CPC Study Guide 3e

American Society of Pension Professionals & Actuaries
CPC
Advanced Retirement Plan Consulting
American Society of Pension ProfessionalS & Actuaries

4245 North Fairfax Drive, Suite 750 | Arlington, VA 22203
www.asppa.org
3rd Edition
CPC Study guide
3rd Edition
www.asppa.org
CPC Study Guide:

3rd Edition
4245 North Fairfax Drive, Suite 750

Arlington, VA 22203
703.516.9300
www.asppa.org
E-mail: education@asppa.org
3rd Edition
ISBN 978-1-935379-45-4
Copyright 2013. All Rights Reserved. ASPPA is a not-for-profit professional society. The
materials contained herein are intended for instruction only and are not a substitute for
professional advice. No part of this book may be reproduced in any form by any means without
permission in writing from ASPPA.
About ASPPA
ASPPAthe American Society of Pension Professionals & Actuariesis the premier national
organization for career retirement plan professionals. The membership is comprised of the
many disciplines supporting retirement income management and benefits policy. Members are
part of the diversified, technical and highly regulated benefits industry. ASPPA represents the
most committed individuals of the professionthose who have made a career of retirement
plan and pension policy work.
The purpose of ASPPA is twofold:
To educate retirement plan and benefits professionals
To preserve and enhance the private pension system
Based in the nations capital, ASPPA is a non-profit professional organization acting on behalf
of its 11,000+ members to improve retirement income policy. In pursuit of these goals, ASPPA
offers extensive educational opportunities for its membersfrom professional credentialing to
continuing education. ASPPA Government Affairs department keeps a close watch on all
legislative and regulatory activities affecting retirement benefits and pension policy.
ASPPA was founded in 1966 originally as an actuarial organization. Since then, ASPPA has
carefully tracked the changing needs of the retirement plan industry. As a result, ASPPA has
expanded and diversified its membership to include all types of pension professionalsfrom
actuaries, consultants and administrators to insurance professionals, financial planners,
accountants, attorneys and human resource managers. Embracing diversity, the 11,000+
members of ASPPA are united by their commitment to the private pension system.
Comprehensive education and examination programs are offered by ASPPA for its members
and other retirement plan professionals because career and industry advancement are
distinguishing characteristics of all ASPPA activities. Dedicated to providing practical and
scholastic education programs, the curriculum is carefully expanded and improved each year to
address legal and legislative changes affecting the pension system and the work of retirement
plan professionals. Visit www.asppa.org for more information about ASPPAs Education and
Examination programs, including course syllabi, reading lists, exam procedures and
requirements for ASPPA credentials.
iii
Acknowledgments
The 3rd edition of the CPC Study Guide is the result of the cooperative effort of past and
present members of ASPPAs Education and Examination Committee, many other ASPPA
volunteers, and ASPPA staff. Their contributions of time and expertise are gratefully
acknowledged.
iv
Introduction
Table of Contents
About ASPPA .............................................................................................................................. iii
Acknowledgments ...................................................................................................................... iv
Table of Contents ......................................................................................................................... v
About this Study Guide ............................................................................................................ xv
Reading Materials ...................................................................................................................... xv
Required Reading .......................................................................................................... xv
Suggested Reading......................................................................................................... xv
Explanation of the ASPPA CPC Examination ...................................................................... xvi
Test Taking Tips ........................................................................................................................ xix
The Grading Process ................................................................................................................. xxi
Chapter 1: Related Groups and Business Transactions
Controlled Groups under IRC 414(b) and 414(c) .................................................................1

Parent-Subsidiary Groups ...............................................................................................1
Brother-Sister Groups .......................................................................................................2
Combined Groups.............................................................................................................3
Attribution Under IRC 1563 for Controlled Groups ..................................................4
Effect of Controlled Group Status on Qualified Plans ................................................7
Affiliated Service Groups (ASG) under 414(m) ......................................................................7
A-Org Groups ....................................................................................................................8
B-Org Groups ....................................................................................................................8
Management Groups ......................................................................................................10
Attribution Under IRC 318 ..........................................................................................10
Effect of ASG Status on Qualified Plans ......................................................................12
Employee Types ..........................................................................................................................12
Common Law Employees ..............................................................................................12
Self-Employed Individuals ............................................................................................12
Independent Contractors ...............................................................................................13
Leased Employees ...........................................................................................................13
Multiple Employer Plans ...........................................................................................................16
Reasons For Adopting a Multiple Employer Plan .....................................................17
Employers that are Related but not Controlled ..........................................................17
Professional Employer Organizations (PEO) ..............................................................17
Treatment of Plan Provisions For Multiple Employer Plans ....................................18
Disadvantages .................................................................................................................19
Qualified Separate Lines of Business (QSLOBs).....................................................................19
Requirements to be a QSLOB under IRC 414(r) .......................................................20
QSLOB Allocation Procedures ......................................................................................20
CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition
Effect of QSLOB Status on Qualified Plans .................................................................21

Mergers and Acquisitions ..........................................................................................................22
Company Acquisitions and Dispositions ....................................................................23
Transition Rules ..............................................................................................................27
Plan Mergers ....................................................................................................................28
Plan Spin-Offs ..................................................................................................................28
Protected Benefits........................................................................................................................29
Benefits that are Protected .............................................................................................29
Benefits that can be Removed .......................................................................................29
Plan Terminations .......................................................................................................................30
Partial Plan Terminations ..............................................................................................30
Full Plan Terminations ...................................................................................................31
Asset Reversion Upon Plan Termination ....................................................................32
Abandoned Plans ........................................................................................................................34
Procedure For Closing an Abandoned Plan................................................................34
Employment Status Under Section 530(d) of the Revenue Act of 1978 ..................37
Chapter 2: Coverage and Nondiscrimination
Minimum Participation Test Under IRC 401(a)(26) .............................................................47

General Rules ...................................................................................................................47
Plans that Automatically Satisfy IRC 401(a)(26) .......................................................48
Disaggregation ................................................................................................................48
Correction Procedures ....................................................................................................49
Minimum Coverage under IRC 410(b) ..................................................................................49
Plans that Automatically Satisfy IRC 410(b) .............................................................50
Coverage Testing Group and Employee Classes .......................................................50
Aggregation and Disaggregation .................................................................................53
Transition Period for Mergers and Acquisitions ........................................................54
Ratio Percentage Test .....................................................................................................55
Average Benefit Test .......................................................................................................56
Qualified Separate Lines of Business (QSLOBs).....................................................................64
Nondiscrimination under IRC 401(a)(4) ................................................................................64
Design-Based and Nondesign-Based Safe Harbors ...................................................65
General Testing ...............................................................................................................66
Relationship Between IRC 401(a)(4) and IRC 410(b) .............................................72
Benefits, Rights and Features ....................................................................................................72
Current Availability ........................................................................................................73
Effective Availability ......................................................................................................75
vi
Introduction

Top-Heavy Requirements under IRC 416 .............................................................................75
Key Employees ................................................................................................................76
Top-Heavy Requirements ..............................................................................................76
Plan Design Considerations ..........................................................................................77
Safe Harbors.....................................................................................................................78
Nonsafe Harbor ...............................................................................................................81
Summary of Testing....................................................................................................................83
Chapter 3: 401(k) Plans
Cash or Deferred Arrangements (CODA) Basics ...................................................................87

Plans that can Contain a CODA....................................................................................87
Types of Contributions in 401(k) Plans ....................................................................................88
Elective Deferrals ............................................................................................................88
Designated Roth Contributions ....................................................................................89
Catch-up Contributions .................................................................................................90
Employer Matching Contributions ..............................................................................91
Employer Nonelective Contributions ..........................................................................93
After-Tax Employee Contributions ..............................................................................93
Contribution Limits ....................................................................................................................94
Contribution Limits under IRC 402(g) .......................................................................94
Catch-up Limits Under IRC 414(v) .............................................................................95
Annual Additions Under IRC 415 ..............................................................................95
Deductibility ....................................................................................................................96
Automatic Contribution Arrangements ..................................................................................97
Eligible Automatic Contribution Arrangements (EACA).........................................97
Qualified Automatic Contribution Arrangement (QACA) ......................................99
Distributions ................................................................................................................................99
ADP/ACP Basics .......................................................................................................................100
Who to Include ..............................................................................................................101
What Contributions to Include ...................................................................................102
Calculating the Tests.....................................................................................................102
Testing Methodology ...............................................................................................................103
Current Year vs. Prior Year Testing ...........................................................................103
Disaggregation of Otherwise Excludable Employees .............................................104
Shifting............................................................................................................................105
Correcting Failed ADP/ACP Tests .........................................................................................107
Recharacterizing Excess Contributions .....................................................................108
Corrective Distributions ...............................................................................................108
Orphan Match................................................................................................................110
vii
QNECs and QMACs .....................................................................................................111

Nondiscrimination Satisfied without ADP/ACP .................................................................114
Plans That Automatically Pass ....................................................................................114
Traditional Safe Harbor 401(k) Plan Under IRC 401(k)(12) ..................................115
Qualified Automatic Contribution Arrangement (QACA) Safe Harbor ..............119
Chapter 4: Defined Benefit Plans
DB Basics ....................................................................................................................................121
Why Adopt a DB Plan ..................................................................................................121
Basic Plan Requirements ..............................................................................................121
Accrued Benefits .......................................................................................................................122
Accrual Rules .................................................................................................................122
Service Crediting Rules ................................................................................................124
Optional Forms of Benefit ............................................................................................125
Reducing Future Benefit Accruals ..............................................................................126
Safe Harbors for DB Plans under IRC 401(a)(4) .................................................................126
Unit Benefit Plan Safe Harbor .....................................................................................127
Fractional Accrual Safe Harbor ...................................................................................127
Alternate Flat Benefit Safe Harbor..............................................................................129
Uniformity Requirements ............................................................................................131
Additional Safe Harbor Availability Rules ...............................................................132
Compensation Definition Under IRC 414(s) ...........................................................132
Average Annual Compensation Under IRC 401(a)(4) ...........................................133
Limitations on Benefits .............................................................................................................133
Minimum Funding Requirements ..........................................................................................135
How Minimum Contributions are Determined .......................................................135
Contribution Ranges .....................................................................................................136
Contribution Fluctuation .............................................................................................137
Benefit Payment Restrictions.......................................................................................138
Restrictions under PPA Based on Plan AFTAP ........................................................138
Investments ................................................................................................................................139
Differences Between DB and DC Investment Objectives ........................................140
Maximum Deduction Rules.....................................................................................................140
Stand Alone DB Plan ....................................................................................................140
DB/DC Combination.....................................................................................................141
Cash Balance Plans ...................................................................................................................142
How They Work ............................................................................................................143
Requirements for Successful Implementation of a Cash Balance Program:.........145
Applicable Defined Benefit Plans ...............................................................................146
Cash Balance Plan Compared to DC Plan .................................................................147
viii
Introduction
Other Plan Types .......................................................................................................................147

Floor Offset Plans ..........................................................................................................147
Fully Insured Plans under IRC 412(e)(3)Formerly irc412(i) ...........................149
PBGC Coverage .........................................................................................................................150
Which Plans are Covered .............................................................................................150
Premiums .......................................................................................................................150
Termination of a PBGC Covered Plan .......................................................................151
"Developing the Right Contribution after PPA," by Tom Finnegan ....................................153
Chapter 5: Distributions and Loans
Vesting ........................................................................................................................................183
Forms of Distribution ...............................................................................................................184
Annuity Forms of Distribution ...................................................................................184
Lump-Sum Payments ...................................................................................................185
Plan-to-Plan Transfers ..................................................................................................185
In-Service Withdrawals ............................................................................................................186
Hardship Withdrawal ..................................................................................................186
Corrective Distributions ...............................................................................................188
Distributions Due to Age or Time ..............................................................................189
Limitation on Distributions Upon Plan Termination for 401(k) Plans ..................189
Qualified Domestic Relations Orders (QDROs) .......................................................190
Required Minimum Distributions ..........................................................................................192
Rules During the Participants Lifetime ....................................................................193
Death Before Required Beginning Date .....................................................................194
Death After Required Beginning Date .......................................................................195
Special Rules ..................................................................................................................197
Involuntary Distributions ........................................................................................................197
Cash Out .........................................................................................................................197
Missing Participant Procedures ..................................................................................198
Taxation ......................................................................................................................................200
General Taxation Rules ................................................................................................200
Rollovers .........................................................................................................................200
Early Distributions ........................................................................................................202
Designated Roth Contributions ..................................................................................202
After-tax Employee Contributions .............................................................................204
Insurance Policies ..........................................................................................................205
Employer Securities ......................................................................................................206
Participant Loans ......................................................................................................................207
General Loan Rules .......................................................................................................207
Loan Refinancing ..........................................................................................................209
ix
Loan Default and Offset ...............................................................................................209

General Leave of Absence............................................................................................211
Military Leave of Absence ...........................................................................................211
Protected Benefits under IRC 411(d)(6) ...............................................................................212
Elimination of Distribution Options in a Defined Contribution Plan ...................213
Elimination of Distribution Options in a Defined Benefit Plan .............................213
Hardship Withdrawals.................................................................................................213
Participant Loans ..........................................................................................................214
Removal of In-Kind Distributions ..............................................................................214
Mergers and Plan-to-Plan Transfers ..........................................................................214
"Is One Loan Per Participant the Right Answer?" by Kimberly Radaker .............................215
Chapter 6: Fiduciary Topics
ERISA Coverage ........................................................................................................................223

Plans Covered by ERISA ..............................................................................................223
Plans Exempt from ERISA Coverage .........................................................................223
What are Plan Assets ....................................................................................................223
Who is a Fiduciary? ..................................................................................................................225
ERISA Fiduciary Under ERISA 3(21) .......................................................................225
Ministerial Administrative Functions ........................................................................225
Named Fiduciary ..........................................................................................................226
Plan Sponsor ..................................................................................................................226
Plan Administrator .......................................................................................................227
Plan Trustee ...................................................................................................................228
Difference Between a Directed Trustee and a Discretionary Trustee ...................229
Investment Manager .....................................................................................................229
Difference between Investment Education and Investment Advice .....................230
Who Cannot be a Fiduciary? .......................................................................................231
Fiduciary Duties ........................................................................................................................231
Exclusive Benefit Rule ..................................................................................................231
The exclusive benefit rule means to: ..........................................................................231
Fiduciary Prudence .......................................................................................................232
Settlor Functions............................................................................................................233
DOL Proposed Regulation to Broaden Fiduciary Status Under ERISA ...........................233
Application to Advisers and Pension Consultants ..................................................233
Disclosure ...................................................................................................................................233
Acceptable Methods of Distribution ..........................................................................234
Summary Plan Description (SPD) ..............................................................................235
Summary of Material Modifications (SMM) .............................................................235
Summary Annual Report (SAR) .................................................................................235
x
Introduction
Blackout Notices ............................................................................................................236

Other Notices .................................................................................................................237
Foreign Language Rule ................................................................................................238
Record Retention ...........................................................................................................238
Qualified Domestic Relations Order (QDRO) ..........................................................239
Plan Expenses ............................................................................................................................239
Expenses that can be Paid by the Plan .......................................................................240
Expenses that cannot be Paid by the Plan .................................................................241
Revenue-Sharing Explained ........................................................................................242
Review of Key Guidance on Revenue-Sharing.........................................................243
DOLs Three Fee Transparency Initiatives ................................................................245
Regulations on Service Providers Making Fee Disclosures to Fiduciaries .......................246
The Regulation ..............................................................................................................246
Participant Fee Disclosure .......................................................................................................247
Covered Plans and Participants ..................................................................................247
Allocation and Delegation of Fiduciary Responsibility ......................................................248
Delegation of Duties .....................................................................................................248
Responsibility that is Retained ....................................................................................248
ERISA 404(c) ............................................................................................................................249
Two Primary Conditions for ERISA 404(c) Relief From Liability ........................249
Investment Requirements ............................................................................................249
Notice Requirements ....................................................................................................250
Exceptions ......................................................................................................................251
Protection for Mapping and Blackouts ......................................................................251
Relief Provided ..............................................................................................................252
Qualified Default Investment Alternatives (QDIA) ............................................................253
Relief Provided ..............................................................................................................253
Conditions for Relief.....................................................................................................253
Requirements for a QDIA ............................................................................................254
Types of investments that qualify as a QDIA ...........................................................254
Summary ........................................................................................................................256
Fiduciary Liability .....................................................................................................................256
Fiduciary Breaches ........................................................................................................257
Civil and Criminal Penalties .......................................................................................257
Correcting a Breach.......................................................................................................259
Fiduciary or Fidelity Bond ...........................................................................................260
Fiduciary Liability Insurance ......................................................................................260
Indemnification Agreement ........................................................................................260
Reduce the Risk of a Breach.........................................................................................261
Prohibited Transactions ...........................................................................................................261
xi
Party-In-Interest ............................................................................................................261
ERISA 406(a) Prohibitions for Parties-In-Interest................................................262
ERISA 406(b) Prohibitions Against Self-Dealing for Fiduciaries ......................263
Prohibited Transaction Exemptions ...........................................................................264
Corrections and Form 5330 ..........................................................................................266
Form 5500 and Plan Audit Requirements .............................................................................267
Small Plan Audit Exemption .......................................................................................268
Chapter 7: Correction Programs and Ethics
Employee Plan Compliance Resolution System (EPCRS) Overview ................................269

Plan Types Covered ......................................................................................................269
General Principles .........................................................................................................270
Three Programs .............................................................................................................270
Qualification Failure .....................................................................................................271
Relief Offered upon Correction...................................................................................271
Correction Principles ....................................................................................................272
Self-Correction Program (SCP) ...............................................................................................275
Eligibility ........................................................................................................................275
Failures that cannot be Corrected under SCP ...........................................................275
Significant vs. Insignificant Failures ..........................................................................275
Practices and Procedures .............................................................................................277
Timing Rules ..................................................................................................................278
Voluntary Correction Program (VCP) ...................................................................................279
Eligibility ........................................................................................................................279
Failures That Can Be Corrected Under VCP .............................................................279
Failures That Cannot Be Corrected Under VCP .......................................................280
Anonymous Submission ..............................................................................................280
Group Submission ........................................................................................................280
Fees For Usage ...............................................................................................................280
VCP Compared to SCP .................................................................................................282
Audit Closing Agreement Program (Audit CAP) ................................................................283
Eligibility ........................................................................................................................283
Fees ..................................................................................................................................283
Audit CAP Compared to Other Correction Programs ............................................284
Correction Methods ..................................................................................................................284
Correction for a Failed ADP and ACP Test...............................................................284
Voluntary Fiduciary Compliance (VFC) Program ...............................................................285
Violations that can be Corrected .................................................................................285
Correction Principles ....................................................................................................287
Requirements to Use the Program..............................................................................287
xii
Introduction
Correction for Failure to Make Timely Deposit of Deferrals ..................................288

Delinquent Filer Voluntary Compliance (DFVC) Program ................................................288
DFVC Process ................................................................................................................288
Program Fees .................................................................................................................289
ASPPA Code of Professional Conduct...................................................................................289
Revenue Procedure 2008-50.....................................................................................................291
ASPPA Code of Professional Conduct (Appendix) .............................................................341
Chapter 8: Plan Design
Plan Types ..................................................................................................................................345

Things to Consider ....................................................................................................................345
Plan Sponsors Needs ...................................................................................................346
Employer and employee demographics ....................................................................346
Plan Types in Detail ..................................................................................................................347
SIMPLE IRA ...................................................................................................................347
SIMPLE 401(k) as Compared to SIMPLE IRA ..........................................................349
SEP...................................................................................................................................349
Individual 401(k) ...........................................................................................................350
Traditional 401(k) ..........................................................................................................351
401(k) with an Automatic Contribution Arrangement............................................352
Safe Harbor 401(k) with Match ...................................................................................353
Safe Harbor 401(k) with Nonelective .........................................................................353
QACA Safe Harbor 401(k) with Match ......................................................................354
QACA Safe Harbor 401(k) with Nonelective ............................................................355
Profit Sharing Only Plans ............................................................................................356
Traditional Defined Benefit Plan ................................................................................358
DB-K ................................................................................................................................359
Cash Balance Plan .........................................................................................................359
Nonqualified Arrangements .......................................................................................360
Employee Stock Ownership Plans (ESOPs) ..............................................................361
Safe Harbor 401(k) with Nonelective and New Comparability .............................361
401(k) Safe Harbor with New Comparability and Cash Balance Plan ..................362
Case Study #1 .............................................................................................................................364
Case Study #2 .............................................................................................................................369
Case Study #3 .............................................................................................................................371
Case Study #4 .............................................................................................................................374
Case Study #5 .............................................................................................................................377
Case Study #6 .............................................................................................................................380
Case Study #7 .............................................................................................................................383
Case Study #8 .............................................................................................................................389
xiii
Case Study # 9 ............................................................................................................................392

Case Study #10 ...........................................................................................................................396
Case Study #11 ...........................................................................................................................399
"How to Choose Between 403(b) and 401(k) for Nonprofits," by Ginny Boggs .................401
"Cash Balance Plans for Defined Contribution Administrators," by Lorraine Dorsa ........433
"Successful DC Plan Design Case Studies," by Eric C. Droblyen and JJ McKinney ............467
"Choosing a Retirement Option for Your Small Business," by EBSA and the IRS ............515
"SEP Retirement Plans for Small Businesses," by EBSA and the IRS ..................................523
"Simple IRA Plans for Small Businesses," by EBSA and the IRS..........................................535
xiv
Introduction
About this Study Guide

This study guide has been prepared for students studying for the ASPPA CPC
examination. It is intended to be a guide to the material that will be tested on the
examination. Should it be necessary to make any corrections to this study guide or should
any clarification of the material in the study guide be required, this information will be
posted on the ASPPA Web site. It is the candidates responsibility to regularly check the
ASPPA Web site at www.asppa.org/errata to obtain this information.
The study guide contains the following information:
An explanation of the ASPPA CPC examination;
A list of suggested readings;
Chapters and articles covering the topics tested on the CPC examination;
Your comments, recommendations, critiques and observations are appreciated. Please
contact education@asppa.org with any comments you wish to share. ASPPA is always
seeking to improve the quality of its educational program, and your comments are a
very important part of that process.
Reading Materials
REQUIRED READING
CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition. Arlington, VA:
ASPPA, 2013.
SUGGESTED READING
Tripodi, Sal L. The ERISA Outline Book, 2013 Edition. Arlington, VA: ASPPA, 2013.
It should be noted that these materials do not constitute the only items available to
prepare for the examination. The materials cited are evaluated by the members of the
Education and Examination Committee for the purpose of increasing candidates
understanding of the various concepts presented.
These readings do not reflect any official interpretation, opinion or endorsement of
ASPPA or its Education and Examination Committee.
Due to the rapid statutory and regulatory changes affecting the topics covered, strict
attention should be paid to the dates of the texts. Please note that this study guide is not
intended to reflect legislation enacted after August 1, 2012. The 2013 CPC examination
will be based on this study guide and will not require knowledge of legislation not
covered in this publication.
xv
Explanation of the ASPPA CPC Examination

1.
What is the purpose of the CPC examination?

The CPC examination is a proctored examination required for completion of the
Certified Pension Consultant (CPC) credential. The purpose of this examination
is to test the candidates ability to apply knowledge meaningfully to realistic
consulting situations.
The 4 -hour examination consists of eight essay questions covering
comprehensive consulting topics. The questions require the candidate to analyze
and solve specific problems as well as demonstrate an understanding of
terminology and concepts that may be encountered in a consulting practice.
2.
What topics may appear on the CPC examination?

Most of the questions on the examination will be based on material taken directly
from the required readings. However, the examination requires the knowledge
tested in prerequisite ASPPA examinations and therefore may include topics
covered in those exams. The prerequisite examinations are RPF-1, RPF-2, DC-1,
DC-2, DC-3, DB and the CPC modules.
The examination will be divided into questions covering eight topics. The
candidate will be required to answer all eight questions.
The topics are:
1. Related Groups and Business Transactions
2. Coverage and Nondiscrimination
3. 401(k) Plans
4. Defined Benefit Plans
5. Distributions and Loans
6. Fiduciary Topics
7. Correction Programs and Ethics
8. Plan Design
3.
Will the CPC examination be given on a computer?

The CPC examination will be administered at Prometric Testing Centers
nationwide as a computer-based examination.
4.
Why is the CPC examination an essay type instead of multiple-choice?

ASPPA feels that an essay examination is the best way to test a candidates
xvi
Introduction
ability to apply knowledge meaningfully to realistic consulting situations.

5.
How are the examination questions structured?

Generally, essay questions are based on factual situations typically encountered
by consultants in their general practice. The questions are constructed to require
the candidate to demonstrate knowledge of certain facts and concepts and apply
them on a practical basis.
6.
How many hours of study are required to pass the examination?

As noted above, this examination is needed to achieve the CPC credential and
therefore must be rigorous to assure a high level of competence. The number of
hours of study needed to pass the examination varies from person to person
depending on the length and breadth of a persons experience in the pension
field. Working knowledge of the Internal Revenue Code, ERISA and the
accompanying regulations is essential. In addition, it is assumed and expected
that all materials in CPC Study Guide: Advanced Retirement Plan Consulting, 3rd
Edition will be read and studied. It is common for persons meeting the above
criteria to spend between 250 and 300 hours studying for the examination. As in
other professional examination programs, such as bar examinations, enrolled
actuary examinations and CPA examinations, it is not unusual for candidates to
take the test more than once before passing.
7.
How should a candidate study for the examination?

As noted above, it is expected that you will read and study all of the required
materials. It is recommended that the majority of your study time be spent on
subjects that are unfamiliar to you, or those that are outside your normal area of
practice, since questions in these areas may be the most difficult for you to
answer adequately. Review questions covering the material along with the
answers can be found at the end of most chapters. However, do not assume that
the specific subject matter covered by the review questions will be on the
proctored exam.
Due to the consulting nature of the examination, it is possible to ask relatively
few questions. Therefore, the examination will not necessarily cover all of the
reading materials. However, a candidate who wants to be prepared for the
examination should study all of the materials. Even if a particular topic is not
covered by the examination, the candidate will have increased his or her
professional capabilities by studying the materials.
Where possible, many candidates form small study groups and work together in
xvii
reviewing prior exam questions and examination topics. Some groups split up
the topics so that each person is responsible for leading the discussion of a
specific topic over one or more weeks. A study group may want to weigh each
chapter as a study session. These study groups keep the candidate on a study
and preparation schedule and provide a forum to discuss unfamiliar or difficult
material.
8.
Are there any calculations on the CPC examination?

The CPC examination may include calculations. Candidates are not allowed to
bring a calculator into the testing center. Candidates will be able to use an
onscreen calculator during the exam. Prometric will furnish, if requested, each
candidate with a handheld calculator. The calculations you encounter could
involve, but are not limited to, determining IRC 404 deduction limits, IRC
401(k) and 401(m) tests, limits under IRC 415 and 402(g), and results of IRC
410(b) or 401(a)(4) tests.
9.
Who selects the articles for the CPC Study Guide and writes the ASPPA CPC
examination?
The Technical Education Consultant (TEC) assigned to the CPC course is primarily
responsible for selecting the articles, maintaining the study guide, and preparing
the CPC examination. Members of the Education and Examination Committee
including ASPPAs other TECs support the CPC TEC in these endeavors.
10.
Who grades the ASPPA CPC examination?

The Technical Education Consultant (TEC) assigned to the CPC course is primarily
responsible for grading the examination. Members of the Education and
Examination Committee provide grading assistance as needed. As part of the
preparation process, each examination including suggested answers and suggested
points for partial answers is thoroughly reviewed and pretested before candidates
sit for the examination. Subsequently, the grading process utilizes these suggested
answers and partial point crediting. Great care is taken by the TEC and any
additional graders to be as consistent as possible in awarding points, given the
subjective nature of the examination.
11.
How is the passing mark determined?

Once all the essay questions have been graded, the Technical Education Consultant
(TEC) assigned to the CPC course reviews the overall grading of the examination.
In consultation with ASPPAs other TECs, the CPC TEC sets the recommended
passing mark.
xviii
Introduction
12.
How many times a year is the examination given?

The CPC examination is offered twice a year once during the spring exam
window and once during the fall exam window.
13.
Where can I obtain additional information on the CPC examination?

Contact ASPPA Customer Support at (703) 516-9300 or education@asppa.org.
Test Taking Tips

Here are some suggestions about test taking. While they may seem obvious, candidates
frequently forget them while taking an examination so it helps to revisit them from time to
time. This is particularly true if it has been some time since you have either been in school
or taken a professional examination.
Get plenty of rest the night before the examination. If you have studied the material,
cramming at the last minute will not be needed and a good nights sleep will prove
much more valuable.
Check with the examination center prior to your testing date to confirm that the center
will be open and to clarify driving and parking directions. Then plan on getting to the
examination center early.
Read the instructions carefully. Even though you may have reviewed the instructions
before, it never hurts to reinforce them.
Plan your examination time. Set aside a few minutes at the beginning of the
examination session to familiarize yourself with the examination. And, give yourself a
few minutes at the end to review your work.
Know how much time you have to spend on each question and/or topic. Read through
the entire examination and divide your time in proportion to the point allocations that
are shown for each question. The examination will contain suggested times for each
question to assist you in planning your time.
While you are reading through the examination, pick out a few of the easier questions
for answering first. This may settle initial testing nerves, improve your confidence, and
potentially start triggering your memory on some of the points that are covered on the
harder questions.
Read each question through quickly to get a feel for the situation/facts and what is
being asked. Try to recognize the key concepts. Then, return to the question and read
it through slowly. Do this only after you have determined precisely what the question
is asking you to do.
xix
Make sure that your answer is relevant to the precise question being asked. While you
may know a considerable amount of information, if your answer is not relevant to the
question being asked you will get no points for it. You also will have lost valuable time
that could have been used on other questions.
While you should make use of the supplied information in formulating your answer,
you will get no credit if you merely rewrite the question.
You should not read obscure interpretations into a question. Each question is designed
to be straightforward. Try to cover all aspects of the question in your answer, including
pertinent facts and details, even if based on your practical experience, they seem
obvious.
Type your answers in short phrases or sentences. Misspelling will not count against
you unless the word is unidentifiable or misinterpreted. If you type something you do
not want to be graded, delete or otherwise indicate clearly the portion you do not want
the grader to consider. If you have second thoughts, or you want to put in clarifying
points, use the insert function to add these thoughts in conveniently and clearly.
Remember that copying and pasting functions are also available.
Although we call them essay questions, many candidates produce their answers in
the form of an outline. The outline presentation of an answer is quite acceptable. A
brief outline is potentially the most effective way of presenting the knowledge that you
have. However, make sure that your outline is not too brief. Add clarifying phrases
and/or make liberal use of adjectives.
If an answer requires a calculation, please show all of your work. For clarification, if
time permits, type a written explanation of the calculations you are performing.
Make an effort to answer each question. At a minimum, provide any relevant thoughts
on the topic and try to earn partial credit.
Since each question is graded separately, your answer to each question should be selfcontained. References to answers on other questions will not be graded.
If a question asks you to discuss an issue or proposal, you should include the
significant arguments both for and against it.
Do not worry if your answer does not appear to be as organized as some model
solutions that you may have seen while you were studying. The examiners recognize
that an answer supplied under examination conditions will not demonstrate the same
organization as the model solutions.
Review the lists of abbreviations and IRC sections found at the end of this
introduction. These lists will be provided as part of the examination and may be used
within the questions and by you in your answers as time-savers.
xx
Introduction
Finally, understand that the examiners are not trying to create trick questions. If you
have studied the material, they want you to get the question right. Therefore, when in
doubt, assume a logical approach to solving a problemit frequently is the right
approach.
The Grading Process

Since new examinations are written for each testing cycle and neither the candidate base
nor the level of the examination is consistent from cycle-to-cycle, each examination
needs to have a pass mark set which fairly represents the appropriate mark for that
examination and the facts in effect at that time.
Although the Technical Education Consultant (TEC) assigned to the CPC course is
primarily responsible for writing and grading the examination, grading assistance from
members of the Education and Examination Committee may be used from time to time
as needed. Should more than one person participate in grading an examination, each
grader will grade the same essay question for all examination candidates. During the
grading process, the candidates identity is kept confidential from the graders.
The Technical Education Consultants (TECs) are trained in the utilization of
examination statistics, utilization of historical examination statistics, and have an
understanding of the intent of the examination. The TECs in consultation with one
another discuss and ultimately agree on the pass mark.
This entire process takes some time. The passing candidates will be posted on the
ASPPA Web site as soon as possible. All candidates will be notified by mail within eight
to ten weeks after the examination date.
We hope this explanation takes the mystique away from the grading process. It is
ASPPAs intent to be fair to the candidate and make the ultimate credentials
meaningful.
Please visit the ASPPA website for the most recent versions of the COLA summary,
commonly found abbreviations & acronyms, and the IRC listing at
http://www.asppa.org/ Document-Vault/Docs/EE/References-andErrata.aspx#References.
xxi
Chapter 1
Related Groups and Business Transactions
The rules of common control have far reaching effects on many aspects of qualified retirement
plans. For this reason, determining whether an employer is a part of a controlled group or an
affiliated service group is critical to ensuring continued qualified status for retirement plans. In
this chapter, the various types of these arrangements and the integral rules of attribution are
examined. Additionally, leased employee status and the complexities involved in
distinguishing common law employees from independent contractors are explored. This
chapter also reviews the effect of business transactions such as mergers and acquisitions on
groups of common control and the retirement plans sponsored by these entities.
Controlled Groups under IRC 414(b) and 414(c)

The three basic types of controlled groups are as follows:
Parent-subsidiary group;
Brother-sister group; and
Combined groups.
IRC 414(b) governs corporations under common control.
IRC 414(c) governs all other entities under common control including sole proprietorships,
partnerships, limited liability companies, tax-exempt entities and any other organization
conducting a trade or business.
PARENT-SUBSIDIARY GROUPS
A parent-subsidiary group exists when one business (common parent) owns at least 80% of the
voting stock or value of the stock of one or more other businesses (subsidiaries). This is a
relationship often found with larger corporations. A company may have multiple subsidiaries
or multiple tiered subsidiaries that constitute a single controlled group.
A parent-subsidiary group may exist even if the parent or subsidiary is a foreign corporation.
Beware of the instance where a foreign parent owns 80% or more of two or more US
subsidiaries.
EXAMPLE: The ownership and country of origin of several related companies is as follows:
Country of Operation
Ownership
Company A
United States
Publicly Traded
Company B
Japan
85% owned by Co. A
Company C
United States
50% owned by Co. A
Company D
United States
95% owned by Co. B
Company E
Germany
100% owned by Co. C
Company F
United States
85% owned by Co. B
Two parent-subsidiary groups exist in this situation. One group is made up of Company A, B,
D, & F. This is because Company A owns 80% or more of Company B which in turn owns 80%
or more of Company D & Company F. The other group consists of Company C & Company E.
Company C & E are not part of the controlled group with Company A because Company A
owns only 50% of Company C but all of the above companies would be considered when
evaluating the IRC 415 limit due to the rules of IRC 415(h). The fact that some companies are
foreign companies is irrelevant to the controlled group determination but it is likely that the
foreign companies would have a limited impact on any testing because most if not all of their
employees would likely be excludable as nonresident aliens.
BROTHER-SISTER GROUPS
A brother-sister controlled group exists when five or fewer common owners satisfy an 80%
common ownership test (controlling interest or common control) and a 50% identical
ownership test (effective control). Common owners must be an individual, trust or an estate.
A brother-sister relationship is often found with smaller businesses, closely held or professional
organizations. Per U.S. v Vogel Fertilizer (1982) each owner must own directly (or indirectly)
some stock in each business or else the owner is ignored for testing purposes.
Methodology for determining brother-sister group is as follows:
Determine who owns stock (consider attribution rules for controlled groups).
Determine groups of five common owners.
Exclude those without interest in both (or all) companies.
Determine common controlat least 80% common ownership.
Determine effective controlmore than 50% identical ownership.
If yes to effective and common control, then a controlled group exists.
Chapter 1: Related Groups & Business Transactions
EXAMPLE: The ownership of two related companies is as follows:

Company J
Company K
Identical
Owner 1
40%
30%
30%
Owner 2
20%
40%
20%
Owner 3
35%
15%
15%
Owner 4
5%
0%
---
Owner 5
0%
15%
---
Total for
95%
85%
65%
common owners
Company J and Company K constitute a brother-sister controlled group because they met the
requirements for both common and effective control. Looking only at owners 1, 2 & 3 the
common control is 95% for Company J and 85% for Company K. Because the common
ownership for both is more than 80% the common control test is met. The identical ownership is
then evaluated. To determine effective control the identical ownership for owner 1, 2 & 3 is
added together. Owner 1s identical ownership is 30%, owner 2s is 20% and owner 3s is 15%.
The total is 65%. Because the identical ownership is more than 50% the effective control test is
met. Owner 4 and Owner 5 are not included in either number because neither of them have
ownership in both companies.
COMBINED GROUPS
Combination parent-subsidiary and brother-sister groups can exist when the parent in the
parent-subsidiary group is the common member in the brother-sister group. If the subsidiary in
a parent-subsidiary group is a common member of a brother-sister group, the combination is
not considered a combined controlled group. Overlapping controlled groups can exist. All
related entities must be included even if the relationship is in existence for less than half a year.
A foreign parent or subsidiary must also be considered.
EXAMPLE: Joe owns 90% of Company M and Company N making them a brother-sister
controlled group. Company M owns 85% of Company P making them a parent-subsidiary
controlled group. Under the combined group rules Company M, Company N, and Company P
are considered to be part of one controlled group.
ATTRIBUTION UNDER IRC 1563 FOR CONTROLLED GROUPS

Attribution is the concept of treating a person or business as owning an interest in a business
that is not directly owned by the person. Attribution may occur due to a family relationship or
a business relationship.
Under the attribution rules of IRC 318, certain family members of business owners are
considered to be owners when determining who is a highly compensated employee (HCE) or
key employee.
For purposes of determining whether a controlled group exists, the attribution rules under IRC
1563 apply. The rules are similar to those found under IRC 318, with an exception applicable
to adult children. Ownership also attributes through ownership of a company or a trust that
own a business or portion of a business.
Family Attribution
Under the family relationship attribution rules a person is considered to own the stock of
certain family members. They are as follows:
Spouse: Individual is deemed to own stock owned by spouse unless legally divorced or
separated by decree.
An exception to spousal attribution exists if all the following conditions are satisfied (Be
aware that a community property interest nullifies this exception):
o
No direct ownership in spouses business (caution: community property

ownership = direct ownership).
Not a director, not an employee and does not participate in management of

spouses business.
No more than 50% of gross income from spouses business derived from passive
income.
No distribution restrictions of spouses stock in favor of the spouse or minor

children. (Be aware that distribution restrictions other than to a current co-owner
are very rarely found and must be specifically included in the companys charter
or operating agreement for this provision to apply). Attribution to a minor child
may still result in a controlled group even when the spousal exception applies.
Minor child: Parent is deemed to own the stock of a minor child (under age 21);
conversely, minor child is deemed to own the stock of parent.
Adult child: Parent is deemed to own the stock of an adult child (age 21 and older) only
if the parent owns (or is attributed as owning) more than 50% of the stock of the
company. Conversely, an adult child is deemed to own stock of parent if adult child
owns (or is attributed as owning) more than 50% of the stock of the company.
EXAMPLE: A father who owns 20% of the stock in Corporation A in his name, is attributed the
20% owned by his spouse and the 15% owned by his minor child. This attribution results in the
father owning more than 50% of the stock of the company, so the father also will be deemed to
own any stock owned by his adult children.
Grandchild: Grandparent is deemed to own the stock of a grandchild only if the
grandparent owns (or is attributed as owning) more than 50% of the stock of the
company. Conversely a grandchild is deemed to own the stock of a grandparent if the
grandchild owns (or is attributed as owning) more than 50% of the stock of the
company.
Legally adopted children are treated as blood children. There is no attribution between siblings.
Double attribution is not applied under family attribution.
EXAMPLE: A woman age 30 owns 10% of a corporation. Her husband also owns 10% of the
corporation. She is attributed the 10% ownership of her husband. Her father owns 60% of the
corporation. The father is deemed to own his daughters 10%, but not the 10% owned by his
son-in-law.
EXAMPLE: Margaret owns 100% of Corporation M. Margaret also owns 51% of Corporation F,
the other 49% of which is owned by Margarets father. (Margaret is an adult.) If we just consider
Margarets ownership of the two companies, they are not a controlled group, because she does
not control at least 80% of Corporation F. However, because of attribution rules, Margaret is
considered to own the stock of Corporation F that is owned by her father (she is his daughter,
and she owns more than 50% of the corporation in her own right). As a result, Corporation F is
considered to be owned 100% by Margaret. As a result, Corporations M and F are part of a
controlled group.
Attribution from Organizations to an Individual
Under the business relationship attribution rules a person will be attributed ownership as
follows:
Corporation: If a corporation has an ownership interest in another organization, that
interest is attributed to any person who owns 5% or more of the corporation. The
person is deemed to own a pro rata share of the stock owned by that corporation.
o
For controlled group definition, stock owned by an IRC 401(a) qualified plan
exempt from tax under IRC 501(a) is attributed to the participants of the plan.
However, if the stock attributed from the qualified plan to the participant meets
the definition of excluded stock, discussed below, the attribution of ownership of
such stock might end up being disregarded.
EXAMPLE: Jenny owns 60% of the stock of corporation X. Brian owns 30% of X. Four other
individuals own the remaining 10%, each owning less than 5%. X has a 25% stock interest in
corporation W. The W stock is attributed to Jenny and Brian in proportion to their ownership
interests in X. Jenny is attributed 60% of the W stock owned by X and Brian is attributed 30% of
the W stock owned by X. Therefore, Jenny is treated as a 15% owner (i.e., she owns 60% of Xs
25% ownership) of W and Brian is treated as a 7.5% owner (i.e., he owns 30% of Xs 25%
ownership) of W. The other shareholders of X are not attributed any ownership in W because
none of them owns at least 5% of X.
Partnerships: If an individual owns at least 5% of the capital or profits of a partnership
then he is deemed to own a pro rata share of any organization owned by that
partnership. The pro rata portion is determined for each partner by multiplying the
greater of his capital or profits interest by the interest the partnership has in the other
organization.
Estates and Trusts: Stock owned by a grantor trust is owned by the deemed owner
under trust rules. The beneficiary of a trust with at least a 5% actuarial interest in the
trust is deemed to own a pro rata share of the trusts stock.
EXAMPLE: Assume a trust holds 1,000 shares of stock and the trust beneficiaries are designated
as follows: Abigail 40%, Brett 35% and Carol 25%. For controlled group purposes under
1563(e)(3) Abigail is considered to own 400 shares, Brett 350 shares and Carol 250 shares.
Options: If someone owns an option to buy company stock then he is treated as owning
that stock.
Some Stock is not Included under IRC 1563 for Controlled Groups
Nonvoting preferred stock;
Treasury stock; and
Other excluded stock as follows:
For parent-subsidiary groups where parent owns at least 50% of the subsidiary,
excluded stock includes:
o
Ownership held by a deferred compensation plan (qualified or nonqualified);
Certain interest held by a subsidiary;
Restricted stock; and
Tax-exempt organization interest.
EXAMPLE: Corporation X owns 60% of Corporation Y. The other 40% is owned by the
Corporation Y 401(k) Plan. The 40% owned by the Corporation Y 401(k) plan is disregarded
when determining controlled group status. Because that stock is disregarded Corporation X
owns 100% of the corporation Y stock that is taken into consideration which makes Corporation
X and Corporation Y a parent subsidiary controlled group.

For brother-sister groups where common owners own more than 50% of the voting
stock, excluded stock includes:
o
Interest in qualified plans;
Restricted stock; and
Tax-exempt organization interest.
EFFECT OF CONTROLLED GROUP STATUS ON QUALIFIED PLANS

Members of a controlled group are treated as a single employer for purposes of the following:
General qualification rules under IRC 401(a);
Nondiscrimination rules of IRC 401(a)(4);
Compensation limits under IRC 401(a)(17);
Eligibility, coverage, and service crediting rules under IRC 410;
Vesting and service crediting rules under IRC 411;
Contribution and benefit limits under IRC 415;
Top-heavy rules under IRC 416; and
SEP/SIMPLE rules under IRC 408.
Compensation from all entities must be aggregated prior to determining HCEs. If someone is
determined to be an HCE of one entity, then he is an HCE of all related entities. Loans from all
plans of the controlled group must also be aggregated to apply the loan limitations under IRC
72(p) (e.g., the $50,000 level).
Under IRC 415(h), for purposes of IRC 415 limitations, a parent-subsidiary group exists if the
parent company owns more than 50% of the subsidiary company (rather than at least 80%). IRC
415(h) does not apply to brother-sister groups.
EXAMPLE: Corporation A owns 60% of Corporation B. Corporation A and Corporation B are not
a controlled group because the ownership is less than 80%. Under IRC 415(h) they are
considered to be a controlled group when applying the benefit limits of IRC 415 because the
ownership is more than 50%. Therefore, benefits earned in the plans sponsored by A and B are
aggregated when applying the limits under IRC 415.
If the controlled group members participate in the same plan then they are aggregated for
computing the deduction limit. Meanwhile, the allocation of the deduction is on an employerby-employer basis. For pension plans, minimum funding under IRC 412 provides that each
member of the controlled group has joint liability for the minimum funding amount.
Affiliated Service Groups (ASG) under 414(m)

An affiliated service group (ASG) consists of two or more organizations that have a service
relationship and, in some cases, an ownership relationship. ASG members are generally in

fields of service organizations (health, law, engineering, architecture, accounting, etc.) or
organizations where capital is not a material income-producing factor. (Banks and other
financial institutions are not considered to be service organizations when applying ASG rules.)
Three categories of ASG are: A-Org group, B-Org group and management group. All ASGs,
with the exception of management groups, must include a first service organization (FSO) and
one or more A-Organizations (A-Orgs) and/or B-Organizations (B-Orgs).
A-ORG GROUPS
An A-Org group consists of a First Service Organization (FSO) and at least one A-Org.
An FSO must be a service organization. An FSO can be any type of entity (corporation,
partnership, etc.). However, for an A-Org group, if the FSO is a corporation then it must be a
professional service corporation.
Professional service corporations are corporations organized for the principal purpose of
providing professional services. Generally, professions where the state requires a license to
provide services, such as a doctor, chiropractor, lawyer, accountant, architect or engineer,
require the formation of a professional corporation.
An A-Org must be a service organization. The A-Org or HCEs of the A-org must have an
ownership interest in the FSO. There is no minimum amount of ownership required. The A-Org
must regularly perform service for the FSO or be regularly associated with the FSO in
performing service for third persons.
EXAMPLE: Doctor A and Doctor B perform services for the AB Medical Practice, a professional
corporation. Doctor A and Doctor B are each employed by their own corporations. Doctor A
and Doctor B each own 50% of AB Medical Practice. The nurses and office staff are employed by
AB Medical Practice. An ASG exists that includes Doctor A, Inc., Doctor B, Inc. and AB Medical
Practice. AB Medical Practice is the FSO and Doctor A, Inc. and Doctor B, Inc. are both A-Orgs.
Employees of all three companies must be considered together when applying qualified plan
rules.
B-ORG GROUPS
A B-Org group consists of an FSO and at least one B-Org.
As with the definition of an FSO for an A-Org group, the FSO must be a service organization;
however, unlike the definition for an A-Org group if the FSO is a corporation it does not have to
be a professional service corporation.

A B-Org is not required to be a service organization. The B-Org must derive a significant
portion of business from the performance of service for FSO or for A-Org related to the FSO.
Significant portion of business is defined by two safe harbors as follows:
Service receipt safe harbor: The B-Organizations services are not considered significant
if its service receipts percentage is less than 5%. The service receipts percentage is the
ratio of the gross receipts derived from services the B-Organization performs for the FSO
and/or the A-Organization(s) to the total gross receipts derived from all services
performed.
Total receipt safe harbor: The B-Organization's services are considered significant if its
total receipts percentage is 10% or more. The total receipts percentage is the ratio of
the gross receipts derived from services the B-Organization performs for the FSO and/or
the A-Organization(s) to the total gross receipts (whether or not service related).
A B-Org provides service to the FSO or a related A-Org that is historically performed by
employees. The B-Org must be owned at least 10% by the FSO or A-org or HCEs of the FSO or
A-Org (attribution of IRC 318 appliessee following section).
EXAMPLE: Norris, a CPA, is a 15% shareholder in an accounting firm. Norris also has a 20%
interest in Corporation X, which provides word-processing and other clerical and secretarial
services. The accounting firm engages the services of Corporation X during heavy workload
periods. Corporation X derives at least 10% of its gross receipts from this relationship. The
accounting firm and Corporation X constitute an affiliated service group. The accounting firm is
the FSO. Corporation X is a B-Organization with respect to the FSO because it performs services
that are historically performed by employees, it meets the total receipts safe harbor test, and
Norris, who is an HCE of the accounting firm, owns at least 10% of X.
In a group consisting of multiple A-Orgs and B-Orgs, all A-Orgs and B-Orgs identified with the
same FSO constitute one ASG.
EXAMPLE: Five doctors each own 100% of their medical corporations. In turn, these medical
corporations each own 20% of a medical practice. The medical practice is an FSO, and each of
the medical operations are A-Orgs with regard to the medical practice the medical
corporations are each owners in the FSO and provide services to the FSO or join with the FSO to
provide services for third parties (the patients).
One of the medical corporations, that belonging to Dr. Sanford, also owns 20% of a medical
imaging center. Dr. Sanford refers patients to the medical imaging center. The medical imaging
center is also an FSO (owned partially by the A-Org and providing services to Dr. Sanfords
medical corporation or joining with the corporation in providing services to common patients),
and Dr. Sanfords medical corporation is an A-Org with regard to the imaging center.
Here, we have two FSOs providing services to a common A-Org. Under the affiliated service
group rules, we have two ASGs one containing Dr. Sanfords medical corporation and the
medical practice, and another containing Dr. Sanfords medical corporation and the imaging
center.
On the other hand, if there are several FSOs with common B-Orgs, those do not constitute one
ASG each FSO gives rise to a separate ASG.
EXAMPLE: Morris, a CPA, is the 100% shareholder in his professional corporation. He is also a
20% shareholder in the accounting firm LMNOP, Inc. LMNOP has 4 other shareholders, each of
which own 100% of a professional accounting corporation and 20% of the accounting firm. The
firm provides word-processing, clerical and secretarial services to all the professional
accounting corporations.
In these situations, Morriss professional corporation and those of the other shareholders are
each FSOs with respect to LMNOP, which is a B-Org (performing services of a type historically
performed by employees) with respect to each FSO. There are five different affiliated service
groups.
MANAGEMENT GROUPS
A management group ASG consists of a recipient organization (and related organizations) and
a management organization. The management organizations principal business must be the
performance of management functions on a regular and continuing basis for the recipient
organization. There is no IRS regulation providing guidance on the exact definition of
management functions. There is also no guidance on what level of activity constitutes the
principal business however in normal usage principal is often considered to be a majority
or more than 50%. No common ownership is required between the management organization
and the recipient.
EXAMPLE: Lorraine is a former executive with corporation G. She has formed a management
consulting firm, corporation L. Her sole client is her former employer, G. Lorraine continues to
provide management functions for G through her wholly-owned corporation, L. G and L
constitute an affiliated service group. This is true even though there is no common ownership
between G and L.
In contrast if corporation L performs management functions for three corporations other than G
and none of these corporations are related to G then corporation L does not derive its principal
business under any one of these relationships so L would not be part of an affiliated service
group with G or any of the other three corporations.
ATTRIBUTION UNDER IRC 318

Under stock attribution for determining ownership of members of an affiliated service group as
defined under IRC 318, stock deemed to be owned by a person or entity can be attributed to
10

anotherpersonorentity.Thisisthesameattributiondefinitionthatisusedindetermining
HCEs&keyemployees.
FamilyAttribution
Betweenspouses(unlesslegallydivorced,legallyseparatedormeettheexceptions
discussedaboveintheIRC1563attributionsection);
Fromparenttochildandchildtoparent(ageofchildirrelevant);
Legallyadoptedchildrendeemedbloodrelatives;
Fromgrandchildtograndparent;
Noattributionfromgrandparenttograndchild;
Nosiblingattribution;and
Nodoubleattribution.
AttributionfromanOrganization
Stockownedbyapartnership,Scorporation,estateortrustisdeemedtobeowned
proportionatelybypartners,shareholders,beneficiaries,etc.StockownedbyCcorporationsis
deemedtobeownedbyits50%ormoreshareholders.Options:Ifsomeoneownsanoptionto
acquirestockthenheisdeemedtoownthestock.
EXAMPLE:TheMNOPCorporation(aCcorporation)hasthefollowingowners:
CorporationM,aCcorporation,owns10%ofMNOP.CorporationMisowned80%by
Monicaand20%byMartha.
PartnershipNO,whichisowned50%byNancyand50%byOliver,owns30%ofMNOP.
CorporationP,anScorporation,owns40%ofMNOP.Pisowned100%byPaul.
Theattributionisasfollows:
Monicaisdeemedtoown8%ofMNOP.Thisisbecausesheownsmorethan50%of
CorporationM,anditowns10%ofMNOP.Therefore,Monicaisdeemedtoowna
proportionateshareofCorporationM.
MarthaisdeemedtoownnothingofMNOP,assheownslessthan50%ofCorporationM,so
attributiondoesnotapply.
NancyandOliverareeachdeemedtoown15%ofMNOP.Stockownedbyapartnershipis
attributedproportionatelytoitspartners,withnominimumownershiprequired.
Paulisdeemedtoown40%ofMNOP.StockownedbyanScorporationisattributed
proportionatelytotheshareholders,withnominimumownershiprequired.
11

Attribution to an Organization
Stock owned by a partner, a shareholder in an S corporation or a beneficiary of an estate or trust
is deemed to be owned by the entity involved in proportion to ownership interest. Stock owned
by a 50% or more shareholder of a C corporation is deemed to be owned by that corporation.
EFFECT OF ASG STATUS ON QUALIFIED PLANS

Many provisions of qualified retirement plans are affected by IRC 414(m). The plans are
treated as a single employer for purposes of the following:
Eligibility, coverage, and minimum participation under IRC 410 and 401(a)(26);
Nondiscrimination rules under IRC 401(a)(4);
Vesting rules under IRC 411;
HCE determination under IRC 414(q);
Top-heavy rules under IRC 416;
Compensation limits under IRC 401(a)(17); and
Compensation from all entities must be aggregated prior to determining HCEs. If someone is
determined to be an HCE of one entity, then he is an HCE of all related entities. Loans from all
plans of the affiliated service group must also be aggregated to apply the loan limitations under
IRC 72(p) (e.g., the $50,000 level).
Employee Types
COMMON LAW EMPLOYEES
Most people who perform services for a company are common law employees. Compensation
for a common law employee is reported on a Form W-2. Wages shown on Form W-2 are subject
to FICA withholding for the employee portion and the company is responsible for payroll tax as
well. Federal income tax withholding is also required on wages paid on Form W-2.
SELF-EMPLOYED INDIVIDUALS
Self-employed individuals are owners of sole proprietorships and partners in partnerships. In
addition, individuals who are owners of LLCs or LLPs that elect to be taxed as partnerships are
considered to be self-employed individuals.
Self-employed individuals do not receive Forms W-2. Their income is shown on Schedule C to
their Form 1040 (if they are sole proprietors) or on a Schedule K-1 (if they are partners). This
income is considered to be their net earnings from self-employment.
To obtain the compensation to be used for retirement plan purposes, the earnings from selfemployment must be adjusted. This adjusted amount is called earned income.
12

Self-employed individuals pay twice the FICA tax of regular employees, because they pay both
the employer and the employee portions. These amounts are not deducted from the income on
the Schedule C or the K-1, but are a deduction on the Form 1040. Therefore, the net earnings
from self-employment must be adjusted by subtracting the employer half of the FICA tax
that is, 50% of the deduction shown on the Form 1040.
Second, the tax deduction for the contribution both salary deferrals and employer
contributions made on behalf of the self-employed individual is not reflected on the Schedule
C or Schedule K-1. Earned income should include salary deferrals, so the fact that these are not
deducted on the Schedule is proper. However, earned income does not include the company
contributions on behalf of the self-employed individual. Therefore, the amount of those
contributions the nonelective contributions or matching contributions must be subtracted
from the net earnings from self-employment to obtain the earned income.
INDEPENDENT CONTRACTORS
Any person who performs services for a company in a non-employee capacity is an
independent contractor. Compensation for an independent contractor is reported on a Form
1099-MISC. There is no FICA withholding on compensation paid to an independent contractor
and there is generally not any federal income tax withholding from that compensation either.
That income is generally reported as self-employment income on the 1040 Schedule C of the
independent contractor.
The IRS issued a 20 factor test (Revenue Ruling 87-41 - see appendix at the end of this study
guide) to determine whether an individual is a common law employee. Not all factors are
given equal weight in determining if someone is an employee or an independent contractor.
The most compelling argument is whether a company for which services are provided has the
right to control and direct the individual who performs the services.
Improper classification of an independent contractor as a common law employee can result in
violation of the exclusive benefit rule per IRC 401(a)(2). The exclusive benefit rule requires that
a qualified plan be maintained for the exclusive benefit of the employers employees and their
beneficiaries. If a non-employee is allowed to participate in the plan the exclusive benefit rule is
violated. Conversely, improper classification of a common law employee as an independent
contractor can result in plan disqualification for not covering eligible employees.
LEASED EMPLOYEES
A leased employee is an individual who is not a common law employee of an organization
(recipient) but is treated as an employee of the recipient for qualified plan purposes. The
recipient is the organization for whom the employee provides services. The leasing organization
provides the leased employees services to the recipient.
13

To be a leased employee the following four conditions must be met:
The recipient pays a fee for the service of the individual the agreement can be formal
or informal.
The individual provides services on a substantially full time basis for at least one year
(1,500 hours in 12 month period or 75% of customary hours for that position). When
determining if an individual has been substantially full time for at least a year any
service as a common law employee for the recipient or a related person or entity must be
included.
EXAMPLE: Corinne is employed by XYZ Company for three years. She is then terminated as an
employee of XYZ Company and is employed by ABC Leasing Company. XYZ Company enters
an agreement with ABC Leasing Company to lease the services of Corinne. Corinnes past
service with XYZ Company is included when determining that she is a leased employee.
The recipient must have primary direction or control over individual services.
The leasing organization (not recipient) is the common law employer of the individual.
A professional employer organization (PEO) is commonly known as an employee leasing
organization. If the recipient is actually the common law employer then the individual is not a
leased employee but is a common law employee of the recipient for qualified plan purposes.
The employment relationship between the workers and the employer sponsoring the plan plays
a major role in determining if the plan is a qualified plan. If a qualified plan provides benefits
for individuals who are not employees of the employer sponsoring the plan, the plan does not
satisfy the exclusive benefit rule and could be disqualified. The confusion caused by
determining who is the employer when leased employees are involved is the driving force
behind PEOs sponsoring multiple employer plans along with their clients. Therefore, it is
recommended that legal counsel be sought on who is the common law employer.
Effect of IRC 414(n) on Qualified Retirement Plans
A leased employee is treated as an employee of the recipient for the following:

Eligibility rules under IRC 410(a);
Coverage testing under IRC 410(b);
Minimum participation rules under IRC 401(a)(26);
Vesting rules under IRC 411;
Compensation limits under IRC 401(a)(17);
HCE determination under IRC 414(q); and
14

The recipient can exclude leased employees from its plan if IRC 410(b) and IRC 401(a)(26) are
satisfied without them.
EXAMPLE: ABC Company is the sponsor of ABC 401(k) Plan. ABC Company has 40 common
law employees and 6 leased employees. Of the 40 common law employees five are HCEs all of
whom are eligible to participate in the plan. The ABC 401(k) Plan excludes leased employees
from participating in the plan. The leased employees are included in the coverage testing group
as nonbenefiting employees. The coverage test is as follows:
HCE Ratio
5/5 = 100%
NHCE Ratio
35/41 = 85.37%
Plan Coverage Ratio 85.37%/100% = 85.37% > 70%

