10 yrs of participation dollar limit reduced by multiplying by (Yrs
of participation)/10. a. Reduction of 100% Compensation Limit: the
fraction by which the regular limit is multiplied is based upon the
employee's of years of service with the employer, rather than the
number of years that the employee has participated in the planD/C
Plans--415(c)(1) Generally, the maximum annual additions that can
be made to a participant's account under a defined contribution
plan cannot exceed the lesser of: $53,000; or 100% of EE
compensation Annual Addition--415(c)(2): Sum for that year of:
Employer Contributions Forfeitures Employee Contributions Self
Employed Individuals--???
404-Employer Tax Deductionsa. Max 25% Payroll (plus 401(K)) b.
4872: 10% penaltya. Solution Plan Document Correction
HYPO: 2012-when Max was $50,000 or 100% of pay. a. Rich Guy :
W2=$500,000b. Cratchit: W2= $50,000c. Rich Guy would pick 10%
contributions so that Cratchet would get $5,000 and Rich guy gets
$50,000 in the account.
401(a)(17): Annual CompSame HYPO as above: add Mid guy with
annual salary of $280,000. a. Because of this rule Rich guy also
looks like he only makes 280,000. b. Now Mid Guy and Rich Guy look
like they make the same amount of $. c. Now Crachet gets 10K and
Rich guy would get 50K and the company policy would be 20% limit.
**This is tension between ERISA and IRS is this trick.
404 EMPLOYER TAX DEDUCTIONS Generally limited to 25% of the
participants compensation Compensation in Excess of $265 not taken
into account. Not Include: Elective deferalls Employee
contributions ESOP of C Corp: 404(a)(9) Payments of Principal:
deductible to extent of 25% limit Payments of Interest: deductible
without regard to limit Dividends: Deductible if: Used to repay
loan, if distributed to plan participants; or Plan gives
participants opportunity to elect either to receive them or have
them reinvested in employer stock and are elected to be reinvested
by participants
Self Employed Earnings:IRS looks at Current wages plus Deferred
compensation: total *if you want to get full 25% of
compensation
404(a)(8)(d)Terms: not tested on.
SECTION 401(k): EE Contributions to Plansa. Max Mandatory EE
contributions: 10%b. 401(m)-as in Matching contributionsc. What is
a mandatory contribution? Section 411c2c amounts contributed to the
plan by the employee which are required1. As a condition of
employment 2. As a condition of participation in such plan or3. As
a condition of obtaining benefits under the plan attributable to
employer contributions.
Compensation and Contribution Limits (401K plans) salary
deferrals- $18,000 $6,000 if the employee is age 50 or older (IRC
Sections 402(g) and 414(v)) annual compensation- $265,000 in 2015
(IRC Section 401(a)(17)) total employee and employer
contributions(including forfeitures) - the lesser of 100% of an
employees compensation or $53,000 for 2015 (not including
"catch-up" elective deferrals of $5,500 in 2014 and $6,000 in 2015
for employees age 50 or older) (IRC section 415(c))Example:Mary,
age 49, whose annual compensation is $360,000 ($30,000 per month),
elects to defer $1,458 per calendar month, up to $17,500 for the
2014 year. Mary may contribute to the plan until she reaches her
annual deferral limit of $17,500 even though her compensation will
exceed the annual limit of $260,000 in September.Employer matching
contributionsIf your plan provides for matching contributions, you
must follow the plans match formula.Example:Your plan requires a
match of 50% on salary deferrals that do not exceed 5% of
compensation. Although Mary earned $360,000, your plan can only use
up to $260,000 of her compensation when applying the matching
formula for 2014. Marys matching contribution would be $6,500 (50%
x (5% x $260,000)). Although Mary makes salary deferrals of
$17,500, only $13,000 (5% of $260,000) will be matched. She must
receive a matching contribution of $6,500 (50% x $13,000) under the
terms of the plan
401(k) only get pre-tax benefit from income tax NOT the social
security amount and Medical
IRS put in incentives so that it is fair for all employees. What
is a 401K plan?a. 401K contributions are legally considered ER
contributions put in at the employees discretion. b. 404 applies to
401Ks because they are viewed as ER contributions. c. **Big
difference with IRA and 401K is the employer cant stop the EE from
taking money out of the plan**Ways to get $ out of 401K while still
working: a. Hardships1. 2 requirements to have a hardshipiii.
Immediate and heavy financial need: Safe Harbors:1. Illness of
self, dependent or spouse. 2. Destruction of property3. Avoiding
eviction 4. Tuition-post secondary education5. Purchase principle
residenceiv. You have no other resources to satisfy that need
(financial necessity) # No Other Sources1. Company office can rely
on the statements on the employee unless there are obvious showing
by the employee that they have other sources. v. Tax Trap: 1. Under
59.5 have a 10% penalty2. Exemptions from 10% penalty:a. Medicalb.
Higher education (IRA)c. 1st Home (IRA)d. **better off taking a
loan than taking a hardship unless meet the specific requreiemtns
because get taxed on the distribution**2. Details to think about
Hardshipsa. Once taken-must have NO contributions to 401(k) for one
year afterb. When resume contributions must be less than
contributions prior to taking the hardship. b. Loans
1. 401(k) Plans: profit share or stock bonus plan that contains
a qualified cash or deferred arrangement.a. Elective Deferral
Max402(g): $18K or, if less, the EEs compensation. i. Pre-Tax basis
ii. Qualified Roth Contribution Program: permits participant to
elect to have all/portion of EDs treated as designated roth
contributions. 1. Not excludable from participants gross income 2.
