Destel Bergen Corporation
Types of Plans
401(k)
Age-Weighted
Money Purchase
Multiple Employer
New Comparability
Profit Sharing
Roth 401(k)
Safe Harbor 401(k)
Solo 401(k)
Plans
What is a 401(k) Plan?
How much can an employee contribute?
Can the employer require an employee to make contributions?
Must a 401(k) plan meet certain tests?
Which employees are considered highly compensated?
Can the employer make additional contributions?
What are matching contributions?
Are there situations where the employer has to make contributions?
How about distributions?
What are hardship withdrawals?
What is the advantage of a 401(k) plan over other qualified plans?
How does a 401(k) plan compare to an IRA?
Are there drawbacks to a 401(k) Plan?
Any suggestions on investments?

What is a 401(k) Plan?

A 401(k) plan is an arrangement whereby the employer offers employees the opportunity to have part of their salary deposited into a tax exempt plan, rather than paid as income. The contributions made by the employee are not considered compensation for income tax purposes. However, they are still considered income for purposes of Social Security and unemployment benefit taxes.

Employee contributions, called "Elective Deferrals," are deposited into a trust fund where they grow tax-free until distributed. Because these funds are derived from employee contributions, employees are always 100% vested in their account balances.

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How much can an employee contribute?

For 2014 the maximum amount an employee can contribute is $17,500. This amount is known as the 402(g) dollar limit and is periodically adjusted from year to year for increases in the cost of living. This cap applies to the total of all amounts the employee contributes in the plans in which the employee is a participant; (i.e., other 401(k) plans, SARSEPs, 403(b) annuity contracts, etc.). Excess contributions with earnings must be refunded to the participant no later than April 15 of the following calendar year.

There is one exception to this limit. Employees who attain age 50 before the end of the plan year can exceed the $17,500 limit by making an additional catch-up contribution. For the year 2014 the catch-up contribution limit is $5,500. This limit is also periodically adjusted for increases in the cost of living.

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Can the employer require an employee to make contributions?

No, participation by an employee in a 401(k) Plan must be voluntary.

Must a 401(k) plan meet certain tests?

The 401(k) plan must meet a mathematical test (called ADP test) to ensure that there is not too great a difference between the contributions of highly and non-highly compensated employees. This test is designed to ensure that the plan is not merely a tax-shelter that only benefits the highly paid.

If the test fails, the employer can either make additional contributions on behalf of the non-highly compensated employees or refund excess contributions made by highly compensated employees. If the excess is not distributed within 2½ months following the end of the plan year, the employer must pay 10% penalty tax on the excess.

NOTE: 401(k) plans that satisfy certain requirements are safe harbor 401(k) plans, and deemed to satisfy the ADP test. This means that no testing would be required and all highly compensated employees could defer up to the 402(g) dollar limit plus catch-up contributions, regardless of what non-highly compensated employees defer.

For a detailed description of safe harbor 401(k) plans click here.

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Which employees are considered highly compensated?

If a top paid group election is not made, highly compensated employees are employees who are more than the five percent (5%) owners in the prior or current year and/or employees whose annual earnings exceed $115,000 in the prior year. (Note: The $115,000 threshold is the amount used for lookback years beginning in 2014).

A top paid group election is when an employee will only satisfy the compensation test if the employee's compensation was in excess of the applicable dollar amount for the lookback year and the employee was also in the top 20% of employees, ranked by compensation, for the lookback year.

Can the employer make additional contributions?

The employer can make matching contributions, which are usually some percentage of the contributions made by the participant. The employer can also make regular profit sharing plan contribution. Thus, a 401(k) provides the employer considerable flexibility. Employee account balances resulting from employer contributions can be made subject to a vesting schedule.

In any event, contributions made by the employee together with any employer contributions may not exceed 100% of the employee's compensation.

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What are matching contributions?

Matching contributions are additional contributions made by the employer. The participants will receive matching contributions only if they make participant contributions.

The matching contributions formula can be defined in the plan and be the same year after year. Alternatively, the formula can be spelled out at the end of each plan year by the employer. A set formula gives the employees more certainty and may result in higher employee participation. On the other hand, the employer will have more flexibility if there is no set formula.

Most often, the formula expresses matching contributions as a percentage of the participants' contributions with a maximum expressed in terms of a percentage of the deferral as a percentage of the participant's compensation, for instance: "The employer matching contribution shall be equal to 30% of participant's deferrals, not exceeding deferrals above 3% of such participant's compensation."

Matching contributions are also subject to mathematical tests. The tests are similar to those for participant contributions.

In addition, total contributions (i.e., participant deferrals and employer matching) are subject to an aggregate limit.

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Are there situations where the employer has to make contributions?

An employer may have to make contributions if the plan is top-heavy. A plan is top-heavy if 60% or more of the assets in the trust, together with any other plans the employer sponsors or sponsored, belong to key-employees.

Key-employees are commonly the owners. If the plan is top-heavy, and any key-employee makes and/or receives a total contribution of 3% or more of his or her earnings (whether paid by the key-employee or the employer or both), then the employer must give each eligible non-key employee a contribution of not less than 3% of the employee's pay.

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How about distributions?

Normally, funds in qualified plans are available upon the participant's death, disability, retirement or his or her separation from service. 401(k) plans can also make distributions of elective deferral accounts:

• When the participant attains age 59½

• In the event of certain hardships where the participant has no other resources.

• Upon plan termination.

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What are hardship withdrawals?

Hardship occurs when the participant has an immediate financial need and no other resources. The money must be used to:

• Pay deductible medical expenses.

• Prevent eviction or foreclosure on a principal residence.

• Pay tuition for post-secondary education for the participant of his or her dependents.

• A hardship withdrawal is taxable when taken and, unless used for deductible medical expenses, may also be subject to the 10% early distribution penalty tax.

• Withdrawals are limited to amount of participant's elective deferrals (but not earnings thereon).

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What is the advantage of a 401(k) plan over other qualified plans?

Because a 401(k) plan is a special form of a profit sharing plan, many of the provisions are the same. However, since contributions towards a 401(k) plan are essentially made by the employees, the cost to the employer will be lower when compared to a profit sharing plan where all contributions are made by the employer.

If the employer already has a plan, changing it to a 401(k) plan allows the costs to be shifted to the employees. Even so, for the plan to be successful and cost effective, a high participant participation rate is essential.

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How does a 401(k) plan compare to an IRA?

There are major advantages over an IRA:

• The annual contribution limit is higher.

• Participants can borrow from their accounts.

• The employer may make additional matching contribution.

• The employer may make additional profit sharing contribution.

• The employer can make the 401(k) plan part of a new-comparability plan, thus optimizing the contributions for selected employees.

• The employer can allow for after tax Roth elective deferrals to the plan.

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Are there drawbacks to a 401(k) Plan?

Yes, there are:

• 401(k) plans have relatively high administrative costs when compared to other plans because of multiple testing and complex record keeping.

• Although the total contributions made by or on behalf of a single participant can be as high as 100% of pay, the combined employer discretionary and employer matching contributions cannot exceed 25% of the total covered payroll.

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Any suggestions on investments?

To avoid participant dissatisfaction (and lawsuits) in the event of investment losses, it is advisable to set up participant-directed accounts for each participant.

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