The ABC 401(k) Plan passes the ratio percentage test while excluding leased employees so the
exclusion is allowed. The demographics should be closely monitored because the addition of
more leased employees could cause a coverage issue.
If the recipient organization includes leased employees in its own plan, it can offset
contributions required by the amount of contributions allocated to the individual in the leasing
organizations plan. The offset must be stated in the recipients plan document. Regardless of
language in the recipients document, benefits in both the recipients plan and the leasing
company plan must be aggregated for the annual additions limit of IRC 415. Total annual
additions from both plans may not exceed the IRC 415 limit.
The recipient can take a deduction for contributions made to leased employees in the recipient
plan, but cannot take a deduction for contribution made for the leased employee by the leasing
organization.
If the leased employee participates in both a leasing plan and a recipient plan, the leasing
organization does not get credit for the contribution made by the recipient employer. Also, prior
service with a recipient organization is not credited to the leasing organization plan for
eligibility or vesting purposes.
EXAMPLE: C company leases its employees from L corporation. L corporation provides a money
purchase pension plan for the leased employees with a 10% of compensation contribution.
C company sponsors a profit sharing plan. This plan is cross-tested. The cross-testing analysis
reflects that the non-owners must receive a contribution equal to 12% of compensation. C
company may take into account the contribution provided to its leased employees by the
leasing organization, and may make a contribution for the leased employees to its plan equal to
2% of compensation. C company deducts the 2% of compensation actually contributed for the
leased employees.
15
The leasing organization, on the other hand, may not take into account the 2% contribution
made by C company for nondiscrimination purposes for its plan.
Consequences of Change in Status from Common Law Employee of the Recipient to a Leased
Employee:
May still get accrual from recipient plan;
Vesting continues in the recipient plan;
Must aggregate IRC 415 limits of leased employee plan with those of recipient plan;
and
No distributable event when an individual changes from a common law employee to a
leased employee, as this is not considered by the IRS to be a severance from
employment.
Leasing Organization Safe Harbor Plan
A leasing organization safe harbor plan provides a limited exception to leased employee rules.
Individuals are not treated as leased employees if the leasing organization maintains a
safe harbor plan.
If the safe harbor plan exists, individuals cannot be covered in a recipient plan.
Safe harbor plan must contain the following provisions:
o
Minimum 10% non-integrated contribution to a money purchase plan based on

IRC 415 compensation;
100% immediate vesting;
Immediate participation (immediate participation does not apply if the

employees perform substantially all of their services for the leasing
organization).
Can only apply if less than 20% of recipients nonhighly compensated workforce is
leased.
Other employee benefit plans (e.g., group term, cafeteria plans, etc.) are affected by leased
employee rules whether or not a safe harbor plan exists.
Multiple Employer Plans

A multiple employer plan is a plan sponsored by two or more employers where at least two of
the sponsoring employers are not members of the same related group (not controlled groups or
affiliated service groups). Care should be taken when establishing multiple employer plans,
because DOL opinions often scrutinize whether the employers constitute a bona fide group of
employers. In some cases this would cause the DOL to regard the multiple employer plan as
many individual plans rather than a single plan.
16
REASONS FOR ADOPTING A MULTIPLE EMPLOYER PLAN

A business relationship or common ownership may exist among participating employers even
though they are not part of a controlled group.
Employers from an organization or common industry may have employees who shift from one
participating employer to another. Multiple employer plans can ease the resulting
administrative burden.
A leasing organization may have a plan held by a leasing organization and recipient employers
who use leased employees. Leasing organization plans can coordinate coverage and
contributions.
A multiple employer plan may be established if a PEO needs to avoid an exclusive benefit rule
violation.
EMPLOYERS THAT ARE RELATED BUT NOT CONTROLLED

A multiple employer plan may be used when a business relationship or common ownership
exists among participating employers even though they are not part of a controlled group.
In a small plan situation this may occur when two or more businesses have common owners but
not at a level to qualify as a controlled group. Establishing a multiple employer plan rather than
several single employer plans may help control costs by reducing administrative expenses or by
providing a larger pool of money to invest.
EXAMPLE: Jim, Joe and Jeff each own one third of company A and company B making them a
brother-sister controlled group. Jeff also owns 100% of company C. All three companies are in
the same industry and office out of the same location. A multiple employer plan could be
established to cover employees of A, B & C. This would ease administration particularly if
employees work for more than one of the companies.
In larger companies this may occur when a common parent owns two or more companies, but
some of them are owned at a level of less than 80%.
EXAMPLE: Company X owns 90% of company Y and 60% of company Z. Companies X & Y
would be a parent-subsidiary controlled group but company Z would not be for purposes other
than the application of the IRC 415 limit. A multiple employer plan could be established to
cover all three companies. It would also make the application of the combined limit for annual
additions much easier to monitor.
PROFESSIONAL EMPLOYER ORGANIZATIONS (PEO)

Professional employer organization (PEO) is not defined by IRS but is generally deemed to be
an organization that contracts with one or more companies to provide employees through
17

staffing or leasing arrangements. The term PEO often implies that the common law employer
status of the leasing company is questionable.
If leased employees are covered solely by a PEO plan and the PEO is not the common law
employer, the exclusive benefit rule under IRC 401(a)(2) is violated. A multiple employer plan
avoids this issue because the exclusive benefit rule is applied to the plan as a whole rather than
on an employer by employer basis.
Rev. Proc. 2002-21 provided relief from the exclusive benefit violation for PEOs that sponsored
plans as a single employer, provided that they converted the plan to a multiple employer plan
or terminated the plan no later than the end of the plan year that begins on or after January 1,
2003.
EXAMPLE: Dr. Patrick and Dr. Quincy each own 100% of their own medical corporations. Both
doctors have terminated all their employees. PEO, Inc. a professional employer organization
immediately hired those employees and leased them back to Dr. Patricks and Dr. Quincys
corporations. Because Dr. Patrick and Dr. Quincy continue to control the activities and
employment requirements for these individuals, there is some doubt whether they are common
law employees of PEO or of Dr. Patricks and Dr. Quincys corporations.
In order to permit the coverage of the employees in the PEO profit sharing plan, Dr. Patricks
corporation and Dr. Quincys corporation both adopt the PEO profit sharing plan as
participating employers. The PEO plan is, therefore, a multiple employer plan. Because the
doctor corporations are participating employers, there is no possible violation of the exclusive
benefit rule.
TREATMENT OF PLAN PROVISIONS FOR MULTIPLE EMPLOYER PLANS

All employers who participate in a multiple employer plan must be treated as a single employer
when applying these plan requirements:
Eligibility rules under IRC 410(a);
Exclusive benefit under IRC 401(a);
Vesting under IRC 411;
Accrual (may provide reciprocal service recognition);
Excise tax on under-funding under IRC 4971; and
Assets reported and held under one trust but must have a hypothetical asset allocation
among participating employers.
Each employer who participates in a multiple employer plan must be treated as a separate plan
for these plan requirements (i.e., each employer or controlled group of employers is evaluated
separately):
Coverage rules under IRC 410(b);
18

Funding for pension plans under IRC 412; and
Deduction limits under IRC 404(a).
EXAMPLE: ME Corporation sponsors a multiple employer 401(k) plan covering employees of ME
Corporation, P Corporation and Q Corporation, three unrelated employers.
When determining whether the 1-year eligibility requirement has been met, an employees
service with any of the three companies will count. So, Marywho worked from January
through March for ME Corporation, and then from March through December for P
Corporationhas completed a year of service.
Similarly, when calculating Marys vesting, all service with both ME and P Corporations will be
considered.
However, separate coverage tests will be performed for each corporation, based on the
employees that have worked for that corporation during the year. Each corporation must cover
a sufficient number of its employees to separately meet the coverage rules of IRC 410(b).
When the 401(k) ADP/ACP testing is performed, it will be performed separately for each
employer, including only the employees and the contributions attributable to that employer.
DISADVANTAGES
The primary disadvantage to a multiple employer plan is that a failure of one portion of the
plan can result in the disqualification of the plan as a whole. When establishing a multiple
employer plan careful consideration should be given to the ability of each participating
employer to provide the information necessary to ensure that all qualification issues are met in
a timely fashion so as not to jeopardize the whole plan.
Qualified Separate Lines of Business (QSLOBs)

The provisions of IRC 414(r) allow an employer that is not part of an affiliated service group to
divide its business into qualified separate lines of business and then apply the minimum
coverage, minimum participation and nondiscrimination tests separately to the employees of
each of the separate lines of business.
A line of business (LOB) is a portion of the employer that is identified by the property or
services it provides to customers of the employer. A LOB does not have to be a separate legal
entity. A LOB may be a separate division within one company.
19
REQUIREMENTS TO BE A QSLOB UNDER IRC 414(R)

A LOB is a separate line of business (SLOB) if the following four conditions are met:
LOB is a separate organizational unit;
LOB is a separate financial unit;
LOB has a separate employee workforce; and
LOB has separate management.
To demonstrate that an employer maintains a qualified separate line of business (QSLOB) the
following three conditions must be met:
The SLOB must have at least 50 employees on each day of the testing year;
o
Include employees covered under collective bargaining agreements.
Exclude employees who:

Normally work less than 17 hours per week;
Work 6 months or less during a year;
Are under age 21; or
Have not completed 6 months of service.
Employer must notify the IRS that it is operating QSLOBs. (Notification through Form
5310-A.)
The SLOB must satisfy the administrative scrutiny test by either:
o
Satisfying one of six safe harbors:

Statutory safe harbor;
Industry category safe harbor;
Merger and acquisition safe harbor;
FAS 14 (industry segments) safe harbor;
Average benefits safe harbor; or
Minimum/maximum benefits safe harbor;
Or, the employer must receive an individual ruling from the IRS that the SLOB
satisfies the administrative scrutiny test.
QSLOB ALLOCATION PROCEDURES

All employees must be allocated to an appropriate QSLOB. Substantial service employees who
perform at least 75% of services for LOB must be allocated to that LOB. Employer may choose to
treat any employee who performs at least 50% of his or her services for a LOB as a substantial
service employee for that LOB.
20

Residual employees are all employees who are not substantial service employees and are
assigned to a LOB using any one of four methods allowable under QSLOB rules:
Dominant line method allocates all residual employees to one QSLOB designated as the
dominant line of business. Generally the dominant line QSLOB must contain at least
50% of all substantial service employees, although under certain circumstances this
percentage might be lowered to 25%.
Pro rata method allocates residual employees among QSLOBs based on each QSLOBs
share of the total substantial service employee population.
HCE percentage ratio method divides the residual employees pro rata based on the
number of HCEs assigned to each QSLOB.
Small group method only is available if total number of residual employees represents
3% or less of the total number of employees. If small group definition is met, employer
may allocate the small group to any QSLOB provided that after the allocation:
o
The allocation of residual employees is reasonable;
Any QSLOB receiving residual employees satisfies statutory safe harbor

administrative scrutiny test; and
Any QSLOB receiving residual employees has been assigned at least 10% of the
residual employees.
Employees not in QSLOB are excludable employees for that QSLOB.
EFFECT OF QSLOB STATUS ON QUALIFIED PLANS

If a gateway test is met, each QSLOB is tested separately to determine if the plan satisfies
minimum coverage, nondiscrimination and minimum participation rules. (IRS consent required
for minimum participation rules.)
Gateway test is passed if each QSLOB satisfies both the nondiscriminatory classification test on
an employer wide basis with respect to all nonexcludable employees of the controlled group
and also satisfies the nondiscriminatory classification test separately with respect solely to the
employees of the QSLOB.
EXAMPLE: As part of a plan redesign, WALA Co. wants to designate its Washington and
Louisiana locations as QSLOBs. To fulfill the nondiscrimination requirement, each
QSLOB must satisfy the nondiscriminatory classification test under IRC 410(b) on both
an employer wide basis and solely with regard to the employees of the SLOB.
Washington
Below plans minimum age of 21
15 NHCEs
Benefiting HCEs
2
Benefiting NHCEs
51
Total employees in division
68
Louisiana
1 NHCE
7
45
52
Total
16 NHCEs
9
96
121
21
Each SLOB uses the statutory age exclusion of under 21, and all statutorily nonexcludable
employees benefit, so the ratio percentage for each individual SLOB passes at 100% when tested
solely with regard to the employees of the SLOB.
(NHCE 100%/HCE 100%)
It then remains for each SLOB to satisfy the nondiscriminatory classification test on an employer
wide basis.
Washington
Louisiana
Benefiting HCEs
2
7
Benefiting NHCEs
51
45
HCE ratio
2/9 =22.22%
7/9=77.78%
NHCE ratio
51/96=53.13%
45/96=46.88%
Ratio Percentage
53.13/22.22
46.88/77.78
=239.11%
=60.27%
PASS
FAIL
NHCE Concentration
96/105 = 91.43%
Safe Harbor for 91% Concentration
26.75%
Unsafe Harbor for 91% Concentration
20.00%
Midpoint
23.38%
Ratio Percentage vs. Midpoint
239.11>23.38
60.27>23.38
PASS
PASS
Testing year for determination of the SLOB is a calendar year. Employers can rely on five year
moving averages for testing whether lines of business satisfy SLOB requirements provided
there are not large fluctuations in the demographics.
SLOBs provide alternative for testing but are expensive, complex, administratively
burdensome, and may result in inadvertent disqualification if not properly monitored.
Mergers and Acquisitions

The acquisition and disposition of businesses through the sale of stock, sale of assets or by the
merger of two or more companies can impact the operation and provisions of qualified plans
involved in the transactions.
A change in ownership can result in the creation (or elimination) of a controlled group or
affiliated service group. A parent-subsidiary arrangement may be created when one
organization purchases the stock of another company. A brother-sister arrangement can arise
when owners of an organization purchase stock of another entity. Affiliated service groups can
form when several owners from a previously unrelated practice form a partnership.
22

The change may result in a merger or consolidation of plans or the transfer and spin-off of plan
assets. A merger is a consolidation of two or more plans into a single plan. A spin-off involves
the splitting of a plan into two or more plans. A transfer is a direct transfer of assets and
liabilities attributable to one or more participants in one plan to another.
Merger, spin-off and transfer transactions must satisfy the provisions of IRC 414(l). Each
participant must receive benefits on a termination basis from the plan immediately after the
merger, spin-off or transfer equal to or greater than the benefits the participant would receive
on a termination basis immediately before the merger, spin-off or transfer. Termination basis
means the benefits that would be provided exclusively by the plan assets pursuant to ERISA
4044 if the plan terminated. It does not include benefits that are guaranteed by the PBGC but
not provided for by plan assets.
IRC 414(l) does not apply to multiemployer plans, governmental plans under IRC 414(d), or
non-electing church plans under IRC 414(e). It only applies if more than a single plan is
involved and the plan assumes the liabilities or obtains the assets from another plan (merger or
spin-off).
COMPANY ACQUISITIONS AND DISPOSITIONS

When companies are bought and sold, any plans sponsored by the companies must be
examined to determine whether the transaction had any effect on the plans operations. This
process can be very complex.
The most important starting point for this analysis is knowing what type of transaction was
involved in the company sale. There are three types: stock transactions, asset transactions, and
company mergers.
Stock Transactions
An individual or a company may acquire control of another corporation by buying a

significant amount (usually a majority) of the targets stock. In that situation, the
targets structure does not change in any fashion by virtue of the transactionall of the
companys operations, its officers and directors, its contracts with other individuals and
companies, its employees all stay the same. Naturally, if the new owner has control, it
may take action to change the officers and directors once the transaction is complete,
but these changes do not occur automatically by virtue of the transaction itself.
Employees of a company whose stock is purchased by a buyer are still employees of the
same company after the acquisition. The transaction does not cause termination of
employment to occur, although layoffs of employees or plant shutdowns may take
place in connection with the transaction. If the company sponsored a retirement plan
prior to the transaction, the company still sponsors that plan after the transaction.
Again, plan changes may be made after the transaction occurs, but the transaction itself
does not impact the plan. If the target company decides to terminate the plan it should
23
do so prior to the stock transaction, otherwise they could trigger successor plan
problems.
In a stock purchase, the buyer takes on all of the rights and liabilities of the target
corporation. This would include, for instance, the target companys contracts and
receivables, as well as the targets debts and legal liabilities.
These rules apply even when one corporation owns the stock of another corporation.
When one corporation owns another, the owner is called the parent and the company
it owns is called the subsidiary. If the parent sells all of the stock of the subsidiary to
other shareholders, the entire subsidiary corporation belongs to the purchasers.
Regardless of the sale, employees of the subsidiary remain employees of the subsidiary.
Because there is no change in the structure of the company in a stock sale, any plans
that are sponsored by the target company continue to be so sponsored after the
acquisition. If the target company is now part of a controlled or affiliated service group,
those plans must be administered accordingly that is, the plan must meet coverage
and nondiscrimination requirements based on the controlled or affiliated service group.
There is a grace period during which no coverage testing is required but beware other
nondiscrimination testing is still required although there is no regulatory guidance on
how to perform these tests.
The employees of the sold company continue to participate in the plan of target after
the transaction. Furthermore, as employees of a controlled group member, they may be
eligible to participate in the plan sponsored by the new parent. It is important that these
plans be reviewed and amended as necessary to ensure that the employees are
participating in the desired plan once the transaction occurs.
Asset Transactions
Instead of buying the stock of the target, it is common for the buyer to purchase the
target corporations assets. These assets may consist of anything the target has that the
buyer can use: buildings, office equipment, machinery, client lists, copyrights, contracts
for services, accounts receivable, even the customer goodwill associated with the
target corporations name and organization. In addition, the buyer may assume
liabilities of the selling corporation (such as liens or mortgages on the purchased assets
or accounts payable associated with the business). In an asset transaction, the
individuals who owned the stock of the target company continue to own that stockthe
only change is that some or all of the stuff owned by the company is sold to someone
else and the selling company received cash or something else in exchange.
The buyer may want to retain the services of employees of the company that sells assets,
24
particularly in relation to the business interest that was purchased. In that case, it is
possible that those individuals employment will be terminated with the seller and the
buyer will then hire them as new employees. (It is also possible that some of the sellers
employees will simply be terminated and not rehired by the buyer, if their services are
needed by neither company after the transaction.)
Sometimes companies sell all of their assets and liabilities. In that case, after the
transaction, the corporation is just a shell. Usually the only asset remaining after the sale
is the money that the buyer paid for the assets and liabilities. However, even when all
the assets are sold and all liabilities are assumed, the number of shares outstanding and
the control of those shares do not change. The person or entity that owned the stock of
that company prior to the transaction continues to be the owner after the transaction.
Companies often sell all of the assets of a discrete business or division, rather than all of
the assets of the company. For example, a company that produces and publishes books
may sell the division that binds the books. Similarly, a corporation that owns and
operates a chain of hotels may sell one of the hotels to another company. When this
happens, the employees of that division or business are frequently laid off by the seller,
and hired by the buyer.
In an asset purchase, unlike a stock purchase, except for the assets that are sold and
liabilities that are assumed, the selling company retains all of its rights, interests, and
liabilities. This would include contracts, receivables, and other things of value, as well
as liabilities, such as possible lawsuits and the obligations to pay debts. Most
importantly, plans that are sponsored by the company that sells its assets continue to be
maintained by that company, unless the buyer takes affirmative action to adopt the
plans as a successor sponsor. Employees that terminate employment with the seller and
go to work for the buyer are treated exactly like other terminees that is, they are
usually eligible for a distribution from the sellers plan.
Similarly, employees of the target company that become employees of the buyer are
new hires. There is no obligation to credit service with the target company in the plan
sponsored by the buyer. In fact, if the buyer wants to credit that service for eligibility or
vesting purposes, it likely must amend its plan to do so. Furthermore, the individuals
that become employees in connection with the transaction will not be highly
compensated employees in the buyers plan, as they will have had no compensation in
the prior plan year. Of course, if any such individuals are granted or are able to
purchase more than 5% of the stock in the buyers company, they will be highly
compensated employees due to their stock ownership.
25

Company Mergers
Rather than buying and selling shares of stock or assets, companies sometimes decide to
join forces and combine two or more companies into one. This is called a merger.
Mergers may take many forms, and can be very complex transactions. Generally, a
merger causes one company to be absorbed into another (and the stock of that company
is exchanged for stock in the absorbing company), or the two companies are combined
into a new company (and the stock of the two original companies is exchanged for stock
in the new company). Therefore, when a merger occurs, there is some effect on the stock
of the shareholders. However, the shareholders will usually still own part of the
resulting company (although they may be bought out as one of the elements of the
transactionthat is, their old stock gets exchanged for cash, rather than stock in the new
entity).
In the case of a merger, the resulting company (usually called the survivor, even if it
is a brand new company) will own all of the assets of the merged companies. Similarly,
it will also be responsible for all of the liabilities of the merged companies.
Employees in a merger situation become employees of the merged company as part of
the transaction. This happens automatically by operation of law. That is, their prior
employer does not have to lay them off, and the new company does not have to rehire
them. If their employment is terminated in connection with the merger, it is a
termination by one of the disappearing companies prior to the merger, or a termination
by the merged company after the transaction.
Any plans sponsored by any of the merging companies are automatically sponsored by
the survivor after the merger is over. No legal documentation is needed to make this
sponsorship happen it is an automatic result of the legal transaction. This is true even
if the plan is not amended to reflect the new sponsorship. None of the employees of any
of the merging companies will experience a termination of employment or a
distributable event because of the merger itself, although the survivor can certainly
engage in reductions in force following the transaction.
Because all affected individuals become employees of the survivor after the transaction
and the survivor sponsors all plans, it is possible that the make-up of the participants in
each plan may change. It is important that the plans be reviewed before the transaction
to make sure that participation is limited to the proper groups once the merger occurs.
Special Plan Considerations in Sale of Subsidiary
If the stock of a subsidiary of one parent is sold to a new parent, the employees will continue to
work for the same company (i.e., the subsidiary). However, the controlled group to which that
26

company belongs will have changed. This produces some special problems if the subsidiary
was a participating sponsor in the former parents 401(k) plan.
The change of controlled groups by the subsidiary is not considered to be a termination of
employment by the subsidiarys employees, because they continue to work for the same
company. Therefore, there is no distributable event in the parents 401(k) plan with regard to
these employees, even if the subsidiary will cease to be a participating employer in the former
parents 401(k) plan after the transaction.
There is an exception to the distribution limitations under 401(k) that applies in this situation.
The former parents 401(k) plan may pay out the employees of the sold subsidiary if:
The buyer is not related to the former parent;
There is no transfer of plan benefits from the former parents 401(k) plan to the new
parents plan (although rollovers, even direct rollovers, by the participants are
permitted); and
At no time after the sale transaction does the subsidiary participate as an employer in
the former parents plan.
This means that the participation by the subsidiary in its former parents plan must cease before
the transaction occurs. If it does not, the ability to distribute benefits from the former parents
plan to the subsidiarys employees evaporates, and the employees may be paid only when they
terminate employment from the former subsidiary. This requires ongoing coordination between
the former parent and former subsidiary and is administratively difficult.
TRANSITION RULES
Transition rules become effective immediately when entities shift into or out of controlled or
affiliated service group status due to company acquisitions, dispositions, mergers, or other
significant changes in ownership. The transition rules are as follows:
The provisions of IRC 410(b) and 401(a)(26) do not apply after the transaction until
after the end of the plan year beginning after the change, provided the participation and
coverage tests are met in each plan prior to the change and the affected plan is not
significantly altered during the transition period. However, the eligibility provisions of
the plans (including provisions relating to which company within the controlled group
employs eligible individuals) must be applied as written on the date of the transaction.
Amendments of these rules after the transaction will terminate the transition period.
Transition period is defined as the period beginning on the date of the change in
members of a controlled or affiliated service group (or the sale of substantially all of the
assets of the company) and ending on the last day of the first plan year beginning after
the date of the change.
The tests for determining Separate Lines of Business are granted same relief timing as
those for participation and coverage.
27

Plans that were not aggregated as of the first day of a plan year are not considered to violate
IRC 415 if they become required to aggregate during the year and the aggregation results in a
total allocation to a participant in excess of the IRC 415 limitations. This exception applies only
if there is no further increase in accrued benefits resulting from employer contributions after the
change.
EXAMPLE: A participant accrues an allocation of $40,000 in Corp. As plan and $20,000 in Corp.
Bs plan during the first 10 months of 2013. Both plans have a calendar plan year. Effective
November 1, 2013, Corp. A and Corp. B become part of a controlled group, and their plans are
subject to aggregation under IRC 415. Even though the total allocation to the participant in the
two plans would exceed the IRC 415 limit of $51,000 for 2013, no violation is considered to
occur so long as the participant receives no further allocations in 2013.
PLAN MERGERS
Merger of Defined Contribution Plans
The sum of the account balances in each plan equals the fair market value (determined as the
date of the merger) of the merged plan assets. The assets of each plan are combined to form the
assets of the merged plan. Immediately after the merger, each participant in the plan has an
account balance equal to the sum of the account balances the participant had in the plans
immediately prior to the merger.
Merger of Defined Benefit Plans
Compare benefits on a termination basis both before and after the merger. If the sum of all
assets of all plans is not less than the sum of the present value of accrued benefits (whether or
not vested), then IRC 414(l) satisfied by combining assets and preserving accrued benefits. If
the sum of the assets of all plans is less than the sum of the present value of accrued benefits
(whether or not vested) then the accrued benefits in the plan as merged cannot be provided on a
termination basis. The merged plan must maintain a special schedule of benefits in accordance
with a modified application of ERISA 4044.
If a smaller plan whose liabilities (present value of accrued benefits) are less than 3% of the
assets of another larger plan (as of at least one day in the larger plans plan year in which the
merger occurs) is merged with the larger plan, IRC 414(l) will be satisfied if a special schedule
of benefits for the participants of the smaller plan are payable in a higher priority than the
highest priority per ERISA 4044.
PLAN SPIN-OFFS
Spin-off of a Defined Contribution Plan
The sum of the account balances for each of the participants in the resulting plan is equal to the
account balance of the participant in the plan before the spin-off. The assets in each of the plans
immediately after the spin-off equal the sum of the account balances for all participants in that
plan.
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Spin-off of a Defined Benefit Plan
All the accrued benefits of each participant are allocated only to one of the plans that have been
spun off. The value of the assets allocated to each of the spin-off plans is not less than the sum
of the present value of the benefits on a termination basis in the plan before the spin-off for all
participants in that spin-off plan.
Certain Spin-off Plans are not Taken into Account for IRC 414(l):
Plans transferred outside of a related group;
Plans transferred outside of a multiple employer plan; and
Terminated plans.
The transfer of assets or liabilities will be considered a combination of separate mergers and
spin-offs.
Protected Benefits
BENEFITS THAT ARE PROTECTED
Protected benefits under IRC 411(d)(6) include the following:
Accrued benefits;
Early retirement benefits and retirement subsidies;
Certain optional forms of benefit including:
o
Payment schedule;
Timing;
Commencement;
Medium of distribution;
The portion of the benefit to which such distribution features apply; and
Election rights regarding the optional forms.
If all merged plans are profit sharing plans, optional benefit forms may be eliminated so long as
a lump-sum distribution is permitted at the time that the other form was to begin payments.
BENEFITS THAT CAN BE REMOVED

Benefits not protected under IRC 411(d)(6) include:
Loans;
Right to make after-tax employee contributions or elective deferrals;
Right to direct investments;
Right to a particular form of investment.
Certain optional forms of distribution
29

o
In a DC plan not subject to J&S, only the lump sum is protected. All other
distribution forms can be eliminated.
In a DB plan, the normal form is protected. Optional forms may be eliminated

if they can be defined as redundant or non-core. If the plan has multiple
uniform Joint & Survivor benefits, these options can be eliminated as long as the
highest and lowest options are preserved.
Plan Terminations
PARTIAL PLAN TERMINATIONS
When a group of participants is involuntarily eliminated from the plan, a partial termination
occurs if the reduction in participants is significant. The IRS has focused on the percentage of
participants, not the number of participants, eliminated from the plan to determine if the
reduction is significant. The IRS provides that a turnover rate of at least 20% of the participants
creates a rebuttable presumption that a partial termination has occurred. See Rev. Rul. 2007-43.
The turnover rate is determined by (1) dividing the number of participating employees who
had an employer-initiated severance from employment during the applicable period by (2) the
sum of all of the participating employees as of the start of the applicable period and the
employees who became participants during the applicable period (generally the plan year). The
applicable period depends on the circumstances: the applicable period is a plan year (or, in the
case of a plan year that is less than 12 months, the plan year plus the immediately preceding
plan year) or a longer period if there are a series of related severances from employment.
An employer-initiated termination is any involuntary termination other than death, disability,
or retirement on or after normal retirement age, even if it is caused by reasons outside of the
employer's control (e.g., depressed economic conditions). No exception is provided for
terminations due to good cause. Presumably the IRS will recognize a firing for cause as a
relevant factor to determine if the employer has rebutted the presumption of a partial
termination, even though the employer has few or no involuntary terminations during its
operating history.
The IRS provides in Rev. Rul. 2007-43 that an employer can support a claim that a termination
was voluntary through items such as information from personnel files, employee statements,
and other corporate records. This confirms that voluntary terminations are disregarded, but
only if the employer can support a determination that the termination is in fact voluntary. This
approach also is consist with IRS audit guidelines published in Announcement 94-101, where
the IRS noted that it presumes all terminations are involuntary unless the employer shows
otherwise.
Turnover for an applicable period that is routine for the employer favors a finding that there is
no partial termination for the applicable period. Relevant factors would include: (1) information
as to the turnover rate in other periods and the extent to which terminated employees were
30

replaced, and (2) whether the new employees perform the same job functions, had the same job
classification, or title, and received comparable compensation.
Small plans have a disadvantage when significance of reduction is based on percentages. For a
small participant population, a significant percentage reduction can result with only a small
number of participants being eliminated from the plan.
EXAMPLE: Suppose a small closely-held business with 6 employees terminates 2 of them during
the plan year. The involuntary reduction is 33%, triggering a rebuttable presumption that a
partial termination has occurred. However, if the 2 terminations are voluntary, then there is no
partial termination because the terminations are not employer-initiated. In addition, a firing for
cause should be a relevant factor in assessing whether the presumption of partial termination
has been rebutted, and possibly given more weight in smaller employer settings where there is
very little margin with respect to turnover rates.
A band around 20% exists for purposes of the determining the range in which a contrary result
can be determined on the basis of the facts and circumstances. That band is from 10% to 40%
reduction. From 10% to 20%, the presumption is that there is no partial termination. From 20%
to 40%, the presumption is that there is a partial termination. Below 10%, the reduction in
coverage should be conclusively presumed not to be a partial termination. Above 40%, the
reduction in coverage should be conclusively presumed to be a partial termination.
FULL PLAN TERMINATIONS

A plan is terminated when it is amended to terminate and it is the intention of the plan sponsor
and administrator that all assets will be distributed to participants as soon as administratively
feasible. If the distribution is not to occur for an extended period of time, the plan is merely
frozen, and not terminated. Distributions that occur within twelve months of the termination
are considered to be as soon as administratively feasible although PBGC covered DB plans may
be subject to different timing requirements.
Generally, all participants must be fully vested upon plan termination. These rules apply to
anyone who has funds in the plan, although individuals who have incurred five one-year
breaks in service (so that the forfeiture of their nonforfeitable interest is irrevocable under IRC
411 rules) do not need to be provided with full vesting. Participants who have taken
distribution prior to the termination (and whose nonvested accounts have been forfeited as a
result of the distribution, despite the fact that they have no breaks-in-service), generally do not
need to be provided with full vesting. If the plan allows for deemed distributions of 0% vested
participants upon termination of employment, these 0% vested terminated participants also do
not need to be provided with full vesting.
A plan sponsor may elect to obtain a favorable determination letter on the termination of the
plan. This, most importantly, will confirm that all plan documentation is up to date (which is
required of terminated plans), or will provide a remedial amendment period in which the
documentation can be updated. The IRS will also review certain operational aspects of the
31

termination, such as which employees are entitled to full vesting. The submission of the plan for
a favorable determination is made on Form 5310, and these submissions are given priority
review, even if they are off-cycle under the 5- or 6-year submission periods.
PBGC-covered defined benefit plans must undergo special termination review processes. A
special notice must be provided to plan participants, and a filing with the PBGC is required.
Furthermore, if a defined benefit plans assets are not sufficient to cover all accrued benefits, it is
possible under the PBGC rules that the plan may not terminate until the assets become
sufficient. An exception to this limitation applies if the company is in bankruptcy or
reorganization procedures or if the PBGC initiates the termination due to concern that its
liability will increase if the plan is permitted to continue. PBGC also recognizes a waiver by a
substantial owner of benefits to allow employees to be paid out in full first and the owner to
receive the remaining amounts in the plan.
Beware, any defined benefit plan that does not have an Adjusted Funding Target Attainment
Percentage (AFTAP) certification of at least 80% is not able to pay lump-sum distributions or
purchase annuities. These plans are not legally able to terminate, even if the substantial owner
waives their benefits. IRS currently suggests applying for a favorable determination letter on
these plans to determine how the plan termination should proceed.
ASSET REVERSION UPON PLAN TERMINATION

As a general rule unallocated assets in a defined contribution may only be returned to the
employer when 415 limits prevent such unallocated assets from being allocated to plan
participants and the plan terminates. The plan may provide for the reversion of assets to the
employer upon termination of the plan of assets held in the plans 415 suspense account (Reg.
1.401(a)-2).
When a defined benefit plan holds assets in excess of what is needed to satisfy benefit liabilities
an opportunity arises for a reversion of plan assets to the plans sponsor upon the termination
of the plan. All or part of the surplus or excess assets might be used to increase benefits under
the plan, or part or all of the excess assets may revert to the plan sponsor.
Plan document provisions must specify how excess assets are treated in the event of plan
termination and have been in effect for at least five years. If provisions were not in place for five
years or plan document does not address excess assets upon plan terminations, excess assets
must be distributed to participants in nondiscriminatory manner.
If plan document allows reversion to plan sponsor, amount of assets reverting is subject to
income taxes and a nondeductible 50% excise tax on the gross amount of the reversion. (Taxexempt and governmental plan sponsors are not subject to the excise tax.) The 50% excise tax
upon reversion of assets may be reduced to 20% under either of the following two situations:
Plan sponsor is in Chapter 7 bankruptcy liquidation or similar court proceeding on plan
termination date; or
32

Plan sponsor establishes or maintains a qualified replacement plan or part of the excess
assets is used to provide benefit increases to participants in the terminating defined
benefit plan.
The qualified replacement plan must satisfy the following three requirements:
The replacement plan must cover as active participants at least 95% of active
participants in the terminated plan who remain employed by plan sponsor after plan
termination;
Before any assets revert to the plan sponsor, a direct transfer of assets must be made
from the terminated plan to the replacement plan. Transfer amount should equal at least
25% of the maximum amount the plan sponsor could receive as a reversion; and
If the qualified replacement plan is a defined contribution plan, the amount transferred
must be either allocated to participant accounts in the year of the transfer or held in
suspense account and allocated to participants over a period not to exceed seven years.
Interest earned on the assets in the suspense account is allocated along with the
transferred assets. Alternately, amounts in the suspense account can be used to pay
reasonable administrative expenses.
EXAMPLE: The ABC Defined Benefit Plan is terminating. The total assets in the plan equal
$1,000,000, but the total benefits earned by the participants equal $750,000. Therefore, the plan
has $250,000 of excess assets.
If the plan so provides, the excess assets may revert to the corporation. If that occurs, they will
be subject to income tax plus a 50% nondeductible excise tax.
Instead, ABC Corporation decides to transfer 25% of the excess assets, $62,500, to a profit
sharing plan that it sponsors for its employees. The $62,500 will be allocated in that plan over
the next seven or fewer years as nonelective profit sharing contributions.
The remaining reversion, $187,500, is now subject to income taxes and a 20% excise tax.
More than 25% of the excess assets can be transferred to the qualified replacement plan. The
20% excise tax would apply only to the amounts reverting to the plan sponsor. No corporate
deduction is allowed for the transferred amounts, and the transferred amounts will not be
subject to corporate tax.
EXAMPLE: ABC Corporation (from the prior example) decides to transfer $200,000 of the excess
assets to the profit sharing plan. Only the remaining $50,000 is subject to income tax and the
20% excise tax. The transferred amount must be allocated as nonelective contributions to
participants in the profit sharing plan over no more than seven plan years.
If benefit increases are given to participants in the terminating defined benefit plan in addition to
establishing or maintaining a qualified replacement plan, the 25% amount required to be
33

transferred directly to the qualified replacement plan is reduced by the aggregate amount of the
benefit increases provided that the amendment providing for the benefit increases under the
terminating defined benefit plan is adopted within the 60-day period ending on the plan
termination date, and the amendment is immediately effective.
EXAMPLE: If the terminating defined benefit plan is amended no earlier than 60 days before the
plan termination date to provide immediate increases in benefits that have an aggregate present
value of 10% of the excess assets, then only 15% of the excess assets are required to be
transferred directly to the qualified replacement plan to allow for a 20% excise tax on the
remaining excess assets that revert to the plan sponsor.
If benefits increases are given to participants in the terminating defined benefit instead of using a
qualified replacement plan to reduce the excise tax on assets reverting to the plan sponsor from
50% to 20%, then:
Aggregate present value of the increases must not be less than 20% of the maximum
reversion amount;
Allocation of excess assets (benefit increases) cannot discriminate in favor of highly
compensated employees; and
Plan amendment to allow for benefit increases must have effective date of plan
termination date; that is, be immediately effective.
Abandoned Plans
PROCEDURE FOR CLOSING AN ABANDONED PLAN
Abandoned or orphan plans are those:
To which no contributions have been deposited nor from which no distributions have
been made for a period of at least 12 consecutive months; or
With regard to which other facts and circumstances are present (such as the bankruptcy
of the plan sponsor) to suggest that the plan is or may become abandoned by its
sponsor.
When an abandoned plan exists, it is likely that no one is taking responsibility for its
administration, and no one is authorized to take action with regard to the plan to maintain its
qualification or to distribute benefits.
The DOL issued three final regulations (29 CFR Parts 2520, 2550, and 2578).
Termination of Abandoned Individual Account Plans; Final Rule) on April 21, 2006 to enable a
practitioner, called a qualified termination administrator (QTA), to take the action necessary to
terminate and distribute benefits from an abandoned plan. A QTA is someone who is:
Qualified to serve as a trustee or issuer of an individual retirement plan under the IRC;
and
34

Holds the assets of the plan that is considered to be abandoned.
The QTA could also be an affiliate of one of those types of entities, such as a person directly or
indirectly controlling, controlled by, or under common control with such entities, or any officer,
director, partner, or employee of that person. In other words, a QTA generally must be a
financial institution or an affiliate of such an institution.
Under the DOL procedures, the QTA must make reasonable efforts to locate or communicate
with the plan sponsor and determine after those efforts are taken that the sponsor no longer
exists, cannot be located, or is unable to maintain the plan. These efforts must include, at least,
sending a certified letter (or other communication requiring acknowledgement of receipt) to the
sponsors last known address and to the person designated as the sponsors agent for service of
legal process (if the sponsor is a corporation). The communication is required to have certain
elements, including:
The plan name;
The name and address of the QTA;
The account number or other identification information for the plan;
A statement that the plan may be terminated if the plan sponsor fails to contact the QTA
within 30 days;
The name, address, and telephone number of who the sponsor must contact;
A statement that, if the plan is terminated, notice of the termination will be provided to
EBSA;
A statement that, The US Department of Labor requires that you be informed that, as a
fiduciary or plan administrator or both, you may be personally liable for costs, civil
penalties, excise taxes, etc. as a result of your acts or omissions with respect to this plan.
The termination of this plan will not relieve you of your liability for any such costs,
penalties, taxes, etc.; and
A statement that the plan sponsor may contact the DOL for more information about the
federal law governing the termination and winding-up process for abandoned plans and
the telephone number of the appropriate EBSA contact person.
More information on ERISA Regulation 2578.1 Termination of abandoned individual account
plans can be found at http://www.dol.gov/ebsa/regs/fedreg/final/2006003814.pdf.
The QTA must also furnish the DOL with a notice of plan abandonment. This must be signed by
the QTA and contain additional information identifying the plan, confirming that the sender
qualifies as a QTA, advising the DOL that the QTA has determined the plan to be abandoned,
and acknowledging the QTAs election to terminate and wind up the plan. Other items that
must be disclosed in this notice include the number of participants, plan asset information, and
information about the other service providers to the plan.
35

The QTA is then responsible for winding up the plan. This includes updating the plan records,
calculating benefits, allocating expenses and unallocated assets, notifying participants, and
paying the benefits. The QTA may also engage the services of other service providers as
necessary, and may pay their reasonable fees from the plan. The QTA procedures also include a
prohibited transaction exemption that permits the QTA to pay its own reasonable fees from the
plan.
The plan wind-up may happen if 90 days passes after the DOL has acknowledged receipt of the
request and the DOL has not, in the interim, either objected to the appointment of the entity as
the QTA or waived the 90-day period and authorized the QTA to go forward. The plan would
then be deemed to be terminated, and the QTA make begin taking the actions needed to
determine and distribute the benefits.
Not later than the end of the second month following the month in which the plan is terminated
and paid out, the QTA must file a Special Terminal Report for Abandoned Plans with the DOL.
The liability of the QTA that undergoes this procedure properly will be limited so long as the
QTA acts prudently in its activities, including the selection and monitoring of other service
providers or the selection of annuity providers in the wind-up process.
36
Rev. Rul. 87-41

1987-1 C.B. 296.
Internal Revenue Service
Revenue Ruling
EMPLOYMENT STATUS UNDER SECTION 530(D) OF THE REVENUE ACT OF 1978
Published: 1987
Section 3121.-Definitions, 26 CFR 31.3121(d)-1: Who are employees.
(Also Sections 3306, 3401; 31.3306(i)-1, 31.3401(c)-1.)
Employment status under section 530(d) of the Revenue Act of 1978. Guidelines are set forth for
determining the employment status of a taxpayer (technical service specialist) affected by
section 530(d) of the Revenue Act of 1978, as added by section 1706 of the Tax Reform Act of
1986. The specialists are to be classified as employees under generally applicable common law
standards.
ISSUE
In the situations described below, are the individuals employees under the common law rules
for purposes of the Federal Insurance Contributions Act (FICA), the Federal Unemployment
Tax Act (FUTA), and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24
respectively, subtitle C, Internal Revenue Code)? These situations illustrate the application of
section 530(d) of the Revenue Act of 1978, 1978-3 (Vol. 1) C.B. xi, 119 (the 1978 Act), which was
added by section 1706(a) of the Tax Reform Act of 1986, 1986-3 (Vol. 1) C.B. ___ (the 1986 Act)
(generally effective for services performed and remuneration paid after December 31, 1986).
FACTS
In each factual situation, an individual worker (Individual), pursuant to an arrangement
between one person (Firm) and another person (Client), provides services for the Client as an
engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled
worker engaged in a similar line of work.
SITUATION 1
The Firm is engaged in the business of providing temporary technical services to its clients. The
Firm maintains a roster of workers who are available to provide technical services to
prospective clients. The Firm does not train the workers but determines the services that the
workers are qualified to perform based on information submitted by the workers.
37

The Firm has entered into a contract with the Client. The contract states that the Firm is to
provide the Client with workers to perform computer programming services meeting specified
qualifications for a particular project. The Individual, a computer programmer, enters into a
contract with the Firm to perform services as a computer programmer for the Clients project,
which is expected to last less than one year. The Individual is one of several programmers
provided by the Firm to the Client. The Individual has not been an employee of or performed
services for the Client (or any predecessor or affiliated corporation of the Client) at any time
preceding the time at which the Individual begins performing services for the Client. Also, the
Individual has not been an employee of or performed services for or on behalf of the Firm at
any time preceding the time at which the Individual begins performing services for the Client.
The Individuals contract with the Firm states that the Individual is an independent contractor
with respect to services performed on behalf of the Firm for the Client.
The Individual and the other programmers perform the services under the Firms contract with
the Client. During the time the Individual is performing services for the Client, even though the
Individual retains the right to perform services for other persons, substantially all of the
Individuals working time is devoted to performing services for the Client. A significant portion
of the services are performed on the Clients premises. The individual reports to the Firm by
accounting for time worked and describing the progress of the work. The Firm pays the
Individual and regularly charges the Client for the services performed by the Individual. The
Firm generally does not pay individuals who perform services for the Client unless the Firm
provided such individuals to the Client.
The work of the Individual and other programmers is regularly reviewed by the Firm. The
review is based primarily on reports by the Client about the performance of these workers.
Under the contract between the Individual and the Firm, the Firm may terminate its
relationship with the Individual if the review shows that he or she is failing to perform the
services contracted for by the Client. Also, the Firm will replace the Individual with another
worker if the Individuals services are unacceptable to the Client. In such a case, however, the
Individual will nevertheless receive his or her hourly pay for the work completed.
Finally, under the contract between the Individual and the Firm, the Individual is prohibited
from performing services directly for the Client and, under the contract between the Firm and
the Client, the Client is prohibited from receiving services from the Individual for a period of
three months following the termination or services by the Individual for the Client on behalf of
the Firm.
SITUATION 2
The Firm is a technical services firm that supplies clients with technical personnel. The Client
requires the services of a systems analyst to complete a project and contacts the Firm to obtain
such an analyst. The Firm maintains a roster of analysts and refers such an analyst, the
Individual, to the Client. The Individual is not restricted by the Client or the Firm from
providing services to the general public while performing services for the Client and in fact
does perform substantial services for other persons during the period the Individual is working
38

for the Client. Neither the Firm nor the Client has priority on the services of the Individual. The
Individual does not report, directly or indirectly, to the Firm after the beginning of the
assignment to the Client concerning (1) hours worked by the Individual, (2) progress on the job,
or (3) expenses incurred by the Individual in performing services for the Client. No reports
(including reports of time worked or progress on the job) made by the Individual to the Client
are provided by the Client to the Firm.
If the Individual ceases providing services for the Client prior to completion of the project or if
the Individuals work product is otherwise unsatisfactory, the Client may seek damages from
the Individual. However, in such circumstances, the Client may not seek damages from the
Firm, and the Firm is not required to replace the Individual. The Firm may not terminate the
services of the Individual while he or she is performing services for the Client and may not
otherwise affect the relationship between the Client and the Individual. Neither the Individual
nor the Client is prohibited for any period after termination of the Individuals services on this
job from contracting directly with the other. For referring the Individual to the Client, the Firm
receives a flat fee that is fixed prior to the Individuals commencement of services for the Client
and is unrelated to the number of hours and quality of work performed by the Individual. The
Individual is not paid by the Firm either directly or indirectly. No payment made by the Client
to the Individual reduces the amount of the fee that the Client is otherwise required to pay the
Firm. The Individual is performing services that can be accomplished without the Individuals
receiving direction or control as to hours, place of work, sequence, or details of work.
SITUATION 3
The Firm, a company engaged in furnishing client firms with technical personnel, is contacted
by the Client, who is in need of the services of a drafter for a particular project, which is
expected to last less than one year. The Firm recruits the Individual to perform the drafting
services for the Client. The Individual performs substantially all of the services for the Client at
the office of the Client, using materials and equipment of the Client. The services are performed
under the supervision of employees of the Client. The Individual reports to the Client on a
regular basis. The Individual is paid by the Firm based on the number of hours the Individual
has worked for the Client, as reported to the Firm by the Client or as reported by the Individual
and confirmed by the Client. The Firm has no obligation to pay the Individual if the Firm does
not receive payment for the Individuals services from the Client. For recruiting the Individual
for the Client, the Firm receives a flat fee that is fixed prior to the Individuals commencement
of services for the Client and is unrelated to the number of hours and quality of work
performed by the Individual. However, the Firm does receive a reasonable fee for performing
the payroll function. The Firm may not direct the work of the Individual and has no
responsibility for the work performed by the Individual. The Firm may not terminate the
services of the Individual. The Client may terminate the services of the Individual without
liability to either the Individual or the Firm. The Individual is permitted to work for another
firm while performing services for the Client, but does in fact work for the Client on a
substantially full-time basis.
39
LAW AND ANALYSIS

This ruling provides guidance concerning the factors that are used to determine whether an
employment relationship exists between the Individual and the Firm for federal employment
tax purposes and applies those factors to the given factual situations to determine whether the
Individual is an employee of the Firm for such purposes. The ruling does not reach any
conclusions concerning whether an employment relationship for federal employment tax
purposes exists between the Individual and the Client in any of the factual situations.
Analysis of the preceding three fact situations requires an examination of the common law rules
for determining whether the Individual is an employee with respect to either the Firm or the
Client, a determination of whether the Firm or the Client qualifies for employment tax relief
under section 530(a) of the 1978 Act, and a determination of whether any such relief is denied
the Firm under section 530(d) of the 1978 Act (added by Section 1706 of the 1986 Act).
An individual is an employee for federal employment tax purposes if the individual has the
status of an employee under the usual common law rules applicable in determining the
employer-employee relationship. Guides for determining that status are found in the following
three substantially similar sections of the Employment Tax Regulations: sections 31.3121(d)-1(c);
31.3306(i)-1; and 31.3401(c)-1.
These sections provide that generally the relationship of employer and employee exists when
the person or persons for whom the services are performed have the right to control and direct
the individual who performs the services, not only as to the result to be accomplished by the
work but also as to the details and means by which that result is accomplished. That is, an
employee is subject to the will and control of the employer not only as to what shall be done but
as to how it shall be done. In this connection, it is not necessary that the employer actually
direct or control the manner in which the services are performed; it is sufficient if the employer
has the right to do so.
Conversely, these sections provide, in part, that individuals (such as physicians, lawyers,
dentists, contractors, and subcontractors) who follow an independent trade, business, or
profession, in which they offer their services to the public, generally are not employees.
Finally, if the relationship of employer and employee exists, the designation or description of
the relationship by the parties as anything other than that of employer and employee is
immaterial. Thus, if such a relationship exists, it is of no consequence that the employee is
designated as a partner, co-adventurer, agent, independent contractor, or the like.
As an aid to determining whether an individual is an employee under the common law rules,
twenty factors or elements have been identified as indicating whether sufficient control is
present to establish an employer-employee relationship. The twenty factors have been
developed based on an examination of cases and rulings considering whether an individual is
an employee. The degree of importance of each factor varies depending on the occupation and
the factual context in which the services are performed. The twenty factors are designed only as
40

guides for determining whether an individual is an employee; special scrutiny is required in
applying the twenty factors to assure that formalistic aspects of an arrangement designed to
achieve a particular status do not obscure the substance of the arrangement (that is, whether the
person or persons for whom the services are performed exercise sufficient control over the
individual for the individual to be classified as an employee). The twenty factors are described
below:
1. INSTRUCTIONS. A worker who is required to comply with other persons instructions
about when, where, and how he or she is to work is ordinarily an employee. This control factor
is present if the person or persons for whom the services are performed have the RIGHT to
require compliance with instructions. See, for example, Rev. Rul. 68-598, 1968-2 C.B. 464, and
Rev. Rul. 66-381, 1966.2 C.B. 449.
2. TRAINING. Training a worker by requiring an experienced employee to work with the
worker, by corresponding with the worker, by requiring the worker to attend meetings, or by
using other methods, indicates that the person or persons for whom the services are performed
want the services performed in a particular method or manner. See Rev. Rul. 70-630, 1970-2 C.B.
229.
3. INTEGRATION. Integration of the workers services into the business operations generally
shows that the worker is subject to direction and control. When the success or continuation of a
business depends to an appreciable degree upon the performance of certain services, the
workers who perform those services must necessarily be subject to a certain amount of control
by the owner of the business. See United States v. Silk, 331 U.S. 704 (1947), 1947-2 C.B. 167.
4. SERVICES RENDERED PERSONALLY. If the Services must be rendered personally,
presumably the person or persons for whom the services are performed are interested in the
methods used to accomplish the work as well as in the results. See Rev. Rul. 55-695, 1955-2 C.B.
410.
5. HIRING, SUPERVISING, AND PAYING ASSISTANTS. If the person or persons for whom
the services are performed hire, supervise, and pay assistants, that factor generally shows
control over the workers on the job. However, if one worker hires, supervises, and pays the
other assistants pursuant to a contract under which the worker agrees to provide materials and
labor and under which the worker is responsible only for the attainment of a result, this factor
indicates an independent contractor status. Compare Rev. Rul. 63-115, 1963-1 C.B. 178, with
Rev. Rul. 55-593 1955-2 C.B. 610.
6. CONTINUING RELATIONSHIP. A continuing relationship between the worker and the
person or persons for whom the services are performed indicates than an employer-employee
relationship exists. A continuing relationship may exist where work is performed at frequently
recurring although irregular intervals. See United States v. Silk.
41

7. SET HOURS OF WORK. The establishment of set hours of work by the person or persons for
whom the services are performed is a factor indicating control. See Rev. Rul. 73-591, 1973-2 C.B.
337.
8. FULL TIME REQUIRED. If the worker must devote substantially full time to the business of
the person or persons for whom the services are performed, such person or persons have
control over the amount of time the worker spends working and impliedly restrict the worker
from doing other gainful work. An independent contractor on the other hand, is free to work
when and for whom he or she chooses. See Rev. Rul. 56-694, 1956-2 C.B. 694.
9. DOING WORK ON EMPLOYERS PREMISES. If the work is performed on the premises of
the person or persons for whom the services are performed, that factor suggests control over the
worker, especially if the work could be done elsewhere. Rev. Rul. 56-660, 1956-2 C.B. 693. Work
done off the premises of the person or persons receiving the services, such as at the office of the
worker, indicates some freedom from control. However, this fact by itself does not mean that
the worker is not an employee. The importance of this factor depends on the nature of the
service involved and the extent to which an employer generally would require that employees
perform such services on the employers premises. Control over the place of work is indicated
when the person or persons for whom the services are performed have the right to compel the
worker to travel a designated route, to canvass a territory within a certain time, or to work at
specific places as required. See Rev. Rul. 56-694.
10. ORDER OF SEQUENCE SET. If a worker must perform services in the order or sequence
set by the person or persons for whom the services are performed, that factor shows that the
worker is not free to follow the workers own pattern of work but must follow the established
routines and schedules of the person or persons for whom the services are performed. Often,
because of the nature of an occupation, the person or persons for whom the services are
performed do not set the order of the services or set the order infrequently. It is sufficient to
show control, however, if such person or persons retain the right to do so. See Rev. Rul. 56-694.
11. ORAL OR WRITTEN REPORTS. A requirement that the worker submit regular or written
reports to the person or persons for whom the services are performed indicates a degree of
control. See Rev. Rul. 70-309, 1970-1 C.B. 199, and Rev. Rul. 68-248, 1968-1 C.B. 431.
12. PAYMENT BY HOUR, WEEK, MONTH. Payment by the hour, week, or month generally
points to an employer-employee relationship, provided that this method of payment is not just
a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the
job or on straight commission generally indicates that the worker is an independent
contractor. See Rev. Rul. 74-389, 1974-2 C.B. 330.
13. PAYMENT OF BUSINESS AND/OR TRAVELING EXPENSES. If the person or persons for
whom the services are performed ordinarily pay the workers business and/or traveling
expenses, the worker is ordinarily an employee. An employer, to be able to control expenses,
42

generally retains the right to regulate and direct the workers business activities. See Rev. Rul.
55-144, 1955-1 C.B. 483.
14. FURNISHING OF TOOLS AND MATERIALS. The fact that the person or persons for
whom the services are performed furnish significant tools, materials, and other equipment
tends to show the existence of an employer-employee relationship. See Rev. Rul. 71-524, 1971-2
C.B. 346.
15. SIGNIFICANT INVESTMENT. If the worker invests in facilities that are used by the
worker in performing services and are not typically maintained by employees (such as the
maintenance of an office rented at fair value from an unrelated party), that factor tends to
indicate that the worker is an independent contractor. On the other hand, lack of investment in
facilities indicates dependence on the person or persons for whom the services are performed
for such facilities and, accordingly, the existence of an employer-employee relationship. See
Rev. Rul. 71-524. Special scrutiny is required with respect to certain types of facilities, such as
home offices.
16. REALIZATION OF PROFIT OR LOSS. A worker who can realize a profit or suffer a loss as
a result of the workers services (in addition to the profit or loss ordinarily realized by
employees) is generally an independent contractor, but the worker who cannot is an employee.
See Rev. Rul. 70-309. For example, if the worker is subject to a real risk of economic loss due to
significant investments or a bona fide liability for expenses, such as salary payments to
unrelated employees, that factor indicates that the worker is an independent contractor. The
risk that a worker will not receive payment for his or her services, however, is common to both
independent contractors and employees and thus does not constitute a sufficient economic risk
to support treatment as an independent contractor.
17. WORKING FOR MORE THAN ONE FIRM AT A TIME. If a worker performs more than
de minimis services for a multiple of unrelated persons or firms at the same time, that factor
generally indicates that the worker is an independent contractor. See Rev. Rul. 70-572, 1970-2
C.B.221. However, a worker who performs services for more than one person may be an
employee of each of the persons, especially where such persons are part of the same service
arrangement.
18. MAKING SERVICE AVAILABLE TO GENERAL PUBLIC. The fact that a worker makes
his or her services available to the general public on a regular and consistent basis indicates an
independent contractor relationship. See Rev. Rul. 56-660.
19. RIGHT TO DISCHARGE. The right to discharge a worker is a factor indicating that the
worker is an employee and the person possessing the right is an employer. An employer
exercises control through the threat of dismissal, which causes the worker to obey the
employers instructions. An independent contractor, on the other hand, cannot be fired so long
as the independent contractor produces a result that meets the contract specifications. Rev. Rul.
75-41, 1975-1 C.B. 323.
43

20. RIGHT TO TERMINATE. If the worker has the right to end his or her relationship with the
person for whom the services are performed at any time he or she wishes without incurring
liability, that factor indicates an employer-employee relationship. See Rev. Rul. 70-309.
Rev. Rul. 75-41 considers the employment tax status of individuals performing services for a
physicians professional service corporation. The corporation is in the business of providing a
variety of services to professional people and firms (subscribers), including the services of
secretaries, nurses, dental hygienists, and other similarly trained personnel. The individuals
who are to perform the services are recruited by the corporation, paid by the corporation,
assigned to jobs, and provided with employee benefits by the corporation. Individuals who
enter into contracts with the corporation agree they will not contract directly with any
subscriber to which they are assigned for at least three months after cessation of their contracts
with the corporation. The corporation assigns the individual to the subscriber to work on the
subscribers premises with the subscribers equipment. Subscribers have the right to require that
an individual furnished by the corporation cease providing services to them, and they have the
further right to have such individual replaced by the corporation within a reasonable period of
time, but the subscribers have no right to affect the contract between the individual and the
corporation. The corporation retains the right to discharge the individuals at any time. Rev. Rul.
75-41 concludes that the individuals are employees of the corporation for federal employment
tax purposes.
Rev. Rul. 70-309 considers the employment tax status of certain individuals who perform
services as oil well pumpers for a corporation under contracts that characterize such individuals
as independent contactors. Even though the pumpers perform their services away from the
headquarters of the corporation and are not given day-to-day directions and instructions, the
ruling concludes that the pumpers are employees of the corporation because the pumpers
perform their services pursuant to an arrangement that gives the corporation the right to
exercise whatever control is necessary to assure proper performance of the services; the
pumpers services are both necessary and incident to the business conducted by the
corporation; and the pumpers are not engaged in an independent enterprise in which they
assume the usual business risks, but rather work in the course of the corporations trade or
business. See also Rev. Rul. 70-630, 1970-2 C.B. 229, which considers the employment tax status
of sales clerks furnished by an employee service company to a retail store to perform temporary
services for the store.
Section 530(a) of the 1978 Act, as amended by section 269(c) of the Tax Equity and Fiscal
Responsibility Act of 1982, 1982-2 C.B. 462, 536, provides, for purposes of the employment taxes
under subtitle C of the Code, that if a taxpayer did not treat an individual as an employee for
any period, then the individual shall be deemed not to be an employee, unless the taxpayer had
no reasonable basis for not treating the individual as an employee. For any period after
December 31, 1978, this relief applies only if both of the following consistency rules are
satisfied: (1) all federal tax returns (including information returns) required to be filed by the
taxpayer with respect to the individual for the period are filed on a basis consistent with the
taxpayers treatment of the individual as not being an employee (reporting consistency rule),
44

and (2) the taxpayer (and any predecessor) has not treated any individual holding a
substantially similar position as an employee for purposes of the employment taxes for periods
beginning after December 31, 1977 (substantive consistency rule).
The determination of whether any individual who is treated as an employee holds a position
substantially similar to the position held by an individual whom the taxpayer would otherwise
be permitted to treat as other than an employee for employment tax purposes under section
530(a) of the 1978 Act requires an examination of all the facts and circumstances, including
particularly the activities and functions performed by the individuals. Differences in the
positions held by the respective individuals that result from the taxpayers treatment of one
individual as an employee and the other individual as other than an employee (for example,
that the former individual is a participant in the taxpayers qualified pension plan or health
plan and the latter individual is not a participant in either) are to be disregarded in determining
whether the individuals hold substantially similar positions.
Section 1706(a) of the 1986 Act added to section 530 of the 1978 Act a new subsection (d), which
provides an exception with respect to the treatment of certain workers. Section 530(d) provides
that section 530 shall not apply in the case of an individual who, pursuant to an arrangement
between the taxpayer and another person, provides services for such other person as an
engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled
worker engaged in a similar line of work. Section 530(d) of the 1978 Act does not affect the
determination of whether such workers are employees under the common law rules. Rather, it
merely eliminates the employment tax relief under section 530(a) of the 1978 Act that would
otherwise be available to a taxpayer with respect to those workers who are determined to be
employees of the taxpayer under the usual common law rules. Section 530(d) applies to
remuneration paid and services rendered after December 31, 1986.
The Conference Report of the 1986 Act discusses the effect of section 530(d) as follows:
The Senate amendment applies whether the services of [technical service workers] are provided
by the firm to only one client during the year or to more than one client, and whether or not
such individuals have been designated or treated by the technical services firm as independent
contractors, sole proprietors, partners, or employees of a personal service corporation controlled
by such individual. The effect of the provision cannot be avoided by claims that such technical
service personnel are employees of personal service corporations controlled by such personnel.
For example, an engineer retained by a technical services firm to provide services to a
manufacturer cannot avoid the effect of this provision by organizing a corporation that he or
she controls and then claiming to provide services as an employee of that corporation.
* * * [T]he provision does not apply with respect to individuals who are classified, under the
generally applicable common law standards, as employees of a business that is a client of the
technical services firm.
2 H.R. Rep. No. 99-841 (Conf. Rep), 99th Cong., 2d Sess. II-834 to 835 (1986).
45