Dollar Limit: same as limit on EDs, reduced by actual EDs not
treated as designated Roth Contributions. 3. Treated the same for
all other purposes as EDs4. Qualified Distributions: a. Defined:
distrib mad after the end of a specified period (usually 5 yrs
after first designated roth contrib) that is i. Made on or after
the date on which the participant againt 59.5ii. Made to a
beneficiary (or estate of the P) on or after the death; iii.
Attributable to disability b. Tax Treatment: excluded from income,
even if including earnings not taxed.5. Roth Conversion: from
nonroth to Roth is okay, but some taxes when contributions were
pretax contributions. b. Catch-Up Contributions414(v): an employee
who will be 50 by end of yr make make an additional $6k. c.
Distributions: elective deferrals, attributable earnings cannot be
distrib b4 the earliest of: i. Severance from employment ii.
Deathiii. Disabilityiv. Attainment of age 59.5; or v. Termination
of plan d. Hardship Distributions: only elective deferrals, not
associated earnings can be distributed. e. Qualified Roth
Contribution Program: permits participant to elect to have f.
Automatic Enrollment: when EE becomes eligible, EDs are made at a
specified rate unless she elects out. i. Notice: ee must have
effective opportunity to elect to receive cash in lieu or have EDs
at different rate. ii. Opt Out Distribution: if elect out w/I 90
days of first contribution, there is no 10% penalty to have that
money given back to you. g. Special Nondiscrimination Test: the
actual deferral percentage test applies to elective deferrals under
a 401k plan. i. Design Based Safe Harbor: a 401k plan with certain
design features w/ respect to contribs (elective, matching, and
nonelective) and enrollment, satisfaction of the minimum coverage
requirement is a sufficient test of the amount of whether EDs and
matching contribs are nondiscrim. 1. 401(k)(12) Safe Harbor: plan
is good on the nondiscrim test if satisfies one of two contribution
requirements and a notice requirement. a. Contribution
Requirements: a plan generally satisfies the contribution
requirement under the safe harbor if the Er either: i. Satisfies a
matching contribution requirement; or ii. Makes a nonelective
contribution to a defined contribution plan of at least three
percent of an EEs compensation on behalf of each NCE who is
eligible to participate in the plan. 2. Page 38 of committee
report
ADP Test: actual deferral percentage testApplication of
participation and discrimination standardsExcess Deferral: a.
Applies to any employeeb. Max $18,000/per yearc. Applies tax payer
per tax payer-cant add together 3 jobs. Its an annual limit for an
individualExcess Contribution ADP TEST:a. Highly Comp Employee a.
Compensated more than $120,000 AND is top 20% of the payroll (all
EEs)b. OR 5% owner of the business own more than 5% so if exactly
5% then not 5% ownerb. Average Deferral of non-highly compensateda.
Limit the HCE on the amount can contribute b. See numbers in HOYTS
sample. How does the owner get employees to contribute more
?-Statute prohibits ER from asking EE to make arrangements. i.e. if
you want health insurance, then contribute 10% of the plan. -What
is excluded is the match option.
HYPO: Looking at the 20% for HCE: All companies will make the
election to add the 20% to classify as HCE. So in Dr. office below:
dr A$ COMPDEFERRAL PERCENTAGE
B320
C300
D280
E2808
F2809
E24010
StaffU602%
W503%
X40
Y30
Z30
HYPO Again: Who is a HCE? TomDianeHarry
Comp100k100k100k
% owner0.330.330.33
Who is HCEHCE b/c 5% HCEHCE
Safe Harbor 401K: Avoid ADP TEST: there will be no ADP testthe
price of the safe harbor may be the match. a. 401(k)(11): Simple
401Ka. Match up to 3% ORb. 2% to every EE (non-elective
contribution)b. 401(k)(12)(B)Match to Contributing Employeesa. Max
4% of payroll costsi. 100% to 3%ii. 50% to 5%iii. Max of 4% totalc.
401(k)(12)(C): a. 3% contribution to every EEi. nonelective
contributiond. 401(k)(13): Auto Enroll with Safe Harbor Match (only
about 6 years old 2008)a. Auto enroll: i. 100% match on first 1% of
EEs contributionii. 50% on the next 2%1. Total of EE contribution
3% and ER contribution of 2%iii. Each year EE contributions enroll
at another 1% up to 6%: yearEE %Match %
13%2%
24%2.50%
35%3.00%
46%3.50%
56%3.50%
66%3.50%
beyond
Total: 9.50%
Mandatory participation: Bottom of page 6: Non-discrimination
test for EE and matching contribution tests.
SIMPLE IRA COST SIMPLE 401(K)ADVANTAGESDISADVANTAGES
1.NO 55003% match exposure?
2.NO ADP TESTLower $ limit than 401(k)12,000 vs. 17,500
3.No Investment responsibility (IRA)No forfeiture
possibility
NO D.O.L Reports on Investment
NO Top Heavy Rates
Automatic Enrollment
Shift Gears: Taking Money out of the AccountsA. Distributions:
Why? To Provide retirement Income. B. Congress Restricted Access to
the $$ b/c want it saved for retirement: a. LAWS: a. Laws that
prevent early distributionsb. Force distributions in Retirementc.
