401k Cross Training


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I created this slide deck for cross training my staff who wanted to learn more about other areas in HR.

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  • Why – loss of compounded interest & the interest rate paid on a plan loan is often less than the rate the plan funds would have otherwise earned. 04/04/12
  • 401k Cross Training

    1. 1. Prepared byTracy VanDenBerg March 28, 2012 1
    2. 2. Agenda What is a 401(k)? Types of 401(k) Plans 401(k) loans Types of distributions What is HR’s major responsibilities? Page 2
    3. 3. What is a 401(k) Plan? A retirement account Only available through an employer An easy way for an employee to contribute a portion of his/her paycheck to savings Lower’s the participant’s current taxable income if contributing to a pre-tax plan  Defers taxes until distribution  Any gains are considered ordinary income at the time of withdrawal (if retirement age) vs. capital gains Provides the option for employers to match employee contributions  Free income Page 3
    4. 4. The Players Plan Sponsor (the employer) Trustee Third Party Administrator (TPA) Financial Institution Financial Advisor (FA) Payroll Administrator & Benefits Admin (if applicable) Page 4
    5. 5. Types of 401(k) Plans Traditional 401(k)  Employee contributions made on a pre-tax basis  Taxes are paid at the time of withdrawal  Maximum allowed for 2012 is $17,000  $5,500 additional (catch-up) for participants 50 years + Roth 401(k)  Employee contributions made on a post-tax basis  Taxes on contributions are paid before contribution  Maximum allowed for 2012 is $17,000  $5,500 additional (catch up) for participants 50 years + Page 5
    6. 6. Annual Contribution Limits 2012 contribution limits - $17,000 max, $22,500 max if age 50+  Maximum is for combined 401(k) and Roth 401(k)  Does not include the employer matching contribution (if any)  Annual maximum of $50,000 combined employer and employee contributions + $5,500 catch up (if applicable).  How is this possible? Limits were increased in 2012 for the first time in 4 years Page 6
    7. 7. Distributions Distributions - to avoid penalties, you may not withdraw funds until age 59 ½ and before 5 years following your 1st contribution. Exceptions include:  Leaving your current employer at the age of 55 or higher  Becoming disabled (as defined by the Internal Revenue Code)  Facing a qualified financial hardship Early Distributions  Subject to income tax  Subject to 10 % penalty with payment due upon tax return filing Page 7
    8. 8. Loans Loans may be allowed and vary by plan Loan maximum – 50% of vested balance to a max of $50k Must be repaid on an after-tax basis at a predefined interest rate.  Is this double taxation? Or Not? Must be repaid within 5 years, or 15 if taken to purchase a primary residence. Loan defaults – amount of loan and accrued interest become a taxable distribution in the year of default and tax penalties are imposed, as applicable Page 8
    9. 9. Loans (continued) Why is taking a 401(k) loan a bad idea?  If your employment is terminated you must repay the full balance in a limited time (generally within 1 quarter)  May result in significantly lower rates of return  Why?  Decreases your ability to save for retirement  Disrupts dollar cost averaging  May lower your rate of return on compounded interest  Interest on the loan is not tax deductible, even if you borrow to purchase your primary residence  Little to no flexibility in changing the payment terms of your loan. Page 9
    10. 10. Loans (continued) Why might it make sense to take a loan from your 401(k)?  Better than taking a taxable hardship withdrawal from the plan  The interest rate may be lower than through a bank  Interest payments go back to yourself instead of a lending institution  No restrictions on what you can borrow money for Page 10
    11. 11. HR Admin/Responsibilities Work with Financial Institution or Third Party Administrator (TPA) to set-up the Plan, complete IRS compliance testing, process & approve loans & distributions Manage payroll deductions Remit payment of deductions and employer matching contributions to Financial Institution Determine and implement remedies if the Company fails compliance testing. Page 11
    12. 12. Important Classifications Highly Compensated Employees (HCEs)  Gross income for prior year is $110,000 or more  2012 gross income is $115,000 or more will be considered HC for 2013.  Owner of at least 5% of the Company, or an immediate relative of an owner (child or spouse) Non HCEs – all other employees Page 12
    13. 13. The ADP Test (Actual DeferralPercentage test) Compares the deferral rates of HCE and NHCE of all qualified employees. Average deferral % of all HCEs cannot be more than 2% higher than NHCEs Page 13
    14. 14. ADP Test What if the Plan Fails? 2 Options  Return excess $ to HCEs to bring the ADP lower to a passing level (taxable distribution by March 15 to avoid company penalties)  TPA manages the refund process and Financial Institution issues 1099  Process a “qualified non-elective contribution” QNEC to some or all of the NHCEs to bring to ADP passing level  QNEC must be 100% vested immediately Page 14
    15. 15. The ACP Test (ActualContribution Percentage Test) Compares the employer matching contribution rates of HCE and NHCE of all qualified employees. ACP ratio is determined The ACP test is met if the average matching contribution % of all HCEs does not exceed 2% Page 15
    16. 16. ACP Test What if the Plan fails the ACP test?  Excess aggregate contributions are distributed back to one or more HCEs in accordance with IRS regulations  Employer can make a one-time QMAC (Qualified Matching Contribution) to NHCEs  QMAC must be 100% vested immediately Page 16
    17. 17. Top-Heavy Test Compares % of plan assets maintained by “key” employees (5% owners, their immediate relatives (child or spouse), and 1% owners whose compensation exceeds $160,000 for the current year)  Key employees cannot maintain more than 60% of plan assets or it is Top Heavy  Based on current year as opposed to prior year If Top Heavy, it triggers a required contribution to all non key employees up to a maximum of 3% of the individuals gross compensation for the year.  Subject to vesting schedules Page 17
    18. 18. Are ACP/ADP Always Required? If all participants of the 401(k) plan are NHCEs or all are HCEs, the test is automatically passed. Employer matches contributions of 100% of the first 3% plus 50% of the next 2% of employee compensation  Immediate vesting is required on these contributions Alternatively, a contribution of 3% of employee compensation to all eligible NHCEs with immediate vesting may be made for automatic passing. Page 18
    19. 19. ERISA Participant RightsProtectionsERISA sets standards for, among other things...  Participant eligibility  Investment choice  Plan funding/bonding  Vesting of employer contributions  Disclosure of plan and investment and investing-related information to current and prospective plan participants and their beneficiaries ERISA aims to ensure that retirement monies actually exist at employees retirements by preventing fund mismanagement by administrators, trustees and others.  Employer’s must purchase an ERISA bond Page 19
    20. 20. Questions? Page 20