Under the facts of Situation 1 the legal relationship is between the Firm and the Individual, and
the Firm retains the right of control to insure that the services are performed in a satisfactory
fashion. The fact that the Client may also exercise some degree of control over the Individual
does not indicate that the Individual is not an employee. Therefore, in Situation 1, the
Individual is an employee of the Firm under the common law rules. The facts in Situation 1
involve an arrangement among the Individual, Firm, and Client, and the services provided by
the Individual are technical services. Accordingly, the Firm is denied section 530 relief under
section 530(d) of the 1978 Act (as added by section 1706 of the 1986 Act), and no relief is
available with respect to any employment tax liability incurred in Situation 1. The analysis
would not differ if the acts of Situation 1 were changed to state that the Individual provided the
technical services through a personal service corporation owned by the Individual.
In Situation 2, the Firm does not retain any right to control the performance of the services by
the Individual and, thus, no employment relationship exists between the Individual and the
Firm.
In Situation 3, the Firm does not control the performance of the services of the Individual, and
the Firm has no right to affect the relationship between the Client and the Individual.
Consequently, no employment relationship exists between the Firm and the Individual.
HOLDINGS
SITUATION 1. The Individual is an employee of the Firm under the common law rules. Relief
under section 530 of the 1978 Act is not available to the Firm because of the provisions of section
530(d).
SITUATION 2. The Individual is not an employee of the Firm under the common law rules.
SITUATION 3. The Individual is not an employee of the Firm under the common law rules.
Because of the application of section 530(b) of the 1978 Act, no inference should be drawn with
respect to whether the Individual in Situations 2 and 3 is an employee of the Client for federal
employment tax purposes.
Rev. Rul. 87-41, 1987-1 C.B. 296.
46
Chapter 2
Coverage and Nondiscrimination
A qualified retirement plan must benefit a minimum number of employees and may not be
designed or operated to favor highly compensated employees (HCEs) by more than the
allowable amount. A qualified plan must also meet the top heavy requirements of IRC 416.
This chapter reviews the coverage and participation tests under IRC 410(b) and 401(a)(26),
incorporating testing methodology as well as procedures for correcting violations and the
special exceptions accorded to qualified separate lines of business (QSLOBs) under IRC 414(r).
In addition, the nondiscrimination rules of IRC 401(a)(4) which limit favoring HCEs in the
amount of benefit or contribution provided and limit favoring HCEs in the availability of
benefits, rights or features are outlined. In addition the compensation used for plan allocations
and nondiscrimination must satisfy the requirements of IRC 414(s). A qualified retirement plan
also must ensure that the effect of any plan amendment or termination is not discriminatory.
This chapter details various options available to prove nondiscrimination in these areas.
Minimum Participation Test Under IRC 401(a)(26)

The minimum participation test under IRC 401(a)(26) requires a plan to benefit a minimum
number of employees on each day of the plan year. This test only applies to defined benefit
plans.
GENERAL RULES
The minimum participation test must be satisfied before proceeding to coverage testing under
IRC 410(b) and is satisfied if the plan benefits the lesser of:
50 employees; or
the greater of:
o
40% of all employees of the employer; or
If only 2 employees, must cover both.
EXAMPLE: ABC Company sponsors both a 401(k) Plan and a Defined Benefit (DB) Plan. The
census information is as follows:
Total # of nonexcludable employees

Employees benefiting under DB Plan
Employees benefiting under 401(k)
HCE
12
5
12
NHCE
65
26
65
Total
77
31
77
The minimum participation test of IRC 401(a)(26) requires that a DB plan cover the lesser of 50
participants or 40% of the nonexcludable employees.
There are 77 nonexcludable employees. Since 40% of 77 is less than 50, the plan must cover 31
(40% * 77 = 30.8) employees.
47
CPC Study Guide: Advanced Retirement Plan Consulting, 3 rd Edition
Because 5 HCEs are covered and 26 NHCEs are covered in the DB plan, the minimum
participation requirement of IRC 401(a)(26) passes because the total number of covered
employees equals 31.
Any prior benefit structure (all accrued benefits as of the beginning of the plan year) must also
satisfy the minimum participation test.
This is a stand-alone test: plans cannot be aggregated to satisfy the requirement so if there are
multiple defined benefit plans each plan must satisfy IRC 401(a)(26) independently.
[Identification of HCE or NHCE is not relevant to the IRC 401(a)(26) test.]
Excludable employees should be disregarded using the same rules as detailed in the coverage
rules under IRC 410(b) section below. Use the same definition of benefiting as used by
coverage rules under IRC 410(b). However, the IRS has taken the position that a DB accrual
must be at least 0.50% of pay in order to be considered to be benefiting for purposes of IRC
401(a)(26). (A 0.50% of pay cash balance hypothetical contribution will only be acceptable if it is
equivalent to at least a 0.50% of pay traditional DB accrual.)
PLANS THAT AUTOMATICALLY SATISFY IRC 401(A)(26)

Plans covering only NHCEs that are not top-heavy and do not aggregate under other
rules;
Multiemployer plans;
Certain underfunded defined benefit plans;
Frozen defined benefit plans, unless subject to the prior benefit structure test mentioned
above; and
Plans of a controlled group of employers that are acquired (or disposed of) during the
transition period, provided the test was met before the acquisition (disposition) and
there was no other significant change in coverage.
DISAGGREGATION
Some disaggregation is required including:
Former employees must be tested separately if they benefit under the plan (for example
through cost of living adjustments to the benefit amount).
Each employer in a multiple employer plan must be tested separately.
Other disaggregation can be performed at the option of the plan sponsor:
May elect to test otherwise excludable employees separately.
May elect to test QSLOBs separately. For purposes of IRC 401(a)(26), portions of the
plan may be treated as QSLOBs without meeting the 50 employee requirement otherwise
imposed for determining QSLOB status.
Union employees may be tested separately.
48

Testing can be on a single day if it is representative of plan population throughout the year.
CORRECTION PROCEDURES
Failure to pass the minimum participation test and failure to correct can result in
disqualification. Further, if the plan is disqualified, the entire vested accrued benefit of the HCEs
will be taxed as if these benefits were distributed in the plan year of the disqualification.
Retroactive correction is permitted subject to the following conditions:
Plan can be amended retroactively to expand coverage and eligibility.
Plan can be modified to improve benefits or contributions.
Plan can merge deeming the merger effective retroactively to the first day of the plan
year if adopted within the relevant correction period.
Consider QSLOB testing.
Correction must be adopted by the 15th day of the 10th month after the close of the plan
year affected.
Minimum Coverage under IRC 410(b)

The coverage provisions of IRC 410(b) are designed to limit the number of employees who can
be excluded from a qualified plan and apply to both defined contribution and defined benefit
plans.
A qualified plan must satisfy one of the following coverage tests each plan year:
Ratio percentage test; or
Average benefit test.
A plan only needs to pass one of the coverage tests each year. The coverage test used can change
from year-to-year.
The ratio percentage test is typically run first as it is easier to perform. If the ratio percentage test
fails, some plans include provisions (i.e., fail-safe provision) requiring correction of the failed
ratio percentage test, thereby precluding the use of average benefit testing as an option.
There are three optional testing periods for satisfying the minimum coverage rules:
Daily testing
Quarterly testing
Annual testing
A plan with 401(k) contributions, an employer matching contribution or after-tax employee
contributions must test on an annual basis. Generally the test is run on the last day of the plan
year taking into consideration all individuals employed at any time during the plan year.
49

Alternatively, a plan may test on a reasonably representative snapshot day during the year
using substantiation quality data (per Rev. Proc. 93-42).
Substantiation guidelines allow for defined benefit plans to use data from the prior plan year,
provided that the data has not changed significantly from one year to the next.
There is also a three year testing cycle option which states that a plan may rely on a coverage
test performed for a particular plan year for up to two succeeding plan years, provided the
employer reasonably concludes that there has been no significant change during those years
that would affect the coverage test results.
PLANS THAT AUTOMATICALLY SATISFY IRC 410(B)

Plans that benefit only NHCEs;
Plans sponsored by companies that have no NHCEs who have satisfied statutory
eligibility requirements;
Plans that only have union employees who benefit; and
Plans of a controlled group of employers that are acquired (or disposed of) are excluded
from the coverage test during the transition period provided coverage was met before
the acquisition (disposition), and there was no other significant change in coverage.
Separate lines of business (SLOBs) may apply for an exception to minimum coverage rules.
COVERAGE TESTING GROUP AND EMPLOYEE CLASSES

To perform the coverage tests, the following employee classes must be distinguished:
Excludable employees, nonexcludable employees, and otherwise excludable employees;
Benefiting employees and nonbenefiting employees; and
HCEs and NHCEs.
Excludable Employees
The following excludable employees are omitted from the coverage testing group:
Employees who do not meet the age and service requirements of the plan being tested;
EXAMPLE: An employer maintains a 401(k) profit sharing plan with immediate eligibility for the
401(k) portion and a one-year eligibility requirement for the profit sharing portion. Joe has been
employed for three months. Joe would be included in the coverage test for the 401(k) portion of
the plan, but would be excluded from the coverage test for the profit sharing portion of the
plan.
Note: Employees who have not met the age/service requirement but are eligible to make rollover
contributions prior to their participation dates are still deemed to be excludable employees.
50

Terminated employees may be omitted if they worked less than 501 hours in the plan
year and did not receive a benefit for the plan year solely because they worked less than
the number of hours required to receive a benefit or because they were not employees on
the last day of the plan year;
EXAMPLE: John met the initial eligibility requirements for XYZ Plan, but did not receive an
employer contribution because he terminated employment during the plan year. John would be
included in the coverage test (as a nonbenefiting employee) if he worked more than 500 hours
during the plan year. John would be excluded from the coverage test if he worked less than 501
hours during the plan year.
Union employees whose retirement benefits were the subject of good faith bargaining;
and
Nonresident aliens with no earned income from the U.S.
Excludable employees are determined separately for each plan of the employer unless
permissive aggregation is being used, in which case the least restrictive provisions will
determine who is excludable. The employee must be an excludable employee for the entire
testing period to be considered excludable.
Nonexcludable Employees
All employees who do not meet the criteria of an excludable employee are considered to be
nonexcludable employees. An employee who waives participation in the plan (even if the
waiver is irrevocable) is not an excludable employee for coverage testing. Also, an employee
who is excluded due to job classification (e.g., hourly, salaried) is not an excludable employee for
coverage testing.
EXAMPLE: Sally has worked for ABC Company as a full time, hourly employee for three years.
ABC Plan has a one year eligibility requirement, but excludes hourly employees from
participation. Sally would be included in the ABC Plan coverage test (as a nonbenefiting,
nonexcludable employee) since she met the initial eligibility requirements and is being excluded
from participation solely due to her status as an hourly employee.
Caution must be exercised to ensure independent contractors and leased employees are
properly classified. Erroneous inclusion of non-employees and exclusion of common-law
employees can result in incorrect test results which can lead to plan disqualification.
Otherwise Excludable Employees
Employees who are eligible to participate in the plan but would have been excludable
employees if the employer had adopted the minimum statutory eligibility requirements of IRC
410(a) of age 21 and one year of service are considered to be otherwise excludable employees.
51

EXAMPLE: An employer maintains a profit sharing plan with immediate eligibility. Amy has
been employed for three months. Amy is eligible to participate in the plan. For coverage testing
purposes, Amy falls into the category of otherwise excludable employee. She would not have
been eligible for the plan if the employer had adopted the statutory eligibility requirements of
IRC 410(a): age 21 and one year of service. Under standard testing procedures Amy would be
included in the plans coverage test but could be excluded if the plan chose to apply the more
restrictive rules of IRC 410(b)(4)(B).
If desired, otherwise excludable employees may be tested separately to improve testing results.
Benefiting vs. Nonbenefiting
An employee benefits under a defined contribution plan:
If the employee receives an allocation of a contribution or forfeiture for the plan year;
If the employee is entitled to an allocation but is limited by IRC 415;
If the employee fails to receive an allocation because of a uniformly applied benefit limit
under the plan; or
If a non-key employee receives a top-heavy allocation even if that employee would not
otherwise be eligible to share in the allocation; however, if the plan passes coverage
considering this employee to be nonbenefiting then it is assured of meeting the uniform
allocation safe-harbor for IRC 401(a)(4).
An employee benefits in a 401(k) or 401(m) arrangement if the employee is eligible to make a
deferral or receive a matching contribution regardless of whether the employee makes a deferral
or if the employee terminated employment.
EXAMPLE: Beth is eligible to participate in FYI 401(k) Plan, but she elects not to make salary
deferral contributions. Beth would be included in the coverage test and treated as benefiting for
the 401(k) portion of the plan. Beth would also be considered to be benefiting for the 401(m)
portion if she would have received a match had she deferred.
EXAMPLE: FYI 401(k) Plan has immediate eligibility for both 401(k) and matching contributions.
However, the plan only makes matching contributions for employees who work at least 1,000
hours during the plan year. Beth has worked 1,000 hours in prior plan years, but she only
worked 679 hours during the current plan year. Although Beth is treated as benefiting for the
401(k) portion of the plan, Beth would be treated as nonbenefiting for the 401(m) portion of the
plan.
An employee is deemed to benefit in a safe harbor target benefit plan if the employee fails to
receive a contribution because the theoretical reserve is equal to or greater than the employees
present value of accrued benefit.
52

An employee benefits under a defined benefit plan:
If an employees accrued benefit increases in a plan year;
If the employee is entitled to an accrual but is limited by IRC 415;
If the employee fails to receive an accrual because of a uniformly applied benefit limit
under the plan or due to a prior accrual resulting from a fresh start adjustment or due to
a post retirement accrual adjustment;
If a non-key employee receives a top-heavy accrual even if the employee would not
otherwise be eligible to receive an accrual;
If surplus assets are allocated to participants as a result of plan termination (resulting in
increased benefits); or
If an employees benefit is reduced under a floor-offset arrangement even though there is
no increase in the accrued benefit.
An employee benefits in an IRC 412(e)(3) plan (fully insured defined benefit plan) only if the
premium is paid.
AGGREGATION AND DISAGGREGATION

Mandatory Disaggregation
Certain plans or potions of a plan must be tested separately for purposes of coverage testing
under IRC 410(b):
401(k), 401(m), and IRC 401(a) components of a plan must be treated as separate plans
when testing coverage under IRC 410(b).
An ESOP portion of a plan is treated as a separate plan for testing coverage.
Collectively bargained employees and noncollectively bargained employees in the same
plan must be tested separately.
Each employer that participates in a multiple employer plan must test for coverage
separately.
If mandatory disaggregation is required for the IRC 410(b) test, then generally must apply
mandatory disaggregation for IRC 401(a)(4) and other nondiscrimination testing as well.
Permissive Disaggregation
Certain groups may be tested separately for coverage under IRC 410(b) at the employers
election:
Otherwise excludable employees may be tested separately from nonexcludable
employees.
QSLOBs allow benefiting employees of different QSLOBs to be tested separately.
If permissive disaggregation is used for IRC 410(b) test then disaggregation must be used for
IRC 401(a)(4) and other nondiscrimination testing as well.
53

Mandatory Aggregation
Certain plans or potions of a plan must be tested together for purposes of coverage testing
under IRC 410(b):
Employers of a controlled group.
Employers of an affiliated service group.
If mandatory aggregation is required for the IRC 410(b) test, then it is also required for IRC
401(a)(4) and other nondiscrimination testing.
Permissive Aggregation
An employer maintaining two or more plans may combine plans for coverage testing under
certain conditions:
The plans must have the same plan year;
Qualified plans may only be aggregated with other qualified plans (not with 403(b),
457(b) or SEP plans);
The plans cannot be aggregated into more than one testing group; and
The ratio percentage test or nondiscriminatory classification test portion of the average
benefit test are eligible for permissive aggregation.
If using permissive aggregation for the IRC 410(b) test, then aggregation must also be used for
IRC 401(a)(4) and other nondiscrimination testing.
TRANSITION PERIOD FOR MERGERS AND ACQUISITIONS

Due to mergers, acquisitions or spin-offs of companies, the make-up of a controlled group or
affiliated service group may change. Also, when there is an asset acquisition, employees may
experience a change of employer due to the business transaction. Under IRC 410(b)(6)(C),
coverage is deemed to be satisfied during a transition period by any plan maintained by an
employer involved in the company-level transaction, if:
The plan seeking relief met the coverage requirements under IRC 410(b) immediately
before the change in employer (or related group), and
The coverage under such plan is not significantly changed during the transition period,
other than by reason of the change in members of a group or the change of employer due
to the company-level transaction.
If a plan satisfies coverage immediately prior to the time of the acquisition or disposition of a
related group member, the plan is deemed to meet coverage during a transition period. The
transition period under IRC 410(b)(6)(C) begins on the date of the change and ends on the last
day of the next plan year beginning after the change (subject to an earlier ending date in the
event of certain significant changes in the coverage of the plan).
54

EXAMPLE: Company A acquired Company B in 2012. Each company sponsors a 401(k) plan at
the time of the acquisition. Assuming the plan coverage does not significantly change and the
plans are merged as a result of the acquisition they may be tested separately under the
401(b)(6)(C) transition rule through the end of the 2013 plan year. The plans could continue to be
maintained separately after that date if both plans met coverage on a stand-alone basis when
considering all employees of both companies.
EXAMPLE: Lets complicate the acquisition described above by assuming one of the companies
sponsors a safe harbor plan. Company A the plan sponsor of a 401(k) plan acquired Company B
the plan sponsor of a safe harbor 401(k) plan in 2012. The plans cannot be merged in 2012 as a
safe harbor plan must generally have a 12 month plan year, and a non-safe harbor plan cannot
be amended into a safe harbor plan midyear. Nor could the safe harbor plan be amended
midyear to include the employees of Company A as a safe harbor plan cannot be amended
midyear for such a purpose. The plans could be tested separately through the end of the
transition period. Company As plan could be amended into a safe harbor plan for 2013 (or
2014) and the plans could be merged together. Another option to consider would be terminating
Company Bs safe harbor plan prior to the acquisition.
RATIO PERCENTAGE TEST

To pass the ratio percentage test, the percentage of NHCEs who benefit under the plan must be
equal to or greater than 70 % of the percentage of HCEs who benefit. The NHCE ratio is the
number of NHCEs in the benefiting group divided by the number of NHCEs in the coverage
testing (nonexcludable) group. The HCE ratio is the number of HCEs in the benefiting group
divided by the number of HCEs in the coverage testing group.
The plan ratio percentage is the NHCE ratio divided by the HCE ratio. As stated above, the plan
ratio percentage must be greater than or equal to 70% in order to pass the ratio percentage test.
EXAMPLE: The plans eligibility requirements are one year of service and age 21. The plan entry
dates are the January 1 or July 1 following completion of these eligibility requirements.
Participants must perform 1,000 hours of service during the plan year to receive a profit sharing
allocation. A participant must also be employed by the employer on the last day of the plan year
to receive a profit sharing allocation.
Workforce during the plan year
Employees who do not satisfy age/service requirements
Eligible employees who terminate before year end with less than 501 hours
Coverage testing group (150 - 30 - 10) = 110

Nonbenefiting employees:
Employees who terminate with >500 hours
Active employees with <1,000 hours of service
150
30
10
HCEs
15
NHCEs
95
1
0
30
5
55
Benefiting Group
Coverage Ratios
Plan Ratio Percentage
14
60
14/15=
60/95=
93.33%
63.16%
63.16% / 93.33% = 67.67%
The plan fails the ratio percentage test because the ratio percentage is less than 70%.
AVERAGE BENEFIT TEST

If a plan fails to pass coverage testing using the ratio percentage test, the average benefit test is
an alternative test that may be used to satisfy coverage testing under IRC 410(b) assuming the
plan does not contain fail-safe language.
The average benefit test consists of two parts:
Nondiscriminatory classification test; and
Average benefit percentage test (also called average benefit ratio test).
Both parts must be passed to satisfy IRC 410(b) using the average benefits test.
Average Benefit Test Part 1: Nondiscriminatory Classification Test
To pass the nondiscriminatory classification test, two criteria must be met:
The allocation groups must be a reasonable classification that is based on all facts and
circumstances and must be established using objective business criteria that clearly
identifies the category of employees who benefit. Classifying by job category, geographic
location or compensation category (e.g., hourly versus salary) is reasonable; classification
by a persons specific name is not reasonable.
Must be a nondiscriminatory classification based on either a safe harbor percentage test
or a facts and circumstances test.
Safe Harbor Percentage Test
The safe harbor percentage test is satisfied if the plans ratio percentage is equal to or greater
than the employers safe harbor percentage.
The coverage ratio is calculated in exactly the same way as it is calculated under the ratio
percentage testthat is, the percentage of benefiting NHCEs divided by the percentage of
benefiting HCEs.
The table of Safe Harbor and Unsafe Harbor Percentages is included below. The highest safe
harbor percentage is 50%, and the lowest unsafe harbor is 20%. So, if the coverage ratio is at
least 50%, the test is satisfied regardless of the concentration percentage. If the coverage ratio is
less than 20%, this test is failed regardless of the concentration percentage.
The safe harbor percentage depends upon the NHCE concentration percentage (the number of
nonexcludable NHCEs as a percentage of all nonexcludable employees).
56

EXAMPLE: The employer has 150 nonexcludable employees; 125 of the nonexcludable employees
are NHCEs. The NHCE concentration percentage is 83.33% (125/150 = 0.8333). The concentration
percentage is always rounded down to the next whole number.
Once the NHCE concentration percentage is determined, the Safe Harbor and Unsafe Harbor
Percentages Table provides a corresponding percentage of NHCEs who must be benefiting.
For plans with an NHCE concentration of 0 to 60%:
A plan is in the safe harbor range if the percentage of NHCEs who benefit is at least 50%
of the percentage of HCEs who benefit.
A plan fails the unsafe harbor if the percentage of NHCEs who benefit is 40% or less of
the percentage of HCEs who benefit.
If the percentage of NHCEs who benefit is between 50% and 40% of the percentage of
HCEs who benefit, the plan will be subject to a facts and circumstances test.
For plans with an NHCE concentration over 60%:
Both the safe and unsafe harbor percentages are reduced as the NHCEs concentration
percentage increases above 60%.
The unsafe harbor percentage is generally 10% less than the Safe Harbor, but never less
than 20%.
For every 1% increase in the concentration percentage, the 50% and 40% safe harbor
percentage levels decrease by 0.75%.
EXAMPLE: If the employers NHCE concentration percentage is 75%, then a plan benefiting 40%
of the NHCEs is in the safe harbor range (which is above 38.75%).
Safe Harbor and Unsafe Harbor Percentages Table
NHCE
Concentration
Percentage
Safe Harbor
Percentage
Unsafe Harbor
Percentage
0 60
50.00
40.00
61.00
49.25
39.25
62.00
48.50
38.50
63.00
47.75
37.75
64.00
47.00
37.00
57
58
NHCE
Concentration
Percentage
Safe Harbor
Percentage
Unsafe Harbor
Percentage
65.00
46.25
36.25
66.00
45.50
35.50
67.00
44.75
34.75
68.00
44.00
34.00
69.00
43.25
33.25
70.00
42.50
32.50
71.00
41.75
31.75
72.00
41.00
31.00
73.00
40.25
30.25
74.00
39.50
29.50
75.00
38.75
28.75
76.00
38.00
28.00
77.00
37.25
27.25
78.00
36.50
26.50
79.00
35.75
25.75
80.00
35.00
25.00
81.00
34.25
24.25
82.00
33.50
23.50
83.00
32.75
22.75
84.00
32.00
22.00

NHCE
Concentration
Percentage
Safe Harbor
Percentage
Unsafe Harbor
Percentage
85.00
31.25
21.25
86.00
30.50
20.50
87.00
29.75
20.00
88.00
29.00
20.00
89.00
28.25
20.00
90.00
27.50
20.00
91.00
26.75
20.00
92.00
26.00
20.00
93.00
25.25
20.00
94.00
24.50
20.00
95.00
23.75
20.00
96.00
23.00
20.00
97.00
22.25
20.00
98.00
21.50
20.00
99.00
20.75
20.00
The concentration percentage is determined using all nonexcludable employees of the employer
(including plans of a controlled group or affiliated service group arrangement).
59
EXAMPLE: ABC, Inc. and XYZ, Inc. are a controlled group and maintain one plan. ABC, Inc.
participates in the plan, but XYZ, Inc. does not. This is acceptable only if the controlled group
can pass coverage including all companies. In this example, the plan fails to satisfy the 70% ratio
percentage test, and the plan document does not require correction of the ratio percentage test.
Thus, the average benefit test must be performed.
Step 1: Calculate the NHCE Concentration Percentage
ABC
HCEs
40
NHCEs
150
Total
190
XYZ
50
360
410
Total
90
510
600
The NHCE concentration percentage is 510 / 600 = 85% (all nonexcludable NHCEs / all
nonexcludable employees). According to the Safe Harbor and Unsafe Harbor Percentages Table,
the NHCE benefiting safe harbor percentage is 31.25%. Therefore, the plan will pass if the
percentage of NHCEs benefiting under the plan is at least 31.25% of the percentage of the HCEs
who are benefiting under the plan.
Step 2: Calculate the Ratio of Benefiting Employees
ABC
HCEs
40
NHCEs
150
Total
190
XYZ
50
360
410
Total
90
510
600
Ratio
40/90 = 44.44%
150/510 = 29.41%
Ratio benefiting = NHCE Ratio / HCE Ratio

29.41% / 44.44% = 66.18%
Step 3: Compare the Ratio of Benefiting Employees to the Safe Harbor Percentage
The Safe Harbor Percentage determined in Step 1 is 31.25%. Since this plan has a ratio of 66.18%,
it passes the Safe Harbor Percentage Test.
Facts and Circumstances Test
The facts and circumstances test is satisfied if the following conditions are met:
The plans ratio percentage is greater than or equal to the unsafe harbor percentage (see
Safe Harbor and Unsafe Harbor Percentages Table); and
The IRS deems the classification to be nondiscriminatory based on various criteria
including but not limited to: the underlying business reason for the classification, the
representative number of employees in each salary range benefiting, the difference
between the plans ratio percentage and the safe harbor percentage.
60

The midpoint is normally used in the general test and is calculated as the average of the safe harbor
percentage and the unsafe harbor percentage.
EXAMPLE: The midpoint with an NHCE concentration percentage of 96% would be 21.50%
[(23.00 + 20.00) / 2].
Average Benefit Test Part 2: Average Benefit Percentage Test
The average benefit provided to NHCEs under all plans of the employer expressed as a
percentage of compensation (average benefit percentage) must be greater than or equal to 70
percent of the average benefit provided to HCEs.
Average benefit percentage =
NHCE actual benefit percentage

HCE actual benefit percentage
The actual benefit percentage of a group of employees for a testing period is the average of the
employee benefit percentages, calculated separately with respect to each of the individual
employees in the group, for the testing period.
All nonexcludable employees of the employer are taken into account for this purpose, even if
they are not benefiting under any plan that is taken into account.
EXAMPLE: The EZ Plan has 4 nonexcludable NHCEs. Employees A, B and C each receive a
contribution of 5% of compensation. Employee D did not receive a contribution because he did
not work 1,000 hours during the plan year. The actual benefit percentage of this NHCE group is
3.75% {[( 5% + 5% + 5% + 0% ) / 4 ] = 3.75% }.
Employee benefit percentages may be calculated on a benefits basis (usually for defined benefit
plans) or on a contributions basis (usually for defined contribution plans). Alternatively, a
defined benefit plan could be tested on a contributions basis, and a defined contribution plan on
the basis of benefits (cross-testing).
Other important things to remember when calculating the average benefit percentage include:
All employer-provided contributions and benefits are taken into account (even IRC
401(k), 401(m) and ESOP).
After-tax employee contributions are not included.
Do not include union employees with nonunion employees.
Do not include employees in or benefits from QSLOBs other than the one being tested.
May exclude otherwise excludable employees.
The benefit percentage is determined in the same manner as under IRC 401(a)(4)
regulations.
A defined benefit plan with an early retirement reduction may have to adjust the benefit
percentage.
61

The benefit percentage may be adjusted by imputing permitted disparity, if within the
limitations and attributable only to plans for which permitted disparity is available.
When an employee benefits under more than one plan of the employer or controlled group,
employee benefit percentages may be determined as the sum of the employee benefit
percentages for each of the plans in the testing group that are aggregated. The percentages for
each plan must generally be consistently determined; however, if it does not significantly
increase the average benefit percentage, permitted inconsistencies are:
IRC 414(s) compensation;
Average annual compensation;
Testing age;
Fresh start dates;
Actuarial assumptions for normalization; and
Underlying definition of actuarial equivalence.
EXAMPLE: The Company X has 4 nonexcludable HCEs and 9 nonexcludable NHCEs. Only 6 of
the nonexcludable NHCEs were benefiting.
Step 1: Calculate the HCE Benefit Percentage
HCE
1
2
3
4
Benefit Percentage (based on benefit/compensation)

7.05%
6.01%
5.31%
4.54%
Total:
22.91%
HCE Benefit Percentage is the total divided by the number of nonexcludable HCEs.
22.91% / 4 = 5.73%
Step 2: Calculate the NHCE Benefit Percentage
NHCE
1
2
3
4
5
6
7
8
9
62
Benefit Percentage (based on benefit/compensation)

9.32%
8.75%
6.32%
5.32%
5.18%
4.87%
0.00%
0.00%
0.00%
Total:
39.76%
NHCEs 1-6 are covered by the plan, NHCEs 7-9 are not covered, but must be included in the
test as zeros.
NHCE Benefit Percentage is the total divided by the number of nonexcludable NHCEs.
39.76% / 9 = 4.42%
The ratio of the NHCE Benefit Percentage to the HCE Benefit Percentage must be at least 70%.
4.42% / 5.73% = 77.14%
Company X passes the average benefit percentage test part of the average benefits test.
Failure to pass the coverage tests and failure to correct (even if the test was passed in prior
years) can result in plan disqualification. Further, if the plan is disqualified, the entire vested
accrued benefit (account balance) of the HCEs will be taxed as if these benefits were distributed
in the plan year of the disqualification.
The procedure for correction may depend on the type of plan document adopted. Plans utilizing
standardized prototype documents automatically satisfy coverage requirements by design.
Plans utilizing non-standardized prototype or volume submitter documents should outline the
method for satisfying coverage. It is important to check plan language in each document as the
procedure may vary.
Individually designed plans have complete flexibility, though many do contain a procedure for
handling coverage testing failures. Absent a procedure in the plan document, a plan may adopt
an amendment from year to year to satisfy coverage.
Retroactive correction is permitted subject to the following conditions:
Plan can be amended retroactively to expand coverage and eligibility to bring in more
NHCEs;
Test results can improve if benefits or contributions are increased;
Amendment to the plan must have substance providing economic benefit for the
employees affected (e.g., additional contributions to terminated employees who are zero
percent vested would not qualify);
Amendments do not have to be permanent;
Correction must be adopted by the 15th day of the 10th month after the close of the plan
year affected;
If the amendment is adopted after the end of the plan year, then the amendment must
benefit a nondiscriminatory group; and
Voluntary correction is available under EPCRS if a coverage violation is not corrected
within 9 months after the plan year-end.
63
Qualified Separate Lines of Business (QSLOBs)

The provisions of IRC 414(r) allow an employer that is not part of an affiliated service group to
divide its business into qualified separate lines of business and then apply the minimum
coverage, minimum participation and nondiscrimination tests separately to the employees of
each of the separate lines of business.
A line of business (LOB) is a portion of the employer that is identified by the property or
services it provides to customers of the employer. A LOB does not have to be a separate legal
entity. A LOB may be a separate division within one company.
A LOB is a separate line of business (SLOB) if the following four conditions are met:
LOB is a separate organizational unit;
LOB is a separate financial unit;
LOB has a separate employee workforce; and
LOB has separate management.
To demonstrate that an employer maintains a qualified separate line of business (QSLOB), the
following three conditions must be met:
The SLOB must have at least 50 employees on each day of the testing year;
The employer must notify the IRS that it is operating QSLOBs by filing Form 5310-A;
The SLOB must satisfy the administrative scrutiny test by either satisfying one of six safe
harbors or the employer must receive an individual ruling from the IRS that the SLOB
satisfies the administrative scrutiny test.
SLOBs provide an alternative for testing but are expensive, complex, administratively
burdensome, and may result in inadvertent disqualification if not properly monitored.
Additional information on QSLOBs can be found in chapter 1.
Nondiscrimination under IRC 401(a)(4)

Three different components are tested for nondiscrimination:
Contributions or benefits must be nondiscriminatory in amount.
Benefits, rights, and features must be provided in a nondiscriminatory manner.
The effect and timing of plan amendments and terminations must be nondiscriminatory.
Contribution and benefit amounts must be nondiscriminatory under IRC 401(a)(4). Defined
contribution plans generally satisfy nondiscrimination requirements by showing contributions
(allocations) under the plan are nondiscriminatory in amount. Defined benefit plans generally
satisfy nondiscrimination requirements by showing benefits under the plan are
nondiscriminatory in amount.
64

Plans may cross-test. Defined contribution plans may satisfy nondiscrimination by showing
equivalent benefits in the plan are nondiscriminatory in amount, a process that involves a
gateway test. Defined benefit plans may satisfy IRC 401(a)(4) by showing the equivalent
contributions in the plan are nondiscriminatory.
DESIGN-BASED AND NONDESIGN-BASED SAFE HARBORS

A plan can demonstrate nondiscrimination in amount of contribution or benefits by adopting a
safe harbor plan. All other plans must prove nondiscrimination by satisfying the general test
(also known as the rate group test).
Safe harbor plans under IRC 401(a)(4):
Can be design-based or nondesign-based;
Require little to no annual testing; and
Allow less flexibility in plan design.
Design-based safe harbor defined contribution plans require a uniform allocation of employer
contributions, either as a percentage of compensation or a dollar amount. The testing period is
the plan year.
If one of the formulas is a top-heavy formula, it does not necessarily fail to be uniform merely
because the top-heavy allocation is available only to non-key employees (even if some of the
non-key employees are HCEs).
If the plan is able to pass coverage under IRC 410(b) by treating an employee as not benefiting
if his or her allocation is determined solely with reference to the top-heavy formula, the plan
will satisfy the uniform allocation of a design-based safe harbor plan.
Defined Contribution Plans
There are two safe harbors for defined contribution plans.
Uniform allocation formula:
Design-based.
Each covered employee is treated uniformly and given either a percentage of plan year
compensation or a flat dollar amount for each uniform unit of service during the plan
year.
May use permitted disparity in accordance with IRC 401(l).
Uniform points allocation formula:
Nondesign-based.
Requires annual testing of the average allocation rates. If the HCE average does not
exceed the NHCE average then the testing is passed. If not then nondiscrimination must
be demonstrated using rate groups under IRC 401(a)(4).
65

Must grant points for units of compensation and for at least age or service.
Average HCE allocation rates must not exceed average NHCE allocation rates.
Forfeitures must be allocated in the same manner as the contribution.
Safe harbor allocations under IRC 401(a)(4) can include an end of year requirement, a 1,000
hour rule, and/or multiple safe harbor formulas.
Defined Benefit Plans
There are four safe harbor plan designs:
Unit Benefit
Fractional Accrual Rule
Flat Benefit
Alternate Flat Benefit
All safe harbor defined benefit plans require uniformity.
More detail on the defined benefit safe harbors and uniformity requirements can be found in
chapter 4.
GENERAL TESTING
Plans that do not satisfy the safe harbor rules must satisfy the general test with respect to the
amount of contributions or benefits. The test is result-based (i.e., the basis for underlying
contributions/benefits is not relevant). Annual testing is required, and it focuses on individual
allocations and accrual rates. General testing allows greater flexibility in plan design.
Determine Allocation Rates
Allocation rate can be expressed as a dollar amount or as a percentage of compensation
determined by dividing the amount of the allocation by the employees plan year compensation.
Allowable measurement periods:
Current plan year (annual) where allocation rate is equal to current year allocation
divided by current year compensation.
Current plan year and all prior years (accrued to date) where allocation rate is equal to
allocation during measurement period divided by average annual compensation times
years of service during measurement period.
Compensation used for nondiscrimination testing must satisfy IRC 414(s).
Determine Accrual Rates
If the general test is based on accrual rates, the normal accrual rate (NAR) and most valuable
accrual rate (MVAR) for each employee must be calculated.
66

Normal Accrual Rate (NAR)
Is the increase in the employees benefit during the measurement period divided by the
employees testing service during the selected measurement period multiplied by
average annual compensation.
To normalize is to convert actuarially into a life only benefit at the testing age using
reasonable assumptions. Standard assumptions are deemed to be reasonable.
Can impute permitted disparity but this is not available if another plan has already fully
utilized the 35 year cumulative rule.
Can exclude the portion of benefit earned prior to a fresh start date.
Most Valuable Accrual Rate (MVAR)
Is the increase in the employees most valuable optional form of payment of the accrued
benefit during the measurement period divided by the employees testing service in that
measurement period multiplied by average annual compensation.
Most valuable optional form of payment is determined by calculating each QJSA benefit
payable for each year from testing date to testing age, normalizing each of these QJSAs
and dividing each benefit option by the appropriate testing service (affected by
measurement period selected) to that point.
Permitted disparity and fresh starts, etc., are available as with NAR.
There is no guidance as to what may be appropriate assumptions for marital status or spouse
age differentials, though the definition of normalize requires reasonable assumptions.
Measurement periods:
Current plan year (annual);
Current plan year and all prior years (accrued to date); or
Current plan year and all prior and future years projected (defined benefit plans only).
Testing service
Dependent upon the measurement period selection; and
IRS training manual indicates using only years during which the employee benefits for
purposes of Treas. Reg. 1.410(b)-3(a).
Compensation used for nondiscrimination testing must satisfy IRC 414(s).
Determine Rate Groups
A rate group must be determined for each HCE benefiting under the plan. A rate group consists
of the HCE and all other employees (HCEs and NHCEs) who have an allocation rate (defined
contribution plans) or a normal accrual rate (NAR) and most valuable accrual rate (MVAR)
(defined benefit plans) equal to or greater than the cornerstone HCE rate.
67

EXAMPLE: HCE A received a contribution of 10% of compensation. HCE B received a
contribution of 5% of compensation. NHCEs C, D, E and F each received a contribution of 6% of
compensation.
Rate group 1 would include only HCE A as no other employees allocation rate was equal to or
greater than HCE As allocation rate of 10%. This rate group would fail if the plan was being
tested on a contribution basis because the NHCE benefiting percentage would be zero and
therefore could not pass either the ratio percentage test or the average benefit test.
Rate group 2 would include both HCEs and all four NHCEs since all of their allocation rates
were equal to or greater than HCE Bs allocation rate of 5%. This rate group would pass when
tested on a contribution basis because 100% of the nonexcludable NHCEs are benefiting in this
group.
Each rate group must satisfy IRC 410(b) by either of two tests. (Note that the rate groups do not
have to employ the same test.)
Average benefit test.
CROSS-TESTING
A cross-tested plan can be a defined contribution plan (not ESOP) that tests with respect to the
equivalent benefit amount, or a defined benefit plan that tests with respect to an equivalent
amount of contribution.
A defined contribution plan must meet one of the following criteria as a precondition to testing
on a benefits basis:
The plan must have broadly available allocation rates;
The plan must have an age based allocation rate based on either a gradual age or service
schedule or uniform target benefit allocation; or
The plan must satisfy a minimum gateway allocation.
A plan has a broadly available allocation rate if each allocation rate under the plan is currently
available to a group of employees that satisfies the ratio percentage test. Permitted disparity is
disregarded for purposes of calculating the allocation rates that are available under the plan.
A gradual age or service schedule is one that defines specific bands that are based solely on age,
solely on service, or solely on points that represent the sum of age and years of service. An ageweighted profit sharing plan will usually satisfy this exception.
Minimum Gateway Test
The minimum gateway allocation for benefiting NHCEs is equal to the lesser of:
One-third of the allocation rate of the HCE with the highest allocation rate (allocation
rate determined with respect to IRC 414(s) compensation); or
68

Each NHCE receives an allocation of at least 5% of compensation (determined based on
IRC 415(c)(3) compensation, which includes compensation earned during the plan year
prior to plan entry). This is the compensation used for HCE determination, 415 limits,
top-heavy allocations, etc.
EXAMPLE: If an HCE in a cross-tested plan receives a contribution of 9% of compensation, the
minimum allocation for each NHCE would have to be at least 3% of compensation under the
gateway rules. One third of the HCEs allocation rate is 3% (9%/3=3%), which is less than 5%.
EXAMPLE: If an HCE in a cross-tested plan receives a contribution of 20% of compensation, the

minimum allocation for each NHCE would have to be at least 5% of compensation under the
gateway rules. One third of the HCEs allocation rate is 6.67% (20% / 3 = 6.67%), which is more
than 5%.
Employer matching contributions cannot be used to satisfy the minimum gateway.
Only NHCEs who benefit under the plan must get a minimum gateway allocation. This means it
is acceptable for an employee to be excluded and not receive any employer nonelective
contribution. However, if an NHCE receives any nonelective contribution including a safe
harbor or top-heavy minimum contribution then he or she must receive the minimum gateway.
This will impact plans that have allocation conditions such as a 1,000 hour requirement or a last
day requirement and may mean that contributions for those employees need to be increased.
Many plan documents contain provisions for increasing allocations to meet the minimum
gateway without an annual amendment removing the allocation conditions.
It should also be noted that the minimum gateway requirement applies only to NHCEs, so it is
permissible for HCEs to receive allocations that are less than the minimum gateway or to receive
no allocation at all.
To cross-test defined contribution plans on the basis of benefits, an equivalent benefit accrual
rate (EBAR) is calculated for each employee by expressing the allocation as an equivalent annual
benefit payable as a single life annuity at the employees testing age (normal retirement age).
This is a normalized benefit.
Normalizing benefits is based on the philosophy of the time value of money. Younger
participants contributions have more years of projected earnings and the potential to grow into
more significant benefits at retirement than the same contributions made for older participants.
From this perspective, higher contributions made to older HCEs are not necessarily
discriminatory.
Equivalent Benefit Accrual Rate (EBAR)
Allocations are converted to a benefit at the participants testing age by bringing the current
allocation forward to the testing age at a given interest rate and then dividing that amount by
69

the appropriate annuity purchase rate. The converted benefit is divided into the participants
current or average compensation to produce the EBAR.
Allocations used may be current year (annual testing) or the entire account balance if the
accrued to date method of testing is used.
Benefit conversions must use a reasonable interest rate, a reasonable mortality table, and be
gender neutral. A standard interest rate and a standard mortality assumption are considered
reasonable. A standard interest rate is an interest rate that is not less than 7.5% or more than
8.5%, compounded annually.
Following is a list of standard mortality tables:
UP-1984 Mortality Table (Unisex)
1983 Group Annuity Mortality Table (Female)
1983 Group Annuity Mortality Table (Male)
1983 Individual Annuity Mortality Table (Female)
1983 Individual Annuity Mortality Table (Male)
1971 Group Annuity Mortality Table (Female)
1971 Group Annuity Mortality Table (Male)
1971 Individual Annuity Mortality Table (Female)
1971 Individual Annuity Mortality Table (Male)
The EBAR can be expressed as a percent of compensation or a dollar amount. The testing age is
the normal retirement age specified in the plan.
If a defined benefit and defined contribution plan are aggregated and tested on a benefits basis,
a separate gateway test requiring minimum benefits applies.
EXAMPLE: Jack and Jill are participants in a profit sharing plan. The plan defines normal
retirement age as age 65.
Jack is 45 years old, has plan year compensation of $100,000, and is allocated a $15,000 profit
sharing contribution. No other contributions or forfeitures are allocated to Jacks account.
Jill is 25 years old, has plan year compensation of $20,000, and is allocated a $1,000 profit
sharing contribution. No other contributions or forfeitures are allocated to Jills account.
Jacks allocation rate based on his contributions is 15% ( $15,000 / $100,000 ). Jill's allocation rate
based on her contributions is 5% ( $1,000 / $20,000 ). However, the plan is being cross-tested.
The EBARs are being calculated based on the allocations for the current plan year only; thus, it
is permissible to use plan year compensation in the calculations. It is not necessary to use
average annual compensation.
70
The interest rate assumption being used is 8.5%. The mortality table being used is the UP-1984
Unisex Mortality Table. The testing age is the plans normal retirement age of 65.
Step 1: Determine the number of years each participant has until testing age is reached.
Jack has 20 years until he reaches age 65 ( 65 - 45 = 20 ).
Jill has 40 years until she reaches age 65 ( 65 - 25 = 40 ).
Step 2: Take the interest rate and project it to testing age for each participant using the number
of years to retirement as the exponent.
Jacks projected interest rate is (1.085)^20 or 5.112.
Jills projected interest rate is (1.085)^40 or 26.133.
Step 3: Determine the projected monthly benefit at normal retirement age.
Multiply each participants contribution allocation by the results of step 2 and divide it by the
annuity purchase rate of 95.4 (as determined using UP-1984 Unisex Mortality Table).
Jacks projected monthly benefit is $803.78
( $15,000 * 5.112 ) / 95.4
Jills projected monthly benefit is $273.93
( $1,000 * 26.133 ) / 95.4
Step 4: Divide each participants plan year compensation by 12 to determine the monthly
compensation amounts.
Jacks monthly compensation is $8,333.33
( $100,000 / 12 )
Jills monthly compensation is $1,666.67
( $20,000 / 12 )
Step 5: Determine the EBAR by dividing each participants projected monthly benefit by the
monthly compensation amount.
Jacks EBAR is .09645 or 9.65%
( $803.78 / $8,333.33 )
Jills EBAR is .16435 or 16.44%
( $273.93 / $1,666.67 )
71
Although Jills contribution allocation rate was only 5% of her plan year compensation, her
EBAR is greater than Jacks. Jill is younger than Jack, so her allocation has 20 more years of
projected earnings than Jacks and represents a larger benefit as a percentage of compensation at
age 65 than Jacks contribution allocation rate of 15%.
RELATIONSHIP BETWEEN IRC 401(A)(4) AND IRC 410(B)

If plans are aggregated for IRC 410(b), they must be aggregated for IRC 401(a)(4); if plans are
disaggregated for IRC 410(b), they must be disaggregated for IRC 401(a)(4).
Restructuring into component plans is an option if each such component independently satisfies
IRC 410(b) and 401(a)(4).
It is essential to have identical plan years when aggregating multiple plans.
Failure to satisfy the nondiscrimination requirements under IRC 401(a)(4) will result in plan
disqualification.
A corrective amendment may increase contributions or benefits for NHCEs or add participants
so that the contributions or benefits satisfy the nondiscrimination requirements. A corrective
amendment must be made by the 15th day of the tenth month after the close of the plan year
affected.
This type of failed test is considered a demographic failure, so once the 15 th day of the tenth
month has passed the plan would need to file under the IRS Voluntary Correction Program
(VCP) when correcting the error.
Benefits, Rights and Features

Benefits, rights and features (BRF) must be provided on a nondiscriminatory basis under IRC
401(a)(4). To satisfy the nondiscrimination tests of IRC 401(a)(4), all benefits, rights and
features must be made currently available and effectively available to participants in a
nondiscriminatory manner.
There are three types of BRF:
Optional forms of benefit (protected benefits under IRC 411(d)(6)) include the following:
Distribution alternatives;
Payment schedule (lump sum vs. annuity);
Timing and commencement of benefits;
Medium of distribution (cash or in-kind);
Eligibility for different options; and
Election rights regarding optional forms.
72

Ancillary benefits include the following:
Ancillary life insurance and health insurance;
Social Security supplement;
Disability;
Death benefits in a defined contribution plan; and
Preretirement death benefits in a defined benefit plan.
All other meaningful provisions, including (but not limited to) the following examples, are
subject to the benefits, rights and features rules:
Loans;
Right to make deferrals or after-tax contributions;
Right to each rate of deferrals or after-tax contributions;
Right to each rate of matching contribution;
Vesting schedules;
Right to make rollover contributions;
Right to direct investments (e.g., If a participant must have a $5,000 balance to direct his
or her investments, the right is not currently available to participants with balances less
than $5,000.); and
Right to a particular form of investment (e.g., a brokerage window, or real estate
investment).
EXAMPLE: XYZ Company is acquired by ABC Company. ABC Company sponsors a profit
sharing plan with a self-directed brokerage account option. XYZ Company sponsors a profit
sharing plan that does not offer a self-directed brokerage account option. If the participants in
XYZ Companys plan are permitted to continue using the self-directed brokerage account, this
option must be tested for discrimination purposes.
CURRENT AVAILABILITY
To satisfy this test the BRF must be currently available on a nondiscriminatory basis.
The BRF is tested using the following coverage tests of IRC 410(b):
Nondiscrimination classification test.
EXAMPLE: A plan provides different matching contribution rates to participants based upon
their years of service.
Less than 1 year of service
1 or more, but less than 5 years of service
5 or more years of service
25% match
50% match
100% match
73
The following chart lists the number of HCEs and NHCEs eligible for each rate of matching
contribution.
Eligible HCEs
Eligible NHCEs
<1 year of
service
0
42
1 or more
but <5 years
of service
6
20
5 or more
years of
service
2
5
Total
8
67
Because the rate of match is not uniform, this is a right that must be tested for nondiscrimination
purposes. This test is done in addition to the ACP test.
Below we have chosen to use the nondiscriminatory classification test because it is generally
easier to pass than the ratio percentage test.
Step 1: Determine the NHCE concentration percentage.
Divide the number of NHCEs by the total number of employees in the testing group
(67 / 75 = 89.33%).
Step 2: Round the NHCE concentration percentage down to 89% and refer to the Safe Harbor
and Unsafe Harbor Percentages Table to determine the safe harbor percentage (28.25%).
Step 3: Determine the percentage of NHCEs receiving the 100% match compared to the
percentage of HCEs receiving the 100% match.
(5/67) / (2/8) = 29.85%.
Because 29.85% is greater than the safe harbor percentage of 28.25%, the group of NHCEs
receiving the 100% match is deemed to be nondiscriminatory.
Step 4: This test must be performed for each level of matching contributions.
Note: You may permissively aggregate groups if one benefit, right or feature is equal to or
greater than another benefit, right or feature. Thus, any participants who have received a higher
level of match than the group being testing are treated as benefiting when testing current
availability for that group, as illustrated below.
Determine the percentage of NHCEs receiving the 50% match compared to the percentage of
HCEs receiving the 50% match.
[{(5+20)/67}/{(2+6)/8}] = 37.31%.
Because 37.31% is greater than the safe harbor percentage of 28.25%, the group of NHCEs
receiving the 50% match is deemed to be nondiscriminatory.
74
EFFECTIVE AVAILABILITY
Effective availability is demonstrated using a facts and circumstances test.
A BRF must be communicated to all participants (e.g, would fail effective availability if a
brokerage account was available to all participants but only communicated to the HCEs). There
is no correction available under SCP for failure of effective availability.
Elimination of a BRF is permitted for future accruals; however, the BRF must meet current
availability as of elimination date. No change in the terms of the BRF is permitted. In a defined
benefit plan the accrued benefit must be based on the accrued benefit as of elimination date. For
defined contribution plans earnings must be credited on the account balance after the
elimination date.
Correction of current availability violation:
Expanding the group covered by the BRF or alternatively removing the BRF prior to the
end of the year.
Adopt amendment within 9 months after plan year-end.
May not abuse amendment procedure. Amendment must remain in effect until the end
of year following the year the amendment was effective.
Effect or timing of plan amendments must be nondiscriminatory under IRC 404(a)(4).
Plan amendments include the establishment or termination of a plan, changing a BRF,
and changing a benefit or allocation.
The timing of a plan amendment cannot have the effect of significantly favoring HCEs or
former HCEs.
Discriminatory effect determined on a facts and circumstances basis.
Past service credits cannot favor HCEs. Safe harbor past service credits limited to five
years.
If an employer receives a favorable IRS determination letter on an amendment, the
determination can be relied on with respect to whether the timing of the amendment is
nondiscriminatory.
An effective availability violation cannot be self corrected. Use of a correction program will be
required.
Top-Heavy Requirements under IRC 416

A top-heavy plan is one in which the value of the account balances (for defined contribution
plans) and the present values of accrued benefits (PVABs, for defined benefit plans) for key
employees exceed 60% of the total of such account balances or PVABs for all employees in the
plan.
75

If the employer maintains more than one plan, the plans must be aggregated for determining
top-heavy status if they are part of a required aggregation group. If they are not part of a
required aggregation group, the plans are tested separately for top-heavy purposes.
If a required aggregation groups top-heavy ratio exceeds 60%, every plan in the group is
considered to be top-heavy, even if the plan would not be top-heavy if it was tested separately.
Plans that are not included in the required aggregation group may be permissibly aggregated
into the group under certain circumstances.
KEY EMPLOYEES
An employee is a key employee if at least one of three tests is met:
5% owner test. An employee satisfies this test if the employee owns more than 5% of the
employer (or more than 5% of a related employer). No minimum level of compensation
is required.
1% owner test. An employee satisfies this test if the employee owns more than 1% of the
employer (or more than 1% of a related employer) and has annual compensation greater
than $150,000. The $150,000 compensation requirement is not indexed for cost-of-living
increases.
Officer test. An employee satisfies this test if the employee is an officer and satisfies the
compensation requirement. The $130,000 compensation requirement is subject to cost-ofliving adjustments, and has been adjusted to $160,000 for 2009 & 2010. There are a
maximum number of officers who must be treated as key employees. The maximum is
10% of the number of employees or 3, whichever is greater. However, no more than 50
officers are treated as key employees, even if the 10% cap is greater than 50.
TOP-HEAVY REQUIREMENTS
There are two main requirements when a plan is top-heavy:
Vesting must be accelerated if the plan is a defined benefit plan. The vesting schedule
must be at least as liberal as one of the two minimum schedules normally applicable to
defined contribution plans: three-year cliff vesting or six-year graded vesting.
Non-key employees must receive minimum levels of contributions (in defined
contribution plans) or benefit accruals (in defined benefit plans).
Defined Contribution Plans
Generally, all non-key employees employed on the last day of the plan year must receive an
employer contribution of at least 3% of compensation (or a contribution equal to the highest
percentage of compensation allocated to the account of any key employee including deferrals)
for the entire plan year. It must be based on full year compensation even if other allocations are
based on compensation from the date of plan entry. Both employer matching and nonelective
contributions can be used to satisfy the 3% requirement.
76

Generally, all non-key employees credited with at least 1,000 hours of service must receive a
benefit that is not be less than 2% of average compensation, multiplied by year of service (up to
ten years).
PLAN DESIGN CONSIDERATIONS