COMPANY POLICIES IN ADDITION TO THE LAWS:C. Prevent Early
distributionsa. 401k no distribution untili. Separation of
serviceii. Dieiii. 59.5iv. Hardshipb. Profit sharing plans:i. Fixed
number of yearsc. Defined benefit plansi. Before the normal
retirement aged. IRAs: NO RESTRICTIONSi. Can take out at any age:
Code 408!ii. What would stop you from taking $ out of your IRA? D.
There is a 10% penalty if you take the $ out before 59.5. 72 (f or
t)? E. Force Distributions: a. Kicks in at age 70.5 or after
deathb. 401(a)(9) Plansc. IRAs 408(a)(6)d. 50% penalty-not taking
the required distribution!i. LOOK for this with widows dont know
when to take it out and get hit with a 50% penalty for not taking
the funds out when the administrator fails.
HYPO: Quit your job at age 30. What is your legal right to take
your money not the permission to take the funds? drafted in 1974
looking at defined benefit plans: 401A14a. It states that the
employer does not have to write a check until you are 65 years old.
b. Company policy will usually make it available to you. c. Can you
make the company keep the money for you. (hold remaining funds in
past ER account)a. Here this a lot in law firms: why?-law firm pays
the admin fees. b. Involuntary cash out: If you account balance is
$5,000 or less.
Lifetime Distributions after age 70.5. a. Exception is if you
marry someone that is more than 10 years younger than you. Hugh
Hefner example. Marry 26 year old, can look at the chart for your
spouse too not your own amount.
On the death of someone and the beneficiary: What happens
HYPO: 80 year old Aunty Em: 5.35%a. Leaves IRA to Neice age 33:
b. Tax law will take IRA- and add 2 words to add to IRA: a. Annty
Em IRA beneficiary Niece. c. Why? Tells the world that we are now
liquidating the IRA. The niece can take out over her life
expectancy. d. Objective is tax deferral: so look at a. Power of a
STRETCH IRA-IRA paid out over the life expectancy of the
beneficiary. All we know is that the IRA will be liquidated over
the life expectancy. b. Niece is paid out at 2% payout. 1/50 = 2%e.
What happens name son who is 51 years old: life expectancy 33 years
1/33 = 3% pay out. f. Power of IRA: Tax code only requires 2-3% g.
When you pick the beneficiary of the IRA-it is better because of
tax deferral. h. If you want to give to kid name a trust account:i.
If you do the STRETCH IRA wrong you have to liquidate in 5 years.j.
If you do it correct, you can go forward for 50 years.
3 definitions need to know: a. RBD: Required Beginning Date: a.
IRA: i. Congress gives you a 3 month grace period: April 1st of the
year you turned 70.5. ii. April 1 following the calendar year the
IRA account owner attains age 70.5. b. Qualified Retirement Plan
(403b)i. Later of: 1. April 1st following the calendar year that
the account owner attains age 70.5 OR2. April 1 following the
calendar year that the employee separates from service (ex. Someone
who works past age 71) Individuals who own 5% or more of a business
are not eligible for this later RBD: their RBD is April 1 following
the calendar year that they attain age 70.5. c. Technical tax
terms: i. Beneficiaries: a. Non-Human beneficiaries cannot do a
stretch IRAb. Designated Beneficiary (DB): Fancy tax term for human
being. Determination Date: How do you get rid of problem
beneficiary a. Disclaimer: someone says they dont want the
inheritance b. Cash out a beneficiary pay out the charityc.
Separate account for different beneficiaries: a. Divide into 3
different accounts for the beneficiaries.
Problem with STRETCH IRA: a. Death: Before or After RBD-required
beginning date: b. PAGE 10 of handout: Chartc. **Worst
beneficiary-your estate!**
HYPO: Child with an IRA from dead father: Cant roll over into
the sons IRA. Instead: can only do an Alex beneficiary Charles IRA.
Instead: Widow: Rollover option is available from dead spouse to
widow to roll over surviving spouse.
Mutiple DBs: Must use the Oldest DB payout:
What if the IRA is payable to a trust? Then the trust 1/3 to
each family member. **This is a big issue because you cant have 3
different trusts**
What you want to do is a STRETCH IRA. Slow you down are multiple
beneficiaries or non-human beneficiaries.
Surviving spouse Dont want a roll over for a young widow: under
age 59.5 Why b/c there is a 10% penalty. She can roll over what she
wants into her own account 700,000 then leave 300K in husbands
IRA.
Conduit Trust: Just a sign over to the beneficiary. Nothing ever
accumulates. Accumulation Trust:
TAXED: a. GR: Ordinary Income (taxed like annuity)b. EXCEPTIONS:
a. Tax-Free Return of Capitalb. NUA. Employer Approved Stocki.
LTCGc. TAX-Free Roll Overd. Born before 1936): Lump Sum
Distributionc. 20% Withholding: anything eligible for rolloverd.