Typically small plans are top-heavy because the employer has a larger number of key
employees compared to non-key employees.
Large plans are rarely top-heavy because the employer has a larger number of non-key
employees compared to key employees.
Plans designed with only employee contributions (elective deferrals and designated Roth) are
still subject to the top-heavy rules. For example, the owners (key employees) of the employer
contribute the IRC 402(g) limit for the year. The plan fails the Actual Deferral Percentage (ADP)
test and is top-heavy. Not only will the HCEs get some or all of their money back in refunds, but
a top-heavy minimum contribution must be made.
The top-heavy minimum contribution can be used towards the minimum gateway for a crosstested plan. Top-heavy minimums should be coordinated with gateway eligibility because an
NHCE may not fulfill the allocation requirements to receive an employer contribution (e.g., if
there is a 1000 hour requirement in a DC plan), but if that NHCE is employed on the last day of
the plan year, he or she must receive the top-heavy minimum allocation which makes the NHCE
a benefiting participant and therefore subject to the gateway requirement. Some plans contain
provisions to automatically increase allocations to meet the minimum gateway without a new
amendment.
401(k) safe harbor plans are not subject to the top-heavy rules as long as the only contributions
to the plan are elective deferrals, including designated Roth, and the required safe harbor
contribution.
SIMPLE IRA and SIMPLE 401(k) plans are not subject to the top-heavy rules.
Additional information on top-heavy can be found in Volume 1: Plan Qualification and Compliance
Basics of the ASPPA Defined Contribution Plan Series.
Compensation Testing Under IRC 414(s)
The definition of compensation used for nondiscrimination testing (also for ADP and ACP
testing, testing under IRC 410(b), permitted disparity, QSLOBs, etc.) must satisfy the rules of
IRC 414(s).
The IRC 414(s) definition of compensation includes four safe harbors and a nonsafe harbor
definition.
77
SAFE HARBORS
The basic safe harbor definition is the same definition used to determine the maximum benefit
or annual additions under IRC 415(c)(3). This definition will apply by default to self-employed
individuals.
Three alternative safe harbors:
IRC 415(c)(3) compensation excluding:
Reimbursements or other expense allowances;
Fringe benefits (taxable and nontaxable);
Moving expenses;
Deferred compensation; and
Welfare benefits.
Compensation subject to federal income tax withholding, as defined in IRC 3401(a),
regardless of limitations based on nature or location of employment.
Compensation reported on Form W-2 (as defined under IRC 6041(d), 6051(a)(3), and
6052).
Current
Includible
Compensation
Safe Harbor
Definition
W-2
Compensation
Federal
Withholding
Wages
Salary
Included
Included
Included
Included
Overtime
Included
Included
Included
Included
Bonuses
Included
Included
Included
Included
Commissions
Included
Included
Included
Included
Included, but
allocated tips
are arguably
excepted
Included, but
allocated tips
are arguably
excepted
Exclude
allocated tips,
noncash tips,
tips <$20 per
month
Exclude
allocated tips,
noncash tips,
tips <$20 per
month
Included
Included
Included
Included
Item of
Compensation
Tips
Elective
deferrals
78
Item of
Compensation
Current
Includible
Compensation
Safe Harbor
Definition
W-2
Compensation
Federal
Withholding
Wages
Expense
reimbursements
- accountable
plan
Excluded
Excluded
Excluded
Excluded
Expense
reimbursements
nonaccountable
plan
Included
Included
Included
Included
Qualified
moving expense
reimbursements
Excluded
Excluded
Excluded
Excluded
Nonqualified
moving expense
reimbursements
Included
Excluded
Included
Included
Nontaxable
fringe benefits
Excluded
Excluded
Excluded
Excluded
Taxable fringe
benefits
Included
Included
Included
Included
Excess group
term life
insurance
Included
Included
Included
Excluded
Taxable medical
or disability
benefits
Included
Excluded
Included
Included
Workers
compensation
Excluded
Excluded
Excluded
Excluded
79
Current
Includible
Compensation
Safe Harbor
Definition
W-2
Compensation
Federal
Withholding
Wages
IRC 83
property that
becomes freely
transferable or
no longer
subject to
substantial risk
of forfeiture
Excluded
Excluded
Included
Included
Income
attributable to
IRC 83(b)
election
Included
Excluded
Included
Included
Nonqualified
plan
contributions
excludable in
year of
contribution
Excluded
Excluded
Excluded
Excluded
Nonqualified
plan
distributions
Excluded
unless plan
provides
otherwise
Excluded
unless plan
provides
otherwise
Included
Included
Qualified stock
options - grant
or exercise
Excluded
Excluded
Excluded
Excluded
Nonqualified
stock option
includible in
income in year
granted
Included
Excluded
Included
Included
Item of
Compensation
80
Item of
Compensation
Current
Includible
Compensation
Safe Harbor
Definition
W-2
Compensation
Federal
Withholding
Wages
Nonqualified
stock option income
includible in
year of exercise
Excluded
Excluded
Included
Included
Safe harbor definitions may be modified. The modifications to the IRC 415(c)(3) definition in
the first alternative safe harbor (above) can be applied to the income tax withholding definition
or the W-2 definition, where applicable, but they must be made as a group, not individually.
All elective deferrals under IRC 125, 132(f)(4), 402(e)(3), 402(h), 403(b), 414(h)(2) and 457(b)
may be excluded as a group, but not individually.
Any form of compensation can be excluded if the exclusion applies only to HCEs.
As an alternative to the safe harbor definition of compensation, any compensation definition
that satisfies these three criteria can be used (e.g., definitions that would require testing could
exclude bonuses, overtime, or commissions).
NONSAFE HARBOR
Nonsafe harbor compensation definitions must be reasonable.
May not favor HCEs by design.
Must satisfy a quantitative test.
The test divides the nonsafe harbor compensation amount into the safe harbor compensation
amount for each employee. The average percentage of safe harbor compensation that is included
in the nonsafe harbor definition for the HCEs may not exceed the average percentage for the
NHCEs by more than a de minimis amount. The de minimis amount is not specified under the
regulations.
If a nonsafe harbor definition is being used and there are self-employed individuals included in
the test, their nonsafe harbor compensation is determined by multiplying their earned income
under IRC 415(c)(3) by the average percentage of safe harbor compensation that is included in
the nonsafe harbor definition for NHCEs.
81
EXAMPLE: XYZ Corporations plan compensation definition excludes bonuses.
Employee
HCE 1
HCE 2
HCE 3
NHCE 1
NHCE 2
NHCE 3
NHCE 4
Total
Compensation
$300,000
$100,000
$100,000
$50,000
$45,000
$32,000
$24,000
Bonus
$20,000
$10,000
$5,000
$4,000
$4,500
$0
$0
Compensation
(less bonus)
$280,000
$90,000
$95,000
$46,000
$40,500
$32,000
$24,000
Compensation
percentage
100%
90%
95%
92%
90%
100%
100%
The compensation percentage is determined by dividing each employees compensation less the
bonus by the employees total compensation.
Although HCE 1s compensation less the bonus is $280,000, compensation for plan purposes
must be limited to the dollar limit in effect under IRC 401(a)(17). Thus, HCE 1s compensation
percentage is 100%.
To determine the compensation ratio for each group, take the average of compensation
percentages for each employee in the group.
HCE compensation ratio = [ ( 100% + 90% + 95% ) / 3 ] = 95%.
NHCE compensation ratio = [ (92% + 90% + 100% + 100%) / 4 ] = 95.5%.
The compensation ratio test is satisfied because the NHCE compensation ratio is greater than
the HCE compensation ratio. If the NHCE compensation ratio had been less than the HCE
compensation percentage, the test would be satisfied only if the difference in favor of the HCE
compensation percentage were not more than a de minimis amount.
The definition of compensation used for nondiscrimination testing does not have to be the same
definition used for contribution allocation, benefit accrual, determination of highly compensated
employees, IRC 401(k) or 401(m) testing, or other purposes, unless otherwise specified by the
plan document.
For defined benefit plans the definition of compensation used must be the average of IRC
414(s) compensation over at least three consecutive years when calculating the accrual rate.
Current compensation can be used with the annual method for defined benefit plans.
The plan definition of compensation may exclude, compensation in year of termination, year in
which the employee performs no service, or years in which employee works less than a
specified number of hours.
The definition of compensation need not use consecutive years if the plan is not integrated and
permitted disparity is not imputed and the plan also utilizes nonconsecutive years.
82
Summary of Testing
Identify
Employer
Single
Controlled
Affiliated
QSLOB
Identify common law employees,

independent contractors, and leased
employees
Identify excludable and nonexcludable

employees
Identify benefiting and nonbenefiting

employees
Identify HCEs and NHCEs
Step 1. Minimum participation test under IRC 401(a)(26) (Defined Benefit Plans Only)
# of nonexcludable, benefiting
NHCEs & HCEs in single plan

# of Nonexcludable NHCEs & HCEs
> 40% of all employees

or 50 employees
If there are only 2 employees, then both must be covered.
83

Step 2. Minimum coverage under IRC 410(b) -- A or B
A. Ratio percentage test
benefiting nonexcludable NHCEs in aggregation group

all nonexcludable NHCEs
=a
# benefiting nonexcludable HCEs in aggregation group

all nonexcludable HCEs
=b
0.70? (retain actual result for later steps)
B. Average benefit test

Actual benefit percentage of nonexcludable NHCEs
Actual benefit percentage of nonexcludable HCEs
Note: If not
0.70?
0.70 this is not an option
Note: Actual benefit percentage is an average of all appropriate persons results

over all annual additions and benefit accruals available within the employer.
Step 3. Reasonable classification: Are eligible employees for plan(s) selected on objective
business criteria? If yes, proceed to nondiscriminatory classification test:
Total # nonexcludable NHCEs
Total # nonexcludable NHCEs & HCEs
= x % (concentration percentage)
x% determines safe harbor ratio percentage and unsafe harbor ratio percentage
(see the previous table)
Step 4. Is ratio percentage result from 2.A. greater than > the safe harbor ratio percentage?
if yes = Pass
if no = Review IRC 410(b) for alternatives
84

Step 5. Nondiscrimination test under IRC 401(a)(4) 1 or 2
Do plan(s) have a safe harbor design? If yes, you are done. If no, proceed to general test.
General test
Calculate accrual or allocation rate(s) representative of only benefit accruals or annual
additions in the plan(s) being tested.
Perform the gateway test if the plan is being cross-tested. Are NHCE allocations at least
5% of the NHCEs IRC 415(c)(3) compensation? If not, are all NHCE allocations at least
one-third of the allocation rate of the HCE with the highest allocation rate?
Determine rate groups one per HCE and all other individuals (NHCEs or HCEs) in
the plan(s) being tested with accrual or allocation rate the rate of the HCE being tested.
Determine ratio percentage test (RPT) result for only individuals in each rate group. That
is, a separate ratio percentage test is performed for each rate group.
Is the average benefit percentage test result in 2.B. above 70%? If so, the rate group
passes if it is greater than or equal to the midpoint of safe and unsafe harbor (see table).
If not, the rate group passes only if ratio percentage is 70%.
All rate groups must pass before plan passes.
85
Chapter 3
401(k) Plans
Cash or Deferred Arrangements (CODA) Basics
Qualified plans that contain elective salary deferral or cash-or-deferred arrangements are
commonly called 401(k) plans after the Internal Revenue Code (IRC) section that governs these
arrangements. The deferral arrangement actually is a special provision added to a qualified
profit sharing or stock bonus plan.
In addition to being subject to the qualification requirements of a profit sharing plan or stock
bonus plan, 401(k) plans must satisfy special qualification requirements. Certain retirement
plans contain a cash-or-deferred arrangement (CODA) allowing participants a choice between
current taxable income (cash) and tax-deferred income (plan contributions). A CODA must
satisfy IRC 401(k) rules.
PLANS THAT CAN CONTAIN A CODA

Retirement plans permitted to contain a CODA include:
Profit sharing;
ESOP;
Stock bonus;
Pre-ERISA money purchase (and rural electric and telephone cooperative money
purchase);
Simplified Employee Pensions established prior to 1997 (SARSEPs);
Tax-Sheltered Annuity 403(b)(TSA);
Nonqualified; and
Savings Incentive Match Plan for Employees of Small Employers (SIMPLE).
To distinguish profit sharing plans with CODAs from those without CODAs, a profit sharing
plan with a CODA is commonly called a 401(k) plan. Likewise an ESOP with a CODA is
commonly called a KSOP.
State and local governments cannot currently adopt and maintain 401(k) plan, but a plan
adopted by state or local government before May 6, 1986, is grandfathered and may continue to
exist.
87
Types of Contributions in 401(k) Plans

ELECTIVE DEFERRALS
Elective deferrals are contributions made by the employer due to an election by the participant.
The most common form of participant election is pursuant to a salary reduction agreement with
deferrals made through payroll deduction.
Elective deferrals may be referred to as salary deferrals, salary reduction contributions, 401(k)
deferrals, 401(k) contributions or pre-tax contributions, to name a few.
A retirement plan cannot require more than one year of service to be eligible to make elective
deferrals. The two years of service option available to profit sharing plans is not available to the
elective deferral component of a 401(k) plan. The elective deferral component can however,
include an entry date provision in addition to one year of service. The most common eligibility
requirement is 1 year of service, age 21 and two entry datesfirst day of the first month of the
plan year and first day of the seventh month of the plan year. Under no circumstances can an
eligibility requirement with entry dates preclude an employee with a year of service from
becoming a participant for more than 18 months from the employment date. Elective deferrals
are always 100% vested.
Elective deferrals are made on a pre-tax basis and as such are not subject to current federal
income taxation (and, for almost all states, state and local taxation). Taxation is deferred until
contributions and related income is distributed from the plans trust or subsequent tax deferred
rollover account, at which time it is taxed as ordinary income. Elective deferrals are however
subject to FICA and FUTA taxes at the time compensation is deferred.
Although elective deferrals are made at the election of the participant, they are considered
employer contributions for purposes of IRC 415 limits. Elective deferrals are always deductible
contributions under IRC 404. Elective deferrals are subject to the IRC 402(g) dollar limit and
satisfy nondiscrimination requirements by means of the ADP test.
There are specific rules regarding how elective deferrals are considered for purposes of topheavy under IRC 416. For example, elective deferrals made by key employees are treated as
employer contributions when determining the required amount of top-heavy minimum
contribution due for non-key employees. However, elective deferrals made by non-key
employees cannot be used to satisfy the top-heavy minimum contribution requirement. For this
reason, careful attention must be paid to top-heavy issues when designing plans. A small
deferral only plan can become top-heavy very quickly if the key employees are deferring
significantly more than non-key employees. Taken to the extreme if the HCE owners are the
only employees who defer, they may receive a refund of all of their elective deferrals and create
a top-heavy plan where they are required to make a top-heavy contribution to all non-key
employees.
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Elective deferrals must be deposited into the plans trust by the earliest date reasonably possible
in conjunction with payroll, but not later than fifteenth business day of the month following the
month in which elective deferrals were deducted from employees payroll checks. The DOLs
Labor Reg. 2510.3-102(a)(2) created a safe harbor deadline of 7 business days following the
payroll date that is applicable to small plans.
Deposits made within 12 months after the plan year end are considered to be made for that plan
year, although penalties would apply.
Note: Final regulations prohibit pre-funding by plan sponsors of elective deferrals on a
deductible basis other than for bona fide administrative reasons. Contributions are considered
deposits of elective deferrals only if elective deferrals are affiliated with service performed prior
to date of contribution to the plans trust.
DESIGNATED ROTH CONTRIBUTIONS

EGTRRA created Roth 401(k) accounts effective for tax years beginning on or after January 1,
2006. 401(k) plans can include a provision to allow participants to make designated Roth
contributions on an after-tax basis in addition to, or in place of, a traditional pre-tax elective
deferral. In order to allow for designated Roth contributions, the plan must already offer pre-tax
elective deferrals. Therefore, a Roth-only 401(k) plan is not allowed.
Designated Roth contributions must meet three basic requirements:
Designated irrevocably as Roth contribution at the time the contribution is made;
Included in employees wages at the time of deferral; and
Maintained in a separate account in the plan until the plan has completely distributed
the account. Gains, losses and expenses must be allocated on a reasonable and consistent
basis. No forfeiture allocation to the account is allowed.
In most cases, designated Roth contributions are treated for plan purposes in the same manner
as pre-tax elective deferrals. They are subject to the IRC 402(g) dollar limit, included as a
deferral in ADP testing, subject to withdrawal restrictions, must be 100% vested, can be treated
as catch-up contributions, can be borrowed against with a participant loan and are subject to
minimum distribution rules under IRC 401(a)(9).
If the plan has an automatic enrollment arrangement, the terms of the plan must specify if the
default contributions are pre-tax elective deferrals or designated Roth contributions. In
addition, employers may choose to make matching contributions on designated Roth
contributions.
The primary distinction and advantage of Roth 401(k) accounts is the taxation upon
distribution. If, at the time of distribution, the amount is a qualified distribution, the
contributions made on an after-tax basis and the gains on such contributions are distributed taxfree. The disadvantage of the Roth 401(k) account is the Roth contribution is currently taxable
89

to the participant, which may affect the participants ability to contribute to the plan. In other
words it costs the participant more now contribute a Roth contribution than a traditional
deferral, however, it may payoff in the end when the earnings are distributed tax free.
CATCH-UP CONTRIBUTIONS
Certain elective deferrals made by catch-up eligible participants into a 401(k) plan are treated as
catch-up contributions. Generally, catch-up contributions are not included in determining
certain limits [e.g., IRC 402(g), IRC 415] and are not included in nondiscrimination testing
(although they are included for certain purposes in top-heavy determinations). Catch-up
contributions are also permitted under 403(b) plans, SIMPLEs, SARSEPs and governmental 457
plans.
Catch-up eligible participants are employees who are eligible to make elective deferrals under
plan and who will be age 50 or older by the end of the employees taxable year (generally
December 31st).
To recharacterize elective deferrals as catch-up contributions, a catch-up eligible participant
must exceed at least one of the following limits:
Statutory limit limit on elective deferrals or annual additions permitted to be made
(without regard to allowable catch-up contributions) with respect to an employee for a
year [e.g., IRC 402(g) dollar limit, IRC 415 limit];
Employer-provided limit any limit on elective deferrals an employee is permitted to
make (without regard to allowable catch-up contributions) contained in the terms of the
plan but not required under IRC (e.g., plan document limits deferrals to 10% of
compensation); and
ADP limit amounts that would be distributed as excess contributions must be
reclassified as catch-up contributions
Although catch-up contributions are excluded from ADP testing, a catch-up eligible participant
deferring a high percentage of compensation, can cause other HCEs to receive a refund.
EXAMPLE: Assume that the ADP of the NHCEs for testing purposes is 3.0%. That means the
HCE ADP can only be 5.0% (the lesser of two times or two plus the ADP of the NHCEs). The
HR director informed the HCEs that they should only defer 5% to avoid testing problems, so all
of the HCEs elect to defer 5% to avoid refunds. This limitation is just a recommendation and
not a limit specified in the plan document. One HCE is age 50 and learned of being catch-up
eligible and elects to do another $5,500 in addition to the 5% deferral. HCE # 1 is age 50 earns
$100,000 and defers $10,500 (5% plus $5,500 or 10.5%). HCE #2 is 30 earns $245,000 and defers
$12,250 or 5%. Under this scenario the ADP for the HCEs is 7.75% and the test fails.
This is where a well-intentioned HCE can cause problems for the other HCEs. HCE#1 has not
deferred his IRC 402(g) limit of $16,500, so his actual catch-up contribution will be determined
once his permissible deferral rate is calculated using the leveling method. HCE#1 deferred
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2.75% too much for the test to pass, so $2,750 will have to be refunded. However under the
leveling method, HCE #2 who deferred the higher dollar amount will have to take most of the
refund. HCE #2s refund would be $2,250 plus allocable earnings. HCE #1s refund would be
$500, however, because of his catch-up eligibility, his refund would be re-characterized as a
catch-up contribution and left in the plan.
Plans allowing catch-up contributions must meet the universal availability requirement in order
to satisfy IRC 401(a)(4). All catch-up eligible participants in any 401(k), 403(b), SIMPLE or
SARSEP maintained by the employer must be provided with effective opportunity to make
same dollar amount of catch-up contributions. The universal availability requirement is not
violated if union employees are not provided the opportunity to make catch-up contributions.
Special rules apply for merger and acquisition situations.
For top-heavy determinations under IRC 416 a plan does not include catch-up contributions in
the determination in the plan year made. A plan does however include catch-up contributions
for prior determination years, eliminating the necessity of keeping separate accounting of
historical catch-up contributions.
EXAMPLE: Assume a Highly Compensated catch-up eligible employee deferred $6,500 to a prior
employer plan and an additional $16,500 to a new employers plan during 2012.
Which plan refunds the $1,000 excess contribution (the maximum deferral is $22,500 = $17,000 +
$5,500.)?
It is the employees responsibility to allocate the excess deferrals among the plans and to notify
each plan of the (of excess) allocated to it. The final regulations require the notification to be
made no later than April 15 (or an earlier date if provided by the plan) of the year after the year
of the excess deferral.
Would the $5,500 in catch-up contributions be excluded from the ADP test of the current
employer?
No. In fact neither plan would treat the catch-up contributions as catch-up contributions for
purposes of ADP testing since the 402(g) limit in that plan was not exceeded. The ADP testing
for each plan would include the total deferrals made to that plan.
EMPLOYER MATCHING CONTRIBUTIONS

Elective deferrals may be matched by the employer. The matching contribution allocation
formula must be definitely determinable under the terms of the plan, although the amount can
be discretionary. A common matching formula is a percentage of the participants elective
deferrals (with or without a maximum on the elective deferrals to be matched). The matching
percentage can be discretionary, and so can the amount of deferrals upon which the match is
based as long as the formula is applied in a uniform manner.
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Eligibility requirements for the employer matching contribution can differ from eligibility
requirements for elective deferrals. It is not uncommon for a plan to have a longer eligibility
period for matching contribution than for elective deferrals; e.g., the plan may allow immediate
eligibility to make elective deferrals but require one year of service before becoming eligible for
matching contribution. However, be aware of top-heavy requirements. If a plan is designed
with two different eligibility requirements and is top-heavy the plan will owe top-heavy
minimum contributions to everyone who is eligible for any portion of the plan.
Employer matching contributions are considered employer contributions for purposes of IRC
415 limits. Employer matching contributions are subject to deductible contribution rules under
IRC 404 and satisfy nondiscrimination requirements by means of the ACP test.
Assuming no more than one year of service for eligibility purposes, matching contributions
must vest according to one of the minimum vesting schedules:
Three-year cliff vesting; or
Six-year graded vesting.
Catch-up contributions can be matched, but it is not a requirement. If the plan applies a single
matching formula to elective deferrals, whether or not they are catch-up contributions, the
matching formula, as applied to the catch-up eligible participants, is not treated as a separate
benefit, right or feature under IRC 401(a)(4). Careful attention should be paid to plans that do
not match catch-up contributions because if deferrals are reclassified as catch-up contributions
the associated match would need to be forfeited.
All matching contributions, including matching contributions on catch-up contributions, must
be included in ACP test unless they are QMACs that have already been shifted to the ADP test
as described later in this chapter.
For purposes of satisfying top-heavy minimum contribution requirements, matching
contributions allocated to key employees are treated as employer contributions to determine
required top-heavy minimum contributions to non-key employees. Unlike elective deferrals,
matching contributions allocated to non-key employees can be used to satisfy top-heavy
minimum contribution requirements.
The deadline for depositing matching contributions into the plans trust for deduction purposes
is the same time that other employer contributions are due (by the deadline for filing the
employers tax return, including extensions). An exception exists for safe harbor matching
contributions calculated per pay period which must be deposited no later than the end of the
quarter following the quarter to which they apply. The definition of match for ACP testing
provides that the matching contribution must be paid to the trust no later than the end of the
12-month period immediately following the year that contains that date. [Treas. Reg. Sec.
1.401(m)-2(a)(4)(iii)(C)]. Likewise the definition of safe harbor contributions provides that the
safe harbor non-elective or safe harbor matching contribution must be deposited to the trust
within 12-months of the end of the plan year [Treas. Reg. Sec. 1.401(k)-2(a) and 1.401(m)-2(a)].
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Any safe harbor contributions that are deposited after the tax filing deadline for the year they
apply to would be deducted for the year in which they are deposited in assuming it is within
the deduction limit for that year. It is possible in such a scenario for an employer to have a
nondeductible contribution for the year in which the contributions were deposited if they do
not have enough eligible compensation for both the prior year and current year even though the
contributions were required to be made to the plan based on the compensation earned during
those plan years.
Note: Final regulations prohibit pre-funding by plan sponsor of matching contributions on a
deductible basis other than for bona fide administrative reasons. Contributions are considered
deposits of matching contributions only if the matching contributions are affiliated with service
performed prior to the date of contribution to plans trust.
EMPLOYER NONELECTIVE CONTRIBUTIONS

Employer nonelective contributions are employer contributions, other than matching
contributions, for which participant had no election to receive cash; e.g., employer discretionary
contribution under a profit sharing plan.
The eligibility requirements can be different from those for elective deferrals and/or matching
contributions, although it is common to see the same conditions as those that apply to the
matching contributions.
Assuming one year of service for eligibility purposes, nonelective contributions must vest under
one of the minimum vesting schedules:
Three-year cliff vesting; or
Six-year graded vesting.
The deadline for depositing nonelective contributions into the plans trust is the same time that
other employer contributions are due (by the deadline for filing the employers tax return,
including extensions).
AFTER-TAX EMPLOYEE CONTRIBUTIONS

Participants can be allowed to voluntarily make employee contributions on an after-tax basis to
a 401(k) plan. Beginning in 2006, the ability to make designated Roth contributions makes this
plan design option somewhat obsolete. However, the after-tax employee contribution option
does allow an employee to contribute more to the plan than the IRC 402(g) limit as after-tax
employee contributions arent included in the IRC 402(g) limit calculation. As a result, some
plans do still contain this feature. In some plans, after-tax employee contributions are
mandatory.
After-tax employee contributions are either made by payroll deduction or personal check, as
allowed by plan. These contributions are subject to federal income taxation (and state and local
taxation, where applicable) in the year they are contributed.
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Cumulativeaftertaxemployeecontributionsrepresentingeachparticipantstaxbasisare
trackedandmaintainedinplanrecordkeeping.Toavoiddoubletaxationtotheparticipant,the
taxbasisisrecoveredandnottaxedagainwhenotherwisetaxableamountsaredistributedfrom
plan.
AftertaxemployeecontributionsaretreatedasannualadditionsunderIRC415(c)andsatisfy
nondiscriminationpurposesbymeansoftheACPtest.Aftertaxemployeecontributionsmade
bynonkeyemployeescannotbeusedtosatisfytopheavyminimumcontribution
requirements.
Contribution Limits
CONTRIBUTIONLIMITSUNDERIRC402(G)
IRC 402(g) limits elective deferrals (and beginning in 2006 designated Roth contributions) on
an individual basis to specified amounts per calendar year:
2005
$14,000
2006
$15,000
2007&2008
$15,500
20092011
$16,500
2012
$17,000
2013
$17,500andthereafter(asindexed)
TheIRC402(g)limitisanindividuallimitandisreduced,dollarfordollar,byelective
deferralsordesignatedRothcontributionsmadetoanyother401(k)plan[includingSIMPLE
401(k),SARSEP,IRC501(c)(18)unionpensionplanor403(b)plan]inwhichtheemployeeisa
participant.
ElectivedeferralsinexcessoftheIRC402(g)dollarlimitarecalledexcessdeferrals.Excess
deferralsareincludedintheincomeoftheparticipantforthetaxableyearinwhichdeferred,
butearningsallocabletoexcessdeferralsaretaxableintheyeardistributed.Excessdeferrals
maybereturnedduringsameyearinwhichexcessdeferralsarose.
Excessdeferralsplusearningsthereonmustbereturnedtotheindividualorrecharacterizedas
aftertaxemployeecontributionsnolaterthanApril15thfollowingcalendaryearinwhichdeferred.
Ifnottimelydistributed,theamountistaxabletotheparticipantintheyearofdeferralandagainin
theyeardistributed(i.e.,doubletaxation).
Ifallexcessdeferralsweremadetotheplanorplansofasingleemployerandexcessdeferralswere
notrefunded,theCODAceasestobequalified.Qualificationisnotaffectedifsomeoftheexcess
deferralsweremadetoaplanofanunrelatedemployer,includingaparticipants403(b)account.
[Treas.Reg.1.402(g)1(e)(3)(i)]
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If timely distributed, excess deferrals are not subject to the 10% additional income tax on early
distributions under IRC 72(t). Excess deferrals for HCEs, whether or not timely distributed, are
included in ADP test; however, all excess deferrals for NHCEs are disregarded in ADP testing.
Excess deferrals are counted for purposes of IRC 415 limits and IRC 416 top-heavy testing.
CATCH-UP LIMITS UNDER IRC 414(V)

Catch-up contributions allowable under 401(k) plans are limited on an individual basis to the
following amounts per tax year of the participant:
2002
$1,000
2003
$2,000
2004
$3,000
2005
$4,000
2006 - 2008
$5,000
2009 and thereafter
$5,500 (as indexed)
Permissible catch-up contributions will not count against the IRC 402(g), 404 and 415 limits
and will not cause plan to fail ADP or ACP tests, IRC 401(a)(4) nondiscrimination or IRC
410(b) coverage tests.
ANNUAL ADDITIONS UNDER IRC 415

Compensation for purposes of IRC 415(c) includes elective deferrals made under a CODA or
IRC 125 plan. Prior to the issuance of new final regulations to IRC 415 in April of 2007, the
regulations recognized certain circumstances under which a violation of the annual additions
limit was considered to be reasonable. If any of those circumstances applied, the plan was able
to use any of the three methods to correct the violations without disqualifying the plan. Under
the new regulations, these correction methods are eliminated, and a plan sponsor would need
to use the correction options outlined in the Employee Plans Compliance Resolution System
(EPCRS). Similarly, situations that do not fall within the corrections permitted below must be
resolved through the EPCRS.
The current EPCRS procedures provide a means to eliminate the excess amounts, i.e., the annual
additions that exceed the IRC 415 limitation. The excess amount, if it derives from employer
contributions is placed in an unallocated account and used (along with earnings on the
unallocated amounts) in the following limitation year (and succeeding years, if necessary) to
reduce employer contributions other than elective deferrals. The excess amounts are treated as
annual additions in the limitation year in which they are removed from the unallocated account
and used as employer contributions. No additional contributions by the employer are permitted
while there are funds in the unallocated account.
If an excess amount is allocated to a participants account and there have been elective deferrals
or after-tax employee contributions made by the participant for the limitation year, the plan
may provide for the distribution of elective deferrals and/or the return of after-tax employee
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contributions equal to the excess amount. Distributed elective deferrals are taxed in the year
distributed. The premature distribution penalty applicable to participants who are under age
59 does not apply. Many, if not most, plans provide for the correction under this method first,
so that an employees allocation of employer contributions is not reduced because of the
employees own elective deferrals or after-tax employee contributions.
If the elective deferral or after-tax employee contribution at issue is matched by the employer,
the related match should be forfeited. The forfeited match is placed in the unallocated suspense
account and must be used before other employer contributions are made to the plan. Because
matching contributions are also annual additions, the reduction and distribution must be
calculated together.
EXAMPLE: Joe, 35, owns Joes Construction, LLC and is a participant in the Joes Construction
401(k) Plan. The company did not have a good year in 2012, so Joe did not pay himself more
than he needed to defer $17,000. The plan has a fixed matching formula of 25% of all deferrals.
The plan administrator calculated Joes match to be $4,250.00. After meeting with his
accountant, he finds out that his earned income for 2012 is $10,000.00. Since he had earned
income for 2012 that was less than his plan contributions of $21,250 ($17,000 deferral + $4,250
match), he violated his IRC 415 limit by $11,250. As the plan is corrected by reducing his
deferrals the match associated with those deferrals must also be forfeited. To figure out how
much of each must be reduced divide $11,250 by 1.25, this results in $9,000 of his salary
deferrals being distributed to him, and $2,250 of the employer match being forfeited for a total
contribution of $10,000 remaining in the plan.
Distributed excess annual additions are disregarded for purposes of deferral limit under IRC
402(g), ADP and ACP tests and IRC 415 limits.
DEDUCTIBILITY
IRC 404(a)(3) limits an employers deduction under a profit sharing plan to 25% of covered
payroll for each fiscal year, but the deduction limit does not include elective deferrals, which
are always deductible.
Compensation for purposes of IRC 404(a)(3) includes elective deferrals made under CODA or
IRC 125 plan as limited under IRC 401(a)(17). In order to be deductible, employer
contributions must be deposited by the due date for filing the employers federal tax return,
including extensions. Matching contributions may only be deducted for the taxable year in
which their corresponding deferrals would have been received as compensation.
Nondeductible contributions are subject to a 10% excise tax. If employer contributions exceed
the deduction limit for a tax year, the excess may be carried forward to the next tax year and be
deducted in a subsequent tax year. Nondeductible contributions must generally be retained in
the plan and cannot be distributed back to the employer.
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Automatic Contribution Arrangements

Employers may choose to establish an automatic enrollment provision (also referred to as a
negative election or automatic contribution arrangement (ACA)) in the plan. This provision
has been an option for several years, but there were many issues which made this particular
provision unpopular. Many of these issues were addressed in the Pension Protection Act of
2006 (PPA) and in subsequent legislation, including:
ERISA preemption of state wage garnishment laws;
Fiduciary protection for contributions deposited into a default investment; and
Addition of a 90-day period in which employees may elect to have salary deferrals
returned without penalty.
Participants must be treated as having elected a uniform percentage of compensation to be
deducted from pay unless the participant makes an affirmative election of a different
percentage. This can be applied to all participants in the plan or only to new participants on a
going forward basis. Later in this chapter we discuss automatic increases to the base
percentage deferred from participants paychecks.
Advantages to adding an ACA to a 401(k) plan include:
Improved testing results due to increased plan participation; and
Greater retirement security for employees.
Disadvantages to adding an ACA to a 401(k) plan include:
Increased administrative burden;
Large number of small account balances in the plan;
Increased administration fees; and
The potential for an increased number of lost participants.
ELIGIBLE AUTOMATIC CONTRIBUTION ARRANGEMENTS (EACA)

PPA created a new class of negative election plans referred to as eligible automatic
contribution arrangements or EACA. By meeting some specific criteria an EACA provides some
additional advantages and protections beyond what is available to an ACA not meeting those
criteria.
The requirements that an ACA must meet to be an EACA are:
A participant is treated as having made an elective deferral election in the amount of a
uniform percentage (no minimum or maximum set by the statute) of compensation until
the participant specifically elects not to have such contributions made (or to have a
different percentage contributed) (i.e., the plan has an automatic enrollment feature), this
is applied to all participants not just new participants going forward; and
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The notice requirements of IRC 414(w)(4) are satisfied.
o
The required notice must be given within a reasonable period of time before each
plan year to each employee to whom the EACA applies for such plan year.
It must include the following information:

An explanation of the employees right under the arrangement to elect
not to have elective contributions made on the employees behalf (or to
elect to have such contribution made at a different percentage ), and
An explanation of how contributions made under the arrangement will
be invested in the absence of any investment election by the employee.
The notice must be written in a manner that is sufficiently accurate and

comprehensive to apprise the employee of his or her rights and obligations
under the plan, and in a manner calculated to be understood by the average
employee to whom the arrangement applies.
The final regulations provide that only those employees who are specified in the plan as being
covered employees under the EACA must be subject to the automatic enrollment provisions for
the EACA . Therefore, automatic enrollment under an EACA is not required to be applied to all
employees eligible to make a deferral election under the plan. However, because of the
requirement that default elective contributions under an EACA be a uniform percentage of
compensation, all automatic contribution arrangements within a plan that are intended to be
EACAs must be aggregated. A plan subject to the minimum coverage requirements of IRC
410(b) may provide for separate EACAs for different groups of employees with a different
percentage for each EACA. However, the disaggregation rules of IRS Reg. 1.401(k)-1(b)(4)
would then apply.
If an EACA is implemented for only certain categories of employees, the plan would not be
entitled to the 6-month correction period described in Treas. Reg. 54.4979-1(c) as it does not
include all eligible employees as covered employees.
Initially, in the absence of a participant investment election, an EACA was required to invest
participant contributions in a Qualified Default Investment Alternatives (QDIA). Under the
final regulations this requirement as been removed, but it is still a good idea to use a QDIA to
reduce fiduciary liability in the absence of participant elections.
The IRS has concluded that while an automatic contribution feature may be adopted at any
time, an EACA cannot be established mid-year. The big benefit provided to an EACA over an
ACA is the extension of the period for making corrective distributions without penalty from 2
months to 6 months.
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Information about the investments that qualify as a QDIA can be found in the Fiduciary Topics
chapter and in the CPC Investments module.
QUALIFIED AUTOMATIC CONTRIBUTION ARRANGEMENT (QACA)

Another type of automatic contribution arrangement established by PPA is a Qualified
Automatic Contribution Arrangement or QACA which combines features of an automatic
enrollment plan with features of a safe harbor plan. Additional information on QACA is
included in the Nondiscrimination Satisfied without ADP/ACP section later in this chapter.
Distributions
Permissible distributions of elective deferrals are more restrictive than distributions of other
types of contributions permitted in profit sharing or stock bonus plans. They are usually
referred to as distributable events. Elective deferrals, QNECs, QMACs and safe harbor
contributions can be distributed as the result of the following distributable events:
Severance from employment (replaced separation from service effective January 1, 2002);
Death;
Disability;
Attainment of age 59;
Termination of plan without establishment of a successor plan; and
Financial hardship [does not apply to QNECs, QMACs or safe harbor 401(k)
contributions].
A successor plan is a defined contribution plan defined in IRC 414(i) other than an ESOP. A
plan is a successor plan if it exists at time the 401(k) plan is terminated or within the 12-month
period beginning on the date the last of the plans assets are distributed. A plan is not treated as
a successor plan if less than 2% of employees in the terminated 401(k) plan are eligible for
another defined contribution plan of the same employer during 12-month period immediately
preceding and the 12-month period immediately following termination of the 401(k) plan.
Designated Roth contributions are after-tax contributions, and earnings on those contributions
may be withdrawn tax-free if the distribution is a qualified distribution. A qualified distribution
is one paid as result of attainment of age 59 , death or disability and occurs no earlier than five
years after the first designated Roth contribution is made (often called the five year holding
period).
If a distribution from a Roth 401(k) account is not a qualified distribution, it is treated as a
distribution or withdrawal from an after-tax employee account. In other words, the amount of
the distribution is pro-rated between basis and earnings under the specific rules applicable to
after-tax contributions. This is in contrast to a Roth IRA where basis in the account is
distributed prior to earnings.
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Certain distributions cannot be considered to be qualified distributions. These include
corrective distributions of excess amounts, deemed distributions, dividends on employer
securities and imputed income from life insurance policies. Distributions of employer securities
from Roth 401(k) accounts are subject to special rules depending on whether or not the
distributions were qualified distributions.
ADP/ACP Basics
ADP and ACP testing is the usual means to demonstrate that elective deferrals and matching
contributions are nondiscriminatory under IRC 401(a)(4) [assuming the plan is not deemed to
satisfy by virtue of being a safe harbor 401(k) or a SIMPLE plan]. Additional testing will be
required for non-uniform matching contributions.
Under final regulations for 401(k) plans issued in December 2004, certain matching, know as
targeted QMACS, allocated to NHCEs, known as targeted QMACs, can no longer be included
in ACP testing if they are considered to be disproportionate matching contributions. Rules
regarding disproportionate matching contributions for NHCEs are effective generally for plan
years beginning on or after January 1, 2006.
Matching contributions for NHCEs are disproportionate if they exceed the greatest of three
limits:
5% of compensation;
100% of employees elective deferrals; or
Two times the plans representative matching rate.
The representative matching rate is calculated by dividing matching contributions by elective
deferrals (and after-tax employee contributions, if matched). If plans matching formula is not
uniform, the rate of match is calculated by assuming a 6% deferral and applying plans
matching formula. Representative matching rate is determined by taking greater of:
Lowest matching rate of any NHCE employed as of the last day of the plan year who
made elective deferrals for the year (or who made an employee contribution if plan
provides matching contribution for after-tax employee contributions); or
Lowest matching rate for any NHCE who made elective deferrals for the year (or who
made an employee contribution for the year if the plan provides matching contribution
for after-tax employee contributions), taking into consideration at least 50% of total
eligible (deferring or contributing) NHCEs.
100
EXAMPLE: Match provided to at least 50% of the deferring NHCE population

NHC
Deferrals
Match
Match Rate
$50
$100
200%
$400
$400
100%
$700
$700
100%
$1,000
$0
0%
$2,000
$0
0%
$3,000
$0
0%
If we look at the matching rates of A, B and C, who represent 50% of the eligible NHCs who
have deferred for the plan year, the lowest matching rate is 100%. As entire amount of
matching contributions could be included in the ACP test because her 200% matching rate does
not exceed twice the matching rate of the lowest matching rate within this group of employees.
The ADP and/or ACP tests are generally performed on plan year basis for any plan year in
which there are elective deferrals (ADP test) or matching and/or after-tax employee
contributions (ACP test).
WHO TO INCLUDE
The ADP test includes all employees eligible to make elective deferrals at any time during the
plan year. The ACP test includes all employees satisfying eligibility requirements for matching
contributions or after-tax employee contributions.
Employees making a one-time irrevocable election not to participate in the 401(k) plan by their
date of plan eligibility are excluded from both tests. Employees suspended from deferring
because of hardship withdrawal safe harbor requirements are included in both tests.
Participants not receiving matching contribution due to allocation requirements (e.g., 1,000
hours during plan year or last day employment) may be excluded from ACP test provided
coverage rules under IRC 410(b) are satisfied. Employees who are eligible for a matching
contribution but did not receive one because no deferrals were made are included in the ACP
test.
Classes of employees excluded from participating are not included in either test provided
coverage rules under IRC 410(b) are satisfied. Examples of this are the exclusion of members of
a controlled group, employees excluded from eligibility due to classification, leased employees,
independent contractors, new employees resulting from mergers and acquisitions, etc.
For testing purposes, a single 401(k) plan covering both union and nonunion employees is
treated as if it were two separate plans: one plan covering only union employees and the other
covering nonunion employees. Separate ADP tests are required for the union and nonunion
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portions of plan. The union portion of plan is deemed to pass the ACP test whether or not there
are union after-tax employee contributions. The nonunion portion of plan is subject to the ACP
test.
Special rules apply to plans with ESOP and non-ESOP components. Under final regulations for
401(k) plans, ESOP and non-ESOP 401(k) arrangements are not subject to mandatory
disaggregation for ADP and ACP testing. Note, however, that ESOP and non-ESOP 401(k)s
and/or ESOP and non-ESOP components of a 401(k) plan must still be disaggregated for
coverage testing under IRC 410(b).
The mandatory aggregation rule applies to any HCE who participates in more than one 401(k)
or 401(m) arrangement with the same or a related employer. When any plan performs the ADP
and/or ACP test, HCEs elective deferrals, matching contributions and after-tax employee
contributions from all plans are combined to determine that HCEs deferral and contribution
ratios.
WHAT CONTRIBUTIONS TO INCLUDE

The ADP test includes all elective deferrals and designated Roth contributions unless they have
been recharacterized as catch-up contributions by exceeding a statutory or plan limit. Elective
deferrals and designated Roth contributions in excess of the IRC 402(g) limit are included in
the test for HCEs and excluded for NHCEs
The ACP test includes all after-tax employee contributions and all matching contributions
unless they are QMACs that have been shifted to the ADP test as described below or they are
disproportionate matching contributions as described above.
Note that the final IRC 401(m) regulations issued in December 2004 require that
disproportionate matching contributions for NHCEs be disregarded. The use of QNECs for
inclusion in ADP and ACP testing is also limited.
CALCULATING THE TESTS

To start, calculate actual deferral ratio (ADR) and/or actual contribution ratio (ACR) for each
employee included in the testing.
The ADR equals total amount of elective deferrals and designated Roth contributions
(excluding permissible catch-up contributions) made by the participant during a plan year
divided by the participants compensation.
The ACR equals total amount of employer matching contributions allocated to the participant
for plan year plus any after-tax employee contributions made by participant during plan year
divided by participants compensation.
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Compensation used in the ADR and ACR must be considered nondiscriminatory under IRC
414(s) but may be limited to compensation paid during the portion of the plan year in which
the participant eligible is to make elective deferrals.
Next, calculate the average of the ADRs (or ACRs) for the HCE group, the HCE ADP (or HCE
ACP), and the average for the NHCE group, the NHCE ADP (or NHCE ACP).
The HCE ADP (or ACP) is limited by the NHCE ADP (or ACP). The HCE ADP (or ACP) cannot
exceed greater of:
1.25 times NHCE ADP (or ACP); or
Lesser of
o
2 times NHCE ADP (or ACP); or
2 percentage points plus NHCE ADP (or ACP).
These rules are summarized in the following table:

ADP (or ACP) of the NHCE Group
Maximum ADP (or ACP) of the HCE Group
2% or less
2 times the ADP (or ACP) of the NHCE group
Between 2% and 8%
2% plus the ADP (or ACP) of the NHCE group
8% or more
1.25 times the ADP (or ACP) of the NHCE group
Testing Methodology
CURRENT YEAR VS. PRIOR YEAR TESTING
The default testing method for ADP and/or ACP testing is the prior year testing method:
comparing current year HCE ADP (or ACP) to prior year NHCE ADP (or ACP). The IRS has
interpreted this to mean the plan document must still specify the testing method.
The alternative is the current year testing method which compares the current year HCE ADP
(or ACP) with the current year NHCE ADP (or ACP).
Subject to provisions of the plan document and IRS restrictions, the current year testing method
may be used instead of the prior year testing method. It is permissible to switch from prior year
to current year at any time. However, a plan must use current year for at least five years before
switching back to prior year unless the plan has used current year since its inception.
If switching from current year to prior year testing, the plan is prohibited from double-counting
QNECs included in either ADP or ACP test.
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For a new plan, or the first year a CODA is effective, if the prior year testing method is used, the
NHCE ADP and/or ACP is deemed to be 3%.
Plans are not required to use same testing method for both ADP and ACP tests unless shifting
of contributions is performed.
An amendment to change testing methods is deemed to be an optional amendment and
therefore must be adopted by the end of the plan year for which the change will apply.
DISAGGREGATION OF OTHERWISE EXCLUDABLE EMPLOYEES

If a plans eligibility provisions are more liberal than the IRS statutory requirements (i.e., age 21
and one year of service), a permissible way to pass ADP and/or ACP testing is the use of
disaggregation. Disaggregation allows participants who have not met the statutory age and
service requirements (otherwise excludable employees) to be excluded from the ADP and/or
ACP tests (if NHCEs), or to be tested separately as a group (NHCEs and HCEs). Disaggregation
of otherwise excludable employees can only be done for ADP/ACP purposes if it is also done
when testing coverage under IRC 410(b).
There are two ways to disaggregate otherwise excludable employees:
Under Treas. Reg. 1.401(k)-1(b)(4); and
Under IRC 401(k)(3)(F).
Disaggregation under Treas. Reg. 1.401(k)-1(b)(4) involves performing two separate ADP (or
ACP) tests. The first test includes all HCEs and NHCEs who meet statutory minimum age and
service requirements. The second test includes all HCEs and NHCEs who are otherwise
excludable employees. Both testing groups must pass coverage under IRC 410(b).
Disaggregation under IRC 401(k)(3)(F) involves performing only one ADP (or ACP) test. The
test includes all HCEs and NHCEs who meet statutory minimum age and service requirements
(which age 21 and 1 year of service); and includes HCEs who are otherwise excludable
employees. Disaggregate only the NHCEs who are otherwise excludable employees and
disregard them from testing.
Note that disaggregation in this manner, which essentially ignores the presence of otherwise
excludable NHCEs, applies only to ADP and/or ACP testing and not to IRC 410(b) testing. If
disaggregating under IRC 401(k)(3)(F), coverage tests are performed in same manner as if
disaggregating under Treas. Reg. 1.401(k)-1(b)(4).
EXAMPLE: Assume a 401(k) plan has an immediate eligibility and entry into the plan. Without
disaggregation the plan sponsor could be limiting the HCEs by allowing employees to become
participants immediately upon hire. Using disaggregation allows the plan sponsor to offer the
benefit to employees sooner without penalizing the HCEs.
104
Using the following census information, please note the difference that disaggregating can
make.
HCE #1
2 years of service with an ADP of 6.0
HCE #2
HCE #3
6 mo of service with an ADP of 3.0
NHCE #1
2 months of service with an ADP of 0
NHCE #2
NHCE #3
Age 19 with 1 year of service with an ADP of 0
Unless otherwise noted all of the employees are 21 or older.

Without disaggregating the test, the ADP for the HCEs is 4.33% ((6+4+3=13)/3=4.33). The ADP
for the NHCEs is 1.3% ((0+4+0=4)/3=1.3) and the test fails.
If you apply Treas. Reg. 1.401(k) -1(b)(4)a separate test would be run for HCE #3, NHCE #1 and
NHCE #3 because they do not meet the statutory minimum age and service requirements. For
the primary test the HCE ADP is 5.0% and the NHCE ADP is 4.0% so the main test passes. For
the otherwise excludable test the HCE ADP is 3.0% and the NHCE ADP is 0.0% so this test fails.
As an alternative, if you apply IRC 401(k)(3)(F) only one test would be run including all three
HCEs and excluding NHCE #1 and NHCE #3. The ADP for the HCEs would be 4.33% and the
ADP for the NHCEs becomes 4.0% and the test passes.
If disaggregation is elected for ADP (or ACP) testing, the plan also must use the disaggregation
election for coverage testing under IRC 410(b) and nondiscrimination testing under IRC
401(a)(4). That is, statutory minimum and otherwise excludable groups must separately satisfy
IRC 410(b) and general nondiscrimination under IRC 401(a)(4).
SHIFTING
If matching contributions are fully vested and subject to the same withdrawal restrictions as
elective deferrals, Treas. Reg. 1.401(k)-1(b)(5) permits that all, or any amount, of the matching
contributions may be shifted and included in ADP test. If a plan does not include after-tax
employee contributions, the plan sponsor might wish to shift all of the matching contributions
into the ADP test to eliminate need for ACP testing altogether. While this may be
administratively simpler to run a single test, the testing results may be adversely impacted as
can be seen in the following example.
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EXAMPLE: Wolf Corporation sponsors a 401(k) plan with a match. Their match meets all the
requirements of a QMAC so to simplify administration a colleague suggests shifting all of the
QMAC into the ADP test to avoid running the ACP test. The census data for the 2008 plan year
is as follows:
Deferral%
QMAC%
Combined %
HCE #1
6.00%
3.00%
9.00%
HCE #2
6.00%
3.00%
9.00%
HCE Average
6.00%
3.00%
9.00%
NHCE #1
10.00%
3.00%
13.00%
NHCE #2
8.00%
3.00%
11.00%
NHCE #3
2.00%
1.00%
3.00%
NHCE #4
0.00%
0.00%
0.00%
NHCE Average
5.00%
1.75%
6.75%
If a single ADP test is run including the deferrals and QMAC the ADP test will fail [6.75% +
2.00% < 9.00%]. If the ADP and ACP tests are run separately the ADP test will pass [5.00% +
2.00% > 6.00%] and the ACP test will pass [1.75% * 2 = 3.50% > 3.00%] both with room to spare.
In this case it would do the client a disservice to run a single test.
If the ADP test is passing but ACP test is failing, Treas. Reg. 1.401(m)-1(e)(1)(i) permits shifting
of elective deferrals into ACP test. ACP test results will be improved, and may even pass, by
shifting the greatest amount of elective deferrals possible from ADP test to the ACP test without
making the ADP test fail. Both HCE and NHCE deferrals may be shifted.
If deferrals are shifted to the ACP test, the plan must be able to pass the ADP test taking into
account all deferrals (including those that are being shifted) and also must pass taking into
account only salary deferrals that are not being shifted to the ACP test. That is, the ADP test
must be passed both before and after shifting deferrals to the ACP test.
EXAMPLE: Assume you have a have a 401(k) plan with a matching formula of 50% of deferrals
up to 3% of compensation. Below are the results of the test for the 2008 plan year using the
current year testing method.
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Participant
Deferral
Match
HCE #1
6.00%
3.00%
HCE #2
8.00%
3.00%
HCE Average
7.00%
3.00%
NHCE #1
15.00%
3.00%
NHCE #2
12.00%
3.00%
NHCE #3
3.00%
1.50%
NHCE #4
2.00%
1.00%
NHCE #5
0.00%
0.00%
NHCE #6
0.00%
0.00%
NHCE Average
5.33%
1.42%
The ADP passes because 5.33 + 2.0 = 7.33 and 7.33 is greater than 7.00.
The ACP fails because 1.42 x 2 = 2.84 and 2.84 is less than 3.00.
However, because there is a margin of 0.33 (7.33-7.00) of room to pass the ADP test we can shift
0.33 of the ADP of the NHCEs to the ACP of the NHCEs making it 1.75. 1.75 x 2 = 3.50 and
suddenly without doing anything but shifting points both the ADP and ACP tests pass.
Remember the ADP/ACP tests are a game of percentages. How the ADP percentages are
manipulated is not regulated as long the ADP test is passed before and after the percentages are
manipulated. In other words, adjusting the HCEs ADP as well as the NHCEs is permissible.
EXAMPLE: Assume you have the following results from the ADP/ACP test.
ADP
ACP
HCE
7.00
3.00
NHCE
5.00
1.00
Shifting 1.00 from the ADP of the HCEs to the HCEs ACP making it 4.00 and shifting 1.00 from
the ADP of the NHCEs to the NHCEs ACP making it 2.00 yields the following passing results:
ADP
ACP
HCE
6.00
4.00
NHCE
4.00
2.00
Remember no actual money must be moved from one money type to another. The percentages
have simply been changed to achieve passing results.
Correcting Failed ADP/ACP Tests

Failed ADP and/or ACP tests must be corrected no later than last day of the 12-month period
following the plan year end. Disqualification of the CODA may result if corrective action is not
timely taken, but note that EPCRS may be available.
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RECHARACTERIZING EXCESS CONTRIBUTIONS

Excess contributions may be recharacterized as after-tax employee contributions. This
correction method is only available if the plan allows for after-tax employee contributions.
Recharacterized excess contributions become taxable to the affected HCEs and must retain the
same withdrawal restrictions they had as elective deferrals. Since recharacterized contributions
must be included in ACP test, this option usually results in adverse consequences and is
consequently rarely a practical solution.
CORRECTIVE DISTRIBUTIONS
The most common correction method for a failed ADP and/or ACP test is corrective
distributions to HCEs. Failure to satisfy the ADP test results in HCEs receiving excess
contributions. Failure to satisfy the ACP test results in HCEs receiving excess aggregate
contributions. Note that only the vested portion of any excess aggregate contributions would
only be refunded to participants, any unvested portion would be forfeited.
The leveling method is a two step process where the first step is used to determine total amount
of excess contributions and/or excess aggregate contributions, and then the second step
determines which HCEs will be refunded what amount. The leveling method starts with the
HCE with the highest ADR (or ACR) in order to determine the total dollar amount of excess
contributions (or excess aggregate contributions).
The HCE with the highest ADR (or ACR) reduced until:
ADP (or ACP) test passed; or
ADR (or ACR) of the HCE with highest ADR (or ACR) equals ADR (or ACR) of the HCE
with next highest ADR (or ACR).
This process is repeated until the ADP (or ACP) test is passed.
After the ADP (or ACP) test is passed, the total amount of excess contributions (or excess
aggregate contributions) is calculated. The second step of the leveling method then looks at the
HCE with highest dollar amount deferred (or employer matching plus after-tax employee
contributions for the ACP test) in order to determine which HCEs will receive refunds of excess
contributions (or excess aggregate contributions).
The HCE with the highest dollar amount deferred (or amount of matching plus after-tax
employee contributions) is reduced until:
The total amount of excess contributions (or excess aggregate contributions) has been
refunded; or
The remaining amount of elective deferrals (or matching plus after-tax employee
contributions) of the HCE with highest dollar amount deferred (or amount of matching
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plus after-tax employee contributions) equals the HCE with the next highest dollar
amount deferred (or amount of matching plus after-tax employee contributions).
This process is repeated until the total amount of excess contributions (or excess aggregate
contributions) is refunded. The plan may not satisfy the ADP (or ACP) test if it is performed on
the contributions remaining after the returns have been made, but as long as the correct dollar
amount is returned there is no retesting required.
EXAMPLE: There are 6 HCEs with the following data for the 2010 plan year. Note catch-up
contributions are not allowed in this plan and the ADP for the NHCEs is 5%.
Participant
Comp
Deferrals
Percentage
HCE #1
$205,000
$13,000
6.34%
HCE #2
$205,000
$13,000
6.34%
HCE #3
$165,000
$13,000
7.88%
HCE #4
$115,000
$11,000
9.57%
HCE #5
$100,000
$8,000
8.00%
HCE #6
$90,000
$9,000
10.00%
The test will pass by reducing the deferral percentages of HCEs 3-6 to 7.33% resulting in a new
ADP for the HCEs of 7%. Leveling is a two step process. The first step is looking at who has the
highest contribution percentages to determine the dollar amount that must be removed from
the plan in this example:
Participant
Deferral
7.33% of comp
Reduction
HCE #3s
$13,000
$12,094.50
$905.50
HCE #4s
$11,000
$8,429.50
$2,570.50
HCE #5s
$8,000
$7,330
$670
HCE #6s
$9,000
$6,597
$2,403
The total corrective amount
$6,549
Now that the total amount of the refund has been determined we move on to step two. Using
the leveling method, HCE#1-4 will receive the actual refunds. HCEs 1-3 will receive $2,137.25
each because they deferred the same highest dollar amount and HCE#4 will receive $137.25.
This equals the same total amount of $6,549.
Excess contributions or excess aggregate contributions (and earnings thereon) are included as
taxable income in the year in which the corrections were made.
There is no employer excise tax on excess contributions or excess aggregate contributions under
IRC 4979(f) if the corrections are made within 2 months after the plan year end. The
employer must pay a 10% excise tax under IRC 4979 on amount of excess contributions or
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excess aggregate contributions (excluding earnings) if the corrections are made after 2 months
after the plan year end. For plan years beginning after December 31, 2007, plans with an Eligible
Automatic Contribution Arrangement (EACA) have 6 months (rather than 2 months) to make
corrective distributions.
Corrective distributions are not subject to the 10% additional income tax on early distributions
under IRC 72(t). No employee or spousal consent is required for an excess distribution, except
to waive 10% withholding, if applicable.
Distributions of excess contributions or excess aggregate contributions (and earnings thereon)
are not eligible for rollover. Therefore, an HCE may elect an amount or a percentage to be
withheld for federal income taxes. In the absence of an election, 10% of the distribution amount
must be withheld.
ORPHAN MATCH
Final regulations for IRC 401(a)(4) generally require that employer matching contributions
attributable to elective deferrals that were refunded to HCEs in order to satisfy the ADP test
(and the ACP was passed) be forfeited and treated as forfeitures in accordance with plan
document.
If these extra matching contributions were not forfeited, HCEs would be receiving a rate of
matching contributions that NHCEs were not able to receive, even though elective deferrals
were refunded and taxable. This would cause the matching contribution to be discriminatory.
EXAMPLE: Assume a matching contribution formula of 50% up to 6%. Also assume the HCE
defers 7% but must receive a refund resulting in an ADR after correction of 5%. His match
should now be 2.5% [50% of 5%] rather than 3%. The 0.50% difference is an orphan match and
must be forfeited regardless of the participants vested percentage.
Forfeitures are not required in all refund situations as many plans only match elective deferrals
up to a certain percentage of compensation, such as 50% up to a maximum match of 3% of
compensation. If refunds of elective deferrals include only those elective deferrals over 6% of
compensation, no matching contributions were made on the refunded amounts, so no forfeitures
are required.
When both the ADP test and ACP test fail, a plan may have to refund matching contributions as
excess aggregate contributions in order to satisfy the ACP test. This refund is done prior to
evaluating whether or not orphan match exists based on deferrals refunded as excess
contributions. Any remaining excess matching contribution over the amount that would
otherwise be allocated based on plans matching formula is then forfeited in order to satisfy IRC
401(a)(4).
110
EXAMPLE: Bobs compensation for the 2009 plan year is $100,000. He deferred $10,000 and
received an employer matching contribution of $5,000 based on the plans formula which
matches 50% of all deferrals. Both the ADP and ACP test fail for 2009 and it is determined that
Bob has $3,000 in excess contributions due to the ADP failure and $1,000 in excess aggregate
contributions due to the ACP failure. Bob is 36 and is therefore not eligible for catch-up
contributions. The $1,000 in excess aggregate contributions (as adjusted for earnings) would be
refunded or forfeited based on Bobs vested percentage. The $3,000 in excess contributions (as
adjusted for earnings) would also be refunded. These refunds result in Bob having a new ADR
of 7% so his match should be 3.5%. After the excess aggregate contributions are refunded Bob
has matching contributions of 4% (or $4,000) an additional $500 must be forfeited regardless of
his vested percentage because the deferrals to which that match is attributable have been
removed from the plan.
QNECS AND QMACS

Subject to the plan document, an employer may choose to correct failed ADP and/or ACP tests,
in whole or in part, by using a qualified nonelective contribution (QNEC) or a qualified
matching contribution (QMAC).
The employer may deposit additional funds as a QNEC and/or a QMAC subject to the limits on
the amount of QNECs and QMACs that can be considered in ADP and/or ACP testing. The
employer may designate all or part of its discretionary contribution as a QNEC, subject to limits
on the amount of QNECs that can be considered in ADP and ACP testing.
The employer may designate all or part of its matching contribution as a QMAC, subject to
limits on the amount of QMACs that can be considered in ADP and ACP testing. Note that
calculation of disproportionate matching contributions for NHCEs does consider QMACs as
part of an NHCEs matching contribution, whether or not those QMACs were shifted to the
ADP test.
QNECs and QMACs may be used in either the ADP or ACP test but the same dollars may not
be used for both tests. QNECs and/or QMACs are treated like elective deferrals and combined
with actual elective deferrals in the ADP test and/or treated as matching contributions and
combined with actual matching contributions in ACP test.
QNECs and QMACs must be fully vested and subject to same withdrawal restrictions as 401(k)
elective deferrals; however, they are not eligible for hardship withdrawal under any
circumstances.
The difference between a QNEC and QMAC is the method of allocation. QMACs are allocated
only to participants who make elective deferrals for plan year. QNECs are allocated to
participants whether or not they make elective deferrals for plan year.
111