Penaltiesa. 10% penalty before 59.5b. 50% penalty- 401a9. If you
dont take the minimum distribution e. Estate Tax:
**NO CONSTRUCTIVE RECEIPT ONLY ACTUAL DISTRIBUTIONS**402:
Taxability of beneficiary of employees trust:
Annuity: Paid $30K55-Life Expectancy 30 yearsAnnuity
$4,000/yeara. $1000 Exclusionb. $3000 Annuity c. $invested/expected
= $30K/30 years
Simplified Method (page 3 handout): Special rules for Qualified
employer retirement plans:
IRS Form: 8606-Non-Deductable IRANonDeductable IRA: 2000
Contribution10000 balance8000 growth.
Lumps all IRAs together-treats them all lumped together. **Stay
away from non-deductible IRAs***Real danger-you have to track and
attach the form for the rest of your life. Really shrinks
non-deductable IRA??
60 Day Roll Over: a. $ payable to employee. Really doing trustee
to trustree transfers. b. Be careful about co-mingiling the funds
in your own account. c. **dont like the 60 day roll over you prefer
the trustee to trustee transfer**
Law of a RollOver: Rules applicable to rollovers from exempt
trusts: page 3 of handout: a. Exclusions from Income: b. Hardship
waivers: a. May waive 60 day requirement: i. What wont work:
ignorance of the law-no excuse. ii. Only a mess up by the bank or a
natural disaster will stop from being taxable. What is hit with the
20% withholding tax-c. Penalties: a. 2 ways to draft a statute: b.
French: anything is permitted c. German: Penalize everything unless
you find an exception.
ONLY exception is a medical exemption. All other hardships are
hit with a 10% penalty.
How to set up a qualified plan?401a. Must notify EEs:a.
SPD-Summary Plan Descriptionb. Receive within 90 days of 1st day of
employment: DOL ruleb. Notify the DOL:c. Notify the IRS? NO legal
requirement to notify the IRSa. Worry about an IRS audit which says
that your plan does not qualify under the IRS Codeb. 5300 Formc.
5302 Form: EE Censusi. Pay the IRS a couple thousand $$ for
reviewing your planii. Determination Letter:1. Only issued for
qualified plans 401a or 501(c) (3)
Regulation 1.401-1 Defined Benefit Defined Contributiona.
Document must be in WRITINGb. Communicated to Employees (through
determination letter from the IRS-or competent retirement lawyer)c.
Established by Employera. Union Plans: Multi Employer Plansd.
Exclusive Benefit of the Employeesa. IRS gets suspicious if ER
wants to co-mingle the ER funds. e. Permanancea. 10 years (at least
3 years)-If you terminate in 1 year IRS says you didnt have a
permanent plan f. Plan: Like a business plan. It is like the idea
lists who puts in money, explains all the rules.g. Trust: Holds the
money and cuts the checks for the employees based on the rules in
the plan. a. Is Tax exempt.
401 Qualifed Pension, Profit-Sharing & Stock Bonus Plans: a.
Trust: U.S. Based ONLYa. Custodial Accounti. Annuity Plan b. Can $
ever revert to the employer?a. Mistake-Yes can b. Defined
Contribution Plan: Profit sharing, 401K, Stock option/ESOPi. $
NEVER can go back to the Employerc. Defined Benefit Plan: i.
Possible for the $ to go back to the employer. HYPO EXAMPLE: D/B
Plan Termination1/1/2013 Assets: $1,000,000Liabilities
($1,100,000)30% MarketAssets $1,300,000 assets exceed the
liabilities above. $200,000
Congress stopped this: a. Taxable Income b. 50% penalty- when $
ever reverted to Employer. a. Could lower penalty down to 20% if
started a new plan. Company Perspective:
Termination vs. a Freeze (Boing 68,000 ees frozen). HYPO
Example: Formula: 2%x #years x Average Compensation 2% x 30 years x
60k= $36,000EE35$30,00055$50,000Freezing here65$60,000New formula
like Sprint/Bowing: 2% x 20 (years in the plan not years of
service) x $50,000 = $20,000*FREEZE is stopping all future credits
funds stay in the account**TERMINATION all money leaves the plan
*
HCE: a. 5% ownerb. $115,000 + Top 20%
New Comparability formula: use allocation formulas which target
particular groups of employees for benefits, referred to as
cross-testing plans. 3.11 Allocation to participants
accounts-Cross-testing or new Comparability.
401(a)(5): Exceptions to legally discriminate (B) Contributions
and benefits bear uniform relationship to compensation. Meaning
that you can put in different $ amounts as long as the percentage
of the $ is the same. (C) Certain disparity permitted. HYPO:
EXAMPLE: First $117,000a. 6.2 % OASDI (old age survivor disability
insurance) b. 1.45% HI-health insurance medicare/Medicaidc. 7.65%
(Total EE Contributions)d. 7.65%(Total ER Contributions-matches the
EE portion)e. 15.3% goes to $0 to $117,000$117,000 +$260,000
401(a)17 ERISA 400,000
A. $50,0005%0
B. $117,0005%10%10%
C. $200,0005%10%10%
D. $400,0005%10%10%0%
401(L)(2) Defined Contribution PlanBase amount (5.7 threshold)
Excess 48%510%611.7%712.7%813.7%
HR 10 KEOGH Rules: A. Owner-EE 1. self employed2. partnership3.
P.C. (doctors and lawyers to incorporating under) 356. More
generous pension rules and out of the Keogh.