QNECs and QMACs may be allocated to both HCEs and NHCEs but are usually only allocated
to NHCEs in order to pass ADP and/or ACP test with the least cost to the employer.
QNECs and QMACs are subject to IRC 410(b) coverage rules. A plan may require that
participants satisfy allocation requirements (i.e., be credited with at least 1,000 hours during
plan year and/or be employed by plan sponsor at end of plan year) in order to be allocated a
QNEC and/or QMAC.
Final 401(k) and 401(m) regulations which are generally effective for plan years beginning on or
after January 1, 2006, set limits on amount of QNECs that can be considered in the ADP and/or
ACP tests. Rules serve to curb, but not eliminate use of targeted QNECs. Under the final
regulations, disproportionate QNECs that exceed the limitations below must be disregarded in
ADP and ACP tests. ADP and ACP tests may only include QNECs that do not exceed the greater
of the following two limits:
5% of compensation; or
Two times plans representative contribution rate expressed as a percentage of
compensation.
For determining the allowable amount of QNECs for inclusion in ADP testing, an individuals
contribution rate is calculated by dividing compensation by the sum of all QNECs other than
those included in the ACP test and all QMACs included in the ADP test. For determining the
allowable amount of QNECs for inclusion in ACP testing, an individuals contribution rate is
calculated by dividing compensation by the sum of all QNECs other than those included in the
ADP test and all QMACs included in the ACP test.
The representative contribution rate is determined by taking the greater of:
Lowest contribution rate of any NHCE employed as of the last day of plan year; or
Lowest contribution rate for any NHCE, taking into consideration at least 50% of total
eligible NHCEs.
112
EXAMPLE: A 401(k) plan has a plan year ending December 31. For the 2009 plan year there are 6
eligible NHCEs. The plan uses the current year testing method. The following QNECs are
allocated to the 6 NHCEs:
Employee
Rate
10%
0%
0%
0%
0%
0%
The plan would only be able to count 5% of As QNEC, because anything above 5% is
disproportionate. The lowest NHCE allocation rate with respect to a sampling of at least 50% of
the eligible NHCEs (i.e., at least 3 NHCEs) is zero percent, yielding a representative
contribution rate of zero percent (i.e., twice zero is still zero).
EXAMPLE: A 401(k) plan has a plan year ending December 31. For the 2009 plan year there are 6
eligible NHCEs. The plan uses the current year testing method. The following QNECs are
allocated to the 6 NHCEs:
Employee
Rate
10%
5%
5%
0%
0%
0%
Now As entire QNEC is eligible for inclusion in the ADP test. A sampling of eligible NHC who
represent at least 50% of the total group consists of A, B and C. The lowest contribution rate
among that group is 5%, so twice that rate (i.e., 10%) is not considered disproportionate.
A pro rata QNEC is allocated on a prorated basis based on compensation all of the eligible
NHCEs so all NHCEs receive the exact same percentage of compensation.
EXAMPLE: Assume the HCEs ADP for testing purposes is 8.0%. The NHCE census data is as
follows:
Participant
Compensation
Deferral
Deferral %
NHCE #1
$60,000
$4,200
7.00%
NHCE #2
$40,000
$2,800
7.00%
113
NHCE #3
$30,000
$1,200
4.00%
NHCE #4
$20,000
$400
2.00%
The NHCEs ADP is 5%. To pass the test the ADP of the NHCEs must be raised by 1%. A pro rata
QNEC in this case would be 1% of compensation for each participant eligible to defer. The total
compensation for all four NHCEs is $150,000 so the pro rata QNEC would be $1,500.
A targeted QNEC is often a less expensive option for the employer.
EXAMPLE: As in the example above, assume the HCEs ADP for testing purposes is 8.0%. There
are 4 NHCEs and all are employed on the last day of the plan year. The NHCE census data is as
follows:
Participant
Compensation
Deferral
Deferral %
NHCE #1
$60,000
$4,200
7.00%
NHCE #2
$40,000
$2,800
7.00%
NHCE #3
$30,000
$1,200
4.00%
NHCE #4
$20,000
$400
2.00%
The NHCEs ADP is 5%. To pass the test the ADP of the NHCEs must be raised by 1%. Since
there are four NHCEs the sum of the ADP must be increased by 4%. This can be accomplished
by giving a targeted QNEC of 4% to NHCE #4 at a cost of $800. This QNEC can all be included
in the ADP test because it is less than 5% of compensation.
In the examples above the employer is able to save a significant amount by using a targeted or
bottom-up QNEC rather than a pro rata QNEC. The savings are even more significant in
larger plans or plans that are failing by a significant percentage. While savings can be achieved
through the use of this technique the employer must also consider the employee issues that
could arise by giving contributions to some participants and not others. Before the final 401(k)
regulations were effective some plans chose to use flat dollar QNECs, where each employee
received the same dollar amount regardless of their compensation (i.e., $500 to each employee).
While this may seem to be equitable, the final 401(k) regulations limitations on what can be
included in the ADP and ACP test have made this a much more complex and somewhat less
desirable alternative.
Nondiscrimination Satisfied without ADP/ACP

PLANS THAT AUTOMATICALLY PASS
Performing the ADP and/or ACP tests may not be required. Certain plans for certain plan years
may be deemed to satisfy the ADP and/or ACP tests.
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401(k) plans may be deemed to satisfy the ADP and/or ACP tests during any plan year because
of:
Employee demographics (e.g., if all participants for plan year are NHCEs the plan is
deemed to pass or if all participants for plan year are HCEs the plan is deemed to pass);
or
Plan design [e.g., if no HCEs benefit, (i.e., they are not allowed to make elective deferral
contributions and/or are not eligible for matching contributions) the plan will
automatically pass].
Plans deemed to pass the ADP and/or ACP testing include:
Governmental plans;
Plans that satisfy SIMPLE-401(k) requirements; and
Plans that satisfy traditional or qualified automatic contribution arrangement (QACA)
safe harbor 401(k) requirements.
TRADITIONAL SAFE HARBOR 401(K) PLAN UNDER IRC 401(K)(12)

A CODA is treated as satisfying the ADP test if the arrangement satisfies:
Contribution; and
Notice requirements.
The safe harbor 401(k) contribution must:
Be allocated to all eligible NHCEs and may or may not be allocated to HCEs (e.g., could
be limited only to employees who meet statutory requirements);
Not have allocation requirements (i.e., 1,000 hours or employment on last day of the plan
year) imposed to receive a contribution;
Be immediately 100% vested;
Be subject to 401(k) withdrawal restrictions except that they are never available for
hardship withdrawal; and
Not be used in the determination of the base contribution and allowable excess
contribution in permitted disparity under IRC 401(l).
The types of safe harbor contributions that satisfy the ADP test are referred to as ADP safe
harbor contributions. ADP safe harbor contributions can be either a safe harbor nonelective
contribution or a safe harbor matching contribution.
Safe harbor nonelective contributions must be at least 3% of employees compensation. This
type of contribution can be decided upon as late as 30 days prior to last day of plan year if a
maybe notice was provided at least 30 days prior to the start of the plan year and a final
notice and plan amendment are made at least 30 days prior to the end of the plan year.
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Safe harbor matching contributions are either a basic matching formula or an enhanced
matching formula.
The basic matching formula is:
100% match on first 3% of compensation deferred; plus

50% match on next 2% of compensation deferred.
The basic matching formula results in a maximum match of 4% of compensation for employees
who defer at least 5% of compensation.
The enhanced matching formula is any formula that meets all of the following requirements:
Matching contributions provided under formula that, at any rate of elective deferrals, is
at least as great as matching contributions provided under basic formula;
Rate of match cannot increase as rate of deferral increases; and
Matching formula may not provide a higher level of match for HCEs than for NHCEs
who contribute at same level.
A common enhanced matching formula is 100% up to 4% of compensation or 100% up to 6% of
compensation.
As described earlier, safe harbor 401(k) plans also must satisfy a notice requirement. Each
eligible employee must receive an annual written notice that meets content and timing
requirements put forth by IRS.
To satisfy the content requirements the notice must contain certain information including, the
safe harbor contribution formula, any other fixed or discretionary employer contributions
(including match), the plan to which the safe harbor contribution will be made, the amount and
type of compensation the participant may defer under the plan, the procedure for making the
deferral, the periods available for making the election, and the contact information to obtain
additional information (i.e., plan contact, phone number and address).
The timing requirements are satisfied if the notice is provided within a reasonable period before
the beginning of the plan year. A reasonable period has been defined as between 30 and 90 days
before beginning of plan year.
Employees who become eligible later than 90th day before beginning of plan year may be given
notice between their date of eligibility and 90 days prior to eligibility. The notice can be given to
eligible employees up to first day of first plan year for a newly established 401(k) plan.
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A safe harbor 401(k) plan is treated as satisfying the ACP test if contribution and notice
requirements are met. The safe harbor matching contributions which satisfy the ACP test
(commonly called ACP safe harbor contributions) must:
Be made under the basic match formula to satisfy the ADP test and no other matching
contributions are made (100% up to 3 % and 50% up to the next 2%);
Be made under enhanced formula to satisfy the ADP test but, cannot match deferrals
exceeding 6% of compensation (for example 100% up to 4% or 200% up to 5%); or
Be a matching formula in which:
o
The match does not take into consideration deferrals of more than 6% of
compensation;
The rate of match does not increase as rate of employee contributions or elective
deferrals increases; and
The rate of matching contributions for any HCE is not greater than any NHCE
with same rate of elective deferrals.
Additional discretionary matching contributions are permitted in addition to the ACP safe
harbor matching contributions, however any discretionary matching contributions must not
exceed 4% of employees compensation.
EXAMPLE: A discretionary match of 100% up to 6% would not meet the ACP safe harbor
requirement because the maximum discretionary match is in excess of 4%. A discretionary
match of 100% up to 4% or 50% on deferrals up to 6% would meet the ACP safe harbor.
The matching contribution used for the ACP safe harbor need not be 100% vested if the ADP
safe harbor is being met with another contribution (i.e., a safe harbor nonelective contribution).
The contribution may not have allocation requirements (i.e., 1,000 hours or employment on last
day of the plan year), may be determined on a plan year or on a payroll basis; and is subject to
the same notice requirements as those for the ADP safe harbor. If an employer wanted to
allocate an additional match and make it subject to any allocation condition, the ADP safe
harbor may still be satisfied however, the ACP safe harbor would not. This is because it may
cause an HCE to receive an allocation greater than that received by an NHCE deferring the
same percentage of compensation, which would violate the ACP Safe Harbor rules under IRC
401(m)(11).
If after-tax employee contributions are made during the plan year, the ACP test is always
required.
The plan sponsor can reduce or discontinue safe harbor matching contributions during plan
year and instead perform ADP and/or ACP testing if a 30-day advance notice to employees is
provided and the necessary amendments are timely signed. Contributions through the end of
the notice period must still be made. Discontinuing safe harbor matching mid-year should be
carefully considered before it is done because the corrections required when the ADP and ACP
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are run may not be worth the money saved on the safe harbor match, particularly if it is already
late in the plan year.
Safe harbor 401(k) plans are deemed not to be top-heavy for the plan year, if the only employer
contributions made to plan are matching contributions or nonelective contributions meeting the
safe harbor requirements described in IRC 401(k)(12) (the ADP safe harbor).
It is possible to provide for a triple stacked match arrangement in a safe harbor plan. This plan
design provides a safe harbor match that satisfies the ADP requirements (basic or enhanced)
then a fixed match (that does not match amounts in excess of 6% of compensation) and
discretionary match (that does not match amounts more than 6% of compensation and is not
more than 4% of compensation) that would satisfy the ACP requirements. The rate of match
cannot increase as deferrals increase. This type of match would allow the employer to focus
contributions only on participants who defer while still meeting the top heavy minimum
exemption [assuming all participants who defer are eligible for the employer matching
contributions and there are no additional employer contributions (including forfeiture
reallocations)].
EXAMPLE: An owner earning at least the 2013 the 401(a)(17) compensation limit of $255,000
could maximize their contributions to the annual addition limit and be exempted from
ADP/ACP and top heavy testing by set up the plan in the following manner:
Deferrals:
$17,500
Safe harbor match of 66 2/3% up to 6% of compensation:
$10,200
Discretionary match of 66 2/3% up to 6% of compensation:
$10,200
Fixed match of 85.6209% up to 6% of compensation:
$13,100
Total Contributions (= the annual addition limit):
$51,000
Safe harbor plans may be designed to allow for discretionary nonelective contributions which
can be subject to accrual requirements like a 1,000 hour requirement and employment on the
last day of the plan year. The nonelective contribution must pass the coverage requirement of
IRC 410(b) or, if permissible under the plan, the general nondiscrimination requirements of
IRC 401(a)(4).
This contribution may be subject to a vesting schedule at least as favorable as a 2/20 vesting
schedule or 3-year cliff. A common plan design is a safe harbor 401(k) plan using the 3% safe
harbor nonelective contribution and an additional cross-tested discretionary nonelective
contribution. Including these contributions would eliminate the automatic pass for top-heavy
that the safe harbor 401(k) plan can provide.
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QUALIFIED AUTOMATIC CONTRIBUTION ARRANGEMENT (QACA) SAFE

HARBOR
The qualified automatic contribution arrangement (QACA) is a safe harbor plan (first available
in 2008) that provides employer relief from ADP and/or ACP testing. A QACA must have the
following provisions:
An automatic enrollment arrangement that meets the minimum requirements of a
minimum contribution percentage. The automatic arrangement must stay in effect until
the participant makes an affirmative election to defer any amount including 0%;
The employer must provide a specific employer contribution which meets the
requirements; and
The employer must provide a notice geared to be understood by the average plan
participant.
The minimum requirements of the automatic enrollment are based on the participants years of
participation. For the first two years of participation, the minimum percentage is 3%. The
percentage must increase to 4% in year three and 5% in year four, and 6% in year five and
subsequent years. The plan may require higher percentages sooner, but not more than 10%. This
provision must be applied in a uniform manner. Any participant that does not make an
affirmative election must be handled the same way. Some plans may choose to set the
percentage at 6% for all employees to avoid the administrative burden of the escalation
requirements.
The employers contribution must be allocated at least to all of the eligible NHCEs. It can either
be a nonelective contribution or an employer match. If the employer nonelective contribution is
used it must be at least 3%. The employer match can be a basic match of 100% of deferrals up to
1% of compensation plus 50% of deferrals that exceed 1% compensation but not 6% of
compensation or an enhanced match. If the employer wishes to contribute an enhanced match,
it must meet the basic match requirements, and cannot be designed to increase as the
percentages of deferral increases.
An example of an enhanced match is 100% of deferrals up to 3.5% of compensation. An
unacceptable match would be 100% of deferrals up to 3% plus a 200% match from 3% to 6% of
compensation.
Unlike the vesting of traditional safe harbor plans which must provide for 100% vesting
immediately, a QACA must provide for 100% vesting after two years. So, the vesting schedule
could be a 2 year cliff or 50% after year 1 and 100% after year 2.
A QACA must meet the same notice requirements all safe harbor plans must meet. In addition
there must be a reasonable amount of time for the participant to make a contrary election after
receipt of the QACA notice and before the first payroll deferral. If the plan provides for
participant directed investing, there must also be a reasonable time for the participant to make
investment election choices.
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Chapter 4
Thischaptercoversdefinedbenefitplansandreviewsthesafeharborplandesignsthatare
availabletosimplifydefinedbenefitdesignandadministration.Nontraditionaldefinedbenefit
planssuchascashbalanceplans,flooroffsetarrangementsandInternalRevenueCode(IRC)
412(e)(3)plansarereviewed.Inaddition,thechapterdiscussesfundingrequirements,benefit
limitationsandtheroleofthePBGC.
DB Basics
WHYADOPTADBPLAN
Adefinedbenefitplancanbeabettervehicleforprovidingretirementbenefitsthanadefined
contributionplanespeciallyforolderemployeesnotpreviouslycoveredbyaplan.Adefined
benefitplanoftenworkswellinconjunctionwithadefinedcontributionplan.Thereasonsfor
thisareasfollows:
Largecontributionscanbemadeforplanssetupforownersofsmallbusinesseswhoare
veryclosetoretirement,farinexcessofwhatwouldbeallowedunderIRCsection415(c)
inadefinedcontributionplan.Forexample,adefinedbenefitplanthatissetupfora
soleparticipantwhoisage55andearning$200,000peryearcouldrequireacontribution
ofmorethan$100,000peryear.Inmanycasesthiswouldbeinadditiontowhatis
contributedtoadefinedcontributionplan(seesectionregardingtaxdeductiblelimits
whenbothadefinedbenefitandadefinedcontributionplanaremaintained).
Participantsareguaranteedabenefitthatprovidestheparticipantalevelofsecurity.
Thereisnosuchguaranteeinadefinedcontributionplanastheaccountbalance
fluctuateswithmarketconditions.
Definedbenefitplanscanprovideforsubsidizedbenefitsifemployeesretireearly,
encouragingtheolder,morehighlypaidemployeestoretireandbereplacedby
younger,lesshighlypaidemployees.Thiscanresultinasubstantialcostsavingsinthe
longrunforemployersbyhelpingthemmanagetheirworkforcemoreefficiently.
Definedbenefitplansareagoodwaytoprovidesubstantialretirementbenefitstolong
termemployeeswhentheemployerhasnotmaintainedaretirementplaninthepast.
Adefinedbenefitplancrosstestedwitha401(k)planallowsforhighercontributionsfor
ownersandotherhighlycompensatedemployeesthana401(k)planonly.Therankand
fileemployeesreceivetheirbenefitsprimarilythroughthe401(k)planwhichthey
understandandappreciate.
BASICPLANREQUIREMENTS
Adefinedbenefitplanmustprovidebenefitsthataredefinitelydeterminable.
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Atraditionaldefinedbenefitplanprovidesamonthlybenefitcommencingattheparticipants
normalretirementdate.Thebenefitiseitherexpressedasapercentageoftheparticipants
averagecompensationorasaflatdollaramount.
Anontraditionaldefinedbenefitplansuchasacashbalanceoraflooroffsetplanhasa
somewhatdifferentbenefitstructure,althougheachprovidesadeterminablebenefit
commencingatretirement.
Anenrolledactuarydeterminesthefundingrequirementsofdefinedbenefitplans,otherthan
foranIRC412(e)(3)fullyinsuredplan.Theenrolledactuarymustadheretotheminimum
fundingrequirementsofIRC430,thefundingbasedlimitsofIRC436andthemaximumtax
deductionrulesofIRC404indeterminingboththeminimumrequiredandmaximum
deductiblefundingamountseachyear.
Accrued Benefits
ACCRUALRULES
AccrualrulesunderIRC411(b)mustbesatisfiedbyalldefinedbenefitplans.Thisrequirement
isindependentofthenondiscriminationrequirementsofIRC401(a)(4),whichmustbesatisfied
inadditiontotheaccrualrequirements.
IRC411(b)describesthreeminimumaccrualrules:the133percentrule,thefractionalaccrual
ruleandthe3%rule.Atleastoneoftheserulesmustbesatisfiedbyadefinedbenefitplanin
orderfortheminimumaccrualrequirementtobemet.Theactualbenefitcanaccruemore
quicklythanrequiredbytheminimumaccrualrules,butcannotaccruemoreslowly.
Theminimumaccrualrequirementsaredesignedtopreventbackloading.Backloadingisa
processwherealargerpercentageofthenormalretirementbenefitisaccruedduringthelater
yearsofemployment.Thiscancausediscriminationissuesbecausethelowerpaidemployees
generallyhavefeweryearsofserviceattheirtimeofterminationofemploymentthanthemore
highlypaidemployees(whotendtobethelongertermemployees).Asaresult,thelowerpaid
employeesreceivemuchsmallerbenefitsiftheaccrualisbackloadedastheyneverreachthe
higherbenefitlevelofaccrual.
EXAMPLE:Thenormalretirementbenefitisdefinedtobe$100permonthforeachofthefirst5
yearsofservice,plus$500permonthforeachadditionalyearofservice.
Sincelowerpaidemployeeswilltendtoworkfortheemployerforarelativelyshortperiodof
time,theywillmostlikelyonlygetthebenefitofthe$100portionofthisbenefitformula.
However,thehigherpaidemployeesandownersofthecompanywhowilllikelybearoundfor
thelongtermwillgetthebenefitofthehigher$500accrualsformostoftheirservice.
Thisisanexampleofanextremelybackloadedbenefitformulawhichwouldbeprohibited
underIRC411(b).Onlylimitedbackloadingisallowed.
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The133percentaccrualrulestatesthatanyyearsaccrualcannotexceedanyprioryears
accrualbymorethanonethird.Thisrulerecognizesallprospectiveyearsofservice.Prior
benefitstructures(benefitformulasthathavebeenamended)canbeignoredforpurposesof
satisfyingthe133percentaccrualrule.The133percentaccrualruleisviolatedifa
participantmightsomedayearnayearsaccrualthatismorethan133percentofanyprior
yearsaccrual.Thestandardisamatterofdesignratherthanofactualoperationalexperience.
yearsofservice,plus$130permonthforeachadditionalyearofservice.
Thebenefitaccruedinthelateryearsof$130isonly130%ofthe$100benefitaccruedinthe
earlyyears,sothe133percentaccrualruleissatisfied.
EXAMPLE:Thenormalretirementbenefitisdefinedtobe1%ofaveragecompensationforeach
ofthefirst10yearsofservice,plus1.35%ofaveragecompensationforeachadditionalyearof
service.
Thebenefitaccruedinthelateryearsof1.35%is135%ofthe1%benefitaccruedintheearly
years,sothe133percentaccrualruleisnotsatisfied.
yearsofservice,plus$120permonthforeachofthenext10yearsofservice,plus$140foreach
additionalyearofservice.
Thebenefitaccruedinthelateryearsof$140is140%ofthe$100benefitaccruedintheearly
years,sothe133percentaccrualruleisnotsatisfied.Notethatthe$140iscomparedtothe
lowestaccrualinanyprioryear.
Thefractionalaccrualrulestatesthataparticipantsbenefitatnormalretirementisearned
incrementallyovertheparticipantsyearsofservice,bothpastandfuture.Thus,atanytime
priortonormalretirement,theparticipantisconsideredtohaveaccruedabenefitequaltothe
projectednormalretirementbenefitmultipliedbyservicetodatedividedbyserviceprojectedto
normalretirement.Yearsofparticipationcanbeusedinsteadofyearsofservice,buttheymust
beusedinboththenumeratorandthedenominatorofthemultiplier.
EXAMPLE:Thenormalretirementbenefitis70%ofaveragecompensation,andnormal
retirementageis65.Theaccruedbenefitisequaltothenormalretirementbenefitaccruedusing
thefractionalrulewithallyearsofservicetakenintoaccount.
Consideraplanparticipantwhowashiredatage30andenteredtheplanon1/1/2011atage40.
Theaccruedbenefitattheendofthefirstyearofparticipationintheplan(12/31/2011)is22%of
averagecompensation(70%11/35),sincetheparticipanthas11yearsofserviceasof
12/31/2011andwillhave35yearsofserviceatage65.
123
EXAMPLE:Theexampleisthesameasthepriorexample,exceptthatthefractionalruleisused
baseduponyearsofplanparticipationonly.Theaccruedbenefitattheendofthefirstyearof
participationintheplan(12/31/2011)is2.8%ofaveragecompensation(70%1/25),sincethe
participanthas1yearofplanparticipationasof12/31/2011andwillhave25yearsofplan
participationatage65.
EXAMPLE:Thenormalretirementbenefitisdefinedtobe1%ofaveragecompensationforeach
ofthefirst10yearsofservice,plus1.35%ofaveragecompensationforeachadditionalyearof
service,andnormalretirementageis65.Theaccruedbenefitisequaltothenormalretirement
benefitaccruedusingthefractionalrulewithallyearsofservicetakenintoaccount.
Consideraplanparticipantwhowashiredatage45andenteredtheplanon1/1/1998atage50.
Thetotalnormalretirementbenefitis23.5%ofaveragecompensation(1%forthefirst10years
plus1.35%forthenext10years).Theaccruedbenefitattheendofthe12thyearofparticipation
intheplan(12/31/2009)is19.975%ofaveragecompensation(23.5%17/20),sincethe
participanthas17yearsofserviceasof12/31/2009andwillhave20yearsofserviceatage65.
The3percentaccrualrulestatesthataparticipantsbenefitatnormalretirementmustbeearned
ataratenotlessthan3percentperyearofaccrual.Thisaccrualruleisnotapplicableforbenefit
formulasthatallowforaccrualserviceinexcessof33years.
yearsofservice,plus$120permonthforeachofthenext10yearsofservice,plus$140foreach
ofthenext11yearsofservice.Notethatthisissimilartothethirdexampleabovewithregardto
the133percentaccrualrule,exceptthattherenowisamaximumnumberofyearsofservice
thatcanbetakenintoaccount.Asdescribedinthatsection,thisbenefitformuladoesnotsatisfy
the133percentaccrualrule.
Inordertotestwhetherthe3percentaccrualruleissatisfied,itisfirstnecessarytocalculatethe
normalretirementbenefit.Sincetheproblemwiththisbenefitformulaisthepotentially
excessivebackloading,wewillconsidertheworstcasewhichissomeonewith26yearsof
serviceatretirement,whowillgetthemaximumuseofthebackloaded$140benefit.The
normalretirementbenefitforthispersonis$3,240($100times5yearsofservice,plus$120times
10yearsofservice,plus$140times11yearsofservice).3%ofthistotalis$97.20(3%of$3,240).
Theaccrualeachyearisatleast$97.20,sothe3%ruleissatisfied.
SERVICECREDITINGRULES
Serviceforyearsinwhichtheemployeeperformsnoservicefortheemployerareexcludedfor
purposesofbenefitaccrual.Serviceforyearsinwhichtheemployeedoesnotparticipateinthe
plancanbeexcluded,butarenotrequiredtobeexcluded.Ayearofservicecanbebasedupon
the1,000hourrule(theemployeemustworkatleast1,000hourstoearnoneyearofservice),
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lessthan1000hours,oranelapsedtimemethod(theemployeeearnsaproratedyearifheor
sheworkslessthanthefullyear).
OPTIONALFORMSOFBENEFIT
Definedbenefitplansarerequiredtoprovideamarriedparticipantsbenefitsintheformofa
qualifiedjointandsurvivorannuity(QJSA)unlessboththeparticipantandspouseconsentto
anotherformofpayment(thisconsentisintheformofawaiveroftheQJSAandanelectionof
anotherspecifiedform,andmustbesignedwithin180daysofthedatethepaymentofthe
annuityistostart).Unmarriedparticipantscanreceivebenefitsinanyformallowedunderthe
termsoftheplanastheyhavenospousefromwhomtoobtainconsent.Participantsmarriedfor
lessthanoneyeararenotsubjecttotheQJSArequirementprovidedtheplandocument
specifiesthisprovision.
AQJSAisanannuityforthelifeofparticipantwithasurvivorannuityforthelifeofthespouse
thatisnotlessthan50percentandnotmorethan100percentoftheamountoftheannuity
payableduringthejointlivesoftheparticipantandspouse.Asinglelifeannuityisanannuity
payableforthelifeoftheparticipantwithallbenefitsceasinguponthedeathoftheparticipant.
PPA2006requiresthatdefinedbenefitplansalsoofferaqualifiedoptionalsurvivorannuity
(QOSA)asanalternativetotheQJSA.AQOSAisanannuityforthelifeoftheparticipantwith
asurvivorannuityforthelifeofthespouse.Thelevelofspousesurvivorannuitydependsupon
thelevelofspousesurvivorannuityprovidedunderaplansQJSA.IftheQJSAprovidesa
survivorannuitythatislessthan75percentoftheamountoftheannuitythatispayableduring
thejointlivesoftheparticipantandthespouse,theQOSAmustprovideaspousesurvivor
annuitypercentageof75percent.IftheQJSAprovidesasurvivorannuityforthelifeofthe
participantsspousethatisgreaterthanorequalto75percent,theQOSAmustprovidea
survivorannuitypercentageof50percent.
Adefinedbenefitplanmayofferotheroptionalformsofpayment,including:
Periodcertainandlifetimeannuityprovidingtheparticipantwithafixedannuityfor
life.Paymentsendatthelaterofdeathoraftertheminimumnumberofpaymentsare
made.Iftheminimumnumberofpaymentsisnotmadebeforethedeathofparticipant,
thenthebeneficiaryreceivespaymentsuntiltheminimumnumberofpaymentshas
beenmade.
Fixedperiodannuityprovidingtheparticipantortheparticipantsbeneficiarywith
equalpaymentsatregularintervalsforafixedperiodoftime.
Lumpsumpaymentprovidingthepresentvalueoftheparticipantsaccruedbenefitina
singlepayment.Thelumpsumiscalculatedusingtheplansactuarialequivalence
assumptions.However,IRC417(e)(3)providesaminimumlumpsumvaluebased
uponanapplicableinterestrateandmortalitytable.Thelumpsumamountcannotbe
lessthantheIRC417(e)(3)minimumlumpsum.IRC415(b)limitsthetotallumpsum
thatcanbedistributed,evenifthatcausesthelumpsumtofallbelowtheIRC417(e)(3)
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oractuarialequivalentlumpsumamounts.TheIRC415(b)limitsarediscussedlaterin
thischapter.
EXAMPLE:Aplanparticipantelectstoreceivealumpsumdistribution.Thepresentvalueofthe
accruedbenefitusingplanactuarialequivalenceassumptionsis$400,000,thepresentvalueof
theaccruedbenefitusingtheIRC417(e)(3)applicableinterestrateandmortalitytableis
$425,000andtheIRC415(b)limitis$550,000.Theplanparticipantmustreceiveapaymentof
$425,000.NotethatiftheIRC417(e)(3)lumpsumvaluehadbeenlessthan$400,000,thenthe
participantwouldhavereceived$400,000.
REDUCINGFUTUREBENEFITACCRUALS
ERISA204(h)requiresanadvancenoticetoparticipantsofanysignificantreductionintherate
offuturebenefitaccrualsoranyplanamendmentthateliminates,ceasesorsignificantlyreduces
anearlyretirementbenefitorsubsidyunderapensionplan.
AnERISA204(h)noticemustbeissuedatleast45dayspriortotheeffectivedateofthe
amendmentunlessoneofthefollowingexceptionsapplies:
Planswithlessthan100participantsontheeffectivedateoftheamendmentmust
providenoticeatleast15dayspriortotheeffectivedate.
Inconnectionwithanacquisitionordisposition,theERISA204(h)noticeperiodis15
dayspriortotheeffectivedateoftheamendmentregardlessofplansize.
Withrespecttoliabilitiestransferredinconnectionwithanacquisitionordisposition,
andwheretheamendmentsignificantlyreducesanearlyretirementbenefitorsubsidy
butnotthefuturerateofbenefitaccrual,thenoticeperiodis30daysaftertheeffective
dateoftheamendmentregardlessofplansize.
AnamendmentreducingfuturebenefitaccrualscanbeadoptedaftertheERISA204(h)notice
isgivenaslongasthenoticeisprovidedwithintheapplicabletimeframes.
Safe Harbors for DB Plans under IRC 401(a)(4)

PlansknownassafeharborplansmeetthenondiscriminationrequirementsofIRC401(a)(4)
byplandesign.Thus,theyarenotsubjecttothegeneraltestfornondiscriminationinlevelor
amountofbenefitsunderTreas.Reg.1.401(a)(4).Plansprovideabenefitformulathatgenerally
allowsparticipantstoaccrueanondiscriminatorypercentageofcompensationorflatdollar
amountofbenefiteachyear.Thebenefitisconstructedupontheconceptofuniformity.
Theuniformityconceptrequiresthatemployeeswiththesameserviceandsalaryreceive
roughlythesamebenefit,derivedfromthesameformula,tobepayableinthesameformatthe
samenormalretirementage(NRA).Anysubsidizedoptionalbenefitsmustbeavailableto
substantiallyallparticipantsonthesameterms.(Uniformityrequirementsareaddressedmore
fullybelow.)
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Thesafeharborbenefitformulascangenerallyberelatedtothebenefitaccrualrequirementsof
IRC411(b)asfollows:
AnybenefitformulathatsatisfiesIRC411(b)byuseofthe133%ruleisdeemedtobe
asafeharborformulaunderIRC401(a)(4).ThisisoftenreferredtoastheUnitBenefit
PlanSafeHarborandisillustratedbelow.
AbenefitformulathatsatisfiesIRC411(b)byuseofthe3%ruleisnotnecessarilyasafe
harborformulaunderIRC401(a)(4).
AnybenefitformulathatsatisfiesIRC411(b)byuseofthefractionalrulemayormay
notbeasafeharborformulaunderIRC401(a)(4).Seethesectionbelowconcerningthe
FractionalRuleSafeHarbor.
PlansthatsatisfytherulesofpermitteddisparityunderIRC401(l)aredeemedtobeasafe
harbor.Inaddition,fullyinsuredplansunderIRC412(e)(3)aredeemedtosatisfythesafe
harbornondiscriminationrequirements.
UNITBENEFITPLANSAFEHARBOR
Aunitbenefitformulaassignsaparticularbenefitincrementtoeachyearofan
employeesservice.Examplesofformulasinunitbenefitplansinclude:
Finalaveragepayplangranting1percentofsuchaveragepayforeachyearofservice;
Finalaveragepayplangranting2percentofsuchaveragepayforeachofthefirst10
yearsofservice,plus2.5percentofsuchaveragepayforeachadditionalyearofservice;
Planprovidingbenefitequalto$25amonthforeachyearofservice;or
Integratedplanproviding1percentperyearofserviceoffinalaveragepayto
integrationlevel,and1.65percentperyearofserviceonaveragepayabovethatlevel.
Underacareeraverageplanoranaccumulationplan,theparticipantearnsanannualaccrual
basedontheparticipantscurrentyearcompensationratherthanonaveragecompensation.An
exampleofthiswouldbeaplanwithabenefitformulaof1percentofeachplanyears
compensation.
Unitbenefitplansafeharborrequirementsapplytounitbenefitplansthatboth:
Definetheaccruedbenefitbyapplyingtheplanformulatotheemployeesactual
compensationandservicehistory;and
Satisfythe133percentaccrualrule.
FRACTIONALACCRUALSAFEHARBOR
Flatbenefitplanscommonlydefinetheaccruedbenefitbyusingafractionalaccrualrule.Thisis
mostcommonwithsmallplans.
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Thesafeharborforthefractionalrulerequiresthatplans:
SatisfythefractionalaccrualruleofIRC411(b)(1)(C);and
Determineaccruedbenefitsbyfractionalrulemethodologydescribedabove.
Thenormalretirementbenefitmustbedeterminedusingthesametypeofserviceasusedfor
benefitaccrualunderthefractionalrule.Forexample,iftheplansnormalretirementbenefitis
equalto1%ofaveragesalaryperyearofserviceforeachofthefirst15yearsofservice,(withno
additionalbenefitsearnedforadditionalyearsofservice),thefractionalrulemustaccruethe
benefitoveryearsofservice(notyearsofplanparticipation,whichisanoptionunderIRC
411(b)).Ifthebenefitaboveisaccruedusingyearsofplanparticipation,thenthebenefit
formuladoesnotqualifyforthefractionalaccrualsafeharbor.
Tocomplywiththesafeharborrequirements,atleastoneofthefollowingconditionsmustbe
met:
Theplanisaunitbenefitplan,andnoparticipantcanaccruemorethan133%ofany
otherparticipant(asapercentageofsalaryorasadollaramount).Inmakingthis
comparison,employeeswithmorethan33yearsofserviceatnormalretirementare
ignored.
Theplanisaflatbenefitplanthatprovidesthattheminimumnormalretirementservice
forentitlementtofullbenefitis25years.This25yearminimumrelatestotheunreduced
benefitdeterminedwithoutregardtotheIRC415(b)maximum.
Theplanisaflatbenefitplanbutdoesnotprovidethattheminimumserviceatnormal
retirementforentitlementtothefullbenefitis25years.Inthiscase,thebenefitformula
isasafeharborformulaonlyiftheplansatisfiesanaveragebenefitpercentagetest
(modifiedfromtheIRC410(b)averagebenefitpercentagetest)withregardtothe
benefitsaccruingfortheyear.Thisisthealternativeflatbenefitsafeharbordescribed
below.
Examplesoffractionalaccrualsafeharborbenefitformulas:
EXAMPLE:Thebenefitformulais1%ofaveragecompensationperyearofserviceforthefirst15
years,plus1.5%ofaveragecompensationperyearofserviceforeachyearthereafter,accrued
usingthefractionalruleoverallservice.
Thisformulaprovidesanaccrualof1%ofaveragecompensationtoallparticipantswith15or
feweryearsofserviceatretirement.However,forparticipantswithmorethan15yearsof
service,theaccrualratereflectsthelargeraccrualforyearsinexcessof15.Theregulationsdo
notrequireconsiderationofanyparticipantwhowillhavemorethan33yearsofserviceat
retirement.Therefore,considertheworstcase,whichistheparticipantwithexactly33yearsof
serviceatretirement.Thetotalbenefitatretirementis42%ofaveragecompensation.(Thisis1%
multipliedby15years,plus1.5%multipliedby18years.)Theannualaccrualratewouldbe
42%dividedby33years,whichis1.27%peryear.Inorderfortheformulatosatisfythe
fractionalrulesafeharbor,noparticipantcanearnarateofaccrualmorethan133%ofany
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otherparticipant.Theparticipantswith15orfeweryearshaveanaccrualrateof1%.The1.27%
accrualrateis127%timesthesizeofthe1%accrualrate,whichsatisfiesthe133%
requirement.Thisformulaisasafeharborformula.
EXAMPLE:Theplanformulais80%ofaveragecompensation,reduced1/25foryearsofserviceat
retirementlessthan25,accruedusingthefractionalruleoverallservice.Thisformulaisnota
unitcredittypeofformulaandcannotusethe133%safeharbor.However,byrequiringat
least25yearsofserviceinordertoreceiveafullbenefit,theplanmeetsthesafeharborrules.
EXAMPLE:Theplanformulais80%ofaveragecompensation,forallparticipants,accruedusing
thefractionalruleoverallservice.Thisformulaisnotaunitcredittypeofformulaandcannot
usethe133%safeharbor.Sinceitdoesnotrequireatleast25yearsofservice(orplan
participation)inordertoreceiveafullbenefit,theplandoesnotmeetthefractionalaccrualsafe
harborrules.Itmay,however,satisfythealternateflatbenefitsafeharbor.
ALTERNATEFLATBENEFITSAFEHARBOR
Thealternateflatbenefitsafeharborappliestoplansthataccruebenefitsusingthefractional
rulebutdonotsatisfytheothersafeharborbenefitformulaconditions.
ThismorelenientstandardissimilartotheaveragebenefitpercentagetestofIRC410(b),
althoughitdoesnotrequirecombiningbenefitsearnedfromotherplansoftheemployer.For
theplanyearbeingtested,theaverageoftheaccrualratesfortheNHCEsmustbenolessthan
70percentofthecomparableaveragefortheHCEs.Allnonexcludableemployeesare
consideredregardlessofwhethertheyareparticipantsintheplan.(Forthispurpose,theaccrual
ratesofthesenonexcludableemployeeswillbezerosincetheyarenotbenefitingintheplan.)
EXAMPLE:AlternativeFlatBenefitSafeHarbor
Normalretirementage:65
Normalretirementbenefit:40%ofaveragesalary
Accruedbenefit:Normalretirementbenefitaccruedusingthefractionalruleforallyearsof
service
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Participantdata:
Employee
HireAge
AverageSalary
HCE#1
35
$200,000
HCE#2
55
$150,000
NHCE#1
25
$40,000
NHCE#2
40
$70,000
NHCE#3
60
$60,000
Thisplanisaflatbenefitplan,soitdoesnotqualifyforthe133%safeharbor.Thereisno
requirementofatleast25yearsofserviceinordertoreceiveafullbenefit,sothealternativeflat
benefitsafeharbormustbetested.Theannualaccrualforeachparticipantis:
HCE#1=40%$200,000(1/30)=$2,667[NotethatHCE1ishiredatage35andwillhave30
yearsofserviceatretirementage65]
HCE#2=40%$150,000(1/10)=$6,000[NotethatHCE2ishiredatage55andwillhave10
NHCE#1=40%$40,000(1/40)=$400[NotethatNHCE1ishiredatage25andwillhave40
NHCE#2=40%$70,000(1/25)=$1,120[NotethatNHCE2ishiredatage40andwillhave25
NHCE#3=40%$60,000(1/5)=$4,800[NotethatNHCE3ishiredatage60andwillhave5
Thebenefitpercentage(accrualrate)asapercentageofaveragesalaryforeachparticipantis:
HCE#1=$2,667/$200,000=1.33%
HCE#2=$6,000/$150,000=4.00%
NHCE#1=$400/$40,000=1.00%
NHCE#2=$1,120/$70,000=1.60%
NHCE#3=$4,800/$60,000=8.00%
Theaveragebenefitpercentageforthedefinedbenefitplanis:
[(1.00%+1.60%+8.00%)/3][(1.33%+4.00%)/2]=132.58%
Theplansatisfiesthealternativeflatbenefitsafeharborfortheyearbecausetheaveragebenefit
percentageisatleast70%.Notethatthispercentagecanchangefromyeartoyear,sotheplan
requiresannualtestingtoinsurethatitremainsasafeharbor.
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UNIFORMITYREQUIREMENTS
TobeconsideredanIRC401(a)(4)safeharbordefinedbenefitplan,theplanmustmeetcertain
uniformityrequirementsinadditiontosafeharboraccruedbenefitrulesasfollows:
Theretirementbenefitformula,formofbenefitpaymentandnormalretirementage
mustbeuniform.Anormalretirementbenefitexpressedasapercentageofaverage
compensationordollaramountmustbethesameforallemployeeswhowillhavethe
samenumberofyearsofserviceatnormalretirement.Forexample,iftwoparticipants
haveidenticalsalariesof$50,000andwereeachhiredatage40,theymustreceivethe
samenormalretirementbenefitatage65.Otherwise,thebenefitformulaisnotuniform.
However,theparticipantscouldreceivedifferentnormalretirementbenefitsifoneof
themhadsalaryotherthan$50,000orwashiredeitherbeforeorafterage40.
TheuniformityrequirementextendstothoseemployeesworkingbeyondNRA.Suchan
employeesaccruedbenefitmustbeequivalent,asapercentageofaverageannual
compensationordollaramount,tothatpayableatnormalretirementtoanemployee
withsamenumberofyearsofservice.
Permitteddisparityisdeemedtosatisfytheuniformityrules.
Uniformretirementagerules:
Theplansbenefitformulamustprovideallemployeeswithabenefitcommencingatthe
sameuniformNRA.
NRAcannotexceedthelaterof:
Age65,or
Fiveyearsofplanparticipation.
IRSissuedregulationswhichrequireplanstouseanNRAofatleastage62exceptunder
limitedcircumstances.TherehasbeensubstantialdebateonthisminimumNRA
requirement.TheemployercanselectanNRAlowerthan62(andgreaterthanage54),
butthereisafactsandcircumstancesdeterminationofiftheNRAisrepresentativeof
thetypicalretirementageoftheindustry.Theburdenofproofforthisiswiththe
employer.AnNRAlessthan55isgenerallypresumedearlierthanareasonable
retirementage.
Averageannualcompensation(AAC)rules:
Benefitsmustbedeterminedeitherasadollaramountunrelatedtopayorasa
percentageofaverageannualcompensation.
Accumulationplans(careeraverageplans)maysubstituteplanyearcompensationfor
AAC.
UniformsubsidiesmustbecurrentlyavailabletosubstantiallyallemployeestoavoidIRC
401(a)(4)generaltestingconductedwithrespecttoaccrualofbothnormalbenefitsandmost
valuablebenefits(benefitsincludinganysubsidies).Asubsidyisoftenintheformofanearly
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retirementbenefit,wherethebenefitispayableatanearlyage(forexample,atage60orlater)
withoutanyactuarialreductionorintheformofalumpsumdistributionwhichoftenhasmore
valuethanthelifeannuityduetotheuseoftheIRC417(e)(3)interestratesandmortalitytable.
ThisresultsinamorevaluablebenefitthanwaitinguntilNRAtoreceivethefullbenefit.Ifthis
earlyretirementbenefitislimitedtoonlyaparticularcategoryofemployees(forexample,
salaried,butnothourlyemployees)thenitisnotuniform.
Theplanisnotasafeharborplanifitisanemployeecontributoryplan.
ADDITIONALSAFEHARBORAVAILABILITYRULES
Useofasafeharborformulaisnotprecludedbyanyoffollowing:
LowerbenefitsforHCEsdonotviolateanyconditionofsafeharboraccess,including
thatofuniformnormalretirementbenefit.
Benefitsaccruedpriortoafreshstartdateunderadifferentformulaand/oraccrual
methodthanthatwhichcurrentlyappliesareexemptfromtheuniformityrequirements.
Multipleformulasdeterminingbenefitsasthegreaterof,orsumof,twoormore
formulasdonotfailsafeharboruniformityrequirementsif:
o
Eachformulaisavailableonthesametermstoallemployees.Ifanyformulais
notavailabletoanyHCEs,itneednotbeavailabletoallNHCEs;
Thetopheavybenefitformulaisappliedasrequiredbytheplan;and
Eachformulaseparatelyqualifiesforsafeharbortreatment,includingconformity
withuniformityconditions.
EXAMPLE:Thebenefitforeachparticipantisequaltothegreaterof:
(1)2.25%offinalcompensationperyearofservice,or
(2)60%offinalcompensation(reduced1/25foryearsofservicelessthan25atretirement),and
accruedusingthefractionalrule.
Formula(1)satisfiestheunitbenefitformulasafeharbor,andformula(2)satisfiestheflat
benefitsafeharborforplansthataccrueusingthefractionalrule.Sinceeachformula
independentlysatisfiesthesafeharborrules,themultipleuseofthetwoformulas(inthiscase,
thegreaterofthetwo)stillresultsinanoverallsafeharborbenefitformula.
Theplanmayprovideforoneormoreentrydatesperplanyear.
Asubsidizedoptionalbenefitformdoesnotfailtobeavailabletosubstantiallyall
employeesifitappliesonlytoagrandfatheredgroupduetoaprioramendmentto
eliminatethesubsidizedoptionformprospectively.
COMPENSATIONDEFINITIONUNDERIRC414(S)
Thedefinitionofcompensationusedbytheplanmustgenerallyconsistofallcompensation,but
insomecasescanexcludecertaintypesofcompensationsuchasovertimeorbonuses.However,
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inordertoexcludesuchtypesofcompensation,itmustbeshownunderIRC414(s)thatthe
definitionbeingusedisnotdiscriminatinginfavoroftheHCEs.Detailedinformationonhow
totestcompensationexclusionsforcompliancewithIRC414(s)canbefoundintheCoverage
andNondiscriminationchapterofthisstudyguide.
AVERAGEANNUALCOMPENSATIONUNDERIRC401(A)(4)
ThedefinitionofAverageAnnualCompensation(AAC)forpurposesofnondiscrimination
testingunderIRC401(a)(4)mustconsistofatleastthreeconsecutive12monthperiods,but
neednotbelongerthantheemployeesperiodofemployment.
Theperiodofaveragingmustrepresenttheperiodintheemployeescompensationhistorythat
producesthehighestaveragecompensation.Plansthatdefinecompensationhistoriesinterms
offixed12monthperiodsmaydropthefollowingperiodsfromconsideration:
Periodbeforetheemployeebecomesaparticipant;
Periodinwhichtheemployeeterminates;
Periodinwhichtheemployeeperformsnoservice;and
Periodinwhichtheemployeeperformslessthanaminimumperiodofservicethatis
notgreaterthanoffulltime.
IfAACisbasedon12monthperiodsthatdonotendonauniformfixeddate,monthsmaybe
droppedinacongruentmanneras12monthperiodsarecompleted.
AACmustbedeterminedinaconsistentmannerforallemployees.
Therequirementthattheaveragingperiodbeconsecutiveiswaivedforaplanwhoseformula
doesnotutilizethepermitteddisparityallowance.
Limitations on Benefits
IRC415limitstheannualbenefitunderadefinedbenefitplantothelesserofthecompensation
limit(100percentoftheparticipantshighestconsecutivethreeyearaveragecompensation)or
thedollarlimitequalto$160,000asindexed($200,000for2012).
Thedollarlimitissubjecttothefollowingadjustments:
Proportionalreductionforyearsofparticipationlessthanten;
Actuarialreductionifbenefitscommencepriortoage62;and
Anactuarialincreaseifbenefitscommenceafterage65.
EXAMPLE:Aparticipantinadefinedbenefitplanwashiredatage57,enteredtheplanatage58,
andactuallyretiresatage66.TheIRCsection415dollarlimitforthisparticipantmustbe
reducedforyearsofplanparticipationlessthan10(theparticipanthas8yearsofplan
participation),andisincreasedactuariallyfromage65toage66.Ifitisgiventhattheactuarial
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factorincreasingthedollarlimitfromage65toage66is1.062,thenthedollarlimitforthe
participantis:
$200,0001.062(8/10)=$169,920
Thecompensationlimitisproportionallyreducedforparticipantswithlessthantenyearsof
service.Thecompensationlimitisnotactuariallyadjustedforbenefitcommencementbeforeor
afteraspecifiedretirementage.
andactuallyretiresatage66,withahighconsecutive3yearaverageannualsalaryof$120,000.
TheIRCsection415compensationlimitforthisparticipantmustbereducedforyearsofservice
lessthan10(theparticipanthas9yearsofservice).Thedollarlimitfortheparticipantis:
$120,000(9/10)=$108,000
Notethatthecompensationlimitisnotadjustedforretirementafterage65orbeforeage62.
Oncethecompensationanddollarlimitshavebeenadjustedforretirementage(inthecaseof
thedollarlimit)andthe10yearphaseins,afurtheradjustmentisnecessaryifthebenefitis
payableinaformotherthanastraightlifeannuity.Theadjustmentisdoneactuarially,fromthe
forminwhichthebenefitispaidtoanequivalentstraightlifeannuity.Thelimitisnotadjusted
ifthebenefitispaidintheformofaqualifiedjointandsurvivorannuity(QJSA).
ThemaximumlumpsumunderIRC415(b)isthesmallestoftheamountdeterminedusing
threesetsofactuarialequivalencefactors:
Planactuarialequivalence,
105%ofthevalueusingtheIRC417(e)rates,and
5.5%andtheIRC417(e)applicablemortalitytable.
TheWorker,RetireeandEmployerRecoveryActof2008(WRERA)changedthemaximum
lumpsumcalculationunderIRC415(b)forsmallplans.Underthenewlaweffectiveforplan
yearsbeginningafter2008fordefinedbenefitplanssponsoredbysmallemployers(100orfewer
employees),thedefinedactuarialequivalencefactors(5.5%interestrateandtheIRC417(e)
applicablemortalitytable)arecomparedtotheplansactuarialequivalentlumpsumforthis
calculation,andthe105%ruleisnotapplied.
Ademinimisannualbenefitof$10,000maybepaidevenifotherlimitationsofIRC415are
exceeded.Thedeminimisbenefitisproportionatelyreducedforparticipantswithlessthanten
yearsofservice,inthesamemannerasthecompensationlimit.Thedeminimisbenefitisnot
availabletoparticipantswhohaveeverparticipatedinadefinedcontributionplanofthe
employer.Additionally,thedeminimisbenefitrulestatesthatnomorethan$10,000canbepaid
inanyyear.Iftheemployeedoesnthaveahighthreeyearaveragecompensationofatleast
$10,000,theemployeewillnotbeabletoreceivethevalueofthedeminimisbenefitasalump
sum.
134
andretiresatage65,withahighconsecutive3yearaverageannualsalaryof$8,000andthe
planformulawouldprovideabenefitof$12,000.Theemployerhasnevermaintainedadefined
contributionplan.Sincetheparticipanthasboth10yearsofserviceandplanparticipation,there
isnoproratareductioninthedollarlimitof$190,000orthecompensationlimitof$8,000.The
lesserofthedollarlimitorthecompensationlimitis$8,000.However,sincethisislessthanthe
deminimisannualbenefitof$10,000,thebenefitfortheparticipantis$10,000.
NotethattheIRC415(b)benefitlimitisamaximumbenefit,andtheplanbenefitcannotexceed
thisamount.
EXAMPLE:Thebenefitusingtheplanformula=$50,000;IRC415(b)benefit=$190,000
Analysis:ThebenefitpayableisequaltothesmalleroftheplanbenefitortheIRC415(b)
benefit.Inthiscase,thatis$50,000.
EXAMPLE:Thebenefitusingtheplanformula=$160,000;IRC415(b)benefit=$140,000
Analysis:ThebenefitpayableisequaltothesmalleroftheplanbenefitortheIRC415(b)
benefit.Inthiscase,thatis$140,000.
Minimum Funding Requirements

HOWMINIMUMCONTRIBUTIONSAREDETERMINED
Plancontributionsmustbedepositednolaterthan8monthsaftertheendoftheplanyear.
(Thisisthesameastherequirementfordefinedcontributionplansthataresubjecttominimum
fundingrequirements,suchasmoneypurchasepensionplans).Toavoidadditionalquarterly
interestcharges,aportionoftheminimumrequiredcontributionmustbemadeonaquarterly
basiscommencing3monthsafterthebeginningofaplanyear(e.g.,foracalendaryearplan,
thequarterlycontributionduedatesareApril15,July15,October15duringtheplanyear,and
January15ofthefollowingyear).Exceptionstothequarterlycontributionrequirementmaybe
madebasedonfundingadequacy.
Priorto2008,theminimumrequiredandmaximumdeductiblecontributionsweredetermined
usingoneofanumberofallowableactuarialfundingmethods,aswellasotherassumptionsas
determinedbytheactuary.ThePensionProtectionActof2006(PPA)changedthefunding
methodologyforsingleemployerplans.PPAspecifiesthatforyearsbeginningafter2007,there
isonespecifiedfundingmethodthatmustbeusedtodeterminetheminimumrequiredand
maximumalloweddeductiblecontribution.Inadditiontheinterestrateandmortalityactuarial
assumptionsarenowspecifiedbytheIRSforallplans.Themandatedfundingmethodis
similartothepriorunitcreditfundingmethod.Thismethodfundstheplanasbenefitsare
accrued,whichisincontrasttoothermethods(stillutilizedbymultiemployerplans)thatallow
forfundingbasedonwhatisprojectedtoaccrueatretirement.
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Beginningin2008,singleemployerplansarerequiredtouseafundingmethodthatisvery
similartotheoldunitcreditactuarialcostmethod.Underthenewmethod,thevalueofthe
accruedbenefitasofthebeginningoftheplanyeariscalledtheFundingTargetandthevalue
oftheincreaseintheaccruedbenefitprojectedtotheendoftheyeariscalledtheTarget
NormalCost.Theincreaseintheaccruedbenefitforthecurrentyear,whetherdueto
compensationincrease,planamendment,currentserviceand/orpastservice,isincludedinthe
TargetNormalCost.Futureexpectedsalaryincreasesbeyondtheendoftheplanyeargenerally
cannotbetakenintoaccountindeterminingtheminimumrequiredcontribution.
TheexcessoftheFundingTargetovertheassetsatthevaluationdateisconsideredaFunding
Shortfallandisamortizedover7years.Thecurrentyearcontributionrequirementwill
generallybeequaltotheTargetNormalCostplustheShortfallamortization.Theminimum
requiredcontributioncanbereducedassumingappropriatedirectionhasbeenprovidedtothe
plansnamedactuarybyanycreditbalanceitem.(Creditbalanceitemsincludethefunding
standardcarryoverbalance,whichisapre2008creditbalance,and/ortheprefundingbalance,
whichisapost2007balanceequaltoanycontributionsthattheemployerhasmadeinexcessof
theminimumthatthePlanAdministratorhasindicatedshouldimpacttheprefundingbalance).
Thedeterminationandmaintenanceofthesecreditbalanceitemsiscomplex,andbeyondthe
scopeofthiscourse.
TheIRSmaywaivealloraportionofplansrequiredcontributioniftheemployercan
demonstratethatthecontributioncannotbemadewithoutatemporarysubstantialbusiness
hardship.Arequestforafundingwaivermustbemadenolaterthan2monthsaftertheclose
oftheplanyear.
FailuretomeettheminimumfundingrequirementsofIRC412and/orIRC430resultsina
nondeductibleexcisetaxof10percentofthefundingdeficiency.Additionally,participants
mustbeinformedoftheemployersinabilitytomeettheminimumfundingrequirements,orof
arequestforawaiveroftheminimumfundingrequirement.
CONTRIBUTIONRANGES
Underthecurrentfundingmethod,contributionrangescanbequitelargeinanygivenyear.A
clientcancontributeanywherefromtheminimumtothemaximumeachyear.Theactuaryand
theconsultantmusthelptheclientdecidewhatcontributiontomaketotheplaneachyear.
Fundingtheminimumrequiredcontributioneachyearwilllikelyresultinincreasingthe
minimumrequiredcontributionsforfutureyearsandleavetheplanunderfundedwhen
benefitsbecomedue.Fundingthemaximumcontributioneachyearwillalmostcertainly
overfundtheplanbyasignificantamount.Iftheplanisoverfundedwhenitterminates,the
overfundingcanbesubjecttoa50%reversiontaxifitcannotbeallocatedtoparticipants
withoutviolatingtheIRC415(b)maximumlumpsumrules.So,itiscriticalfortheconsultant
totalktotheclientabouttheclientsdesiredcontributionlevelinthefutureanddesignand
fundtheplanaccordingly.
136
EXAMPLE:Theplansactuarydeterminesthattherequiredminimumcontributionpursuantto
PPAfundingmethodologyis$3,000.Themaximumdeductiblecontributionisdeterminedto
be$8,000,000.Theclientwillrequiremoreguidancethansimplybeingtoldtocontribute
somewherebetween$3,000and$8,000,000.So,theactuarydeterminesthevalueofthe
IRC415(b)lumpsumsandaftersubtractingcurrentassetsdeterminesthatnomorethan
$4,000,000shouldbecontributedtotheplanortheplanwillbeoverfunded.Inaddition,the
plansponsorwishestoavoidusingupthecurrent$3,000,000creditbalance,sotheactuary
determinestheminimumrecommendedcontributionshouldbeatleast$3,000,000.Theactuary
communicatesthatacontributionbetween$3,000,000and$4,000,000wouldbebest.
CONTRIBUTIONFLUCTUATION
Thecurrentfundingmethodrequiresfundingshortfallstobeamortizedover7yearsandthe
minimumcontributionisthetargetnormalcostplustheshortfallamortization.Definedbenefit
planscanhavewidelyfluctuatingcontributionsfromyeartoyearbasedonassetreturnand
censuschanges.Thefollowingthreeexamplesillustrategenerallyhowthefluctuating
contributionsarisetheyarenotintendedtoillustratealldetailsofthecalculationsinvolved.
EXAMPLE:XYZdefinedbenefitplanhad$1,000,000inassetsonJanuary1,2008.OnJanuary1,
2009,theplansassetshadfallento$600,000.Thefundingshortfallwillbeatleast$400,000
simplybecauseoftheeconomicdeclinethathappenedin2008.Asaresult,theemployers
minimumcontributionwillbethetargetnormalcostplusabout$65,000inshortfall
amortization.Underthesenewrules,theemployerwillmakeuptheinvestmentlossover7
years.Theemployerstargetnormalcosthasrunabout$100,000historicallyandthatisthe
contributiontheemployerisexpecting.Theemployerwilllikelybesurprisedtodiscoverthat
therecessioncauseda65%increaseinrequiredcontributions.
EXAMPLE:IntheABCcashbalanceplan,interestiscreditedat5%peryearandemployer
contributionsaredefinedintheplandocument.OnJanuary1,2008,thetotalhypothetical
accountbalanceswere$1,500,000andtheplanhad$1,400,000inassets.Therecommended
contributionfor2008was$100,000($1,400,000inassetsplusa$100,000contributionwould
resultinplanassetsequaltothehypotheticalaccountbalances).Whenthevaluationisrun
January1,2009,itisdeterminedthatthetotalhypotheticalaccountbalanceshaveincreasedto
$1,700,000whiletheplanassetshavedroppedto$1,100,000.Therecommendedcontributionfor
2009wouldbe$600,000($1,100,000inassetsplusa$600,000contributionwouldresultinplan
assetsequaltohypotheticalaccountbalances),a500%increaseover2008.
Whilesubstantialdropsinassetvaluesincreasecontributions,gainsonassetsthatexceed
expectationsdecreasefuturecontributions.
137
EXAMPLE:UndertheABCcashbalanceplan,interestiscreditedat5%peryearandthe
contributionsaredefinedintheplandocument.OnJanuary1,2009,thetotalhypothetical
accountbalanceswere$1,700,000andtheplanhad$1,100,000inassets.Therecommended
contributionfor2009was$600,000($1,100,000inassetsplusa$600,000contributionwould
resultinplanassetsequaltohypotheticalaccountbalances).WhenthevaluationisrunJanuary
1,2010,itisdeterminedthatthetotalhypotheticalaccountbalanceshaveincreasedto$1,800,000
whiletheassetshaveincreasedto$1,900,000duetobetterthanexpectedassetperformanceas
partofamarketrecovery.Therecommendedcontributionfor2010is$0($1,900,000exceedsthe
$1,800,000neededtofullyfundthehypotheticalaccountbalances).Itisunlikelytheemployeris
expectingnotaxdeductionforthisyearsimplybecauseassetsoutperformedexpectations.
Itisimportantfortheactuaryandtheconsultanttodiscussthefluctuationofcontributionswith
clientsandtheirinvestmentadvisors.Unexpectedchangesintheamountofcontributionthat
canbedeductedinanygivenyeararelikelytocauseanemployertoquestiontheadvantagesof
thedefinedbenefitplan.Theaboveexamplesalsoillustratetheimpactthatinvestment
performancecanhaveonplancontributions.Manyoftheselargefluctuationscanbeavoided
byinvestingtheassetsinamannerthatwouldprovideafairlyconsistentreturnthatiscloseto
theassumedinterestrate,whichmaybeaspecificrateormaybetiedtoanindex.
BENEFITPAYMENTRESTRICTIONS
TwoIRCsectionsacttorestrictpotentialpayoutstoexistingparticipants.Thefirstsectionisthe
high25rule.ThisprovisionlimitstheleveloflumpsumpaymentstoHCEswhoareamong
thehighest25paidinthecurrentoranyprioryeariftheplanislessthan110%funded.This
restrictionisintendedtopreventhighlypaidemployeesfromdepletingthetrustandcreatinga
situationwhereassetsarenotsufficienttomakedistributionstorankandfileemployees.
TheotherrestrictionondistributionswasimposedondefinedbenefitplansbyPPAandis
discussedintheAFTAPsectionbelow.
RESTRICTIONSUNDERPPABASEDONPLANAFTAP
TheapplicationofthePPAbenefitrestrictionsruledependsonaplansAFTAP(Adjusted
FundingTargetAttainmentPercentage).TheserestrictionsarefoundinIRC436.AFTAPcan
bethoughtofastheassetsheldinthetrustminuscreditbalances,dividedbytheplansliability.
TheliabilityistheFundingTarget,thevalueoftheaccruedbenefitsundertheplan.AFTAPis
determined,certifiedandprovidedtotheplansponsoratleastannuallybytheplansenrolled
actuary.
ThetimingofaplansAFTAPcertificationisveryimportantaswell.Forthefirstthreemonths
oftheyeartheprioryearsAFTAPisused.IftheactuaryhasnotcertifiedtheplansAFTAP
within3monthsfromthebeginningoftheplanyear,theprioryearsAFTAPisusedand
reducedby10percentagepoints.ThisPresumedAFTAPisusedtemporarilyuntilthe
certificationoccurs.Furthermore,iftheactuaryhasnotcertifiedtheAFTAPbythefirstdayof
138

the10thmonthoftheplanyear,theAFTAPisdeemedtobelessthan60%fortheremainderof
theplanyearregardlessofwhattheactualplanassetsarerelativetotheactualplanliabilities.
PPArequiresthatlimitationsbeplacedonaccrualsand/ordistributionswhentheAFTAPis
under80%or60%.Definedbenefitplansthatofferlumpsumdistributions,periodcertain
annuitiesorSocialSecuritylevelingannuitiesareaffectedunlesstheymeetcertaintarget
fundinglevels.Sponsorsofpoorlyfundedplanscanalsoberequiredtofreezeaccrualsordelay
planamendmentsincreasingbenefitlevelsandrestrictfundingfornonqualifiedplans.Also,
additionalparticipantnoticesarerequired.
OfthefourAFTAPrelatedbenefitrestrictionsunderPPA,themostfrequentlyobserved
restrictiondealswiththepaymentoflumpsums.Adefinedbenefitplanwhichpaysunlimited
lumpsumsmustgenerallyhaveanAFTAPfundinglevelofatleast80%determinedasofthe
valuationdate.IftheAFTAPisbetween60%and80%,theotherwisepayablelumpsumamount
isgenerallylimitedto50%oftheaccruedbenefit.Actuariesoftentargetrecommendedplan
contributionlevelstoensureassetsaresufficienttomeetthesefundinglevels.Theotherthree
restrictionscontainedinPPAareplanamendmentsincreasingbenefits,forcingabenefitfreeze,
andplantshutdownbenefits.Inthefirstfiveyearsofanewplanonlytherestrictiononlump
sumpaymentsapplies.
Thechartbelowoutlinestheimplicationsatvariousfundinglevels.
AFTAP
Restrictions
Lessthan60%
Mustfreezeaccruals
Cannotpaylumpsums
Cannotpayshutdownbenefits
Between60%and80%
Limitedabilitytoadoptplanimprovements
Only50%oflumpsumscanbepaid
Over80%
Generallynotsubjecttobenefitrestrictions
Investments
Theplansponsorisresponsibleforcreatingtheassetinvestmentstrategysincetheplansponsor
isatriskforassetperformance.Theassetallocationchosenshouldbeconsistentwiththe
employerscomfortlevelforfluctuationsincontributionlevelsfromyeartoyear.Forexample,
anaggressivestockallocationwillbesubjecttomorefluctuationinvalueascomparedtoa
conservativebondportfolioandwillcausemuchlargervariationinthecontributionlevelsfrom
yeartoyear.Duetomarketfluctuationwhichoccurredduring2008,manyplansponsorsare
revisitingtheirinvestmentstrategywithadvicefromtheiradvisorstodevelopportfolio
allocationsthatmorecloselymatchthefundinginterestrateassumptions.
139
DIFFERENCESBETWEENDBANDDCINVESTMENTOBJECTIVES
Definedbenefitanddefinedcontributionplanshaveinherentlydifferentobjectiveswhen
establishingfundingpoliciesandinvestmentstrategies.
Adefinedbenefitplanpromisesadefinitebenefittoparticipantsatretirementagewiththeplan
sponsorand/ortrusteegenerallyresponsibleforselectingtheinvestments.Theplansponsor
bearstheriskforinvestmentperformanceinadefinedbenefitplan.Thismeansthatifthe
investmentperformancedoesnotmeetexpectationslargercontributionswillberequiredinthe
future,andifinvestmentperformanceexceedsexpectationsthefuturerequiredcontributions
willbelower.Theprimarygoalininvestingfordefinedbenefitassetsistoprovideforthe
benefitsthatareduetoparticipants.Thisisgenerallydonebyinvestinginassetswhosereturns
willmirrortheassumptionsmadeintheplantominimizethefluctuationsinannual
contributionamounts.
Adefinedcontributionplanplacestheresponsibilityfortheinvestmentriskontheplan
participant.Thecontributionsbythesponsordonotchangebasedoninvestmentperformance.
Theplansponsorisresponsibleforprovidinginvestmentoptionsforparticipantsthatshould
enablethemtorealizemeaningfulretirementbenefitsthroughappropriateinvestingfortheir
longtermneeds.Definedcontributionplansareconcernedwithenablingparticipantstomake
informeddecisionsregardingwhichinvestmentrisksareappropriateforthemandtotailor
theirownindividualinvestmentobjectivesaccordingly.
Maximum Deduction Rules

STANDALONEDBPLAN
Ingeneral,theemployermaydeductthegreateroftheamountnecessarytosatisfytheplans
minimumfundingrequirements,orthetotalofthetargetnormalcost,thefundingtarget,and
anadditionalcushionamount(equalto50%ofthefundingtargetplustheincreaseinthe
fundingtargetifassumedincreasesinsalaryweretakenintoaccount)adjustedforatrisk
plans.
Aplanisatriskiftwoconditionsapply:
Theplanassets(generallyreducedbycreditbalances)arelessthan80%oftheplans
fundingtarget,computedusingthegenerallyapplicableactuarialassumptionsas
describedabove;and
Theplanassets(generallyreducedbycreditbalances)arelessthan70%oftheplans
fundingtarget,computedusingatriskactuarialassumptions.
Between2008and2010therewasatransitionrulethataffectedthe80%thresholdabove.This
rulenolongerapplies,butunderthistransitionrule,thetriggerforthefirstconditionwas
phasedinat65%for2008,70%for2009and75%for2010.Itisnowfullyphasedinat80%asof
2011.
140

Notethatplanswithfewerthan500participants,aggregatingallplansoftheemployerandthe
employerscontrolledgroup,arenotsubjecttotheatriskrules.
Intheyearofplantermination,themaximumdeductibleamountisusuallynotlessthanthe
amountneededtomakeplanassetssufficienttofundbenefitliabilitiesasdefinedbythePBGC.
Nondeductibleplancontributionsaresubjecttoanexcisetaxof10%oftheamountof
nondeductiblecontributionsfortheyear.Theamountthatisnondeductibleisleftintheplan
anddeductedinfutureyears,unlesstheemployerobtainsIRSapprovaltoreturnthe
contributiontotheemployerasamistakeoffactcontribution.
DB/DCCOMBINATION
IfanemployersponsorsbothDBandDCplanscoveringatleastonecommonemployee,the
totaldeductionforallplansforaplanyearmaybelimitedunderIRC404(a)(7).Thelimitation
ofIRC404(a)(7)doesnotapplyif:
ThedefinedbenefitplaniscoveredbythePBGC(mostdefinedbenefitplansarecovered
bythePBGC,althoughaplansponsoredbyaprofessionalservicecorporationwhichhas
neverhadmorethan25planparticipantsisexemptfromPBGCcoverage;plans
coveringonlyemployeeswhoownatleast10%oftheemployer(andtheirspouses)are
alsoexempt);or
Theemployercontribution(matchandnonelective)totheDCplandoesnotexceed6%
ofeligibleparticipantscompensationaslimitedbyIRC401(a)(17).
ForplansthatarecoveredunderIRC404(a)(7),thedeductiblelimitforbothplanscombinedis
limitedtothegreaterof:
25%ofcompensationplusupto6%ofsalarytotheDCplan(inotherwords31%if6%is
contributedtotheDCplan);or
TheamountnecessarytomeetDBplansminimumfundingrequirementfortheyear,
plusacontributionof6%ofsalarytotheDCplan.
Ineffect,thedeductiblelimitunderIRC404(a)(7)isequaltothegreaterof31%of
compensation(25%plustheextra6%)orthedefinedbenefitminimum(orunfundedfunding
target,ifgreater)plus6%ofcompensationallocatedtotheDCplan.Notethatelectivedeferrals
undera401(k)planareexcludedfromthelimitationofIRC404(a)(7),sincetheyarealways
deductibleunderIRC404(n).
TheDBplanmaximumisalsosubjecttothemaximumtaxdeductibleamountbasedonthe
rulesforastandaloneDBplan.
EXAMPLE:Theminimumrequiredcontributiontoadefinedbenefitplanis$80,000.The
employercontributiontoadefinedcontributionplanis$50,000.Allemployeesareparticipants
inbothplans,thedefinedbenefitplanisnotcoveredbythePBGC,andtotalcompensationfor
allemployeesis$200,000.
141
Analysis:25%oftotalcompensationis$50,000($200,00025%).ThatistheDCplan
contribution,soIRC404(a)(7)appliessincemorethan6%wascontributedtotheDCplan.
Thegreaterof$50,000(25%ofcompensation)or$80,000(theDBminimumcontribution).In
addition,$12,000(6%ofthe$200,000compensation)oftheDCplancontributioncanbe
deductedforatotalof$92,000.Sincetheemployercontributed$130,000($80,000+$50,000),this
leaves$38,000asanondeductiblecontributiontotheDCplan.Anexcisetaxof$3,800(10%of
thenondeductiblecontribution)wouldapply.
Cash Balance Plans

Acashbalanceplanisanontraditionaldefinedbenefitplanthatprovidesthebenefitprotection
ofadefinedbenefitplanwiththelook,visibilityandappreciationassociatedwithanindividual
accountdefinedcontributionplan.Typicallyonlyemployercontributionsaremadetotheplan.
Acashbalancearrangementisveryflexibletoemployerneeds.
Itcanbeestablishedasanentirelynewplanonafreestandingbasis;
Itcanbeestablishedtoprovidebenefitsincombinationwithadefinedcontribution
plan;
Anexistingdefinedbenefitplancanbecompletelyconvertedintoacashbalance
arrangement.Accruedbenefitsderivedfromtheconvertedplanmustbeatleastasgreat
asaccruedbenefitsthatwouldhavebeenprovidedintheabsenceofthisconversion;or
Acashbalancefeaturecanbeaddedtoanexistingdefinedbenefitplantoactasa
supplementtoexistingpensionplanprovisions.Iftheemployerdesirestoreducecosts,
existingbenefitformulasmaybereducedorfrozenonaprospectivebasis.Ifexisting
formulasarefrozen,thenfutureaccrualsaredeterminedsolelybythecashbalance
feature.
Cashbalanceplansgivegreaterweighttopayrelatedallocationsmadeearlierinanemployees
career,becausethoseallocationsearninterestcreditsformanyyears.Atraditionaldefined
benefitplanbasingretirementbenefitsonaparticipantsfinalaveragepaycalculatesbenefitsin
amannerthatgivesgreatestweighttothemostcostlypayrelatedaccrualswhichoccurlaterin
theemployeescareer.
AllcashbalanceplansaredeemednottoviolatetheagediscriminationrulesofERISA,the
InternalRevenueCode,andtheADEAbutonlyonaprospectivebasis(forperiodsbeginning
afterJune29,2005),providedthepayandinterestcreditsofolderworkersarecomparableto
thoseofsimilarlysituatedyoungerworkersandthattheinterestcrediteddoesnotexceeda
marketrate.
Previouslytherewasaconcernthatsomecashbalanceplandesignsmightbeconsideredto
discriminateagainstolderemployees.Hypotheticalaccountbalancesofolderemployeeshave
lesstimetoaccumulateattheplansspecifiedinterestratetoNRAthandohypotheticalaccount
142

balancesofyoungeremployees,resultinginlargeraccountbalancestoyoungerparticipants
uponreachingretirementage.
CashbalanceplansaresubjecttotheQJSAandQOSArequirements;however,theyoftenallow
unlimitedlumpsumdistributionoptionsforincreasedportability.Thismaycomeatan
increasedcosttotheplan.Whenadefinedbenefitplanpaysonlylumpsumsallparticipants
receivetheirdistributionrightaway.ThelumpsumamountsarebasedonIRSspecifiedinterest
rateandmortalityassumptionsunlesstheplanisanapplicabledefinedbenefitplaninwhich
casethelumpsumamountsareequaltothehypotheticalaccountbalances.Acashbalanceplan
doesnotgenerallyprovideearlyretirementsubsidies.
HOWTHEYWORK
Eachparticipanthasahypotheticalaccountbalance.Bookkeepingentriesreflectingpaycredits
andinterestcreditsaremadeonaperiodicbasis.Interestcreditedisintendedtobecomparable
toactualinterestadjustmentsinadefinedcontributionplan,butisatarate(eitherfixedortied
toanindex)specifiedintheplandocument.
Themethodfordeterminingallocations(paycredits):
Mustbesetforthintheplandocument;
Cannotbesubjecttoemployerdiscretion;and
Mustcomplywithvariousotherstatutoryandregulatoryrequirements,suchas:
o
Planbenefitsaresubjecttoa3yearcliffvesting.
Theplanmaynotcreditinterestataratethatishigherthanamarketrate.
Conversionsfromatraditionaldefinedbenefitplantoacashbalanceplanafter
June29,2005,aremandatedtofollowthesocalledA+Bapproach(thebenefitat
retirementisequaltothesumofthebenefitaccruedunderthedefinedbenefit
planbeforetheamendment(A)andthebenefitaccruedunderthecashbalance
plan(B))andtoprohibitwearawayofearlyandnormalretirementbenefits.
Allowablesafeharbormethodsunderproposedregulationsfordetermininginterestcreditsare:
Therateofinterestonlongterminvestmentgradecorporatebonds[asdescribedinIRC
412(b)(5)(B)(ii)(II)priortoamendmentbyPPAforplanyearsbeginningpriorto
January1,2008,andthethirdsegmentratedescribedinIRC430(h)(2)(C)(iii)for
subsequentplanyears];
Therateofintereston30yearTreasurysecurities[asdescribedinIRC417(e)(3)priorto
amendmentbyPPA];or
Thesumofanyofthestandardindicesandtheassociatedmarginforthatindexas
describedinpartIVofIRSNotice968.
Cashbalanceprogramsmustofferbenefitspayableintheformofanannuityatnormal
retirementage.However,cashbalanceprogramsmayalsooffersinglesumdistributionoptions
143

toterminatingemployees.Generally,thesinglesumpayoutequalsastatedamountinthecash
balanceaccountiftheinterestrateisthesameastheIRC417(e)(3)mandatedinterestrate.
After2007,iftheplanqualifiesasanApplicableDefinedBenefitPlan,thelumpsumcan
equaltheaccountbalanceeventhoughtheinterestratedoesnotequaltheIRC417(e)(3)
mandatedinterestrate.Thischangeeliminatedthepriorissuewherethelumpsumpayable
usingtheIRC417(e)(3)ratewasinexcessofthehypotheticalaccountbalancecreatingfunding
issuesfortheemployer.
Ifacashbalancearrangementisestablishedaspartofanexisting,traditionaldefinedbenefit
plan,thentrustassetsassociatedwithtraditionalandcashbalancefeaturesarecommingledand
usedtofundboththetraditionaldefinedbenefitportionoftheplanandthecashbalance
arrangement.Thiswouldtypicallyhappenifanexistingdefinedbenefitplanisamendedand
theformulaisreplacedbyacashbalanceformula.Eachparticipantwhowasaroundatthetime
oftheconversionwouldreceiveaportionofhisorherbenefitcalculatedundertheoldplan
formulaandanotherportionunderthecashbalanceformula,allpaidfromthesametrust.
EXAMPLE:ABCRubberCompanyhassponsoredatraditionaldefinedbenefitplansince1972.
Theplanformulaprovidedabenefitof1.5%ofpaytimesyearsofservice(limitedto30years).
AsofJanuary1,2008,theplanformulawasamendedtoacashbalanceformulatoprovidean
annualallocationbasedonthefollowingservicetable:
Lessthan10yearsofservice 3.0%ofW2compensation
>=to10years,but<20
>=to20years
5.0%ofW2compensation
4.0%ofW2compensation
Samhasbeenwiththecompanysince1992andisaparticipantintheplan.Hisaccruedbenefit
atthetimeofconversion(tocashbalance)was$750permonth.
SamsdateofbirthisJanuary1,1972.Hisbenefitof$750convertedtoalumpsumasofJanuary
1,2008is$26,348.
His2008W2compensationwas$40,000.HisbenefitstatementasofJanuary1,2009willlook
likethis:
January1,2008cashbalance:$26,348.00
InterestCredit:
1,267.34
[.0481*26,348]
PayCredit:
1,600.00
[.04*40,000]
January1,2009cashbalance $29,215.34
Note:4.81%representsthe3rdsegmentrateunderIRC417(e)(3)(D)asofJanuary1,2008.
144

Asdiscussedabove,employercontributionstoacashbalanceplanarenotnecessarilyequalto
thepaycreditsfortheyearastheycanfluctuatefromyeartoyearbasedonactualinvestment
performance.Theparticipantsareguaranteedarateofreturnontheirhypotheticalcashbalance
accounts.Theplanhasagainifassetsoutperformtheguaranteedrateofreturnandalossifthe
planunderperformstheguaranteedrateofreturn.Inotherwords,theemployeristheone
assumingtheinvestmentrisk.Ifassetsunderperformtheguaranteedrateofreturn,the
employermusteithercontributetheshortfalltotheplanorcontributeapieceoftheshortfall
eachyearandearnbacktheremainderbyinvestingtooutperformtheguaranteedrate.
Effectively,theemployerisinsuringtheassetsoftheplanagainstinvestmentloss.
REQUIREMENTSFORSUCCESSFULIMPLEMENTATIONOFACASHBALANCE
PROGRAM:
Participantsmustberegularlyapprisedoftheirhypotheticalaccountbalances.
Hypotheticalallocationsandinterestcreditsmustbecorrectlyaddedtoparticipants
balances.
Generally,singlesumdistributionsaremadefromtheplantoterminatingparticipants.
Treas.Reg.1.417(e)1(d)imposesmandatedinterestratestobeusedbyalldefined
benefitplanstocalculateminimumsinglesumactuarialpresentvaluesofparticipants
accruedbenefit.Plansponsorsshouldbeawarethatdistributionsthatexceedthe
participantscashbalanceaccountarepossible,thoughPPAincludedlanguageto
addressthisconcernforapplicabledefinedbenefitplansmakingitlesslikelytooccur
inpractice.
AntibackloadingprovisionsoftheInternalRevenueCodearedesignedtolimitthe
extenttowhichplanscanpostponeaccrualstothedetrimentofshortserviceemployees.
Becauseofthelongerinterestcreditingperiodonearlieraccruals,manycashbalance
plandesignsactuallyfurnishmoregenerousaccrualsforearlieryearsofservice,andso
wouldappeartosatisfyantibackloadingprovisions.However,antibackloading
requirementsshouldbeconsideredwhendesigningthecashbalancefeature.
EXAMPLE:Abackloadedformula(i.e.onetobeavoided)isasfollows:
AcashbalanceformulaforaplanthatwassetuponJanuary1,2008provides:
6%ofpayperyearofserviceforservicebeforeJanuary1,2008
4%ofpayperyearofserviceforserviceafterJanuary1,2008.
BenefitspayablefromacashbalanceplanarelimitedbyIRC415(b)undertherulesfor
definedbenefitplans.
Adefinedbenefitplancannotbeamendediftheresultisasignificantreductioninthe
rateoffuturebenefitaccrualsunlesstheplanadministratorprovideswrittennoticeof
theplanamendmenttoeachplanparticipant.Inaconversionofalloraportionofthe
conventionaldefinedbenefitplanintoacashbalanceplan,theremaybeasignificant
reductioninrateoffuturebenefitaccrual.IftheemployerconcludesthatanERISA
145

204(h)noticeisrequired,thentheemployermustdecidewhetherthecompleteplan
textpertainingtothecashbalancefeatureshouldbesenttoeachparticipant.
APPLICABLEDEFINEDBENEFITPLANS
Plansmeetingtherequirementsforanapplicabledefinedbenefitplanwillavoidthestatutory
andregulatoryuncertaintiesrelatedmostlytohybridplans(thatis,lackofregulation).The
requirementstobemetinclude:
Theinterestcreditmustnotresultinthelossofprincipal[IRC411(b)(5)(B)(i)(II)].An
interestcredit(oranequivalentamount)oflessthanzeroshallinnoeventresultinthe
accountbalanceorsimilaramountbeinglessthantheaggregateamountof
contributionscreditedtotheaccount.
Participantsmustbe100percentvestedafter3yearsofservice[IRC411(b)(13)(B)].The
vestedpercentageapplicabletoaparticipantwhoterminatesemploymentduringthe
firsttwoyearsofservicecanbelessthan100%.
Theaccruedbenefitofanolderparticipantmustbeequaltoorgreaterthanthatofa
youngerparticipantthatissimilarlysituated.
o
Similarlysituatedidenticalineveryrespect(i.e.,service,compensation,
position,dateofhire,workhistory,etc.)
Aparticipantsaccruedbenefitmustbemeasuredasanannuitypayableat
normalretirement,anaccountbalance,orasthecurrentvalueofanaccumulated
percentageoffinalaveragecompensation.
CASHBALANCEPLANCOMPAREDTOTRADITIONALDBPLAN
Acashbalanceprogramderivestheamountofaparticipantsannuityatnormalretirementage
(NRA)fromtheparticipantshypotheticalaccountbalance,ratherthanfromtheparticipants
finalaveragepay.
Cashbalanceplanprovisionsprescribefactorsforconvertingaparticipantscurrent
hypotheticalaccountbalanceintoanannuitypayableattheparticipantsNRA.Theannuity
derivedfromtheparticipantshypotheticalaccountbalanceprojectedtoNRAisdefinedasthe
participantsaccruedbenefit.However,thelumpsumoptionpayableatterminationisthe
hypotheticalaccountbalance.
Thereisnodirectconnectionbetweenthehypotheticalratescreditedtoparticipantaccounts
andratesofreturnearnedonassetsheldinthetrust.However,theinvestmentsforacash
balanceplanareofteninvestedtoachievereturnsascloseaspossibletotheratecredited.In
bothcashbalanceandtraditionaldefinedbenefitplans,theemployerbearstheinvestmentrisk.
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Acashbalanceplancannotcurrentlybewrittenonapreapproveddocumentsuchasa
master/prototypeorvolumesubmitter.Allcashbalanceplansareindividuallydesigned.
CASHBALANCEPLANCOMPAREDTODCPLAN
Acashbalancearrangementprovidesamoresecurebenefitspromisetoemployeesbecauseit
providesaguaranteedinterestcredit.Additionally,theparticipantsaccountinanapplicable
definedbenefitplancannotfallbelowthesumofthecontributionsmadeforthatparticipant.
Theamountofbenefitreceivedbyparticipantsunderacashbalancearrangementisbased
entirelyonthetermsoftheplandocument,andisindependentoftheperformanceofthe
underlyingplanassets.Cashbalanceinterestcreditscanbedesignedtovaryaccordingto
independentinterestindicesorcostoflivingindices.
CashbalancebenefitsaregenerallyinsuredbythePBGCbecausetheyaredefinedbenefitplans.
Cashbalanceplancontributionscanbesubstantiallyhigherthandefinedcontributionplan
contributionsascashbalanceplansaresubjecttoIRC415(b)ratherthanIRC415(c).
Other Plan Types

FLOOROFFSETPLANS
Aflooroffsetplanisanontraditionaldefinedbenefit(DB)planusingemployerprovided
benefitsfromaseparatelymaintaineddefinedcontribution(DC)plantomeetsomeofits
benefitobligations.TheseplansaresubjecttospecialnondiscriminationrulesunderIRC
401(a)(4).
TheDCplanbalance(whichoffsetstheDBplansaccruedbenefit)mustbederivedentirely
fromemployercontributionsandmustbeconvertedtoanannuityaccordingtoassumptions
whicharecontrolledbytheregulationsandspecifiedintheplandocument.Theoffsetneednot
bebasedontheentireDCaccountbalancebutmayinvokeonlyaspecifiedpart.Forexample,
theoffsetmaybebasedontheprofitsharingaccountbalance,butignorethe401(k)and
matchingbalancesina401(k)plan.PriordistributionsfromtheDCaccountmustbeconsidered
aspartoftheDCaccountbalance.
TheDBandDCplansparticipatinginaflooroffsetarrangementmustbesponsoredbythe
sameemployer,coverthesameemployeesandtheoffsetmustbeappliedtoallemployeesina
consistentmanner.TheDBplancannotbeacontributoryplan(havemandatoryemployee
contributions).TheDCplanmustofferallemployeesthesameinvestmentoptionsandthe
sameoptionsofpreretirementwithdrawalastheDBplan.
ForpurposesofnondiscriminationtestingunderIRC401(a)(4),theflooroffsetplanmust
satisfyoneofthefollowingtworequirements:
TheDBplan,onagrossbenefitbasis(beforeoffset),mustsatisfytheunitcreditplansafe
harborforDBplansunderIRC401(a)(4),includingtheuniformityrequirementforsafe
147

harboraccess,andtheDCplanmustindependentlybenondiscriminatoryinamount
(eitherthroughasafeharborformulafordefinedcontributionplansunderIRS
regulation1.401(a)(4)2(b)orbysatisfyingthegeneraltestfordefinedcontributionplans
underIRSregulation1.401(a)(4)2(c));or
TheDCplanmustsatisfyauniformallocationsafeharborforDCplansunderIRS
regulation1.401(a)(4)2(b)(2),andtheDBplanmustonagrossbenefitbasis(thebenefit
priortooffsetbytheDCplanbenefit)beprovennondiscriminatorybyamount
accordingtoanysafeharborformulafordefinedbenefitplansunderIRSregulation
1.401(a)(4)3(b)(2)orbysatisfyingthegeneraltestfordefinedbenefitplansunderIRS
regulation1.401(a)(4)2(c).
Theobjectiveofcombiningthesedisparateplansistoassureaminimumlevelofbenefitstoall
employees(ataminimum,allparticipantswillreceivethebenefitpromisedunderthedefined
benefitplan).Fortheplansponsor,aflooroffsetplanprovidesthebestofbothworlds:
guaranteeingaminimumbenefitforolderemployees(thoseclosetoretirement)andproviding
moremeaningfulbenefitsforyoungeremployeeswhoaremanyyearsawayfromretirement.
Keepinmindthatthedefinedbenefitplanismorebeneficialtoolderemployees,andthe
definedcontributionplanismorebeneficialtoyoungeremployees.Theyoungeremployeeswill
oftenreceivenobenefitfromthedefinedbenefitplaninaflooroffsetsituation,asthe
accumulatedvalueoftheirDCaccountbalancewillmorethanoffsetthebenefitprovidedby
theDBplan.
EXAMPLE:TCFFloorCovering,Inc.sponsorsaflooroffsetplan.Theplanprovidesaminimum
benefitinthedefinedbenefitplanof1.25%ofaveragesalaryperyearofservice,uptoa
maximumof30years.Thebenefitinthedefinedbenefitplanisoffsetbythebenefitequivalent
tothevestedaccountbalanceinaprofitsharingplan.Actuarialequivalenceisdetermined
usinganinterestrateof8%andthe94GARmortalitytablewithanannuitypurchaserateatage
65of112.25.
JaneparticipatesintheTCFFloorCovering,Inc.definedbenefitandprofitsharingplans,and
leavesthecompanyatage45whensheis40%vestedinthedefinedbenefitplanand60%
vestedintheprofitsharingplan.Heraccruedbenefitinthedefinedbenefitplanis$900per
monthandshehasanaccountbalanceof$30,000intheprofitsharingplan.
Janesbenefitiscalculatedasfollows:
VestedaccruedbenefitundertheDBplan:$900x40%=$360permonth.
VestedaccountbalanceundertheDCplan:$30,000x60%=$18,000.
AccumulationofvestedDCbalancetoage65:$18,000x1.0820=$83,897.
Conversiontomonthlyannuity:$83,897/112.25=$747.(Basedonthe94GARMortalityTable
and8%interest).
148
SincetheDCbenefit($747permonth)isgreaterthantheDBbenefit($360permonth),Janes
benefitundertheflooroffsetarrangementwillsimplybeherDCvestedaccountbalanceof
$18,000.
JimalsoparticipatesintheTCFFloorCovering,Inc.definedbenefitandprofitsharingplans,
andleavesthecompanyatage60whenheis100%vestedinthedefinedbenefitplanand100%
vestedintheprofitsharingplan.Hisaccruedbenefitinthedefinedbenefitplanis$2,000per
monthandhehasanaccountbalanceof$90,000intheprofitsharingplan.
Jimsbenefitiscalculatedasfollows:
AccumulationofvestedDCbalancetoage65:$90,000x1.085=$132,240.
Conversiontomonthlyannuity:$132,240/112.25=$1,178.(Basedonthe94GARMortality
Tableand8%interest).
DBoffsetbenefit=$2,000$1,178=$822permonth
SincetheDBbenefitisgreaterthantheDCbenefit,Jimsbenefitundertheflooroffset
arrangementwillbehisDCaccountbalanceof$90,000,plushisDBoffsetbenefitof$822per
month,payablebeginningatage65.
FULLYINSUREDPLANSUNDERIRC412(E)(3)FORMERLYIRC412(I)
AnIRC412(e)(3)planprovidesthesametypeofbenefitasatraditionaldefinedbenefitplan.
However,fundingvehiclesarelimitedtoinsuranceproducts,andfundingrequirementsare
determinedbytheinsurancecompany(theinsurancepremiumistherequiredcontribution).
IftherequirementsofIRC412(e)(3)aremet,theplanisexemptfromtheminimumfunding
rulesofIRC412thatapplytotraditionaldefinedbenefitplans.TheIRC412(e)(3)
requirementsinclude:
Planmustbefundedsolelybyindividualorgroupinsurancecontractsthatarepartof
thesameseries(thiscanbeannuityand/orlifeinsurancecontracts);
Contractsmustfundbenefitsusinglevelpremiumsforallbenefits;
Planbenefitsmustbeprovidedonlybythesecontractsandbeguaranteedbyan
insurancecompany;and
Participantsmaynottakeloans.
ThebiggestdifferencebetweenatraditionaldefinedbenefitplanandanIRC412(e)(3)planis
methodoffunding.Thepremiumspaidtoaninsurancecompanytofundplanbenefitsare
basedsolelyoncontractguarantees.Excessinterestordividendpaymentswilllowerfuture
premiums.
AnIRC412(e)(3)planmustcomplywiththecoverageandparticipationrulesofIRC410(b)
and401(a)(26)aswellasthemaximumbenefitrequirementsofIRC415.Also,anIRC
412(e)(3)planmustmeettheincidentaldeathbenefitrulesofRevenueRuling74307.
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During2004,theIRSissuedguidancerelatingtoIRC412(e)(3)plans.IRSregulationsstatethat
thefairmarketvalueshouldbeusedtodeterminetheamounttobeincludedasincomewhena
distributionofpropertyismadefromanIRC412(e)(3)plan.Thisisintendedtodiscourage
dispositionofthecontractswhenthecashsurrendervaluedoesnotreflectthecurrentfair
marketvalueofcontract.
TheIRSidentifiedpotentiallydiscriminatoryfeaturesinIRC412(e)(3)plans.Ifpolicieswith
temporarilydepressedcashvaluesareonlyavailabletoHCEs,theplanmaybeinviolationof
IRC401(a)(4).IRC412(e)(3)planscannotusedifferencesinlifeinsurancecontracts(i.e.,whole
lifevs.termlife)todiscriminateinfavorofHCEs.Beware,ifIRC412(e)(3)plansarenotdone
correctly,theycanbedeemedabusivetaxpracticessubjecttosubstantialpenaltiesbytheIRS.
PBGC Coverage
WHICHPLANSARECOVERED
ThePensionBenefitGuarantyCorporation(PBGC)wascreatedtoprovideaninsurance
programtosafeguardbenefitsundercovereddefinedbenefitplansmaintainedbyprivate
employersintheeventofbankruptcy.
Plansmaintainedbyaprofessionalserviceemployerthathaveneverhadmorethan25
participantsandplanscoveringonlysubstantialowners(individualswhoownmorethan10%
ofacompany)areexemptfromPBGCcoverage.
EXAMPLE:Alawfirm(whichisaprofessionalserviceemployer)establishesadefinedbenefit
planon1/1/2004,covering15participants.In2007,thenumberofactiveparticipantsrisesto28.
On1/1/2009,thenumberofparticipantsdecreasesto22.Thedefinedbenefitplanisexempt
fromcoveragebythePBGCfrom2004through2006.In2007,theplanbecomescoveredbythe
PBGC.Thiscoveragecontinuesin2009eventhoughthenumberofparticipantsnolonger
exceeds25becauseoncetheplaneverexceeds25participants,itcanneveragainbeexempt
fromPBGCcoverageonaccountoftheprofessionalservicecorporationexemption.
EXAMPLE:Adefinedbenefitplancoversonlythe100%owneroftheemployerandthatowners
spouse.Sincetheonlyplanparticipantsaresubstantialowners,theplanisexemptfromPBGC
coverage.
PREMIUMS
Allsingleemployerplansarerequiredtopayaflatperparticipantpremiumof$35for2012(as
adjustedforinflation)plusavariableratepremiumbasedontheplansfundedstatus.The
variableratepremiumis$9(notsubjecttoinflationadjustments)per$1,000ofunfundedvested
benefits.FullyinsuredplansunderIRC412(e)(3)andplansinwhichnoparticipantshave
vestedbenefitsareexemptfromthevariableratepremium.
150

Thereisa$1,250perparticipantperyearterminationpremiumforthreeyears(notsubjectto
inflationadjustment).Thisterminationpremiumgenerallyappliesifanemployerterminatesan
underfundedplaninadistressorinvoluntaryterminationandcontinuesinbusiness.This
additionalpremiumdoesnotapplytoanemployerwithaplanthatisfullyfundedand
terminatesinastandardtermination.
TERMINATIONOFAPBGCCOVEREDPLAN
AsingleemployerplansubjecttoPBGCcoveragemayonlyvoluntarilyterminateasastandard
terminationoradistresstermination.
Astandardterminationispermittedonlyifplanassetsaresufficienttocoverbenefitliabilities.
Benefitliabilitiesequalallbenefitsearnedbyparticipantsthroughtheterminationdate,
includingvestedandnonvestedbenefits.Benefitliabilitiesincludeearlyretirementsubsidies
andcertaincontingentbenefits.Aplanwithassetsinsufficienttocoverthebenefitliabilities
maybefullyfundedthroughacontributionfromtheemployerinordertoqualifyasastandard
terminationunlessthereisawaiverofbenefitsfromoneormoremajorityowners.This
contributiontofullyfundtheplanwouldbedeductibleunderIRC404aslongasitis
contributedfortheyearofterminationandinnocaselaterthanthedateoffinaldistributionof
planassets.
EXAMPLE:Afertilizercompanyestablishedadefinedbenefitplanin2004andnowwishesto
terminatetheplan.ThecompanyisownedbyJohn(50%owner)andhiswifeKim(50%owner).
Theyhave3employees.TheplanisPBGCcoveredasfertilizershippingisnotaprofessional
servicecorporationandtheplancoversemployeeswhoarenotowners.Theactuarycalculates
thepresentvalueofaccruedbenefits(PVAB)ontheplanterminationdatetobeasfollows:
PVAB
John
$500,000
Kim
$300,000
Employee1
$55,000
Employee2
$25,000
Employee3
$20,000
Total
$900,000
Thevalueofplanassetsontheplanterminationdateis$750,000.Theplanisshort$150,000if
everyoneistobepaidtheirfullbenefitsandtheplanistoterminateinaPBGCstandard
termination.Theemployerhasthreeoptions:
Contribute$150,000totheplaninordertobringtheplanassetsupto$900,000sothatthe
plansassetsequalthelumpsumdistributionsthatwillneedtobemade;or
151
HaveeitherJohnorKimwaive$150,000oftheirbenefits.Sincebothownatleast50%ofthe
company,eithercansignamajorityownerwaiver.Oncethemajorityownerwavieris
signed,theplancanbesaidtohaveaPVABofonly$750,000whichequalstheplansassets.
Anycombinationof1or2.Forexample,$100,000couldbecontributedtotheplan,and
eitherJohnorKimcouldwaive$50,000oftheirbenefits,bringingboththeassetvalueand
theremainingPVABto$850,000.
Distressterminationsoccurwhenassetsarenotsufficienttocoverbenefitliabilities,andoneof
thefollowingfourcriteriaismet:
Allmembersofthecontributingsponsorscontrolledgrouparebeingliquidatedin
bankruptcyorinsolvencyproceedings;
Allmembersofthecontributingsponsorscontrolledgrouparebeingreorganizedin
bankruptcyorsimilarproceedings;
ThePBGCdeterminestheplanterminationisnecessarytoallowtheemployertopay
otherdebtswhileremaininginbusiness;or
Theemployerhasexperiencedadeclineintheworkforceresultinginunreasonably
burdensomepensioncosts.ThePBGCcandeterminethattheplanterminationisneeded
toavoidthesepensioncosts.
Aplancanalsobeinvoluntarilyterminatedbycourtorder.ThePBGCcaninstitutecourt
proceedingsiftheplanhasnotmetminimumfundingstandards,willbeunabletopaybenefits
whendue,hasamajorityownerwhohasreceivedadistributiongreaterthan$10,000whilethe
planhasunfundednonforfeitablebenefits,ormayreasonablybeexpectedtoincreasethe
PBGCslongtermlossunreasonably.
Onplantermination,planassetsareallocatedbasedonsixprioritycategoriesprescribedby
ERISA4044(a).Onceallbenefitsinaparticularcategoryaresatisfied,planassetsarethen
allocatedtothenextlowerprioritycategoryandtheprocesscontinuesuntilallassetsare
allocatedorallliabilitiesaresatisfied.
Whenaplanterminatesinadistressorinvoluntaryterminationandtheassetsareinsufficient
topayguaranteedbenefits,theplangoesintoPBGCreceivershipandthePBGCbecomes
responsibleforplan.NotethatnotallbenefitsareguaranteedbythePBGC.
Followingadistressorinvoluntarytermination,allmembersofthecontributingsponsors
controlledgrouparejointlyandseverallyliabletothePBGCfortheexcessofthevalueofplans
liabilitiesasofthedateofterminationoverthefairmarketvalueoftheplansassetsonthedate
oftermination.
152
CPC Study Guide:

DevelopingtheRightContributionAfterPPA
TomFinnegan,MSPA,CPC,QPA
2008AdvancedActuarialConference,June1011,2008
153
154
Developing The Right

Contribution After PPA
Sessions 3 and 10
Tom Finnegan
The Savitz Organization
Philadelphia / Atlanta / Boston
Contents
PPA Rules
Minimum is too low
Maximum is too high
Funding Policy Contribution is Just Right
Funding Policy
What is it
Level Funding
Frontloading deductions
Partnerships
Prefund 415 / 401(a)(17) Increases
155
PPA Rules
PPA allows a single funding method (unit credit) for

minimum funding
Requires use of yield curve for valuing benefits
Minimum contribution is unit credit normal cost plus 7
year amortization of unfunded liability
Max deduction is essentially the amount necessary to
bring the plan to 150% funded
Net result is lower minimums and higher maximums
than under old law
Minimum is too low
156
Under old law the PPA funding method would have

been deemed unreasonable for final average pay
plans
Fails to recognize the effect of future pay
increases
Particularly inappropriate for small plans since it
amortizes gains and losses over 7 years, could cause
underfunding at termination
Assuming no pay or limit increases contribution will
grow at preretirement interest rate, with increases, it
will grow much more quickly
Example
Consider a small plan that provides a traditional

benefit of 8.25% for each year of participation with a
minimum benefit of 8.25% of pay
NRA = 62
Plan Act. Equivalence PPA mortality 6%
Yield Curve Rates
5.31%
5.90%
6.41%
Salary Scale- 5% (Rounded to $1000)
Assumed benefit form-Lump Sum
Actual return 6%
Example
Example assumes that there are no

significant gains or losses
Significant losses in the year before

retirement could leave the plan with a 7
year funding on a benefit payable
immediately
157
Census
2005
2006
2007
2008
2008
Pay
Pay
Pay
Age
Pay
Owner
210000
220000
225000
52
230000
Staff 1
35000
37000
39000
43
41000
Staff 2
33000
35000
36000
35
38000
Staff 3
33000
35000
36000
28
37000
Staff 4
30000
32000
33000
26
34000
Staff 5
27000
29000
30000
22
31000
Limits
158
Year
415 Limit
401(a)(17) Limit
2008
185000
230000
2009
190000
235000
2010
195000
245000
2011
200000
250000
2012
205000
255000
2013
210000
260000
2014
215000
270000
2015
220000
275000
2016
225000
280000
2017
230000
285000
Contribute PPA Minimum

Year
Minimum
Maximum
Funding
Percent
Policy
Increase
2008
$29,270
$223,208
$29,270
2009
$192,325
$376,063
$192,325
657%
2010
$214,977
$474,195
$214,977
112%
2011
$239,014
$590,056
$239,014
111%
2012
$264,949
$725,870
$264,949
111%
2013
$285,991
$876,981
$285,991
108%
2014
$332,215
$1,107,229
$332,215
116%
2015
$338,894
$1,304,679
$338,894
102%
2016
$376,013
$1,574,977
$376,013
111%
2017
$385,694
$1,832,397
$385,694
103%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,492,297
Maximum is too high
PPA allows an employer to essentially fund to

150% of PVAB
If you communicate the maximum deduction to a

small employer, you run the risk of gross
overfunding
159
Maximum is too high
Technical corrections would provide that the

deduction limit is 150% of Funding Target plus 150%
of Target Normal Cost
IRS has issued no guidance on deduction limits
Several Issues outstanding
Plans with under 100 lives cannot include the
effect of amendments for HCEs in the last two
years for purposes of the 50% funding cushion
Maximum is too high
160
Several Issues outstanding

PBGC covered plans can include the impact of
anticipated COLAs to 401(a)(17) and perhaps
415 in determining cushion
IRS has traditionally considered 401(a)(17) and
415 COLAs to be plan amendments
What does a PBGC covered plan under 100
lives consider for the funding cushion?
Contribute PPA Maximum

Funding
Percent
Year
Minimum
Maximum
Policy
Increase
2008
$29,270
$223,208
$223,208
2009
$0
$170,490
$170,490
76%
2010
$31,910
$279,433
$279,433
164%
2011
$0
$315,284
$315,284
113%
2012
$0
$353,765
$353,765
112%
2013
$0
$388,405
$388,405
110%
2014
$0
$480,779
$480,779
124%
2015
$0
$483,165
$483,165
100%
2016
$0
$551,244
$551,244
114%
2017
$0
$561,495
$561,495
102%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$5,025,803
Funding Policy is Just Right
Prior to PPA, actuaries had discretion in choosing the

assumptions to value benefits as well as the overall
funding method
Small plan methods assured that the plan was
adequately funded when the principal(s) reached
retirement age
404 limited deductions for benefits to 100% of the
415 limit (rather than 150%)
The FFL prevented plans from funding in excess of
the PVFB
161
In many cases, the actuarys choice of funding

method and assumptions set the contribution
levels
since under most methods the min and max
were the same
Under PPA virtually all discretion is removed in
412 and 404
The pure min and max valuation becomes a
commodity
162
By removing discretion and judgment from the

min/max valuation process, PPA has paved the
way for a sea change in small plan industry
Greater uniformity leads to greater opportunity
for standardization
Standardization leads to institutionalization
The institutional providers will gain greater
market share and reduce prices
How does the traditional small plan provider (i.e.

TPA) compete?
Adding Value
Plan Design and testing
Customer Service
Consulting
Consulting
Consulting
Beginning in 2008, consulting is all about the
funding policy
What is a funding policy
A funding policy is simply an orderly, rational

means of paying for the plans promised benefits
It is the plans funding method for determining the
actual contribution
As opposed to the required methods for determining the

minimum and maximum
It will not be the same for all plan sponsors

Every year you need to discuss sponsors needs
goals and circumstances
163
Sponsors needs/goals/circumstances
Cash flow available for plan contributions

Consistency of cash flow
How much can you afford?
Can you afford it consistently?
Can you afford it if it increases 6% per year?
Can you afford it if it increase 12% per year?
164
Expected actual retirement age for principal

If partnership, expectations upon dissolution of plan or
partnership
Likelihood of business sale
What is the likelihood of an early termination of the
plan?
What if the plan is over/underfunded at the early
termination?
If more than one principal, how would funding
inequities be dealt with at early termination?
Likelihood of business expansion

Expected staff turnover
You currently have 6 employees, is that expected to
remain somewhat constant?
If it is to remain constant, will it be these six (i.e. are
these career positions or high turnover jobs)?
If you are expecting growth, do you have any
expectation as to size /makeup of your employees in 5
years ? 10 years?
Statutory / Regulatory restrictions
430 and 404
PBGC Coverage
Funding policy should be limited by these

Likelihood of future PBGC coverage
Impacts deduction rules
Impacts cost of maintaining plan with unfunded
liabilities
Excise tax on reversions
Must be considered when prefunding accruals
165
Level Funding
Some actuaries are planning to continue to fund

based on Individual Aggregate using the same
assumptions they were already using
Expectation is that the IA normal cost will be greater

than the minimum and less than the maximum
contribution
Level funding is a misnomer, because increases in 415
and 401(a)(17) limits are funded over a shorter and
shorter period each year
Actually an increasing contribution but not at as
high a rate as the PPA cost
Level Funding
166
In early years, will work as anticipated. However, if

plan provides staff accruals over an accelerated period,
such as top heavy or other unit accruals, 430 cost will
overtake Indiv Aggregate cost
This is because staff benefits are earned over a short
period under the plan formula but funded over entire
career in Individual aggregate
If staff turnover is high, may be an adequate solution,
but is hopelessly inadequate for career employees
Census
2005
2006
2007
2008
2008
Pay
Pay
Pay
Age
Pay
Owner
210000
220000
225000
52
230000
Staff 1
35000
37000
39000
43
41000
Staff 2
33000
35000
36000
35
38000
Staff 3
33000
35000
36000
28
37000
Staff 4
30000
32000
33000
26
34000
Staff 5
27000
29000
30000
22
31000
Limits
415
401(a)(17)
Year
Limit
Limit
2008
185000
230000
2009
190000
235000
2010
195000
245000
2011
200000
250000
2012
205000
255000
2013
210000
260000
2014
215000
270000
2015
220000
275000
2016
225000
280000
2017
230000
285000
167
Fund Indiv Aggregate Cost

Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$167,508
2009
$45,793
$229,532
$174,116
104%
2010
$78,955
$338,173
$181,521
104%
2011
$130,293
$481,335
$189,854
105%
2012
$201,814
$662,735
$199,715
105%
2013
$288,216
$879,206
$211,668
106%
2014
$413,356
$1,188,370
$226,682
107%
2015
$536,769
$1,502,554
$246,675
109%
2016
$683,512
$1,882,476
$276,390
112%
2017
$817,243
$2,263,946
$334,674
121%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$2,980,774
Greater of IA and PPA Costs
168
Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$167,508
2009
$45,793
$229,532
$174,116
104%
2010
$78,955
$338,173
$181,521
104%
2011
$130,293
$481,335
$189,854
105%
2012
$201,814
$662,735
$201,814
106%
2013
$285,991
$876,981
$285,991
142%
2014
$332,215
$1,107,229
$332,215
116%
2015
$338,894
$1,304,679
$338,894
102%
2016
$376,013
$1,574,977
$376,013
111%
2017
$385,694
$1,832,397
$385,694
103%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,492,297
Front load contributions
If employer has short earnings horizon, or unsure

earnings beyond a few years, may want to take
advantage of PPA deduction limits
Careful for plans with chance of early termination due
to assets in excess of PV of 415 limit, excise tax
problems
Funding Policy should limit deduction to the amount
necessary to bring plan assets equal to the total PVFB
Depending on plan design, may want funding
policy to fund PVFB for staff only with respect to
the benefit they are expected to have accrued by
owners NRA
Census
2005
2006
2007
2008
2008
Pay
Pay
Pay
Age
Pay
Owner
210000
220000
225000
52
230000
Staff 1
35000
37000
39000
43
41000
Staff 2
33000
35000
36000
35
38000
Staff 3
33000
35000
36000
28
37000
Staff 4
30000
32000
33000
26
34000
Staff 5
27000
29000
30000
22
31000
169
Limits
415
401(a)(17)
Year
Limit
Limit
2008
185000
230000
2009
190000
235000
2010
195000
245000
2011
200000
250000
2012
205000
255000
2013
210000
260000
2014
215000
270000
2015
220000
275000
2016
225000
280000
2017
230000
285000
Contribute PPA Maximum
170
Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$223,208
2009
$0
$170,490
$170,490
76%
2010
$31,910
$279,433
$279,433
164%
2011
$0
$315,284
$315,284
113%
2012
$0
$353,765
$353,765
112%
2013
$0
$388,405
$388,405
110%
2014
$0
$480,779
$480,779
124%
2015
$0
$483,165
$483,165
100%
2016
$0
$551,244
$551,244
114%
2017
$0
$561,495
$561,495
102%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$5,025,803
Lesser PPA Max or PVFB (No Scales)

Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$223,208
2009
$0
$170,490
$170,490
76%
2010
$31,910
$279,433
$279,433
164%
2011
$0
$315,284
$315,284
113%
2012
$0
$353,765
$353,765
112%
2013
$0
$388,405
$388,405
110%
2014
$0
$480,779
$474,062
122%
2015
$0
$490,285
$74,520
16%
2016
$0
$991,955
$78,992
106%
2017
$0
$1,529,236
$83,731
106%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,493,567
Lesser PPA Max or PVFB (with Scales)

Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$223,208
2009
$0
$170,490
$170,490
76%
2010
$31,910
$279,433
$279,433
164%
2011
$0
$315,284
$315,284
113%
2012
$0
$353,765
$353,765
112%
2013
$0
$388,405
$388,405
110%
2014
$0
$480,779
$474,062
122%
2015
$0
$490,285
$223,600
47%
2016
$0
$833,931
$0
0%
2017
$0
$1,445,461
$0
0%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,493,614
171
Partnerships/Professional Groups
QUESTION
What do the following types of plans for
partnerships have in common?
Traditional DB plans
Cash Balance Plans
Pension Equity Plans
Floor Offset Plans
ANSWER
172
THE PARTNERS BELIEVE THAT THEY ARE

DEFINED CONTRIBUTION PLANS
I should get out what I put in. plus interest
The problem is that what they want never happens

My kids have that same problem
Cash balance plans cant do it because of funding

whipsaw
Variable Annuity/Indexed plans claim to be able to do
it, but it is not clear how they meet 411(b) / 401(a)(4)
/ 417(e), while doing it
And they appear, post PPA, to be subject to funding

whipsaw
PPA funding rules appear to provide enough leeway in

funding assumptions such that you can get close
Proposed funding regs and the PPA statute provide

sufficient guidance
Statute provides that the deductible contribution is
never less than unfunded at-risk liability plus at-risk
normal cost for the year
At risk liability is calculated by assuming that
everyone who will be eligible to retire in the next ten
years
actually retires at their earliest retirement date
Elects to receive their benefit in the MV form
Anyone who can terminate and take a distribution is
deemed to be eligible to retire...
173
Proposed Regs provide that for funding lump sums you

may assume the 417(e) mortality table and the funding
yield curve, or if greater, the plan factor lump sum at
expected payment date discounted using the yield curve
Combined, these rules allow a deduction equal to
unfunded end of year lump sums.
Thus, each partner fully and precisely funds his/her
benefit once a year
174
In a BOY val, difference between discount rate (1st

segment) and actuarial equivalence rate and actual
return will cause a mismatch
Contribution generally tracks the PPA target normal cost
(i.e increases 11-15% per year)
Cost more stable than PPA min if lump sums are based
on plan rates
No interest rate fluctuation in funding policy
valuation
Policy does not maximize deductions,
Sacrifices front loading of deductions in favor of
matching benefit accrual to contributions
Avoids nightmare of dividing excess assets or shortfall
among partners
Fund PVAB
Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$149,463
2009
$64,921
$248,659
$170,981
114%
2010
$102,553
$361,771
$191,455
112%
2011
$144,777
$495,819
$214,634
112%
2012
$190,901
$651,822
$240,026
112%
2013
$233,919
$824,909
$267,692
112%
2014
$296,416
$1,071,429
$297,814
111%
2015
$337,412
$1,303,197
$337,412
113%
2016
$376,013
$1,574,977
$376,013
111%
2017
$385,694
$1,832,397
$386,891
103%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,493,567
175
Pre-Fund 415 / 401(a)(17) Increases
As mentioned earlier, plans over 100 lives covered by

the PBGC can recognize anticipated 415 and
401(a)(17) increases in the funding cushion
Plans under 100 lives and covered by the PBGC may
be able to recognize future increases
IRS is currently working on 404(o) guidance
Plans not covered by the PBGC cannot recognize

future increase as part of the cushion
Technical corrections would add 50% of the TNC to
the funding cushion
Pre-Fund 415 / 401(a)(17) Increases
Regardless of whether future increases can be

recognized in the determination of the funding
cushion, future increases can be recognized in the
funding policy
However, all good funding policies insure that
deductions do not exceed the 404 maximum
176
In plans that cannot recognize the increases, funding

policy may have to be adjusted, especially in early
years
Funding policies that front load deductions are
especially limited
Census
2005
2006
2007
2008
2008
Pay
Pay
Pay
Age
Pay
Owner
210000
220000
225000
52
230000
Staff 1
35000
37000
39000
43
41000
Staff 2
33000
35000
36000
35
38000
Staff 3
33000
35000
36000
28
37000
Staff 4
30000
32000
33000
26
34000
Staff 5
27000
29000
30000
22
31000
Limits
415
401(a)(17)
Year
Limit
Limit
2008
185000
230000
2009
190000
235000
2010
195000
245000
2011
200000
250000
2012
205000
255000
2013
210000
260000
2014
215000
270000
2015
220000
275000
2016
225000
280000
2017
230000
285000
177
Flat Dollar FundingNonPBGC Covered- No Tech Correction

Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$223,208
2009
$0
$170,490
$170,490
76%
2010
$31,910
$279,433
$267,000
157%
2011
$0
$328,463
$267,000
100%
2012
$0
$418,916
$267,000
100%
2013
$0
$549,436
$267,000
100%
2014
$39,580
$780,162
$267,000
100%
2015
$72,445
$1,027,116
$267,000
100%
2016
$162,912
$1,356,967
$267,000
100%
2017
$264,806
$1,716,860
$267,000
100%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,488,951
Flat Dollar FundingNonPBGC Covered- With Tech Correction
178
Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$225,677
2009
$0
$251,858
$251,858
112%
2010
$0
$190,407
$254,000
101%
2011
$0
$247,876
$254,000
100%
2012
$0
$347,274
$254,000
100%
2013
$0
$487,276
$254,000
100%
2014
$0
$728,051
$254,000
100%
2015
$30,988
$985,659
$254,000
100%
2016
$123,547
$1,326,803
$254,000
100%
2017
$246,612
$1,698,666
$254,000
100%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,494,457
Flat Dollar FundingPBGC Covered- With Tech Correction

Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$280,571
$249,000
2009
$0
$331,303
$249,000
100%
2010
$0
$407,254
$249,000
100%
2011
$0
$512,335
$249,000
100%
2012
$0
$648,386
$249,000
100%
2013
$0
$806,871
$249,000
100%
2014
$0
$1,063,106
$249,000
100%
2015
$29,850
$1,305,599
$249,000
100%
2016
$123,989
$1,609,222
$249,000
100%
2017
$240,618
$1,900,886
$249,000
100%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,478,939
Level Percentage Increase

Needs Year 2 Tech Correction
Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$212,500
2009
$0
$181,840
$221,000
104%
2010
$0
$237,923
$229,840
104%
2011
$0
$323,852
$239,034
104%
2012
$6,260
$443,673
$248,595
104%
2013
$23,795
$595,188
$258,539
104%
2014
$78,048
$837,627
$268,880
104%
2015
$131,256
$1,086,037
$279,636
104%
2016
$213,362
$1,406,029
$290,821
104%
2017
$298,548
$1,743,616
$302,454
104%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,498,171
179
Lesser PPA Max or PVFB (with Scales)

Funding
Percent
Increase
Year
Minimum
Maximum
Policy
2008
$29,270
$223,208
$223,208
2009
$0
$170,490
$170,490
76%
2010
$31,910
$279,433
$279,433
164%
2011
$0
$315,284
$315,284
113%
2012
$0
$353,765
$353,765
112%
2013
$0
$388,405
$388,405
110%
2014
$0
$480,779
$474,062
122%
2015
$0
$490,285
$223,600
47%
2016
$0
$833,931
$0
0%
2017
$0
$1,445,461
$0
0%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,493,614
Front Load Contributions

PBGC Covered With Tech Corrections
180
Funding
Percent
Year
Minimum
Maximum
Policy
Increase
2008
$29,270
$280,571
$280,571
2009
$0
$297,838
$297,838
106%
2010
$0
$320,012
$320,012
107%
2011
$0
$344,586
$344,586
108%
2012
$0
$369,251
$369,251
107%
2013
$0
$383,522
$383,522
104%
2014
$0
$471,762
$330,000
86%
2015
$0
$592,915
$0
0%
2016
$0
$1,117,717
$0
0%
2017
$0
$1,643,831
$0
0%
PVAB @ 1/01/2018
$3,478,411
Assets @ 1/01/2018
$3,487,478
Summary
PPA simplified the rules for determining minimum and

maximum contributions
Lowered minimums raised maximums
Actuarys responsibility is now less to determine min and
max and more to determine where, between min and
max, client belongs
Minimum is volatile due to interest rate changes and it is
increasing at a 12% rate for plans at 415 limit
Maximum is simply too high in a lot of cases
Excess assets, overfunding
Summary
Key is knowing clients wants, needs, budgets, business

plans, goals, in advance and using value added services
of plan design and contribution modeling to
Keep clients
Avoid Lawsuits
181
182
Chapter 5
Distributions and Loans
The rules governing distributions and loans are complex and extensive. This discussion
assumes that an intermediate knowledge of distributions and loans has already been achieved.
The following is a group of issues that a consultant may encounter in practice.
Vesting
All distributions are subject to vesting pursuant to the terms of the plan document. All active
participants are required to become 100 percent vested upon attainment of normal retirement
age, regardless of the vesting schedule in the plan document. Additionally, the plan document
may require that active participants become 100 percent vested upon death, disability or
attainment of early retirement age.
Defined contribution plans must have a vesting schedule that is at least as generous as one of
the following two schedules:
Year of Service
Less than 2
2
3
4
5
6 or more
Vested Percentage
0%
20%
40%
60%
80%
100%
Year of Service
Less than 3
3 or more
Vested Percentage
0%
100%
or
A defined contribution plan may use a schedule that is more rapid than the above, as long as all
years areat least as generous as one of the above schedules.
Top-heavy defined benefit plans also must meet the same requirements as defined
contributions plans. However, if the defined benefit plan is not top-heavy it must meet one of
the following two schedules:
183