1982: TOP HEAVY RULES: a. were most of the account balance for
the owners? 401(a)(10)(B) Top Heavy Plan:
D/B Annuity:a. Married Employees 417a. Issuing QJSA-Qualifed
Joint Survivor Annuitiesi. Must issue unless there is a waiver by
the spouse. 1. Waiver Must be: a. Witnessed ORb. Notarized b.
QPSA-Qualified Payout(?) Survivor Annuity i. 50% DropP/S? 401k?NO
Annuitites.Married? -Death 100% surviving spouse (ERISA)
Death of Male:QRP (401)IRA's (408)
Beneficiary: Kids from 1st marriedBy law-$ goes to 2nd WifeGoes
to Kids
Pre-Nupp-give to each other says each retirement account goes
kids from first marriage 2nd wife (federal law)Goes to Kids
*legal argument is signed before they were married. Kids can sue
for breach of contract of the pre-nupp
Post-Nupp sign after the marriage to make the pre-nupp agreement
valid Kids of Kids
Life Insurance Will401KIRA
Beneficary Named2nd Wife2nd Wife2nd Wife
Divorce 2012State Law-goes to kids (not ex spouse by
default)
2013 DeathKidsFederal Law: 2nd Wife?? Unknown
401A (11)D/B: Corp 2% x # of years x Comp2% x 20 Years x $10K =
$40K
New: 1% x # of years x comp= $20K *new company cant take away
old benefit. 401A(12) Any merger or consolidation with or transfer
of assets or liabilities to any other plan.would receive a benefit
immediately after the merger, consolidation, or transfer which is
equal to or greater than the benefit he would have been entitled to
receive immediately before the merger, consolidation, or
transfer.
401(A)(13): Assignment and Alienation: CREDITOR PROTECTION WITH
ERISA. a. Assignment: Where you say to someone I will transfer my
account to you. b. Alienation: (ira part of bankruptcy estate)c.
Retirement account is completely protected from creditors. d. 5
exceptions of where people can get to your retirement account: a.
Administration fees up to 10%b. Loans-borrow from your plan (401a
plans) a. 4 issues: i. Sec 401a 13ii. 4975 Prohibited
Transactionsiii. 72 (q) Loan presumed to be a distributioniv. Does
plan offer loans? you dont have to offer loans (it is permissible
but not required)1. (IRA-LOANS ARE PROHIBITED!! 408 IF YOU BORROW
IT DISQUALIFIES THE PLAN THAT DAY!! )c. QDRO (qualified domestic
relations order)-if you get a divorce and making a paymentd. IRS
Levy: Seize account if behind on taxese. Embezzle (Guidry-supreme
court case)
ERISA Rules: 4975 Prohibited Transactions: Ellis Case. Applies
to QRPs, IRA, health savings account, medical savings a. There is
hereby imposed a tax on each prohibited transaction. b. 15% of the
amount involved with respect to the prohibited transaction for each
year. c. The tax imposed by this subsection shall be paid by any
disqualified person who participates in the prohibited transaction.
What are the PROHIBITED TRANSACTIONS? a. Sale or exchange or
leasing, of any property between a plan and a disqualified person.
b. Lending of money or other extension of credit between a plan and
a disqualified person. c. Furnishing of goods, services, or
facilities between a plan and a disqualified person; d. Transfer to
or use by a for the benefits of a disqualified person of the income
or assets of a plan. Who is a DQd Person? Fiduciary Person
providing services to the plan An employer any of whose emplyees
are covered by the plan An employee organization any of whose
members are covered by the plan An owner, direct or indirect, of 50
percent or more of And so onSpecific Exemption: UMB says to
Department of labor: we want to use some mortgage funds as a
qualification of an exemptionthey are a great product, will you
approve of this transaction? They will then publish the results in
the federal register, you search the federal register and will see
it there! Special Exemptions: a. You supply the DOL a waiver and
the DOL approves-if DOL says the employees are protected then the
IRS wont subject the employees to the penalty. b. Waivers are
published with the federal register. c. Most common: People just
dont realize this is a prohibited transaction. a. Then it is caught
on the IRS audit. IRS doesnt care if you find that if they would
have applied for the waiver and the DOL would have granted the
waiver. b. IRS doesnt care-they just impose the 15% penalties.
Special rules for Prohibited Transactions INDIVIDUAL RETIREMENT
ACCOUNTS IRA: Stops being an IRA on the date of the prohibited
transactionsso just borrowing money from the IRA will destroy.
Rental Property: Common transaction-Unspecified:
ELLIS CASE: 401K = $250,000a. Wants to convert to IRA=
$250,000b. Creates LLC CST used cars 98% is owned by the IRA and
Ellis owning 2% c. Check the box and have it taxed as a
corporationd. Ellis: President- paid salary of $10,000e. IRS says
this is a prohibited transaction and that he received $250K when
the IRA was disqualified. f. Shows how harsh the prohibited
transactions rules are by the IRS.
General Rules: A corp w/o shares or shareholders does not fit
w/I the def of a DQ person under 4975(e)(2)(G). The corp becomes a
DQ person only after the corp issues its stock to the IRA. The TP
becomes a DQ p as president and director of the corp that isues the
stock to the IRA only after the stock was issued.
General Exemption: 4975 D1: Its ok to have a loan, President can
borrow from their individual retirement account as long as it is
available from all qualified participants.
Section 72(p): GR: Not a taxable distribution if the following
requirements are met: a. Max amount able to borrow is the lesser
of: a. $50K or of your retirement account ie. BALANCEi. Ie. Balance
$40K you can borrow $20K: ii. $90K/ Borrow $45K (50%) ; 120/only
$50K allowed to borrow. b. Term of the Loan has to be 5 years or
less and no balloon payment amounts. a. Exception is if for home
loan- 15 years b. Cant deduct the interest to buy the home. (better
to have the mortgage where you can deduct your interest)c. Level
amortization: d. 2 things a plan administrator does: a. Payroll
deductions to pay the loan back. b. Terms the of the loans become
due the day your quit your job.
Qualified domestic relations order defined: 401 a 13 P A
qualified domestic relations order: basically a divorce decree. a.
Can use this to collect child support. Normally just splitting the
account, but here you can use this to get to the retirement account
in the future. b. If given wife the QDRO then any distributions
will be taxed to the wife.c. If the distribution is given to
support a child in college-then the amount would be taxed to the
dad.
What does it take to be a qualified Domestic Relations Order? a.
which creates or recognizes the existence of an alternate payees
right o , or assigns to an alternate payee the right t, receive..
b. Must have: a. Paragraph 3 stays it CANNOT contain: does not
require a plan to provide any type or form of benefit or any
option, not otherwise provided under the plan HYPO: says pay wife x
amount for the rest of her lifeplan administrator refuses to offer
this this is an annuity. Similarly defined benefit plan: Go to the
plan administrator and see if it will work prior to getting the
judge to sign off on the plan. To get the QDRO to work. Never
surprise the plan administrator may not be able to do it under the
plan.
401(a)(16)401(a)(17): Compensation Limit: a. $150Kb. $265K
(current limit)(indexed for inflation)i. For purposes of ERISA:
only look at income up to $250K (or 260) of their W2 earnings.
401(a)(19): a. Vesting on Match (once you are 50% vested in
employer contributions- then you are 100% vested in matching
contributions to matching contributions from employer).
Defined Benefit plans (opinion of speaker): best plan-bedrock of
the plan.
Participation/Vesting Plans: 410(a)Participation: Employee by
employee a. AGE-exclude anyone under age 21 (NO MAX age) (if
education institution can be 26) AND b. SERVICE-less than 1 year
can exclude (more than 1,000 hours- time) (401K always)-When reach
1 year at the beginning of the next plan year OR within 6 months of
obtaining the right. -Could have a bi-annual entry date (July and
January)-Minimum requiredc. EXCEPTION: 2 years of service if
(b)Coverage: Workforce 70% of all employees participation a. Test:
1.70% at least of the Non-HCE participation-kind of ridiculous test
when 100% participation-so the real test is #22. Percent of Non-HCE
at least 70% of the %HCE (more than 115K or 5% owners)3. Fair Cross
Section: For companies that have various divisions (like separate
businesses within oneGE/Omaha steak) Reasonable classifications for
multiples cross section. Can have different types of plans for
different cross sections.
VESTING Schedule: 411: EMPLOYER CONTRIBUTIONSVesting Schedules:
ERISA Minimums: (see chart below) Only comes into play for a profit
sharing plan: a. Cliff Vestingb. Graded VestingOther Vesting:
Special (all from different statutes) a. EE Contributionsa. Always
100% Vested Non-deductible contributionsb. 401(K)a. ER
contributions at the election of the employee (not called employee
contributions)b. 100% vested for the EE c. Matchinga. 401(a)(19)
more than 50% vested in regular vesting, the match must be 100%
vested. CliffGraded (6 year)More generousMatching 401(a)(19)Bad Boy
Clause
00000Revert to ERISA min
100200If Breach contract
20204020
3100406040
41006080100
510080100100
6100100100100
7100100100100
HYPO: VERY common question. Employee who quits their job then
returns to the same employer. a. $10K balance. 3 years working.
Quit in 2000a. Check $4,000 forfeit $6,000b. 3 more years: $10K
again: -does the EE have the right to get the $6,000 back. -is the
employee 40% vested or 100%-$6,000 is gone forever-forfeited
forever-BREAK in SERVICE: work less than 500 hours in the year.
-TEST is 5 years break in service. Then EE gets no credit for the
$10k. -BUT if quit in 2007: if less than 5 years they get credit
for the years of service.
1962: Keogh self employed-partnership-owner ees-Harsh-Faster
vesting had strict rules in regards to vesting and discrimination
Missouri Statutes: General: Ch 351 P.C.: Ch 356 Issues was that
people were upset that w/ Corp articles you could put $45k in the
pension plans but only $7,500 in a partnership.
Definition of Top Heavy Plans 416 (ABA says we should repeal
416)1982: Tefra after the control of the control of few owners. a.
Took the Keogh rules and applied them to Top Heavy Plan-more than
60% of the account balance goes to key employees - *every year the
top heavy rules become less and less important. -*ABA has
recommended that the congress repeal the Top Heavy. b. What happens
if a plan becomes Top Heavy? -used to be faster vesting-but this in
no longer effective-Minimum Benefits (DB plans) and Minimum
Contributions (D/C plans). -NO exception that you are integrated
for social security-Most top heavy you will have to pay is 20%
FiduciaryDisqualified person: Party in Interest
Affirmative Obligationsa. Proper investment: proper investorb.