Year of Service
Less than 3
3
4
5
6
7 or more
Vested Percentage
0%
20%
40%
60%
80%
100%
Year of Service
Less than 5
5 or more
Vested Percentage
0%
100%
or
A defined benefit plan may use a schedule that is more rapid than the above, as long as all years
areat least as generous as one of the above schedules.
The HEART Act created a requirement to 100 percent vest a participant who leaves
employment to join the military and subsequently dies while still with the military. This and
other HEART Act provisions should be reviewed carefully if any participant leaves the plan
sponsors employment to join the military.
Forms of Distribution
ANNUITY FORMS OF DISTRIBUTION
Single Life Annuity;
Joint and Survivor Annuity;
Variable Annuity;
Fixed-Period Annuity; and
Period Certain and Life Annuity.
Annuity Starting Date
The annuity starting date is the first day of the first period for which an amount is received as
an annuity under plan rules.
Qualified Joint and Survivor Annuity (QJSA)
Defined benefit plans and defined contribution plans subject to the minimum funding
standards of IRC 412 (e.g., money purchase plans) are required to have a Qualified Joint and
Survivor Annuity (QJSA) as the primary form of benefit. Other defined contribution plans are
required to comply if they have received transfers from plans subject to IRC 412. Some defined
contribution plans voluntarily comply with the QJSA, or are subject to these rules because they
offer certain options to the participant.
184

The QJSA is an annuity payable for the life of the participant with payments continuing for the
life of the participants spouse at a pre-determined percentage of the payments made during the
participants lifetime. The spousal annuity continuation percentage must be between 50 percent
and 100 percent of the amount payable during the participants lifetime.
In plans with QJSA provisions, spousal consent is required for distributions and loans if the
participants total vested accrued benefit or account balance exceeds $5,000.
LUMP-SUM PAYMENTS
Under prior regulations, distributions that constituted a lump-sum distribution were eligible
for special tax treatment. One of these special rules, ten-year forward averaging, is still available
for employees who were born before 1936 if their distribution qualifies as a lump-sum
distribution. Because of that special tax treatment a lump sum was a specific type of
distribution, defined in the IRC, but the term is now often used to describe any distribution of
the participants full account balance in one payment.
Most distributions from qualified plans are made in cash. However, property other than cash
may be distributed, an in-kind distribution of stock or mutual fund shares for example.
Distributions in property other than cash are valued at fair market value at the time of the
distribution unless certain exceptions apply.
There are special rules regarding when a lump-sum distribution can be rolled over to an IRA or
other qualified plan. There are also special rules regarding the taxation of lump-sum
distributions that contain employer securities, life insurance, designated Roth contributions,
after-tax employee contributions, loans and other things that create basis in the participants
account. All of these are discussed below.
Under the Pension Protection Act, lump-sum distributions from defined benefit plans may be
restricted or impermissible depending on the plans AFTAP. Refer to the defined benefit
chapter of the CPC program for additional information on AFTAP distribution restrictions in
DB plans.
PLAN-TO-PLAN TRANSFERS
A plan-to-plan transfer by definition is not a plan distribution. Direct rollovers are also not
plan-to-plan transfers. A plan-to-plan transfer occurs when the trustee of one plan directs all or
some of the money to be transferred to another plan without obtaining the consent of the
affected plan participants. Plan-to-plan transfers are not subject to current taxation because the
benefits stay in a plan. Generally, in a true plan-to-plan transfer, all characteristics previously
associated with the funds travel to the receiving plan. Plan-to-plan transfers happen most
frequently when two plans are merged into one.
Elective transfers (as distinguished from plan-to-plan transfers) are transfers between qualified
plans that are elected by a participant and that result in the transferred assets being subject to
the distribution options in the receiving plan (but not those of the distributing plan).
185

A loan can be maintained in both the transferor and transferee plans. In many cases, the loan
can simply be maintained and carried over in the plan-to-plan transfer. However, loan
documentation will need to be updated to reflect that repayments will be made to the transferee
plan following the plan-to-plan transfer.
In-Service Withdrawals
In-service withdrawals occur while a participant is still employed. Some of these include,
hardships withdrawals, corrective distributions, in-service withdrawals due to age or time, and
those that occur upon plan termination or as a result of a QDRO.
HARDSHIP WITHDRAWAL
Profit sharing plans, including 401(k) plans, may permit hardship withdrawals.
Sources Available for Hardship Withdrawal
Hardship withdrawals can be made from elective deferrals and designated Roth
contributions, as well as employer matching and profit sharing contributions. Some
employer contributions, including QNECs, QMACs and 401(k) safe harbor
contributions are considered to be restricted sources and cannot be withdrawn as part
of a hardship withdrawal.
Limitations on Amount Available for Hardship Withdrawal
The current balance in all nonrestricted sources may not be available as a hardship
withdrawal. The amount available for a hardship withdrawal is reduced by any
hardship withdrawals the participant has previously received. In addition, earnings on
elective deferrals made in 1989 and later and designated Roth contributions may not be
distributed on account of a hardship. The distribution cannot be for more than the
amount needed to satisfy the financial need, grossed up for the amount it is estimated
will be necessary to pay the taxes on the distribution. This gross up can include the 10%
additional income tax on early distributions in addition to any federal, state and local
taxes that will be due.
EXAMPLE: Samantha has requested a hardship withdrawal in the amount of $15,000 (which
includes the taxes she will owe) to pay medical expenses that were not covered by insurance.
The plan allows hardship withdrawals from all sources permitted by law. She began
contributing to the plan in 2001. Her account information is as follows:
Pre-tax Deferrals
Safe Harbor Contributions
QNEC
186
Current
Balance
$11,000
$6,000
$1,500
Inception to
Date Contrib
$10,000
$4,000
$1,000
Profit Sharing Contributions
$4,500
Prior Hardship Withdrawal
$3,000
$3,000
The amount available for hardship withdrawal is $11,500. This is achieved with the following
calculation: Inception-to-Date deferrals of $10,000 + current profit sharing balance of $4,500 prior hardship withdrawal of $3,000 = $11,500. Because $11,500 is less than the amount of the
need ($15,000), the whole $11,500 is available as a hardship withdrawal.
Reasons a Hardship Withdrawal may be Made
For elective deferrals, the 401(k) regulations provide safe harbor standards for determining the
need and the necessity of the hardship distribution. If the safe harbor rules are not used, a plan
may determine whether there is a hardship based on the facts and circumstances. Safe harbor
reasons were expanded in the 2006 final 401(k) Regulations.
Safe Harbor Hardship Rules
Under the safe harbor standard the events test is deemed satisfied if the withdrawal request
pertains to any of the following events:
Medical expenses (not limited by 7.5 percent of adjusted gross income) described under
IRC 213(d) incurred or anticipated to be incurred by the employee or the employee's
spouse or dependent.
Purchase (excluding mortgage payments) of a principal residence of the employee.
Tuition and related educational fees for the next 12 months for post-secondary (i.e., posthigh-school) education for the employee, spouse, children or dependents.
Payment to prevent eviction from the employee's primary residence or foreclosure on
the mortgage on the employee's primary residence.
Funeral expenses of parents, spouse, children or dependents of the employee.
Certain expenses relating to the repair of damage to the employees principal residence
that would qualify for the casualty income tax deduction. This includes things like a
pipe bursting and destroying all of the flooring as well as hurricane, flood and other
natural disaster damage (determined without regard to whether the loss exceeds 10
percent of adjusted gross income).
The Working Families Tax Relief Act expanded the definition of dependent to include
noncustodial children.
PPA expanded hardship provisions to allow for distribution to participants in the event that a
beneficiary designated under the terms of the plan (even if not a spouse or dependent)
experiences a qualifying hardship.
187
EXAMPLE: Ron had a particularly bad week and has requested a hardship withdrawal to pay
several large expenses. The plan uses the safe harbor hardship standards. The expenses he has
incurred are as follows:
He broke his leg and he has a huge insurance deductible
His sons high school tuition is due
His mother passed away and there are funeral expenses
His car died and needs to be replaced
His house flooded when a pipe burst and insurance wont pay
$3,000
$2,000
$6,000
$5,000
$7,000
Assuming he has a large enough account balance, the amount available for hardship
withdrawal is $16,000. His broken leg is an eligible medical expense. His sons high school
tuition is not eligible because education expenses are limited to post-secondary education.
Funeral expenses for his mother would be covered. Replacement of his car does not meet any of
the safe harbor hardship definitions. Repair of his primary residence after a flood would qualify
under the casualty deduction.
This amount could also be grossed up to cover any federal, state or early distribution taxes he
will need to pay on the distribution. Assuming that Ron is in the 28% federal tax bracket, lives
in a state with a 7% income tax, and is currently 48 years old, the distribution could be as much
as $29,090.91 [$16,000/[1-(28%+7%+10%)]].
Hardship distributions are not eligible for rollover and are, therefore, not subject to mandatory
20 percent federal income tax withholding. They are subject to the 10 percent additional tax on
early distributions if the participant is under 59, even in the case of a first time home purchase
that would exempt a distribution withdrawn from an IRA from the additional tax.
CORRECTIVE DISTRIBUTIONS
Several types of corrective distributions exist: excess contribution refunds (ADP), excess
aggregate contribution refunds (ACP), excess deferral refunds (IRC 402(g)) and IRC 415
excess refunds. Of these corrective distributions, IRC 415 excesses are probably the least
common. These occur when an employer chooses to refund deferrals to allow a participant to
receive the full employer contribution.
All corrective distributions have the following in common:
Not eligible for rollover;
Subject to 10 percent federal income tax withholding unless the participant elects
otherwise;
Not subject to the 10 percent additional tax on early distributions;
Allocable earnings should be distributed with the excess; and
188

Any match attributable to refunded deferrals must be forfeited. However, matching
contributions can be refunded or forfeited based on the vesting schedule for an ACP
correction if the deferrals to which the match is attributable remain in the plan.
Corrective distributions differ:
Starting with the 2008 plan year, all are taxable in the year distributed, except
distribution of excess deferrals (i.e., violations of IRC 402(g)), which continue to be
taxable in the prior year and are taxable in both the prior year and the year of
distribution if not timely corrected; and
Excess deferral refunds for HCEs are included in ADP testing; all other types of
corrective distributions are excluded from nondiscrimination testing.
DISTRIBUTIONS DUE TO AGE OR TIME

Pension plans can only permit in-service distributions after the earlier of normal retirement age
or age 62. Generally, a profit sharing plan or stock bonus plan may distribute all or a portion of
an account balance after a fixed number of years (generally after two years have elapsed since a
contribution was made); after completion of a specified period of service (at least 60 months of
participation); after the attainment of a stated age (often age 59); or upon the occurrence of
some event, such as layoff, hardship or termination of employment. Rollovers and after-tax
employee contributions are distributable at any time subject to the provisions of the plan
document.
Additional restrictions apply to elective deferrals, designated Roth contributions, QNECs,
QMACs and 401(k) safe harbor contributions. These amounts may not be distributed after a
fixed number of years, after completion of a specified period of service or after the attainment of
a stated age if that age is earlier than age 59.
LIMITATION ON DISTRIBUTIONS UPON PLAN TERMINATION FOR 401(K) PLANS

Distributions of the full account including restricted sources are normally permitted upon
termination of a 401(k) plan. However, if elective deferrals, designated Roth contributions,
QNECs and/or QMACs are distributed, the employer may not establish or maintain an
alternative defined contribution plan during the period beginning on the date the plan is
terminated and ending 12 months after distribution of all assets from the terminated plan. An
alternative defined contribution plan is a defined contribution plan as defined in IRC 414(i)
other than an ESOP, SEP, SIMPLE IRA, 403(b) plan or 457 plan. A plan is not treated as an
alternative defined contribution plan if less than 2 percent of the employees in the terminated
401(k) plan are eligible to be in the plan during the 24-month period beginning 12 months
before the date of the 401(k) plan termination.
189
QUALIFIED DOMESTIC RELATIONS ORDERS (QDROS)

QDRO Determination
A qualified domestic relations order (QDRO) creates or recognizes the existence of an alternate
payees right to (or assigns to an alternate payee the right to) receive all or a portion of the
benefits payable with respect to a participant under a plan and does not alter the benefits or
rights of another alternate payee under a prior QDRO.
The anti-alienation rules of ERISA and the IRC do not apply if payments are made
under a QDRO.
A distribution for the alternate payee on behalf of a QDRO can occur:
On the participants earliest retirement age; or
Sooner if the plan document designates that a QDRO distribution to the alternate
payee may occur sooner, regardless of the status of the participant.
A domestic relations order must meet the following requirements:
The order must be a judgment, decree or order relating to child support, alimony
payments or marital property rights, which is made pursuant to State domestic
relations law. The order can also be an approval of a property settlement
agreement.
The order must create or recognize the existence of an alternate payees right to, or must
assign to an alternate payee the right to, receive all or a portion of the benefits payable
with respect to a participant under a plan.
The order must include certain identifying information including the name and last
known mailing address of the participant and the alternate payee covered by the order.
However, the DOL notes that an order may be incomplete only with respect to factual
identifying information within the plan administrators knowledge or easily obtained
through a simple communication with the alternate payee or the participant. In such
cases, the DOL recommends that the plan administrator supplement the order rather
than rejecting it as not qualified.
The plan involved must be identified. The participant might have benefits in
more than one plan maintained by the employer. This requirement will make it
clear from which plan or plans the alternate payee will receive benefits.
The amount or percentage of the participant's benefits to be paid to the alternate payee
must be specified.
The number of payments or the period to which the order applies must be specified.
Stating a form of payment (e.g., lump sum, installments over a specified period) would
satisfy this requirement.
The order may not require a form of benefit or option that is not authorized by
the plan.
190

Timeline and Procedures
ERISA requires the plan to establish procedures for determining whether a domestic relations
order is a QDRO. These procedures must be set out in writing.
The QDRO procedures should address the following issues:
The actions the plan administrator must take when a domestic relations order is
received.
What the plan administrator must do with the affected benefits when it receives a
QDRO.
Establish procedures to determine the qualified status of a domestic relations order. In
other words, to determine whether the order is a QDRO.
Establish procedures to administer the distribution of benefits that are awarded to the
alternate payee under a QDRO.
The DOL has provided some guidance regarding QDRO procedures in its publication, "QDROs:
The Division of Pensions Through Qualified Domestic Relations Order," available at
http://www.dol.gov/ebsa/publications/qdros.html
Notifications
The administrator must notify the participant and each alternate payee of its receipt of the
order. Upon receipt of the order, the administrator must send an acknowledgment letter to the
participant and each alternate payee named in the order. A copy of the plans QDRO
procedures should be enclosed with the acknowledgment letter. The letter should be sent to the
addresses shown in the QDRO. This will serve as a good check to see if the mailing addresses
are valid and also to see if the order provides the addresses, which is one of the requirements
for an order to be a QDRO. If the plan administrator knows that the participant or alternate
payee is represented by legal counsel, copies of the acknowledgment letter (and QDRO
procedures) should also be sent to counsel.
Distribution Timing and Taxation
A QDRO can provide for benefit payments to the alternate payee beginning as early as the
earliest retirement age under the plans provisions, even if the participant has not separated
from service or otherwise begun to receive payments from the plan.
Earliest retirement age is the earlier of:
The earliest date when the participant is eligible for a distribution under the plan; or
The later of the participants 50th birthday or the earliest date upon which the participant
could begin receiving distributions from the plan if the participant separated from
service.
In other words, if a distribution is available immediately upon termination then the QDRO
would be payable immediately. A plan may permit payment to the alternate payee immediately
upon the approval of the QDRO by the plan administrator, even if a payment to the participant
191

would not be permitted. A QDRO cannot require payment of benefits immediately unless the
plan contains this feature or the participant has attained a distributable event.
Distributions to a spouse or former spouse who is an alternate payee under a QDRO are
generally includible in the income of the alternate payee. Distributions to an alternate payee
other than the spouse or former spouse of the participant are generally includible in the gross
income of the participant rather than the alternate payee.
The allocation of an employees investment in the plans assets is made on a pro rata basis
between the present value of the distribution made to the alternate payee and the present value
of the benefits payable to the participant to whom the QDRO relates. This is the case only if the
alternate payee is the spouse or former spouse.
QDRO payments are not subject to the IRC 72(t) 10 percent additional income tax on early
distributions.
A spouse or former spouse alternate payee can roll over distributions received pursuant to a
QDRO. However, the ability to defer taxation of net unrealized appreciation on employer
securities is not available to the alternate payee.
Participants should keep track of distributions made to an alternate payee when calculating
their RMD.
Required Minimum Distributions

Taxation is deferred on amounts contributed to a qualified plan. To ensure that this deferral is
not infinite, the required minimum distribution rules (RMD) of IRC 72 were enacted. Under
these rules, participants must begin taking distributions during their lifetimes by the later of age
70 or their date of termination. (Certain owners of the plan sponsor must begin distribution by
70 regardless of their working status.) Furthermore, if the participant dies before he or she is
required to begin distributions, the beneficiary must meet certain minimum distribution
requirements.
A 50 percent excise tax is imposed on the payee under a qualified plan, contract or IRA that is
subject to the minimum distribution rules to the extent that the total distributions during the
payees tax year from each such plan fall short of the RMD. An excise tax is imposed on any
amount of required distributions that is not made.
A participant in more than one qualified plan must meet the minimum distribution
requirements separately for each plan. A participant with more than one IRA account balance
can calculate the RMDs for each IRA and then take a distribution or distributions equal to that
amount from any single IRA or any combination of IRAs.
The rules that apply depend on whether the participant dies before or after the date RMDs are
required to begin (called the required beginning date), as well as the type of beneficiary. In
192

addition, the fundamentals of the RMD rules of IRC 401(a)(9) are made up of three subsets
dealing with payments made during the participants lifetime, after death when the participant
has not reached the required beginning date and after death when the participant has already
reached the required beginning date.
RULES DURING THE PARTICIPANTS LIFETIME

Required Beginning Date
An individuals required beginning date is the date when distribution must begin under IRC
401(a)(9).
For most individuals, this date is the April 1st of the calendar year following the calendar
year in which the individual attains age 70 or, if later, the calendar year in which the
individual retires.
For more than 5 percent owners, the required beginning date is April 1st of the calendar
year following attainment of age 70 even if the participant is still employed.
The first RMD must be made to the participant beginning no later than the required beginning
date, in an amount that spreads the payments over the life of the participant or over the joint
lives of the participant and the designated beneficiary. In subsequent years, the required
minimum distribution must be paid by the last day of the year (i.e., December 31).
Amount of Required Minimum Distribution
Usually, the Uniform Lifetime Table found in the regulations to IRC 401(a)(9) is used to
determine the payment period (that is, the participants and beneficiarys life expectancies) and,
therefore, the amount of the RMD for the year. This table shows rates to be used based on the
participants age. However, if the participants spouse is the sole beneficiary at the time the
distribution is being taken and he or she is more than ten years younger than the participant,
the rate for both individuals ages in the Joint and Last Survivor Table also found in the
regulations should be used, as it produces a higher number of years in the payment period, and
a lower required distribution. Age is defined as the participant or beneficiarys age on the
birthday that occurs during the year for which the distribution is being determined (generally
called the distribution calendar year).
The first RMD is made for the year in which the participant either attained age 70 or
terminated employment, even though it may be paid on or before the following April 1.
Therefore, the age for that distribution will be the age as of December 31 of the year in which
the participant attained age 70. A second RMD will be payable for the year that includes the
required beginning date, and that will be due by December 31 of that year.
The account balance to be used for calculating the RMD is the balance as of the latest valuation
date in the year before the distribution calendar year.
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EXAMPLE: Katie was born on June 23, 1940. She turned 70 on December 23, 2010. She is a
terminated participant in the XYZ retirement plan. Her required beginning date is the April 1st
following the date she turns 70 or April 1, 2011.
Account balance December 31, 2009: $125,000
Account balance December 31, 2010: $130,000
Designated Beneficiary:
Her spouse
Spouses Date of Birth:
May 16, 1935
Because her spouse is not at least 10 years younger than Katie (in fact, hes older), use the
Uniform Lifetime Table to get the life expectancy factor. In 2010 (the year for which the
distribution is being taken), Katie turned 70 years old, so the factor is 27.4. Divide her account
balance December 31, 2009 (the year before the distribution calendar year of 2010) by the life
expectancy factor to get the first RMD: $125,000 / 27.4 = $4,562, due to be paid by April 1, 2011.
The second RMD (for 2011) will equal Katies account balance as of December 31, 2010, divided
by her life expectancy factor on December 31, 2011 (at age 71, her age on her birthday in 2011):
$130,000 / 26.5 = $4,905, due to be paid by December 31, 2011.
DEATH BEFORE REQUIRED BEGINNING DATE

Beneficiaries
The first thing that must be determined when calculating an RMD after the participant dies is
who is the beneficiary of the death benefit under the plan, and whether the beneficiary is a
designated beneficiary for purposes of the RMD rules.
A designated beneficiary must be an individual (i.e., a human being) designated either by the
participant or by the plan document. An individual does not have to be formally designated by
the participant in order to be a designated beneficiary. The plan document may make the
designation instead. This most likely would occur when a participant has failed to name a
beneficiary before his/her death. In that case, the plan document usually contains a default
provision that designates the beneficiary (e.g., spouse).
A person who becomes a participant's beneficiary by will or by operation of state law (e.g.,
participant dies intestate) is a designated beneficiary for RMD purposes only if the individual is
designated (by name or by class) as a beneficiary under the plan.
The following are not designated beneficiaries for RMD purposes:
The participants estate;
A trust (although the underlying beneficiaries of the trust may be treated as designated
beneficiaries under certain circumstances); or
An organization, such a charity or church.
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This is not to say that a participant is precluded from naming (or the plan document is
precluded from designating) the participant's estate, a trust or an organization as the
participant's beneficiary. But if the beneficiary is not a designated beneficiary for RMD
purposes, the RMD calculations will be affected.
Although a trust itself cannot be a designated beneficiary for RMD purposes, the underlying
beneficiaries of that trust may be treated as designated beneficiaries. For this rule to apply,
however, the following four requirements must be satisfied:
The trust must be irrevocable (or will become irrevocable no later than the participants
death);
The trust must be valid under state law [or would be except for the fact that it currently
lacks a corpus, (e.g., a testamentary trust that will not have a corpus until the participant
dies)];
The beneficiaries of the trust must be identifiable from the trust instrument; and
The plan administrator must be provided with either a copy of the trust instrument or a
list of the beneficiaries of the trust.
Calculating the Required Minimum Distribution
If death occurs before the required beginning date, there are two methods for calculating the
remaining distribution period for the beneficiary, the five-year method and the life expectancy
method.
The five-year method requires that the entire interest must be fully distributed by the end of the
calendar year that contains the fifth anniversary of the participants death. This method must be
used if there is no designated beneficiary. The five-year method becomes a six-year method if
the five-year span covers 2009, due to the passage of PPA technical corrections in late 2008.
The life expectancy method requires that the benefit be distributed over the life expectancy of a
designated beneficiary. For nonspousal and multiple beneficiaries, payments under the life
expectancy method must commence by the end of the calendar year following the year of
participants death. If the sole designated beneficiary is the participants spouse, then
distribution may be delayed until the end of the calendar year in which the participant would
have attained age 70. In 2009, no RMD was required under this method.
DEATH AFTER REQUIRED BEGINNING DATE

If the participant dies on or after the required beginning date and has not received the RMD for
the distribution calendar year in which the participant died, the required distribution amount
for that year is calculated as if the participant was still alive, and payment is made to the
designated beneficiary.
For distribution calendar years following the year in which the participant died, the period used
for distribution is the remaining life expectancy of the designated beneficiary. If there is no
designated beneficiary, the remaining life expectancy of the deceased participant is used. The
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finalregulationsspecifythattheSingleLifeExpectancyTablefoundintheregulationstoIRC
401(a)(9)willbeusedfordeathdistributioncalculations.
Ifthesolebeneficiaryisthesurvivingspouse,theRMDamountisdeterminedusingthegreater
of:
Thespouseslifeexpectancydeterminedeachyearusingthespousesageonhis/her
birthdayinthedistributioncalendaryear,or
Theparticipantslifeexpectancyatthetimeofdeath,reducedbyafactorofoneforeach
subsequentyear.
EXAMPLE:Christinediesatage75.HersoledesignatedbeneficiarywasherhusbandJohn,age
78atthetimeofherdeath.TodetermineJohnsRMDfortheyearfollowingtheyearofher
death,thelifeexpectancyfactoristhegreaterofthefollowing:
Christineslifeexpectancyfactoratage75,herageonherbirthdayduringtheyearof
death,ontheSingleLifeTable,reducedby1:13.41=12.4
Johnslifeexpectancyfactoratage79,hisageattheendofthedistributioncalendaryear
(whichistheyearfollowingherdeath),ontheSingleLifeTable:10.8
TheaccountbalanceonDecember31oftheyearofChristinesdeathwas$100,000.Thegreater
ofthetwolifeexpectancyfactorsis12.4.Dividetheaccountbalancebythelifeexpectancyfactor
togettheRMDfortheyear,$100,000/12.4=$8,065.
Ifthebeneficiaryisnotthespouse,theRMDisdeterminedusingthegreaterof:
Thedesignatedbeneficiaryslifeexpectancyintheyearfollowingtheyearofthe
participantsdeathreducedbyafactorofoneeachsubsequentyear;or
Theparticipantslifeexpectancyatthetimeofdeath,reducedbyafactorofoneforeach
subsequentyear.
EXAMPLE:Fionadiesatage75.Hersoledesignatedbeneficiarywasherson,Barry,age44atthe
timeofherdeath.TodeterminetheRMDintheyearfollowingFionasdeath,thelife
expectancyfactoristhegreaterofthefollowing:
LifeexpectancyfactorforFionaatage75,herageonherbirthdayduringtheyearof
death,ontheSingleLifeTable,reducedby1:13.41=12.4
LifeexpectancyfactorforBarryatage45,hisageintheyearfollowingtheyearof
Fionasdeath,ontheSingleLifeTable:38.8
TheaccountbalanceonDecember31oftheyearofFionasdeathwas$200,000.Thegreaterof
thetwolifeexpectancyfactorsis38.8.Dividetheaccountbalancebythelifeexpectancyfactorto
gettheRMDfortheyear,$200,000/38.8=$5,155.
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For multiple beneficiaries, the minimum distribution is computed in the same way as above,
using the beneficiary with the shortest life expectancy.
EXAMPLE: George dies at age 75. His designated beneficiaries are his three children who are 44,
42 and 40 at the time of his death. To determine the RMD in year following Georges death, the
life expectancy factor is the greater of the following:
Life expectancy factor for George at age 75, his age on his birthday during the year of
death, on the Single Life Table, reduced by 1: 13.4 1 = 12.4
Life expectancy factor for the child with the shortest life expectancy, the 44 year-old,
who will be age 45 in the year following the year of Georges death, on the Single Life
Table: 38.8
The account balance on December 31 of the year of his death was $150,000. The greater of the
two life expectancy factors is 38.8. Divide the account balance by the life expectancy factor to get
the RMD for the year, $150,000 / 38.8 = $3,866.
SPECIAL RULES
There are special rules regarding RMDs for the portion of the benefit payable to an alternate
payee under a QDRO. A former spouse is treated as a spouse of the participant for purposes of
the minimum distribution rules.
If the portion allocated under the QDRO is treated as a separate account, then it must meet the
minimum distribution requirements separately. For instance, the distribution may only be made
over the participants life or the joint lives of the participant and the alternate payee, not the
joint lives of the alternate payee and a designated beneficiary.
If the alternate payees portion of the benefit is not treated as a separate account, then it is
aggregated with any amount distributed to the participant and is treated as having been
distributed to the alternate payee for purposes of the minimum distribution rules as applied to
the participant.
Involuntary Distributions
Distributions may occur when there is a distributable event such as retirement, death, disability
or separation from service. They may also occur involuntarily to distribute small vested balance
in the plan or because the participant cannot be located.
CASH OUT
A plan may permit the involuntary distribution of a participants benefit if the vested benefit is
$5,000 or less. When making the determination of whether or not a participants balance is over
the $5,000 threshhold rollover balances may be excluded if so elected in the plan document.
This can be advantageous for the plan sponsor as it reduces the number of small balances in the
plan and makes it less likely that former participants will have to be located in the event of a
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subsequent plan termination. An involuntary distribution in excess of $1,000 must be rolled
over automatically to an IRA or individual retirement annuity unless the participant makes an
affirmative election otherwise. Some plans choose to set the involuntary distribution limit at
$5,000 and adopt the automatic rollover rules as discussed below while others choose to
provide for involuntary distributions only if the vested benefit is $1,000 or less. Reduced
notification requirements are available for distributions of under $200 because they are exempt
from withholding and direct rollovers.
Automatic Rollover
The DOL issued safe harbor regulations to provide fiduciary relief for automatic
rollovers. The safe harbor regulations address the selection of individual retirement
plan service providers, initial investments, permissible fees, participant disclosure and
written agreement requirements.
The IRS followed with additional guidance regarding implementation of the automatic rollover
rules including a sample amendment.
MISSING PARTICIPANT PROCEDURES

If the plan is covered by the PBGC, ERISA 4050 provides for the transfer of assets to PBGC for
the benefit of the missing participant. Before remitting any benefits to the PBGC, a diligent
search must be completed. This diligent search requires the use of a third-party locator service.
If, after a diligent search, the participant is not located, the plan benefit may be transferred to
the PBGC. Under such circumstances, Schedule MP should be filed along with the postdistribution certification submitted to the PBGC.
If the plan is NOT covered by PBGC, a reasonable attempt should be made to locate a missing
participant. DOL has issued guidance on determining who is missing that must be followed
before a missing participant IRA can be established. FAB 2004-2 provides this guidance which
can be found at http://www.dol.gov/ebsa/regs/fab_2004-2.html. A portion of which says:
In the context of a defined contribution plan termination, one of the most important functions
of the plans fiduciaries is to notify participants of the termination and of the plans intention to
distribute benefits. In most instances, routine methods of delivering notice to participants, such
as first class mail or electronic notification, will be adequate. In the event that such methods fail
to obtain from the participant the information necessary for the distribution, or the plan
fiduciary has reason to believe that a participant has failed to inform the plan of a change in
address, plan fiduciaries need to take other steps to locate the participant or a beneficiary. In
our view, some search methods involve such nominal expense and such potential for
effectiveness that a plan fiduciary must always use them, regardless of the size of the
participants account balance. A plan fiduciary cannot distribute a missing participants benefits
in accordance with the distribution options discussed below unless each of these methods
proves ineffective in locating the missing participant. However, a plan fiduciary is not obligated
to take each of these steps if one or more of them are successful in locating the missing
participant. These methods are:
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Use Certified Mail. Certified mail can be used to easily ascertain, at little cost, whether
the participant can be located in order to distribute benefits.
Check Related Plan Records. While the records of the terminated plan may not have
current address information, it is possible that the employer or another plan of the
employer, such as a group health plan, may have more up-to-date information with
respect to a given participant or beneficiary. For this reason, plan fiduciaries of the
terminated plan must ask both the employer and administrator(s) of related plans to
search their records for a more current address for the missing participant. If there are
privacy concerns, the plan fiduciary that is engaged in the search can request the
employer or other plan fiduciary to contact or forward a letter on behalf of the
terminated plan to the participant or beneficiary, requesting the participant or
beneficiary to contact the plan fiduciary.
Check With Designated Plan Beneficiary. In connection with a search of the terminated
plans records or the records of related plans, plan fiduciaries must attempt to identify
and contact any individual that the missing participant has designated as a beneficiary
(e.g., spouse, children, etc.) for updated information concerning the location of the
missing participant. Again, if there are privacy concerns, the plan fiduciary can request
the designated beneficiary to contact or forward a letter on behalf of the terminated plan
to the participant, requesting the participant or beneficiary to contact the plan fiduciary.
Use A Letter-Forwarding Service. Both the Internal Revenue Service (IRS) and the Social
Security Administration (SSA) offer letter-forwarding services. Plan fiduciaries must
choose one service and use it in attempting to locate a missing participant or beneficiary.
The IRS has published guidelines under which it will forward letters for third parties for
certain humane purposes, including a qualified plan administrators attempt to locate
and pay a benefit to a plan participant.(9) The SSAs letter forwarding service may be
used for similar purposes, and is described on the SSAs Web site.(10) It is our
understanding that to use either the IRS or SSA program, the plan fiduciary/requestor
must submit a written request for letter forwarding to the agency, and must provide the
missing participants social security number or certain other identifying information.
Both the IRS and SSA will search their records for the most recent address of the missing
participant and will forward a letter from the plan fiduciary/requestor to the missing
participant if appropriate. In using these letter-forwarding services to notify a missing
participant that he or she is entitled to a benefit, the plan fiduciarys letter should
provide contact information for claiming the benefit. This notice may also suggest a date
by which the participant must respond, as neither the IRS nor the SSA will notify the
plan fiduciary as to whether the participant was located.
Other Search Options
In addition to using the search methods discussed above, a plan fiduciary should consider the
use of Internet search tools, commercial locator services and credit reporting agencies to locate a
missing participant. Depending on the facts and circumstances concerning a particular missing
participant, it may be prudent for the plan fiduciary to use one or more of these other search
options. If the cost of using these services will be charged to the missing participants account,
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plan fiduciaries will need to consider the size of the participants account balance in relation to
the cost of the services when deciding whether the use of such services is appropriate.
If the participant is not located using one of these methods, the automatic rollover rule under
IRC 401(a)(31)(B) requires that plan benefits valued between $1,000 and $5,000 must be
automatically rolled over into an IRA. Alternatively, an annuity may be purchased from an
insurance company that would pay the participants benefit once the participant is located.
PPA 2006 allows non-PBGC covered plans the option to use the PBGCs missing participant
program, although participation is voluntary. At this time the PBGC has not issued regulations
on the usage of the program for noncovered plans.
Taxation
GENERAL TAXATION RULES
In general, a distribution from a qualified plan is taxable as ordinary income at the time it is
distributed. There are exceptions to this rule for designated Roth contributions and after-tax
employee contributions, both of which are discussed in detail below. Any eligible rollover
distribution that is paid directly to the participant is subject to 20 percent mandatory federal
income tax withholding. There is also a 10 percent additional income tax on early distributions
applicable to distributions prior to attainment age 59 with some exceptions as discussed
below. Periodic payments from qualified plans are taxed under the general annuity rules of the
Internal Revenue Code (IRC).
ROLLOVERS
An eligible rollover distribution from a qualified plan can be rolled over in whole or in part.
(See below for a description of the plans to which a qualified plan amount may be rolled over.)
The portion of the eligible rollover distribution paid directly to another plan or IRA at the
distributees direction is considered a direct transfer. If a rollover is not made under the direct
transfer rules, the rollover must be made within 60 days of the participants receipt of the
distribution. This rule applies separately to each eligible rollover distribution. An eligible
rollover distribution that is paid to the participant will be subject to the 20 percent mandatory
withholding.
A participant who received an eligible rollover distribution and then decides to rollover the
distribution will need to add back the funds that were withheld for the 20 percent mandatory
withholdings to avoid taxation on the mandatory withholding amount. The amount added back
will need to come from other assets of the participant. When the participant files their income
tax return for the year, the withholding amount may be reimbursed by the IRS, if no other taxes
were due.
A hardship exception exists that permits the IRS to grant extensions of this 60-day time period.
The hardship exception applies to situations in which an individual suffers a casualty, disaster
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or other event beyond his or her reasonable control and not waiving the rule would be against
equity and good conscience.
A surviving spouse may roll over an eligible rollover distribution. The surviving spouse is
permitted to roll the distribution into another qualified plan, an IRA, an IRC 403(a) qualified
annuity, a 403(b) tax-sheltered annuity or a 457 plan. An alternate payee who is the participants
spouse or former spouse also may roll over an eligible rollover distribution. PPA 2006 gave
nonspouse beneficiaries a limited rollover option. Nonspouse beneficiaries are now allowed to
elect a direct transfer by the plan of the participants death benefit to an inherited IRA. Starting
in 2010, the distribution is treated as an eligible rollover distribution for withholding purposes.
Amounts that are Not Eligible for Rollover Include:
Any one of a series of substantially equal periodic payments;
Any distribution which is an RMD;
A corrective distribution due to excess annual additions and income thereon;
A corrective distribution of excess contributions, excess deferrals and excess aggregate
contributions and income thereon;
Loans that are treated as deemed distributions;
Dividends paid on employer securities under IRC 404(k);
Deemed income attributable to life insurance under P.S. 58; and
Similar items designated by the IRS.
Plans Eligible to Receive Rollovers are:
Individual retirement accounts under IRC 408(a) or (b);
Qualified trusts under IRC 501(a) (conduit IRA);
Annuity plans under IRC 403(a);
Another qualified IRC 401(a) plan;
SEP IRAs;
403(b) tax-sheltered annuity plans; and
457 plans.
The plans listed above are eligible to receive eligible rollover distributions from IRC 401(a)
qualified plans and any of the other plan types listed above. Distributions from the plans listed
above are also eligible to be rolled over to any of the plans listed above, provided the plan
document provisions permit this.
Roth 401(k) accounts can be rolled over directly into another Roth 401(k) plan or a Roth IRA.
Roth 401(k) accounts cannot be rolled over into a Roth 403(b) plan. In contrast, a Roth IRA
cannot be rolled over into a Roth 401(k) or a Roth 403(b) plan. It should be noted that, unlike a
Roth IRA, which does not require distributions until after the account owners death, Roth
401(k) accounts are subject to RMD rules. Additionally, special rules apply to partial rollovers
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and tracking of the five-year holding period for determining if a distribution is a qualified Roth
401(k) distribution.
When a participant elects a rollover of a non-Roth account to Roth IRA, the participant must
include in income the amount that would have been taxed had the amount been distributed to
the participant. Special income averaging rules apply for these rollover transactions that occur
during 2010.
EARLY DISTRIBUTIONS
A 10 percent additional income tax is imposed on the portion of certain distributions from a
qualified plan that is included in gross income. It is payable at the same time as regular income
taxes.
There are numerous exceptions:
Any distribution made on or after the date the individual attains age 59;
Any distributions made by reason of the participants death;
A distribution made to a person after he or she has become disabled;
A distribution that is made after the participant terminates employment and begins
receiving periodic payments in substantially equal amounts over the participants life or
life expectancy;
A distribution made to an employee who was older than age 55 when the employee
separated from service;
Distributions used for medical expenses that exceed 7.5 percent of adjusted gross
income; and
Payments made to an alternate payee under a QDRO.
DESIGNATED ROTH CONTRIBUTIONS

Contributions to Roth 401(k) accounts are after-tax contributions, and earnings on those
contributions may be withdrawn tax-free if paid in the form of a qualified distribution. Roth
401(k) money must be tracked separately from pre-tax 401(k) money.
Qualified Distributions
A qualified distribution is one that:
Is paid as the result of attainment of age 59, death or disability; and
Occurs no earlier than five years after the first day of the calendar year in which the first
designated Roth contribution was made (often referred to as the five-year holding
period).
Nonqualifying Distributions
If the distribution from the Roth 401(k) account is not a qualified distribution, it is treated as if it
were a distribution or withdrawal from an after-tax employee account as described below.
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Distributions of employer securities from Roth 401(k) accounts are subject to special rules
depending on whether or not the distributions were qualified distributions.
Certain distributions are never qualified distributions. These include corrective distributions of
excess amounts, deemed distributions, hardship distributions, dividends on employer securities
and imputed income from life insurance policies.
Designated Roth balances are eligible for direct rollover to a Roth IRA even if the distribution is
a nonqualifying distribution. The five-year holding period will start over at the time of transfer
unless the Roth IRA was already in existence, in which case the five-year period will be based
on the date the first deposit was made to the Roth IRA.
Withdrawal Rules and Restrictions
Designated Roth contributions in a 401(k) or 403(b) plan are subject to the RMD rules of IRC
72. Roth IRAs do not require any distributions during the account holders lifetime.
Designated Roth contributions are subject to the same withdrawal restrictions as elective
deferrals. This is in contrast to the Roth IRA, which permits the account owner to take a
withdrawal up to the amount originally contributed at any time, for any reason without tax or
penalty.
EXAMPLE: Jimmy has been contributing to both a Roth 401(k) and a Roth IRA. He has decided to
retire early at age 55 and wants to take a distribution on December 31, 2009 in the amount of
$10,000 to travel around the world. The information about his accounts is as follows:
Date of First Deposit
Roth 401(k)
Roth IRA
January 15, 2007
April 1, 2001
Total Contributions Made
$15,000
$25,000
Current Account Balance
$20,000
$40,000
If Jimmy takes a distribution from the Roth 401(k) it will be a nonqualifying distribution
because the first deposit was made less than five years ago. It will also be nonqualifying
because he is under age 59. Because the distribution is nonqualifying, the distribution would
be taxed as a pro rata return of basis and earnings, so $7,500 ($10,000 x $15,000/$20,000) would
be a return of basis and the balance of $2,500 of the distribution would be taxable earnings. The
$2,500 that is taxable would not be subject to the additional 10% tax on early withdrawal
because Jimmy is separating from service after age 55.
As an alternative, Jimmy could take the $10,000 distribution from his Roth IRA. Although the
Roth IRA meets the 5-year holding period, the distribution is nonqualifying because Jimmy is
under age 59. Any distribution from a Roth IRA is taxed as if it was made first from basis and
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only from earnings once all basis in the account is gone. Under this scenario, he could take the
$10,000 (which is less than his $25,000 basis) with no income or additional tax.
AFTER-TAX EMPLOYEE CONTRIBUTIONS

Pension plans may allow participants to make contributions on an after-tax basis. When
distributed from the plan, special care must be taken to ensure proper taxation of these after-tax
amounts. Depending on when and how these contributions are invested, specific rules govern
the taxation of earnings applicable to these after-tax employee contributions.
General Rule Requires Pro Rata Portions of Basis and Earnings be Distributed
Generally, distributions of after-tax contributions are subject to the exclusion ratio or pro
rata rule. This rule treats a percentage (called the exclusion ratio) of each distribution as a
return of after-tax employee contributions. This is true for both lump-sum distributions and
annuity payments.
The percentage is determined by dividing the total after-tax employee contributions by the total
of the employees accounts in the plan as of the date of distribution. Nonvested portions of the
employees accounts are not considered in this calculation. The total of the employees accounts
is based on fair market value, including net unrealized appreciation other than net unrealized
appreciation on employer securities as discussed below. Alternate methods of determining the
employees account values exist using a date other than the date of distribution.
EXAMPLE: Michael made after-tax employee contributions to his retirement plan during 2007
and 2008 that total $5,000. The current value of his after-tax employee contribution account is
$6,100. The current value of his employer account is $8,500, in which he is 60% vested. The
general exclusion ratio is calculated as follows:
$5,000 / [($8,500 x 0.60) + $6,100] = 0.4464
Thus, 44.64% of any distribution made to Michael would be considered nontaxable to him.
Exceptions to the Pro Rata Rule:
Plans that use separate contracts; and
Plans that involve pre-1987 employee contributions.
For both exceptions to the pro rata rule, the entire vested account is not always used in
determining the nontaxable portion of the withdrawal.
A separate contract refers to a separate account set up only for after-tax employee contributions
and earnings thereon under a defined contribution plan or certain defined benefit plans. Only
one separate account holding after-tax employee contributions can be set up under the plan for
a participant, and the plan must have a reasonable and consistent method for allocating gains,
losses, distributions, etc. to that separate account. Since the after-tax employee contributions
and earnings thereon are separately accounted for, the calculation of the nontaxable portion of a
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withdrawal from the separate contract is based only on the account values from the separate
contract. Thus the exclusion ratio is calculated by dividing the total after-tax employee
contributions by the total value of the separate contract only.
EXAMPLE: Jan has made after-tax employee contributions totaling $8,500. These contributions
have been deposited to a separate account that holds only after-tax employee contributions and
applicable earnings. The current vested value of this account is $10,100. The current vested
value of her account including employer contributions is $22,500. The after-tax return of basis is
calculated with regard only to the after-tax account, as follows:
$8,500 / $10,100 = 0.8416
Thus, 84.16% of any distribution made to Jan from the after-tax source would be considered
nontaxable to her.
The pre-1987 employee contribution exception was created by a grandfather rule that allows
after-tax employee contributions that were in the plan on December 31, 1986, to be withdrawn
first if the plan as of May 5, 1986, permitted in-service withdrawals of after-tax employee
contributions. Under this exception, first all the pre-1987 after-tax employee contributions are
withdrawn tax-free, and then the pro rata rule is applied going forward. When the pro rata rule
takes effect, the pre-1987 after-tax employee contributions are ignored in the calculations.
EXAMPLE: David made after-tax employee contributions totaling $5,000 in 1985 and 1986. He
also made after-tax employee contributions totaling $15,000 from 1987 through 1994. These
contributions have been deposited to a separate account that holds only after-tax employee
contributions and applicable earnings. The current vested value of this account is $32,000. He
has requested a distribution of $10,000. The after-tax return of basis is calculated as follows:
The first $5,000 is a tax-free return of basis on his pre-1987 contributions.
The next $5,000 is a pro rata return of basis and earnings.
$5,000 * ($15,000 / $27,000) = $2,777.78 in basis
Thus, $7,777.78 would be nontaxable return of basis and $2,222.22 would be taxable earnings.
Provisions exist for application of the pre-1987 employee contribution exception to the pro rata
rule in merger and acquisition situations.
A plan may qualify for both exceptions to the pro rata rule.
INSURANCE POLICIES
The value of life insurance protection obtained through a plan on behalf of a participant is taxed
to the participant. The current value of the cost of life insurance protection is computed under
IRS tables. These are referred to as P.S. 58 costs or term costs. Alternatively, the cost of life
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insurance protection may be determined using the insurance companys rates for a one-year
term policy. The participant receives a Form 1099-R and pays tax on the term costs each year.
The distribution of a life insurance policy to a participant or beneficiary from a qualified plan
generally results in taxable income. The taxable income usually equals the cash surrender value
of the policy less the amount that has already been taxed as P.S. 58 or term costs. If a participant
dies before the policy is distributed from the plan the life insurance proceeds are generally not
taxable. However, the cash surrender value immediately prior to death (minus the accumulated
term costs) is taxable.
EXAMPLE: John is a participant in the XYZ plan. The plan purchases life insurance policies for
plan participants. John first became a participant in 2008. His P.S. 58 cost for 2008 was $150. His
PS 58 cost for 2009 was $200. He terminates employment on May 1, 2010 at which time his
policy is surrendered. After surrender of the policy, his account balance is $2,900. The amount
of Johns distribution subject to income tax is his $2,900 account balance less the P.S. 58 costs on
which he has already been taxed of $350. His Form 1099-R will show a taxable distribution of
$2,550.
EMPLOYER SECURITIES
There are special rules that apply to distributions of employer securities that are received as
part of a distribution that qualifies as a lump-sum distribution.
The term securities means stocks and bonds or debentures issued by a corporation that have
interest coupons or are registered in form. The term securities of an employer corporation
includes securities issued by a parent or subsidiary corporation. The determination of whether
the securities are considered employer securities is made at the time the securities are acquired
by the plans trust.
Net Unrealized Appreciation
Net unrealized appreciation (NUA) is the excess of fair market value of the security at the time
of the distribution over the plans cost or basis and occurs when employer securities are
distributed from the plan in kind rather than being liquidated to make the distribution in cash.
If the special rules apply, the NUA on employer securities will be excluded from taxable income
at the time of the distribution unless a recipient elects to include it. If a distribution of employer
securities does not qualify as a lump-sum distribution, only the employer securities that are
attributable to employee contributions qualify for the exclusion for NUA.
For this purpose, a lump-sum distribution is a payment in one taxable year of the employee
of his or her entire plan interest on account of the employees death, disability or separation
from service or after age 59. To the extent that the previously unrecognized NUA is realized in
a subsequent sale or disposition of the employer securities, the NUA is treated as long-term
gain on a disposition of a capital asset; that is, it does not matter how long the plan or the
employee held the employer securities.
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Additional unrealized appreciation (in excess of the above) on the employer securities occurring
after they have been distributed from the plan is taxable upon the subsequent sale of the
securities as either long-term or short-term capital gain. Sales of assets held for one year or less
generate short-term capital gains, while sales of assets held for more than one year create longterm capital gains. Long-term capital gains are generally taxed at a lower rate than short-term
capital gains. The holding period that determines long-term or short-term status begins on the
day after the distribution from the plan.
When a participant takes a withdrawal of employer securities purchased with employee
contributions, the NUA in the employer securities is not taxed at the time of distribution. In this
case, all of the NUA is excluded from the calculation of the exclusion ratio.
The percentage to apply to the applicable distribution amount to determine the portion treated
as a return of after-tax employee contributions thus becomes:
The participants total after-tax employee contributions divided by
The total value of the participants account LESS the NUA in the employer securities.
The resulting percentage is multiplied by the amount of the withdrawal less the NUA of
employer securities included in the withdrawal. As a result, the withdrawn amount received by
the participant includes a tax-free return of employee contributions, tax-deferred NUA in the
employer securities withdrawn and a taxable portion.
EXAMPLE: Joe has a total account balance of $20,000 including $4,000 after-tax employee
contributions and $8,000 in NUA in employer securities. The employee withdraws $10,000
including employer securities with $4,000 in NUA. The exclusion ratio is 1/3, $4,000 (total aftertax employee contributions) divided by $12,000 ($20,000 total account value LESS $8,000 NUA).
The $10,000 withdrawal amount includes $4,000 in NUA, so the withdrawal amount LESS the
NUA is $6,000. The nontaxable portion of the withdrawal is $2,000, determined by multiplying
$6,000 by 1/3. Thus, the $10,000 employee withdrawal is represented by $4,000 in tax-deferred
NUA, $2,000 in tax-free return of employee contributions, and a $4,000 taxable amount.
Participant Loans
GENERAL LOAN RULES
The proceeds of a loan from a qualified plan are not taxed provided that the loan meets a set of
detailed criteria found in IRC 72(p). If the loan does not meet these criteria, the loan is subject
to taxation.
To avoid income taxation, a participant loan must meet these requirements:
The amount of the loan may not exceed the lesser of:
o
$50,000 minus the excess of the highest outstanding principal balance of all loans
from the plan to the participant during the preceding 12 months, over the
outstanding principal balance of loans from the plan to the participant on the date
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the loan is made; or
o
The greater of one-half of the present value of the participants nonforfeitable

accrued benefit in the plan or $10,000.
This maximum loan is then reduced by the outstanding principal balance of loans from
the plan to the participant on the date the loan is made to get the remaining amount
available for the participant to borrow.
The loan must have a term that does not exceed five years, unless it is used to acquire a
dwelling unit used as the principal residence of the participant.
The loan must be repaid with level payments of principal and interest, with payments
no less frequent than quarterly.
EXAMPLE: Jenice has requested a loan from her account. The plan allows two loans to be
outstanding at the same time. The information regarding this loan request is as follows:
Loan Amount Requested 10/31/2010
Vested Account Balance on 10/31/2010
Loan Outstanding on 10/31/2010
$15,000
$50,000
$8,000
$14,000
The maximum loan amount is the lesser of:

$50,000 * 50% = $25,000; or
$50,000 - $14,000 (highest loan balance in the period 10/31/09 to 10/31/10) = $36,000
So, Jenice can have a maximum loan of $25,000. Since she already has an outstanding loan of
$8,000, she can borrow $17,000 more on 10/31/10.
Jenice can receive a loan for the $15,000 she requested.
EXAMPLE: George has requested a loan from his account. The information regarding this loan
request is as follows:
Loan Amount Requested 3/31/2010
Vested Account Balance on 3/31/2010
The loan allowed is the lesser of:
$75,000 * 50% = $37,500; or
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$30,000
$75,000
$0
$25,000
$50,000 - $25,000 (highest outstanding loan balance in the past 12 months) = $25,000
George may not receive a loan for the $30,000 he requested. He is eligible for a $25,000 loan. If
he took a loan for $30,000, then the $5,000 that exceeded the loan limit under IRC 72(p) would
be a deemed distribution at the time the loan is made and potentially disqualify the plan for
failure to follow the terms of the plan document.
Loans may be transferred from one plan to another as long as the recipient plan is willing to
accept the loan. Withholding on the distribution of a loan to a participant is required only if
there is a transfer of cash or property from the plan at the same time as when the loan becomes
taxable.
LOAN REFINANCING
Special loan limits apply when refinancing an existing participant loan. This situation arises
most frequently when a participant wants to borrow an additional amount, but a new loan
would cause the participant to exceed the number of loans allowable under the plan.
When an existing loan is refinanced and replaced by a new loan, if the replacement loan has a
payment period ending after the longest permissible term of the loan being replaced, then both
loan amounts are considered when determining whether the loan limits of IRC 72(p) have been
met. In other words, the loan that is being refinanced is considered to be outstanding for
purposes of calculating the maximum amount that can be borrowed as a replacement loan.
An exception to this rule exists: If the outstanding balance of the replaced loan is amortized in
substantially level payments over a period ending no later than the latest permissible
repayment date of the replaced loan, resulting in the full payment of the replaced loan amount
within the maximum permissible term, then the additional amount borrowed by the
replacement loan can be repaid over a longer term. This results in different loan repayment
amounts throughout the term of the replacement loan.
In addition, when the replacement loan does not extend beyond the latest possible term of the
replaced loan, then only the replacement loan is considered in calculating the maximum loan
available (that is, the refinanced loan is not considered to be outstanding at the time that the
replacement loan is being made).
For a more detailed discussion of the issues surrounding loan refinancing and examples
showing the application of the above rules please read the article Is One Loan Per Participant
the Right Answer? located at the end of this chapter.
LOAN DEFAULT AND OFFSET

Loans must be repaid according to the terms of the promissory note unless a leave of absence
occurs. Failure to repay the note in accordance with its terms, or in accordance with the leave of
absence rules, has negative tax consequences for the participant and causes additional
administration.
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The IRS has issued guidance on exactly when the loan is considered as having failed to be
repaid in accordance with its terms. The IRS defines a cure period during which a missed
payment can be repaid. If the missed payment isnt repaid by the end of the cure period, the
loan is considered to be in default. The maximum cure period under the law is the last day of
the calendar quarter following the calendar quarter in which the loan payment is missed. In
other words, if the participant misses the June 5th loan payment and doesnt make that payment
by September 30th, the loan will be considered in default.
When a loan goes into default, it is taxable to the participant. This taxable event is called a
deemed distribution. A Form 1099-R should be issued for the outstanding balance of the loan
for that year. Defaulted loans cannot be rolled over since they are not eligible rollover
distributions. In the event there is a distributable event that occurs with the default, the loan can
be offset. If a loan is offset, it is subtracted from the participants account or it reduces the
participants accrued benefit and is no longer considered a plan asset. If there is no distributable
event, the loan must continue to be tracked as a plan asset and can be repaid until such time as a
distributable event occurs.
EXAMPLE: Joe terminates his employment with XYZ Company on April 5, 2010. He has an
outstanding loan from the XYZ 401(k) Plan for $10,000. XYZ company has elected not to
accelerate a loan upon termination as long as the terminated employee continues to make
payments. Joe fails to make the necessary payments. On September 30, 2010, his loan is declared
in default. Whether he has actually received a distribution or not, he has a distributable event
because he has terminated employment. His loan should be offset and a Form 1099-R issued for
2010 to reflect the default of the loan.
EXAMPLE: Jamies plan allows him to make loan repayments via personal check, not through
payroll deduction. Jamie forgets to send in the checks starting with the January 15, 2010
payment due date. In the absence of the plan receiving the checks, Jamies loan will go into
default on June 30, 2010. However, Jamies loan cannot be offset because there is no
distributable event. Jamie has not terminated employment, died or become disabled. So, the
plan must issue a Form 1099-R to him to reflect the deemed distribution of the loan, but the loan
will continue to show up in his account and accrue interest. He may repay the loan.
Repayments on defaulted loans that cannot be offset will be treated as after-tax contributions.
They create basis in the account that must be tracked. Additionally, the Form 5500 instructs that
account information be provided net of any loans that have been treated as deemed
distributions, so the Form 5500 information will not match the participant accounting if there
are any defaulted loans that cannot be offset.
If a participant has previously defaulted on a loan and requests a new loan, the new loan will be
treated as a deemed distribution unless one of the two following requirements is met:
Repayments on the subsequent loan are made by payroll withholding; or
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Adequate security is provided for the subsequent loan in the form of collateral in
addition to the participants accrued benefit under the plan.
In addition to the requirements above, the amount available for any new loan must take the
defaulted loan (including interest that accrues after default) into consideration as though it is
still outstanding.
GENERAL LEAVE OF ABSENCE

It is possible to stop making loan repayments during an approved leave of absence
provided certain conditions are met.
The level amortization requirement of IRC 72(p)(2)(C) does not apply for a period of not longer
than one year, during which a participant is on a bona fide leave of absence, either without pay
from the employer or at a rate of pay (after applicable employment tax withholdings) that is less
than the amount of the installment payments required under the terms of the loan. However,
the loan (including interest that accrues during the leave of absence) must be repaid within the
longest permissible term of the loan and the amount of the installments due after the leave ends
must not be less than the amount required under the terms of the original loan
EXAMPLE: Sally is commencing an unpaid six-month maternity leave of absence. She currently
has an outstanding loan, with a 5-year repayment term. Sally may suspend her loan payments
for this six-month period of time, although interest continues to accrue. Upon her return, Sally
may resume her original payments, with a balloon payment of the outstanding balance due at
the end of the 5-year term. Alternatively, she may re-amortize the loan and make higher
payments for the remainder of the repayment period.
MILITARY LEAVE OF ABSENCE

Special rules apply to loans in existence at the time a participant is called into military service.
Payments may be suspended during the period of military service, even if the period exceeds
one year. Additionally, the requirement that the leave be without pay or at a rate of pay less
than the amount of the loan payment does not apply to a military leave of absence.
The interest rate on the loan during the period of military service may not exceed 6 percent per
annum in accordance with the Soldiers and Sailors Relief Act, regardless of whether the loan
payments are suspended during the military leave; however to receive the lower rate the service
member is required to provide notice of the military service to the plan sponsor. The original
loan interest rate will resume upon return from military service.
The original term of the loan may be extended after the completion of military service. The loan
must be repaid in full within the longest permissible term allowed under IRC 72(p) plus the
period of the military service. Additionally, loan payments must resume upon the completion
of the military service at a frequency and amount not less than the frequency and amount
required under the terms of the loan at the time military service began.
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Thus, a participant returning from military service with an outstanding loan has at least the
following options:
Resume payments at the same frequency and amount as those prior to the military leave
making a balloon payment at the end of the extended term, representing accrued
interest accumulated during the period of military leave; or
Re-amortize the outstanding loan balance and interest accrued to create level payment
amounts throughout the extended loan term, with no balloon payment.
EXAMPLE: On July 1, 2007, Jack was called to active military duty. Six months prior, he took out
a participant loan with a 5-year repayment term. While Jack is gone, he is not required to make
any loan payments, even though his leave extends past one year. When Jack returns from a 3year military tour on July 1, 2010, he must resume making payments. He may extend the term
of the loan to December 31, 2014 (three years from the maximum permissible term for the loan
under IRC Section 72(p)(2)(B)). He may continue making the same regular payments he made
before the leave, in which case he will have a balloon payment at the end of the extended term.
Alternatively, he may re-amortize the current balance of the loan over the remainder of the
extended term. The current balance (and thus the balloon payment or the re-amortized
repayments) must include interest accrued while Jack was on military leave (at a rate not to
exceed 6%).
Protected Benefits under IRC 411(d)(6)