Diversify exempt from a duty to diversify ESOPc. Sufficient cash on
hand (duty) a. Laddered securities. Bonds that d. Reasonable rate
of return rather than look investment by investment-just look at
overall portfolio. e. Duty to Comply with the plan documentsa. Ie.
If someone is vested or if someone has the right to a loanf.
Exclusive benefit of employeesa. Simply resigning-does not relieve
you from this duty-must pursue correction to resign safely. Handles
Money:g. Plan can insure itselfh. Fiduciary must be bondeda. Banks
and Inurance does not have to do thati. Fiduciary personally liable
for mistakesa. Compare to exculpatory clausesb. Plan cannot buy
insurance for the fiduciary i. Cant do like you would corporate
law-no legal defense clause.ii. NORMALLY: Corporation buys the
insurance-but plan cant buy itj. Entire Board of Directors are
Fiduciary to the company.
HYPO: go to company and worry about something. Even if you
resign, does not protect you from liability: a. How to get out of
this realm: LABOR 404(c): if you let the employee invest their own
account, you wont be liable if they make bad investments. b. DOL
came out with regulations that were more restrictive:
Ways around prohibited transactions: 4975 Classic prohibited
transaction is between the fiduciary and the plan: a. DOL looks at
the standards. a. They say yes or nob. Blanket exemptions-loansDOL
wants damages from Fiduciary if there is a prohibited transaction.
IRS: 15% penalty. 100% penalty if you dont correct within a year
(if the plan loses money)15% penalty is on the amount involved:
Amount involved: a. Greater of: a. Amount paid ORb. FMV of
propertyb. HYPO: Example: a. Corporationi. Owner gives building
valued at 1.5M 2.0 Mb. Plan : gives $1M to corporationc. Is this
prohibited transaction? Yes 15% penalty unless undo the deal within
1 year then 100% penalty. d. Fix: put the plan in the same position
would have been before this transaction. e. $2M plus interest f. If
the plan gave 4M instead of 1, the amount on the penalty would be
on the 4M not the 1M because a greater amount. Disqualified Person:
a. A fiduciaryb. A person providing services to the plan a. This
could be a law firm giving legal fees for advice on the planc. An
employer any of whose employees are covered by the plan the company
would be prohibitedd. An employee organization
ERISA Litigation: 2 types of claimsa. Someone that filed for
benefit and didnt get it 95% b. 5% fiduciary litigationERISA covers
2 types of plans: a. Retirement accountsb. Welfare benefit plansa.
See ALL company policies-vacation, company xmas turkey etc. Benefit
to plaintiffs attorneys: a. What makes it qualified as ERISA?a.
Written Plansb. Notify Employees (SPD)-vacation policy, benefits
etc. c. Appeals process within the company before denied the
claims. Generally with ERISA litigation it helps the DEFENSE in 2
ways: a. Procedural hurdle: a. You cant sue me in court b/c the
court will want you to go through the appeals process. b. EE would
have to appeal the Christmas turkey with the company. i. Plaintiffs
hate this b/c it delays the process. ii. Sometimes will say dont
have to appeal because it will be FUTILE (ceo took home all the
turkeys for himself). c. Remove the case to Federal Court: b/c
ERISA is a federal lawi. Often what happens is there is a grievance
from employees. Normal contract claimii. Plaintiffs dont like this
because it is more formalb. Remedies Hurdle: a. ERISA in federal
court: can only get $ you claimed and attorney fees. b. NO punitive
NO Pain and suffering (none of the state court remedies). c.
***Most powerful preemption law: conflict between state and federal
law federal trumps state law***i. ERISA is the most powerful
preemption law. ii. MO Law: any state statute that relates to ERISA
is just null and voidperiod. 1. Why? Uniform administration.
Companys nationwide-want one law in all 50 states. What they pushed
for in 1974 of preemption of 50 states laws. 2. One exception is
Insurance: states can regulate health insurance.
Egelhoff v. Egelhoff: 2nd marriages caseFacts: Dad designated
2nd wife as beneficiary of his pension. They divorced and he died
intestate. Children from 1st marriage sued 2nd wife for the $$ b/c
the State statute revokes beneficiaries upon divorce. Wife argues
ERISA preempted the state statute. Issue: does Erisa preempt?
Holding: YES. Erisas Preemption Section: 29 usc 1144(a): ERISA
shall supersede any and all State laws insofar as they may now or
hereafter relate to any employee benfit plan covered by ERISA. A
state law relates to an ERISA plan if it has a connection with or
reference to such a plan. B/c ERISA requires plan documents to
specify the basis on which payments are made to and from the plan,
the State statute implicates a core ERISA concern. State statute
has prohibited connection w/ ERISA b/c it interferes w/ national
uniformity of plan admin
ERISA will also preempt state slayer statutes D.N. v. US Facts:
Child was paid his fathers 401(k) after his wife killed him and
became ineligible to receive it. Child argues he is not subject to
income tax because he was not the distributee, his mother, as the
primary beneficiary, was the distributee. Issue: who is the
distributee subject to income recognition when 401(k) funds
transfer to the participants lineal descendants instead of the
listed beneficiary as a result of a State Slayer statute? Holding:
Child is distributee because the mother never received it and
because she was no longer entitled to it when the plan refused to
distribute upon notice of the murder investigation.
ERISA & Divorce Decrees: Kennedy v. Plan Admin Dupont:
Facts: Decedent had a Saving and Investment Plan (SIP) with the
power to name a beneficiary and revoke that designation as
prescribed by the plan administrator. He named his wife with no
secondary beneficiary. Upon their divorce, wife was divested from
her interest by the decree but decedent did not execute a document
removing her. Issue: Must a plan administrator follow a divorce
decree that is not a QDRO that redirects beneficiaries without
modifying the documents? Holding: No. There is no exception to the
plan administrators duty to act in accordance with plan documents.
Solution: Company could insert in plan document that after a
divorce, if former spouse is still named as beneficiary, the form
spouse shall not be entitles to benefits. No violation of ERISA OK
to follow plan document
ERISA preemption of State Common Law Actions for Wrongful
Discharge in Avoiding Pension Contributions Ingersoll-Rand v.
McClendon Facts: filed wrongful discharge action under state tort
and K theory alleging principal reason for termination was desire
to avoid contributing to s pension fund. Issue: Does an action for
recovery of future wages, mental anguish and punitive damages,
rather than lost pension benefits relate to any covered employee
benefit plan? Holding: yes 514 of ERISA broadly supercedes state
law and decisions having the effect of law. relates to the plan b/c
the Tx Supreme Courts remand requires a finding of an ERISA plan in
existence in for liability, this sufficiently relates. ERISA Cause
of Action: for terminations interfering w/ rights guaranteed by
ERISA provides the exclusive remedy for those rightsthe right to
not be terminated for pension contributions
ERISA Preemption of State Statute Prohibiting Subrogation FMC v.
Holliday: FACTS: s self-funded health care plan paid a portion of
medical bills from accident that was involved in a personal injury
case. The sponsoring company notified they will seek reimbursement
under the Plans subrogation provision from any recovery. sought
declatory judgment that Penn. Statute precluding reimbursement from
a claimants tort recovery prohibited subrogation rights under the
plan. Issue: Is ERISA preempted by state statute for subrogation
rights/ Holding: No. ERISA preempts the application of the state
statute because ERISAs deemer clause states that a plan shal not be
deemed to be an insurance company or in the business of insurance.
The Subrogation statute applies to insurance companies.
Appeals court: want to give-only reverse of egregious look to
trial court as fact finder. De Novo: brand new, will just take
note, but no obligation of what the trial court did. arbitrary
& capricious-shock the human caution. no longer Firestore case:
now look at De Novo:Loop hole: under state law, when you have a
trust, decision of the trustee is final is not subject to review.
Retirement plans and these types of plans are basically trusts.
(Firestone case). Termination of Plans: Formal termination: Board
of Directorsa. Meet and put on the agenda and vote to terminate the
plan. b. IRS: 5310 Form to terminate a plan(give comfort for
termination of plan)i.Qualified on Paper-did the plan document meet
everything for ERISAii. Qualified in Operation: -What find: Bad ADP
plan for 401aTop Heavy Plan 3% What cures: take money from the
owners account. c. Permanent-Regs say you can terminate in 10
years.-Safe with 3 years. Practitioners say. -laws change,
employees dont like it, D/B Plan: Termination: actually pay out all
of the $$Freeze: dont pay out the $$ just dont add new participants
and not going to give any credit for future service. No going to
liquidate the assets.
What happens when a plan is terminated? If there is a plan
termination the EE is 100% vested. MC question for EXAM. So if 20%
vested with 10K balancethe employee gets full 10K not 2K of what
was vested. Therefore can cost the company more money.
Partial Termination: HYPO: Tyson plants in multiple states: AR
33%Mo 33%OK 33%-decide to shut down and no longer have any
employees here. Does the employee get a check for 2k or 10K because
the company is still in existence? A: If less that 20% of the
workforce loses job then not a termination. If more than 33% then
yes a termination plan and YES the employee substantial reduction
in the workforce is fully vested in the benefits.
ESSAY Questions Back Page: Style: a. State what the law is:
General Rule is and the exceptions. b. Apply the facts: Do these
facts fit the general rule or fit the exceptions.c. Reach
Conclusion: d. What does the client need to know about?
$500,000GR: Taxed as ordinary income. Exceptions: Dont really
apply to this situation (but can get an extra point or two for
mentioning)LSD bornd 1935Conclude: Taxed as Ordinary Income. *Talk
about 10% penalty before 59.5-GR all penalty is taxed -Ex:
Termination employees greater than 55 Can take an exemption from
company plan. -Facts are he is 53-Conclude that there is a $50,000
penalty tax. What can you do to avoid this? Advise: 60 day roll
over-you wont have to pay tax on distribution-avoid ordinary income
and the 10% penalty. Facts: April 1st may 1stYes he can still do
this roll over
$300,000 Profit Sharing Plan: -Never a distribution-want to go
to 2 kids. 2 legal issues? -Never distribution: -401(a)(a) 70.5
must take the distributions-50% penalty Conclusion: you are wrong
you always have to take distributions from the plan.
Kids/2nd wife: 401(a)(11)-surviving spouse gets 100% 401
(ERISA)-Doesnt matter that you named the 2 kidsby law the wife gets
the funds. Mention the Kenndy case. Advise: IRA-408-issue is you
have to get the spouses