In the course of operating a plan the sponsor may find that certain distribution or loan features
in the plan are not desirable either because they are being abused, arent being used at all or
have become administratively burdensome. In the realm of distributions and loans some
benefits are protected and cannot be removed from a plan for money that is already in the plan
while others may be removed at any time. Changes to options can always be made
prospectively to benefits that accrue after the amendment, but that is generally not feasible from
an administrative standpoint as pre and post amendment benefits must then be tracked
separately.
In general, optional forms of benefit are protected under IRC 411(d)(6). Common examples of
optional forms of benefit include:
Form of payment (e.g., single-sum distribution option, life annuity distribution option,
joint and survivor annuity option, and installment options)
Timing of payment following severance of employment (e.g., distribution immediately
upon severance from employment, distribution in the first plan year which begins after
severance of employment, or distribution delayed until normal retirement age is
attained)
Timing of payments while in service (e.g., hardship withdrawals, distribution after
reaching age 59, or distribution available from employer contributions that have
accumulated for at least two years)
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Medium of payment (e.g., cash, employer securities, or in-kind)
As discussed below, not all optional forms of benefit (even some of those listed as examples
above) are immune from elimination by plan amendment with respect to accrued benefits.
However, an exception must exist in order for such an amendment to satisfy IRC 411(d)(6).
The rules are slightly different for defined contribution plans than they are for defined benefit
plans.
ELIMINATION OF DISTRIBUTION OPTIONS IN A DEFINED CONTRIBUTION PLAN

In general IRC 411(d)(6) protects the form of distribution for money that is already in the plan,
but in 2000 an exception was provided. Under current law, a defined contribution plan that is
not subject to the QJSA rules may be amended to eliminate any periodic payment option
available to a participant if, after the amendment, the participant at least has available a singlesum distribution option. The regulations do not override the statutory requirements regarding
the QJSA rules. For example, a money purchase plan may not be amended to replace annuity
distribution options with installment options, because a money purchase plan must offer the
QJSA option. Similarly, if a profit sharing plan is the direct transferee of a money purchase plan,
as described in IRC 401(a)(11)(B)(iii)(III), it would not be permitted to eliminate the QJSA
option, at least with respect to the transferred benefits. This means that as long as there are not
transferred balances from a plan subject to QJSA installment and annuity options can be
removed from a profit sharing plan at any time. There are also special exceptions to IRC
411(d)(6) that apply to ESOPs. More information on ESOP distribution options can be found in
the CPC ESOP elective module.
ELIMINATION OF DISTRIBUTION OPTIONS IN A DEFINED BENEFIT PLAN

The exceptions to IRC 411(d)(6) are much more limited for defined benefit plans than for
defined contribution plans. Still some options can be removed. For example if a defined benefit
plan offers, joint and survivor annuities with survivor annuities of 100%, 75% and 50%, the 75%
annuity option can be removed as long as the highest (100%) and lowest (50%) are maintained.
HARDSHIP WITHDRAWALS
A profit sharing plan or stock bonus plan, including a section 401(k) arrangement under such
plan, may be amended to eliminate a hardship distribution option or to modify the conditions
for a hardship distribution, without having to protect the pre-amendment option with respect to
accrued benefits. This exception is an apparent recognition by the Treasury of the additional
administrative complexities involved in implementing a hardship distribution rule, and the
Treasurys not wanting to discourage companies from offering hardship distributions by
precluding them from eliminating those options at a later date with respect to accrued benefits.
This also helps conform divergent hardship programs into a single set of requirements when
two or more plans are merged. Also, because hardship withdrawals are not a protected benefit
hardship provisions can also be tightened up at any time. For example, a plan that provides
hardship distributions from all sources allowed by law could amend the plan to allow hardship
from the deferral source only.
213
PARTICIPANT LOANS
The ability to receive a participant loan is not a protected benefit under IRC 411(d)(6). Since
loans are not a protected benefit loan provisions can be removed entirely at anytime even with
respect to balances that are already in the plan. Loan provisions can also be tightened up to
restrict reasons loans can be taken, the sources that can be borrowed from or the number of
loans available at one time.
REMOVAL OF IN-KIND DISTRIBUTIONS

A defined contribution plan may be amended to modify the right to receive distribution in the
form of marketable securities (other than securities of the employer) by substituting cash for the
marketable securities. This rule does not permit the substitution of cash for the right to elect a
distribution in the form of employer securities or in an investment which is not a marketable
security, such as a limited partnership interest or real property, but amendments could be
adopted to restrict the availability of such in-kind investments and to eliminate the right to
invest in such investments.
MERGERS AND PLAN-TO-PLAN TRANSFERS

If two plans are merged, the merged plan must continue to protect any section 411(d)(6)
protected benefits with respect to the plans involved in the merger, unless an exception applies.
If plan assets of one plan are transferred in a direct trustee-to-trustee transfer to another plan,
either through a spinoff transaction, which would create a new plan with the transferred assets,
or through a transfer between existing plans, the transferee plan (spinoff plan, in the case of a
spinoff transaction) must continue to protect any section 411(d)(6) protected benefits which
apply to the transferred benefits, unless an exception applies.
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CPC Study Guide:

IsOneLoanPerParticipanttheRightAnswer?
KimberlyRadaker,CPC,QPA,QKA
CCHPensionPlanGuide,March2006
215
Is One Loan Per Participant the Right Answer? (March 2006)

By Kimberly Radaker, CPC
Kimberly Radaker is a retirement plan consultant with experience in virtually all areas of retirement plan
design and administration. She is the subject matter expert for the 401(k) topic on the Education and
Examination committee for the American Society of Pension Professionals and Actuaries (ASPPA). Kim is
the Retirement Plan Installation Manager for Simpkins & Associates, a third-party administrator in Dallas,
Texas, where she works with clients and brokers to ensure a smooth transition to the firm, assists with inhouse education and training programs, and serves as a resource for her colleagues when complicated
issues arise. She received a Bachelor of Business Administration degree with a major in Finance and
concentrations in Accounting and Economics prior to starting her career in the retirement plan industry.
Kim can be reached via e-mail at kradaker@simpkinsassoc.com or by phone at (972) 960-9630.
Dealing with participant loans is one of the most difficult aspects of retirement
plan administration. Much of the frustration from the service provider side is that it is
virtually impossible to charge enough to actually cover the time it takes to answer
participant questions, calculate the available loan, prepare the loan paperwork, issue the
check, and then process the payments over the next few years. Enhancements to
automated systems have started to reduce the burden, but participant loans continue to be
a time-consuming proposition for the plan sponsor, administrator, and recordkeeper.
Participant loans are governed under the statutory requirements of IRC Sec. 72(p),
which provides the tax rules relating to participant loans, and IRC Sec. 4975(d)(1) and
ERISA Sec. 408(b)(1) that provide rules that exempt participant loans from the
prohibited transaction rules. This article will address the tax rules covered under IRC Sec.
72(p).
Each plan sponsor must make a determination as to whether or not to allow loans
in its plan. The loans must be authorized in the plan document and a loan policy must be
established. Additional restrictions placed on the minimum amount of a loan, the number
of loans a participant may have at one time, what sources of money a participant can
borrow from, etc., can be addressed in the plan document, adoption agreement, or the
loan policy.
The primary concerns of every participant are How much can I borrow? and
How long do I have to pay it back? IRC Sec. 72(p)(2) addresses the issues of the
maximum loan amount, maximum term, and minimum payment requirements
participants can incur without triggering adverse tax consequences.
72(p)(2)(A) GENERAL RULE.-[The prohibited transaction rules] shall not apply to any loan to
the extent that such loan (when added to the outstanding balance of all other loans from such plan
whether made on, before, or after August 13, 1982), does not exceed the lesser of72(p)(2)(A)(i) $50,000, reduced by the excess (if any) of72(p)(2)(A)(i)(I) the highest outstanding balance of loans from the plan
during the 1-year period ending on the day before the date on which such
loan was made, over
217
72(p)(2)(A)(i)(II) the outstanding balance of loans from the plan on the

date on which such loan was made, or
72(p)(2)(A)(ii) the greater of (I) one-half of the present value of the nonforfeitable
accrued benefit of the employee under the plan, or (II) $10,000.
For purposes of clause (ii), the present value of the nonforfeitable accrued benefit shall be
determined without regard to any accumulated deductible employee contributions (as defined in
subsection (o)(5)(B)).
72(p)(2)(B) REQUIREMENT THAT LOAN BE REPAYABLE WITHIN 5 YEARS.72(p)(2)(B)(i) IN GENERAL.-Subparagraph (A) shall not apply to any loan unless
such loan, by its terms, is required to be repaid within 5 years.
72(p)(2)(B)(ii) EXCEPTION FOR HOME LOANS.-Clause (i) shall not apply to any
loan used to acquire any dwelling unit which within a reasonable time is to be used
(determined at the time the loan is made) as the principal residence of the participant.
72(p)(2)(C) REQUIREMENT OF LEVEL AMORTIZATION.-Except as provided in regulations,
this paragraph shall not apply to any loan unless substantially level amortization of such loan (with
payments not less frequently than quarterly) is required over the term of the loan.
The application of these rules is fairly basic when there are not any other outstanding
loans at the time the new loan is issued but is a bit more complex if the plan allows
multiple loans. In the case where multiple loans are permitted, the other loans must be
considered when determining the maximum amount of the new loan.
In an attempt to simplify participant loan administration, many plan sponsors include
provisions in the plan document, summary plan description, or loan policy limiting
participants to one loan at a time. This limit is a noble goal, but participants often want to
borrow additional money before their original loans are paid off. In order to respond to
that desire, plan sponsors can either increase the number of loans permitted or decide to
allow participants to refinance their loans to get more money out of the plan without
requiring that they payoff the other loan first. The calculation of the maximum additional
amount that can be loaned as part of a refinancing transaction is complicated and may be
confusing--particularly when the participant wants to make repayments over the
maximum term allowable.
The rules governing these refinancing transactions are found in Treas. Reg. Sec. 1.72(p)1, Q&A-20 issued December 3, 2002:
Q-20: May a participant refinance an outstanding loan or have more than one loan outstanding
from a plan?
A-20: (a) Refinancings and multiple loans--(1) General rule. A participant who has an outstanding
loan that satisfies section 72(p)(2) and this section may refinance that loan or borrow additional
amounts if, under the facts and circumstances, the loans collectively satisfy the amount limitations
of section 72(p)(2)(A) and the prior loan and the additional loan each satisfy the requirements of
section 72(p)(2)(B) and (C) and this section. For this purpose, a refinancing includes any situation
in which one loan replaces another loan.
218
(2) Loans that repay a prior loan and have a later repayment date. For purposes of section 72(p)(2)
and this section (including paragraph (a)(3) of this Q&A-20 and the amount limitations of section
72(p)(2)(A)), if a loan that satisfies section 72(p)(2) is replaced by a loan (a replacement loan) and
the term of the replacement loan ends after the latest permissible term of the loan it replaces (the
replaced loan), then the replacement loan and the replaced loan are both treated as outstanding on
the date of the transaction. [Emphasis added.] For purposes of the preceding sentence, the latest
permissible term of the replaced loan is the latest date permitted under section 72(p)(2)(C) (i.e.,
five years from the original date of the replaced loan, assuming that the replaced loan does not
qualify for the exception at section 72(p)(2)(B)(ii) for principal residence plan loans and that no
additional period of suspension applied to the replaced loan under Q&A-9 (b) of this section).
Thus, for example, if the term of the replacement loan ends after the latest permissible term of the
replaced loan and the sum of the amount of the replacement loan plus the outstanding balance of
all other loans on the date of the transaction, including the replaced loan, fails to satisfy the
amount limitations of section 72(p)(2)(A), then the replacement loan results in a deemed
distribution. [Emphasis added.] This paragraph (a)(2) does not apply to a replacement loan if the
terms of the replacement loan would satisfy section 72(p)(2) and this section determined as if the
replacement loan consisted of two separate loans, the replaced loan (amortized in substantially
level payments over a period ending not later than the last day of the latest permissible term of the
replaced loan) and, to the extent the amount of the replacement loan exceeds the amount of the
replaced loan, a new loan that is also amortized in substantially level payments over a period
ending not later than the last day of the latest permissible term of the replaced loan.
To summarize the response, either the replacement loan must be amortized within the
maximum allowable term (generally five years) of the replaced loan or the replacement
loan limit must be calculated as though the replaced loan is still outstanding on the date
of the refinance. This is most clearly illustrated with an example:
Maria took out a loan for $10,000 on July 14, 2005. She elected to have the payments
amortized over 5 years with repayments made weekly. The interest rate on this loan is
6.75% and the required loan payment is $45.34. Her final payment is scheduled to be
made on July 8, 2010.
On February 15, 2006, Maria requested a new loan in the amount of $4,000. Maria has
made 30 payments on her original loan so her outstanding principal balance as of
February 15, 2006 is $9,010.72. Her current vested account balance is $40,000.
General Loan Limit Calculation
First Limitation
1. Enter the participants highest outstanding balance during
the 12 months ending the day before the new loan is made.
$ 10,000.00
2. Enter the participants outstanding loan balance
$ 9,010.72
3. Subtract the amount on line 2 from the amount on line 1
4. Subtract the amount on line 3 from $50,000

(Statutory limit under IRC Sec. 72(p)(2)(A).)
$ 49,010.72
989.28
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Second Limitation
5. Enter the participants current vested account balance
$ 40,000.00
6. Multiply the amount on line 5 by 50%
$ 20,000.00
7. Enter amount on line 6 or $10,000, if greater

(Use of $10,000 requires additional collateral and
may not be permitted by the plan.)
$ 20,000.00
Paticipants Loan Limit under the General Rule

8. Enter the lesser of line 4 or line 7
$ 20,000.00
$ 9,010.72
10. Subtract the amount on line 9 from the amount on line 8
$ 10,989.28
The calculated amount on line 10 is the maximum new loan Maria could take out if the
plan allowed two or more loans to be outstanding at the same time. Because line 10 is
more than $4,000, Maria would be able to take out the amount that she wanted and the
second loan could be amortized over a period of five years at the current interest rate of
8.5%, resulting in 260 weekly payments of $18.90. She would continue making
repayments of $45.34 on the first loan resulting in total payments of $64.24 until July 8,
2010, and then make payments of $18.90 until February 11, 2011.
Now assume that Marias plan only allows participants to have one loan outstanding at a
time. Because the plan allows only one loan at a time, the first loan will be paid off by the
new loan. In order to provide Maria with $4,000 in cash now, the replacement loan will
be issued in the amount of $13,010.72 [$9,010.72 + $4,000 = $13,010.72].
As long as she repays the replacement loan within 5 years from the date the replaced loan
was issued (in this case no later than July 14, 2010), she can get additional cash out up to
the amount on line 10. She takes out $4,000 in cash for a total replacement loan of
$13,010.72. The repayments are calculated using the current interest rate of 8.5% for the
full amount borrowed. This brings her new payment amount to $67.91 per week and she
must repay the loan over 230 payments. Because this is a replacement loan, the term of
the loan remains the same. Therefore, the amount of time for repayment is the 260
weekly payments under the terms of the original five-year loan less the payments already
made [260 30 = 230].
In order to prevent abuse of the refinancing rules, Treas. Reg. Sec. 1.72(p)-1, Q&A-20
provides that for the replacement loan to be taken with repayments extending beyond the
time limit for the replaced loan, the sum of the replaced loan and the replacement loan
must be under the limit calculated on line 8 above.
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Maria would like her payments to be as low as possible, so she would like to take the
replacement loan for a period of five years. This would make her payments $61.47
weekly for the next 260 weeks. To see if this is possible we must complete the following
calculation:
Refinancing Loan Limit Calculation
Determine the maximum available if the Replacement loan will extend
beyond 5 years from the date the Replaced loan was issued (July 14, 2010)
11. Enter the number from line 8 above
(This is the maximum total replacement loan.)
$ 20,000.00
$ 9,010.72
13. Enter the amount of the proposed replacement loan
$ 13,010.72
14. Add the amounts on line 12 and line 13 together
$ 22,021.44
15. Subtract line 14 from line 11
$ (2,021.44)
If line 15 is negative, this loan amount is not permissible. Issuing the loan under
these terms would result in a deemed distribution. To avoid adverse tax
consequences, either Maria will have to receive less cash than she originally
anticipated or she will have to repay the new loan prior to the five-year deadline
that applies to the old loan as discussed above.
It is clear from the illustration above that the administrative complexity increases
substantially when a plan limits its participants to a single loan but permits refinancing as
opposed to permitting multiple loans. In addition, participants are less limited in their
loan options when multiple loans are possible.
In summary, the best course of action is to allow only one loan at a time if the plan
sponsor and administrator enforce the limit by requiring any prior loan to be paid off
through regular payments or in a lump sum from an outside source. This avoids the
possibility of a profit sharing plan with a loan feature turning into a loan plan with a
profit sharing feature. However, if the attitude of the sponsor and the demographics of
participants are such that a limit of one loan just puts the plan sponsor or administrator in
a refinancing situation, the plan is often better served by imposing a limit of either two or
three loans at a time. This provides additional flexibility to participants and reduces the
administrative burden of refinancing calculations for plan sponsors, administrators, and
recordkeepers.
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Chapter 6
Fiduciary Topics
ERISA Coverage
PLANS COVERED BY ERISA
Plans subject to ERISA fiduciary rules include any plan, fund or program that is an employee
welfare benefit plan or employee pension benefit plan, except those without common-law
employees.
PLANS EXEMPT FROM ERISA COVERAGE

Owner-only plans (e.g., any plan that would file a Form 5500-EZ)
Governmental plans
Nonelecting church plans
IRAs are exempt from ERISA if:
o
No contributions are made by an employer or employee organization;
Participation is voluntary;
The employer or organization does not endorse the program; and
The employer or employee organization does not receive consideration other

than reasonable compensation for services actually rendered in connection with
payroll deductions.
TSAs are exempt from ERISA if:

o
The purchase of the annuity contract is pursuant to salary reduction agreements;
Participation is voluntary;
Rights can be enforced only by employees, beneficiaries, or their representatives;
The employer does not endorse any funding media; and
Employer involvement is limited to allowing sales, service, collection of

contributions, and holding an annuity contract in its own name.
Unfunded top hat pension plans are not subject to ERISA.
WHAT ARE PLAN ASSETS

Plan assets must be segregated from the employers assets and held in trust. Participant
contributions, including participant loan payments, are treated as plan assets as of the earliest
date on which they could reasonably be segregated from the employers general assets. DOL
regulations define this as the earlier of the 15th business day following the end of the month
during which the participant contributions were withheld from pay; or the earliest date the
assets can be segregated from the employers general assets.
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Determination of the applicable deadline typically involves an examination of the employers
payroll practices. For example, if participant contributions usually are deposited into the plan
two days after the date when paychecks are delivered to participants, then the earliest date the
plans assets can be segregated from the employers general assets is two days after paycheck
delivery. The deadline for depositing participant contributions into the plan when assets are
held in trust is two days after paycheck delivery and not the 15th business day of the month
following the month in which the paychecks are delivered. Any deposit taking longer than
those two days may be considered a delinquent deposit under DOL rules.
On January 13, 2010, the DOL released its final regulations providing a seven business day safe
harbor for small plans with fewer than 100 participants at the beginning of the plan year. Under
this safe harbor for small plans, participant contributions to a pension or welfare benefit plan,
will be treated as having been made timely when contributions are deposited no later than the
7th business day following the day on which such amount would have otherwise been payable
to the participant in cash, in other words the applicable pay date. The 7th business day rule is
just a safe harbor and when it is not used and late deposits are made, as soon as
administratively feasible is still the standard that must be used when determining how late the
contributions are.
Since 1995, the DOL has been actively pursuing abuse by employer or employee organizations
that do not timely segregate contributions from the general assets of the employer or employee
organization. Most DOL audits automatically include a review of participant contribution
deposit timing.
Plan assets considered part of an insurance company or held by an insurance company need not
be held in trust. Custodial accounts may be used instead of trusteed accounts, although the plan
must still have a trustee.
A plans assets generally include only investments in another entity and not the underlying
assets of the entity unless a look-through exception applies. In that instance, plan assets include
the plans equity interest in the entity and a proportional interest in the underlying assets held
by the entity.
Look-through exceptions are:
The look-through rule applies if the plans equity interest in an entity is neither a
publicly offered security nor a security issued by an investment company registered
under the Investment Company Act of 1940.
The look-through rule does not apply to a guaranteed benefit policy of an insurer.
Benefits under such a policy are guaranteed by the insurance policy and are unaffected
by the investment performance of the insurers pooled separate account.
Investments in an operating company are generally exempt from the look-through rules.
An operating company is defined as a company primarily engaged in the production or
sale of a product or service.
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If the investment in an entity is not significant, the look-through rules do not apply. An
investment would not be considered significant if, after the most recent acquisition of
any equity interests, less than 25% of the value of any equity interests is held by benefit
plan investors.
Who is a Fiduciary?
ERISA FIDUCIARY UNDER ERISA 3(21)
ERISA defines a fiduciary as a person (defined as an individual, partnership, corporation, joint
venture, trust, estate, unincorporated organization, association or employee organization) who:
Exercises any discretionary authority or control over management of a plan or its assets;
Renders investment advice for a fee or other compensation (direct or indirect) or has any
authority or responsibility to do so; or
Has any discretionary authority or responsibility in the administration of the plan.
A person does not need to have exclusive, complete or final decision-making authority to be a
fiduciary under ERISA 3(21)(A)(iii).
A person can be a fiduciary by being named in the plan document or by the business or by
performing fiduciary functions. Function rather than title determines fiduciary status relating to
management, investment or administration of a qualified plan.
These functions include, but are not limited to:
Appointing other fiduciaries;
Delegating responsibilities to or allocating duties among other plan fiduciaries;
Selecting or monitoring plan investment vehicles;
Giving investment advice to the plan for compensation;
Acquiring or disposing of plan assets;
Interpreting plan provisions;
Making decisions on behalf of the plan;
Negotiating the compensation of third party providers; and
Exercising discretion in denying or approving benefit claims.
MINISTERIAL ADMINISTRATIVE FUNCTIONS

Under DOL Reg. 2509.75-8 the following are ministerial administrative functions that can be
performed by a person who is not a fiduciary:
Applying rules determining eligibility for participation or benefits;
Calculating services and compensation credits for benefits;
Preparing employee communications material;
Maintaining participants service and employment records;
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Preparing reports required by government agencies;
Calculating benefits;
Orienting new participants and advising them of their rights and options under the
plan;
Allocating contributions as provided in the plan;
Preparing reports concerning participants benefits;
Processing claims; and
Making recommendations to others for decisions with respect to plan administration.
Professional service providers and third party administrators (TPAs) are generally not
fiduciaries, but they may become fiduciaries if they exercise discretionary control or
management with respect to plan assets or a plans administration. TPAs or service providers
are not considered plan fiduciaries solely by reason of rendering professional services. If a TPA
performs ministerial functions with respect to a plan within guidelines established by a plan
fiduciary the TPA is not a fiduciary.
NAMED FIDUCIARY
There is no maximum number of fiduciaries required by ERISA. The plan must have at least one
named fiduciary to serve as plan administrator and must have at least one trustee if assets are
held in trust. It is possible that the same person may serve as both plan administrator and plan
trustee.
A named fiduciary is either designated in the plan document or designated as such by the
employer or employee organization. Some common examples of named fiduciaries are the
sponsoring employer, the employers board of directors, the joint board of union and
management trustees, an unincorporated organization, an association, a partnership, a joint
venture, a mutual company, a joint stock company, a trust or an estate.
A nonindividual fiduciary (e.g., a bank) should provide for the designation of specified
individuals or other persons to act on its behalf. The purpose of designating a named fiduciary
is to enable employees and other interested persons to determine who is responsible for plan
operation.
PLAN SPONSOR
The plan sponsor is an employer for which the plan was established or an employee
organization where the plan is maintained by the employee organization. The plan sponsor may
also be an association, committee, joint board of trustees or similar group of representatives
who establish and maintain the plan when the plan is established by two or more employers
and/or employee organizations.
The plan sponsor does not have any fiduciary duties assigned to it by law. Technically,
the plan sponsor is like any other person in that it is a fiduciary only to the extent it
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meets the definition of a fiduciary under ERISA 3(21). The plan sponsor is not a
fiduciary solely by establishment, amendment or termination of a plan. As a practical
matter however, the plan sponsor is almost always a fiduciary because the sponsor will
almost always meet the ERISA definition. In a typical plan the plan sponsor appoints a
plan administrator and a plan trustee as the two principal fiduciaries of the plan,
responsible for all aspects of overseeing the plan. The sponsor is thus a fiduciary by
virtue of having exercised discretionary authority or control in appointing these
fiduciaries, and has the implicit duty to monitor the fiduciaries. This is the only
fiduciary function of the plan sponsor in this circumstance.
PLAN ADMINISTRATOR
The plan administrator is one of the two main broad scope fiduciary positions in a qualified
plan along with the trustee. The plan administrator manages day-to-day affairs of the plan. The
definition of the plan administrator is found in ERISA 3(16)(A). The term administrator
means:
The person specifically so designated by the terms of the instrument under which the
plan is operated;
If an administrator is not so designated, the plan sponsor; or
In the case of a plan for which an administrator is not designated and a plan sponsor
cannot be identified, such other person as the Secretary may by regulation prescribe.
There is no specific section of the law that enumerates the duties of the administrator; instead
there are references throughout ERISA to such duties. Here is a listnot necessarily
comprehensiveof duties of importance for our understanding of the role:
ERISA 403(c)(2): charged with determining whether an employer contribution was
made due to a mistake in fact;
ERISA 101-104: responsibility for providing summary plan description (SPD),
summary of material modifications (SMM), and summary annual report (SAR);
ERISA 103(b)(1): responsibility for filing annual report (Form 5500 with Schedules and
attachments, such as plan audit) with DOL;
ERISA 103(b)(2): responsibility for filing terminal and supplementary reports on
terminating plan with DOL;
ERISA 103(i): responsibility for meeting blackout notice requirements; and
29 USC 1056(d)(3): responsibility for satisfying the (Qualified Domestic Relations Order
(QDRO) requirements.
In addition, there are general fiduciary and ERISA duties which apply to the administrator,
such as:
The ERISA 107 records retention requirement;
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Enforcing anti-alienation provisions;
Enforcing ERISA 200s requirements with respect to participation and vesting (such as
by ensuring the appropriate language is in the plan document, and enforcing those
document provisions);
The ERISA 404(a) fiduciary duties if applicable, such as the requirement to ensure that
service providers are prudently selected and overseen; and
The requirement to ensure that plan expenses are reasonable.
In other words, the Plan Administrator ensures the plan is run in accordance with ERISA,
except to the extent such a responsibility is allocated to another (such as the responsibility of
the trustee to manage plan assets in accordance with ERISA).
PLAN TRUSTEE
ERISA does not require a particular entity to act as trustee. A trustee may be a bank, individual,
organization or trust company. It may not be a person convicted of committing certain felonies.
Trustees are appointed by being named in a written trust instrument or by appointment by a
named fiduciary. Generally, trustees must acknowledge in writing their fiduciary status.
The law gives the trustee the broad scope responsibility for plan assets. There are few specifics
as to what this entails. ERISA provides for certain duties that all fiduciaries have, and certain
duties unique to the trustee alone. Here are examples of trustee duties:
Maintain the indicia of ownership within the jurisdiction of the U.S. district courts;
Safeguard the plan assets;
Commit no prohibited transactions;
Follow a reasonable process for ensuring that other parties in interest and fiduciaries do
not commit prohibited transactions with respect to plan assets;
Follow a prudent process to manage the plan assets, including a responsibility to select
and monitor investments;
Take action to secure contributions, improperly distributed benefits, and late deferral or
loan repayment remissions;
Follow participant directions in accordance with plan document provisions where they
exist, unless those directions conflict with ERISA;
Prudently select and monitor service providers with respect to plan assets;
Ensure any expenses paid by the trust are reasonable; and
Follow the terms of the plans governing documents unless they conflict with ERISA, in
which case the trustee has the duty not to follow those terms.
The responsibilities of a trustee may not typically be allocated or delegated unless to an

investment manager with authority over assets. A trustees responsibility may be delegated to
an investment manager as the fiduciary if the investment manager has power to manage,
acquire and dispose of plan assets, if the investment manager is either a registered investment
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advisor under the Investment Advisors Act of 1940, or if the investment manager is a bank or
insurance company qualified in more than one state and has acknowledged in writing its
fiduciary status.
A trustee must reject an employer contribution of property unless it is qualifying employer real
property to avoid a prohibited transaction. Plan trustees are relieved for acts of omission of the
investment manager. However, trustees are responsible for monitoring the investment
manager.
DIFFERENCE BETWEEN A DIRECTED TRUSTEE AND A DISCRETIONARY TRUSTEE

A fully discretionary trustee is responsible for all aspects of plan assetsthe full
statutory role of the trustee undiluted by allocation or delegation to other fiduciaries.
The directed trustee, on the other hand, does not itself exercise discretion to make
decisions but is instead directed by a named fiduciary making the decisions. The
directed trustee has no responsibility to scrutinize or second-guess the directions it
receives, but does have some residual responsibility for ensuring the directions are
consistent with ERISA and the terms of the plan. Because of the limit of liability for a
directed trustee, appointing a directed trustee provides only very limited relief to the
other plan fiduciaries.
INVESTMENT MANAGER
An investment manager is a person registered under the Investment Advisors Act of
1940, a bank or trust company or an insurance company. An investment manager must
have the power to manage, acquire or dispose of plan assets and must acknowledge in
writing that it is a fiduciary under ERISA. The plan trustee or the named fiduciary who
directs the trustee appoints an investment manager.
Broker-dealers are generally not deemed fiduciaries if they are registered under the Securities
Exchange Act of 1934, reporting dealers in U.S. government securities or supervised banks that
execute securities transactions and perform such transactions as a normal course of business.
The broker-dealer may not be affiliated with a plan fiduciary who issues the investment
instructions. The broker-dealer must receive direction from an authorized plan fiduciary
regarding any transaction involving plan assets. Brokers can become fiduciaries if they engage
in unauthorized acquisitions or dispositions of plan assets or render investment advice or in
any other way function as a fiduciary.
Insurance companies and brokers may become fiduciaries if they perform or have authority or
responsibility to control or manage a plan or its assets, render investment advice or in any other
way act as a fiduciary. They may be considered to have rendered investment advice if they give
advice concerning the value of securities or other property, make recommendations regarding
the purchase or sale of securities or other property or directly or indirectly have discretionary
authority or control over plan investments.
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The best answer to what is the definition of an investment advisor? is that one is an
investment advisor for ERISA purposes (i.e., a fiduciary by virtue of giving investment
advice) if he or she meets the five-part functional definition. He or she:
Renders advice for compensation;
On a regular basis;
Subject to a mutual agreement, written or unwritten;
With the understanding that the advice will form a primary basis for decisions; and
Where the advice is individualized to the needs of the plan.
The Pension Protection Act of 2006 (PPA) amended the Employee Retirement Income Security
Act of 1974 (ERISA) to create a new statutory exemption from the prohibited transaction rules
to expand the availability of fiduciary investment advice to participants in 401(k)-type plans
and individual retirement accounts (IRAs), subject to safeguards and conditions. In October
2011, the Department of Labors Employee Benefits Security Administration (EBSA) released a
final rule to implement these PPA provisions and make fiduciary investment advice more
accessible for millions of Americans in 401(k) type plans and individual retirement
arrangements (IRAs). The final regulations are effective on December 27, 2011 and apply to
transactions occurring on or after that date.
The statutory exemption allows fiduciary investment advisers to receive compensation from
investment vehicles they recommend if either (1) the investment advice they provide is based
on a computer model certified as unbiased and as applying generally accepted investment
theories, or (2) the adviser is compensated on a "level-fee" basis (i.e., fees do not vary based on
investments selected by the participant). The final regulation provides detailed guidance to
advisers on compliance with these conditions. More detail on the final regulations can be found
at http://www.dol.gov/ebsa/newsroom/factsheet/fsinvestmentadvicefinal.html#.UM3853fhd8E.
DIFFERENCE BETWEEN INVESTMENT EDUCATION AND INVESTMENT ADVICE

The ERISA 3(21)(A) definition of a fiduciary says that giving investment advice makes
one a fiduciary. DOL Reg. 2510.3-21(c) takes the statute a step further with the five
part functional definition of advice. DOL Interpretive Bulletin 2509.96-1 defines advice
as distinguished from education, which one can provide without being a fiduciary. The
distinction between education and advice was provided by DOL for purposes of
clarifying the definition of a fiduciary.
So the difference between education and advice for ERISA purposes is that certain
information and interactive services, provided to participants and fiduciaries, do not
constitute advice for purposes of the fiduciary definition. The distinction is not
important for any other reason. Examples of education include (but are not limited to):
Plan information (e.g., benefits, provisions, information on investments);
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General financial and investment information (e.g., risk and return, dollar cost
averaging, compounding, etc. including information on how to assess risk
tolerance, future financial needs, and time horizon);
Asset allocation models (online, on paper, or via interactive materials); and
Interactive materials (e.g., questionnaires, worksheets, software).
WHO CANNOT BE A FIDUCIARY?

An individual convicted of certain crimes is not permitted to serve as a fiduciary.
Fiduciary Duties
Under ERISA a fiduciary must:
Act solely in the interest of plan participants and their beneficiaries;
Act for the exclusive purpose of providing benefits to plan participants and their
beneficiaries and defraying reasonable expenses of administering the plan;
Exercise the same care, skill, prudence and diligence that a prudent person acting in a
like capacity and familiar with such matters would exercise in the conduct of an
enterprise of a like character and with like aims;
If the fiduciary is involved in investing plan assets, diversify plan investments so as to
minimize the risk of large losses (unless it is clearly prudent not to do so under the
circumstances). Diversification is not violated if an individual account plan holds
qualifying employer real property or qualifying employer securities; and
Act in accordance with the documents and instruments governing the plan (insofar as
the documents and instruments are consistent with ERISA).
In short the fiduciary duties under ERISA 404(a)(1) can be summarized as loyalty, prudence,
diversification and following the governing document of the plan.
EXCLUSIVE BENEFIT RULE

THE EXCLUSIVE BENEFIT RULE MEANS TO:
Act solely in the interest of the plans participants or beneficiaries;
To provide benefits to them; and
To defray reasonable administrative expenses.
A transaction may incidentally benefit the employer without resulting in a violation of the
exclusive benefit rule. However, a conflict of interest may occur when a plan fiduciary acts as
agent of the employer in context of an acquisition or disposition of businesses.
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FIDUCIARY PRUDENCE
ERISA 404(a)(1)(B) requires a fiduciary to exercise the same care as a prudent man acting in a
like capacity and familiar with such matters. Prudence depends on circumstances that a
prudent expert having similar duties and familiar with such matters would consider relevant.
Substantive prudence in connection with plan investments means the:
Transaction has been evaluated as part of the overall portfolio;
Design of the portfolio must be reasonable;
Risk of loss/opportunity must be favorable;
Diversification of portfolio uses appropriate consideration;
Liquidity and current return of the entire portfolio is relative to anticipated cash flow
needs; and
Projected return is relative to the funding objectives of the plan.
To exercise procedural prudence means a fiduciary must:
Employ proper methods to investigate, evaluate and structure the investment;
Act in the same manner as others who act in a like capacity and are familiar with such
matters;
Exercise independent judgment when making investment decisions; and
Diversify investments to minimize risk of large losses unless under the circumstances it
is not prudent to do so.
To exercise prudence in diversification, a fiduciary must:
Consider the purpose of the plan;
Amount of plan assets;
Financial and industrial conditions;
Type of investments;
Distribution as to geographical location;
Distribution as to industries; and
Dates of maturity.
ERISAs prudence standard requires a fiduciary lacking expertise or education on a particular
issue to seek the assistance of an expert in order to fulfill his fiduciary obligations. Relying on
the advice of an expert does not relieve the fiduciary of liability. A fiduciary must still review
the experts work before relying on it.
SETTLOR FUNCTIONS
A settlor function is an action or decision made by the plan sponsor rather than by a fiduciary
exercising discretion. Common settlor functions include making decisions regarding
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establishing a plan, plan benefits to be provided, the discretionary amendment of a plans terms
and termination of a plan. You will often see the term settlor functions in relation to what
expenses the plan can and cannot pay. See section Expenses That Cannot Be Paid By the Plan for
details.
DOL Proposed Regulation to Broaden Fiduciary Status Under

ERISA
Information provided by ASPPA ASAP No. 10-35
On October 22, 2010, the U.S. Department of Labor (DOL) published in the Federal Register a
proposed regulation to update the definition of a fiduciary under ERISA
(http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24328). The proposed
regulation would modify and expand the definition of fiduciary in the context of providing
investment advice to a plan fiduciary, as well as to a plan participant or beneficiary. According
to the preamble, the DOL believes the current fivepart test is insufficient to protect plans
because no matter how egregious the abuse, plan consultants and advisers have no fiduciary
liability under ERISA, unless they meet every part of the fivepart test. This proposal rewrites
rules that have been untouched for 35 years.
APPLICATION TO ADVISERS AND PENSION CONSULTANTS

The proposal would expand the reach of the fiduciary definition found in ERISA 3(21)(A)(ii).
The new rule would apply to persons (whether acting directly or indirectly through an affiliate)
who for a fee or other compensation make recommendations regarding the advisability of
investing in, buying, holding, or selling securities or other property or giving advice regarding
the management of securities or other property. This expansion would increase the potential
liability of many advisors and TPAs in the retirement plan industry which could have a
significant effect on the cost of providing services to a plan and therefore the expenses of
operating a plan. This was a primary concern raised during the comment period and as such the
final regulations have yet to be issued at the time of this publication.
Disclosure
Fiduciaries owe a duty to the plans participants and beneficiaries to provide them with
information about the plan and the benefits provided thereunder.
There are two general categories of disclosure to participants and beneficiaries:
1. Mandated disclosure to be furnished to participants at specific times or upon specific
events including the SPD (further discussed below), SAR, SMM, blackout notices and
period participant statement; and
2. Material required to be furnished when requested by beneficiaries or participants
including copies of the Annual Reports (Forms 5500), applicable collective bargaining
agreements, trust agreements, contracts or other documents pursuant to which the plan
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was established or has been operated and a complete list of employer and employee
organizations sponsoring the plan.
ACCEPTABLE METHODS OF DISTRIBUTION

Acceptable methods of distribution under ERISA include measures reasonably calculated to
ensure actual receipt of material, such as mailing, personally delivering to the address provided
by requesting individual or disclosure through electronic media.
The plan administrator must comply with the following guidelines for disclosure through
electronic media:
Ensure that the participant actually received the material by either use of a returnreceipt electronic mail feature or by periodic surveys;
Prepare electronic disclosures in a manner consistent with the style, format and content
of the written documents;
Notify plan participants and beneficiaries electronically or in writing of which
documents are being provided electronically; and
Allow participants and beneficiaries to receive the material in writing at no additional
charge, if requested.
Material that is required to be given to all participants must be sent by a method or methods
likely to result in full distribution including hand delivery; inserting information in a periodical
or publication; and 1st, 2nd, or 3rd class mailing if forwarding postage is guaranteed and
address correction is requested.
Electronic delivery is permitted for participants who access the plan sponsors electronic
information system as an integral part of their job duties and who can access the information
where they work. For others electronic delivery is only permitted if certain conditions are met,
including participant consent. For participants who dont have access to computers at work,
documenting compliance with the electronic delivery rules may be burdensome.
Regarding electronic delivery of benefit statements the requirements may be satisfied through a
continuous-access website if advance notice is furnished to participants. Technical Release
2011-03R confirmed that a continuous-access website may be used for making electronic
disclosures. However, depending on the type of information being disclosed consent may still
be required by the plan participant. There is a penalty of $110 per day for a plan administrators
failure or refusal to provide the requested information within 30 days, for anything the
participant has the right to receive upon request.
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SUMMARY PLAN DESCRIPTION (SPD)

An SPD is a detailed summary description of plan provisions intended to be understood by the
average plan participant and is often the only document provided to participants summarizing
plan features.
It must be provided within 90 days after becoming a participant in the plan (or if later within
120 days after the plan becomes subject to ERISA). Beneficiaries must receive the SPD within 90
days after benefit payments begin.
The SPD must not mislead, misinform or fail to inform participants and beneficiaries. A
disclaimer does not generally negate inaccuracies in the SPD. The SPD should reserve the right
of fiduciaries to interpret the terms of the plan and resolve inconsistencies and should also
reserve the right to amend or terminate the plan. A fiduciary can be held liable for inaccuracies
in the SPD, so the SPD should stipulate that the plan document controls where there are
inconsistencies between plan document and the SPD.
SUMMARY OF MATERIAL MODIFICATIONS (SMM)

An SMM is required under ERISA 102(a)(1) when there has been a material modification to the
plan or when the information provided in the SPD has changed. The summary must explain the
amendment or change in a manner that can be reasonably understood by the average
participant.
The plan administrator must provide a copy of the SMM to each participant and to each
beneficiary who is receiving benefits under the plan no later than 210 days (approximately 7
months) after the close of the plan year in which the amendment was adopted. The reference to
"in" which the amendment is adopted is important, because it means that even if an amendment
adopted in a plan year is retroactive to an earlier year, the 210-day deadline is measured by
reference to the end of the plan year in which the adoption of the amendment occurs.
If a participant or beneficiary is receiving the SPD for the first time, any previously prepared
SMMs that describe amendments not yet incorporated into the SPD must accompany that SPD.
If before the time delivery of the SMM is required, an updated SPD is prepared that
incorporates the amendment to the plan, delivery of the updated SPD will satisfy the SMM
disclosure requirement.
SUMMARY ANNUAL REPORT (SAR)

ERISA 104(b)(3) requires the plan administrator to furnish to each participant and to each
beneficiary receiving benefits under the plan a summary of the plan's financial status. This is
known as a summary annual report, or SAR, because it summarizes the information on the
plan's annual report (Form 5500 series) filed with the government. The Form 5500 filing
contains this information, but providing a copy of the form to participants will not satisfy this
requirement.
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The SAR for a plan year must be furnished no later than 9 months after the close of the plan
year. This deadline provides the plan administrator 2 months after the Form 5500 filing is due to
prepare and distribute the SAR. If the Form 5500 filing is extended the SAR is due 2 months
after the extended due date.
The SAR has become more important in recent years because inclusion of additional
information in the SAR is a requirement for the small plan audit waiver to apply.
Effective for plan years beginning in 2008, defined benefit plans that are subject to the funding
notice requirement under ERISA 101(f) are exempt from the SAR requirement. The funding
notice requirement applies only to defined benefit plans that are subject to Title IV of ERISA
(i.e., PBGC-covered plans). The effect of this change is to limit the SAR requirement to DC plans
and to non-PBGC defined benefit plans.
BLACKOUT NOTICES
A blackout period is defined as a period in which any of the following abilities of
participants are suspended, limited or restricted for more than three consecutive
business days:
Ability to direct or diversify assets;
Ability to obtain loans; or
Ability to obtain distributions.
The blackout notice must be written in a manner calculated to be understood by the
average plan participant and must include:
The reasons for the blackout period;
An identification of the investments and other rights affected;
The expected beginning date and length of the blackout period;
In the case of investments affected, a statement that the participant or beneficiary
should evaluate the appropriateness of their current investment decisions in light
of their inability to direct or diversify assets credited to their accounts during the
blackout period;
If 30 days advance notice is not furnished, an explanation as to why the plan was
unable to furnish at least 30 days advance notice; and
The name, address and telephone number of the plan administrator or other
contact responsible for answering questions concerning the blackout period.
Advance notice with specified content required must be provided 30 to 60 days prior to
the blackout beginning date. The notice period can be shortened to less than 30 days
(and the notice given as soon as reasonably possible instead) if:
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It would be imprudent not to, and a plan fiduciary so certifies in writing; and
Unforeseeable events or circumstances occur beyond a reasonable control of the
administrator.
If the length of the blackout period changes, participants must be notified as soon as
possible.
In the case of a plan that holds employer securities, the issuer of the employer securities
must be notified as well.
Remember that the blackout notice requirement only applies if the blackout is for more
than three consecutive business days. When replacing a failed investment option in a
401(k) plan (i.e., one that fails to meet the responsible fiduciarys criteria for prudence),
it is important to complete the replacement in three days or less to avoid triggering a
blackout. Stated another way, the blackout MUST be completed in three days or less,
and one must know in advance that it WILL be completed in three days or less, or else a
notice is required. A fiduciary planning a two-day blackout (without notice) that
stretches inadvertently to four days violates the notice requirement no matter what the
intent. For this reason it is often prudent to issue a blackout notice when replacing a
fund if the transfer cannot be guaranteed to be completed in less than three days.
OTHER NOTICES
An ERISA 204(h) notice must be furnished to participants in a pension plan subject to
minimum funding requirements if the amendment provides a significant reduction in the rate
of future benefit accrual. The notice must be received by the participants after the adoption of
an amendment, but 15 days prior to the effective date of the amendment. If the plan has over
100 participants, the notice must be given 45 days prior to becoming effective.
An IRC 402(f) rollover notice to participants is required to explain special taxation of
distributions from a qualified plan. The notice must be provided to a distributee no less than 30
days and no more than 90 days before the date of a distribution. However, if the distributee,
after having received the IRC 402(f) notice, affirmatively elects a distribution, a plan will not
fail to satisfy IRC 402(f) merely because the distribution is made less than 30 days after the IRC
402(f) notice was provided.
ERISA requires adequate notice in writing to participants and beneficiaries of the benefits claim
procedures. The benefit claim procedure must be described in the SPD. A claim is considered
filed when the claimant follows reasonable procedures established by the plan. The procedure
may not contain a provision that unduly hampers the filing or processing of claims and must
comply with DOL regulations, which specifically provide for certain written notices to the
participant and beneficiary. Denial of claims must be made in writing within a reasonable time
after a claim is filed and contain specific reasons for the denial including reference to pertinent
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plan provisions on which the denial was based. In addition, a denial of claims must include an
explanation of additional material necessary for filing an appeal to the decision and specify why
the additional material is needed. An appeal must be made within 60 days after denial.
There are numerous other notices that were added by PPA 2006 including but not limited to the
ERISA 101(j) notice of funding-based limitation on certain forms of distributions for defined
benefit plans, the qualified default investment alternative (QDIA) notice, the automatic
enrollment notice, and the safe harbor notice.
FOREIGN LANGUAGE RULE

Plans with more than a prescribed number or percentage of participants who are
literate only in the same non-English language (i.e., not bi-lingual in the other language
and English) must include instructions for how to receive assistance in that language.
This requirement applies to SPDs, SMMs, and SARs as well as some additional notices
mandated by PPA 2006.
Plans subject to this requirement:
Small Plans: plans covering fewer than 100 participants at the beginning of the
plan year with 25% or more of the participants literate only in the same nonEnglish language; and
Large Plans: plans covering 100 or more participants in which the lesser of 500 or
10% of participants speak the same non-English language.
If two separate groups speaking two different languages independently meet the
requirements, information must be provided in both foreign languages.
RECORD RETENTION
ERISA requires that certain records be retained by any party who is required to provide reports
or disclosures. Employers must maintain sufficient records for each participant to determine
any benefits due and payable to that participant. These records must be available for
examination for a period of not less than six years after the filing date of the documents based
on the information which they contain. Electronic media can be used for the storage of such
records as long as the information is readily available and can easily be converted into paper.
Proper back-up storage must be maintained.
A denial of a claim for benefits or a challenge of the amount of benefits by a participant is not
uncommon. As such, it is necessary to retain all records of the plan that contain information on
the calculation of benefits or the amount of benefits distributed in any year back to the inception
of the plan. Even upon the plans termination, records should be maintained with regard to
benefit calculations and distributions to dispute any future claims. In other words, certain
records must be kept forever.
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QUALIFIED DOMESTIC RELATIONS ORDER (QDRO)

A fiduciary generally may not pay benefits to someone other than the participant or beneficiary,
this is part of the application of the exclusive benefit rule. A spendthrift clause prohibits
assignment or alienation of a participants benefits. There are exceptions for QDROs, voluntary
and revocable assignments not in excess of 10% of payments, participant plan loans and seizure
or offset of benefits of a fiduciary who breaches the plan.
The plan administrator is responsible for determining if a Domestic Relations Order (DRO) is a
QDRO. A QDRO provides child support, alimony payments or marital property rights to a
spouse, former spouse or other dependents of a participant from most tax-qualified retirement
plans.
The plan must have an established procedure to determine the qualified status of a DRO and to
distribute benefits pursuant to the QDRO. The plan document treats an alternate payee as a
beneficiary under the plan. A QDRO may not require a plan to provide any form of benefit not
otherwise provided by the plan. Expenses relating to the determination of the DROs qualified
status may be charged directly to the participant account or the alternate payee. QDRO rules do
apply to IRAs.
Plan Expenses
One short line, defraying reasonable expenses, in the exclusive benefit rule tells us
that fiduciaries have an affirmative duty to ensure expenses are reasonable. We also
know that:
The prohibited transaction rules tell us that any compensation for service
providers and fiduciaries is prohibited unless the vendor or fiduciary qualifies
for an exemption.
The self-dealing rules further clarify that fiduciaries may not act in a capacity
where they stand to benefit based on the choices they make or the advice they
render, such as when some funds pay more than others.
The statutory prohibited transaction exemptions and the regulations thereunder
tell us that the contracts or arrangements and the expenses themselves must be
reasonable.
We can reasonably infer that any fiduciary who agrees to pay a service provider
or other fiduciary in a manner that is prohibited is guilty of breaching the duty of
prudence.
Fiduciaries must discover the full extent of plan costs and service provider
compensation, from whatever source derived, including hidden revenue-sharing
and conflicts of interest.
The following issues should be considered when paying plan expenses:
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Fees from benefit professionals should be subdivided between settlor and
administrative functions to determine the appropriate payment source.
In Field Advisory Bulletin 2003-3, the DOL reversed its previous position and stated that
expenses for processing benefit distributions may be charged to participants from their
accounts. The DOL specifically cited the following expenses that could also be charged
to specific participant accounts:
o
Processing hardship distributions,
Calculating the value of optional forms of benefits,
Processing of benefit distributions,
Administering separated vested participants accounts that remain in the plan,

and
Administering QDRO-related fees.
The funded status of the plan should be considered in deciding whether to pay expenses
from a defined benefit plan.
The plan document should provide that expenses may be paid out of plan assets. Furthermore,
reimbursement to the plan sponsor for expenses related to the plan must be authorized by the
plan document. Only direct expenses can be reimbursed without violating prohibited
transaction rules.
EXPENSES THAT CAN BE PAID BY THE PLAN

Under the requirement to maintain the plan for the exclusive benefit of the participants and
beneficiaries, fiduciaries must monitor the payment of expenses from plan assets. Payment of
expenses out of plan assets is allowed for reasonable administrative expenses such as:
Management and custody of plan assets;
Determination letter expenses for obtaining initial qualification of the plan;
Plan administration;
Recordkeeping;
Reporting and disclosure;
Expenses associated with maintaining plan qualification including nondiscrimination
testing;
PBGC premiums;
Bonding;
Fiduciary liability insurance;
Audit fees;
Investment and advisory fees;
Trustee fees;
Expenses to comply with the PBGCs termination procedures;
Payment for office space or certain services; and
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Amendments to maintain qualified tax status.
A participants account may be directly charged for administrative services not guaranteed by
ERISA such as loans or directed investments. The participant can also be charged for
distribution fees or expenses related to a QDRO. The plan also may assess reasonable charges to
the participant for furnishing copies of plan documents and instruments requested by
participants or beneficiaries.
ERISA 408(b)(2) regulations give us the following conditions for service providers to
receive compensation from the plan:
The service is necessary;
The service is provided according to a contract that is reasonable; and
The service is provided for reasonable compensation.
And if the provider is a fiduciary
The fiduciary may not use his influence to cause the plan to pay him (or a party
in whom he has an interest that may affect his best judgment) directly;
The fiduciary may not use his influence to pay him (or a party in whom he has
an interest) indirectly; and
The decisions to hire the fiduciary and how much to pay must therefore be made
by another, independent fiduciaryindependent by virtue of being unrelated to
the fiduciary who seeks to provide services.
Thus there is a three-part test for establishing that compensation is reasonable and
therefore permissible for a service provider who is not a fiduciary, and a six part test for
fiduciaries.
EXPENSES THAT CANNOT BE PAID BY THE PLAN

Expenses related to settlor functions may not be paid from the plan. A settlor function is
an action or decision made by the plan sponsor rather than by a fiduciary exercising
discretion. Examples of settlor expenses include:
Fees for conducting plan design studies;
Legal fees for amendment of the plan document when the amendment is not
required to maintain the plans qualified status;
Costs associated with starting a plan or transitioning to a new vendor;
Expenses associated with union negotiations on the subject of plan benefits;
Consulting fees to analyze the cost impact of implementing various plan designs;
Plan amendment fees in connection with establishing a participant loan program;
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That portion of the cost of producing participant enrollment kits that is attributed
to information for employees that is not related to the plan; and
Fees incurred for making a decision to terminate a plan.
REVENUE-SHARING EXPLAINED
The term revenue-sharing means different things to different people in the industry.
In the ERISA world, revenue-sharing refers to virtually any payment from a fund or
manager to a platform or provider. In the SEC and securities world, however, 12b-1s,
shareholder servicing fees, and sub-transfer agency fees are distinct types of payments
called by their distinct names, and revenue-sharing refers to payments by a fund
family from its own assets for business purposes. The distinction might seem merely
semantic, but is important to securities regulators. The emphasis for fiduciaries is
dramatically different than the emphasis SEC has for funds and brokers.
Regardless of what they are called, mutual funds and money managers make these
payments to vendors as a legitimate marketing or servicing fee. The payments typically
take the form of rebates of fund expense ratios (or revenue-sharing in the SEC sense,
meaning the payments come from the fund familys own assets) in amounts ranging
from 0.25% to 0.50%, though the full range is more like 0% to 1.00%. We can divide
revenue-sharing into the following five primary types of payments:
Finders Feestypically a 1.00%, one-time payment to the broker of record that
does not incur any sales charge to the client. The payment comes from the fund
familys pocket. These payments are becoming less common as fund families
realize the economics do not support these payments, and many of the big load
fund families (only load funds pay finders fees) have already discontinued most
finders fee payments.
12b-1sanother form of commission to the broker of record, typically a 0.25%
trail payment commencing as soon as assets are transferred or, for funds paying
a finders fee in year one, commencing in the thirteenth month.
Shareholder Servicing Feesanother name for fees similar to 12b-1s paid by no
load families, since 12b-1s are considered a commission, or load. Fund families
known as no load families can pay up to 0.25% and not be required to call it a
12b-1, but only service providers, not brokers, can receive these payments.
Sub-Transfer Agency Fees (Sub-TA Fees)originally a payment to a recordkeeper
with an omnibus account at the fund family, which allows the fund family to
eliminate hundreds or thousands of individual client accounts in exchange for
one big account. Eliminating all those small accounts saves money, and the fund
family passes part of the savings on to the recordkeeper. In recent years,
however, the use of sub-TA fees has expanded to become an alternate means of
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providing revenue-sharing to various service providers, not just recordkeepers.

For example, the same no load fund families that are limited to a 0.25%
shareholder servicing fee often offer an advisor or similarly-named share class
that offers an additional 0.25% sub-TA payment, for a total of 0.50% revenuesharing. Again, however, brokers are not eligible to receive these payments.
Revenue-sharing in the SEC sense of the termpayments from a fund familys
assets as opposed to from a funds assets. For example, a fund family might offer
a high-producing broker an additional 10 basis points (0.10%) trail commission
as a reward for production.
Commissionsa sixth form of revenue-sharing is the standard sales commissions
paid by load funds. Since virtually no qualified plans pay up-front sales loads
anymore, loads are generally considered as being separate from revenue-sharing.
REVIEW OF KEY GUIDANCE ON REVENUE-SHARING

ERISA 404(a)(1)(a), the exclusive benefit rule says that fiduciaries must act in the exclusive
interests of plan participants and beneficiaries. In other words, fiduciaries may not even
consider the size of their own compensation in making investment decisions for the
plan; they may consider only what is best for participants.
ERISA 406(b) contains a broad prohibition against fiduciary self-dealing in a variety of
forms. In the case of revenue-sharing, fiduciaries are prohibited from receiving

compensation of any sort that might influence the decision-making process. Since a
.50% payment by Fund Y might influence a fiduciary to choose fund Y over Fund X,
which only pays .25%, the receipt of such payments is a prohibited transaction. Overall,
fiduciaries may not receive any consideration from any party dealing with a plan in
connection with a transaction involving plan assets, though specific exemptions exist.
DOL Advisory Opinion 1997-16A is called the Aetna Letter in which DOL clarifies that a
nonfiduciary can keep revenue-sharing payments. More importantly, however, the

Aetna Letter provided a crucial insightthat plan fiduciaries have an obligation to
discover the full amounts of compensation from whatever source derived, including
revenue-sharing payments. In other words, DOL believes that plan fiduciaries are
expected to discover the existence and amounts of revenue-sharing payments to all
vendors. Considering that the available disclosure is limited, proper discovery can be
quite difficult.
DOL Advisory Opinion 1997-15A, is called the Frost Letter in which DOL clarifies that a
fiduciary advising the plan sponsor on investment selections for a plan may collect
revenue-sharing payments on behalf of the plan but must account for each payment
and pass it on 100% to the plan in the form of an expense offset or direct payment. The
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problem with the Frost Letter is that it suggests that any fiduciary, including an ERISA
investment advisor or other fiduciary who did not have discretion, is also bound by the
prohibition against keeping the revenue-sharing payments. Thus a directed trustee, a
fiduciary with no discretion over plan assets, could be prohibited from accepting
revenue-sharing payments, contrary to the existing practice of many directed trustees
and other vendors. This concern led ABN AMRO to seek clarification, which DOL
provided in DOL Advisory Opinion 2003-09A.
DOL Advisory Opinion 2003-09A, the ABN AMRO Letter clarified that a directed trustee
with no discretion over plan assets and not giving investment advice as defined by
the regulations could keep revenue-sharing payments. Thus, those vendors who offer
co-fiduciary services under various labels but do not accept full discretion over plan
assets or give investment advice avoid the problem of not being permitted to continue
accepting revenue-sharing payments. Since many plan platforms are predicated on such
payments, a different ruling from DOL would have had immediate and far-reaching
consequences for the industry. In the ABN AMRO case, ABN AMRO serves as plan
trustee but as directed, not discretionary, trustee and even though a trustee is always a
fiduciary, which would seem to require conformance with the Frost Letter, this ruling
agreed with ABN AMRO that it could keep the revenue-sharing payments.
EXAMPLE: There are two TPAs. The first is a nonproducing TPA that serves
exclusively as a nonfiduciary contract administrator and does not sell investments or
provide investment advice. The second is a producing TPA whose advisory arm
meets the definition of a fiduciary investment advisor found in the regulations.
Situation A: NonProducing TPA. The nonproducing TPA accepts revenue-sharing
payments from qualified plan vendors, typically in one or more of the following forms:
Sub-transfer agency fees;
Basis point payments directly from a provider based on plan assets; or
A commission or commission override from an insurance company.
Analysis: Thats Okay. The TPA is a nonfiduciary, and the nonfiduciary status of TPAs
has been well documented, as long as the TPA is careful not to exercise discretion with
respect to plan assets or administration. Note, however, that there is some risk that a
vendor with undisclosed compensation may be considered to be setting its own
compensation, and that the act of choosing a compensation amount is a fiduciary
decision. Thus, it could be argued that a TPA accepting undisclosed payments from an
insurance company has in effect set its own compensation and thereby become a
fiduciary by virtue of exercising the discretion to choose the compensation. Also,
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if/when the new ERISA 408(b)(2)(c) contract rules become effective, disclosure is likely
to become an affirmative obligation.
Solution: Full Disclosure. As long as the TPA fully discloses its compensation, it
should be immune to the argument that it exercises discretion in setting its own
compensation. ASPPAs Code of Professional Conduct requires full disclosure of
compensation anyway. The TPA should have a mechanism for accurately accounting
for and reporting the actual amounts of compensation received with respect to each
plan and each vendor. The actual mechanism for accomplishing this feat of accounting
requires powerful software that is seldom, if ever, found off the shelf and often
requires customized programming. Other than this concern about how to deliver
accurate and complete disclosure, it is perfectly acceptable under DOL Advisory
Opinion 97-16A, the Aetna letter, for a nonfiduciary TPA to receive and keep revenuesharing payments.
Situation B: Producing TPA. The second TPA, the one with a sister company that
performs investment advisory services, operates in much the same way as the first TPA.
It accepts revenue-sharing payments from insurance companies and other vendors in
the form of sub-transfer agency fees or basis point payments. To be safe, the TPA gives
a one-line disclosure to the effect that it may receive such compensation from various
vendors. But the disclosure does not name the vendor or the amount of compensation.
The client receives no annual reckoning of the compensation. At no time does the client
see the actual dollar or percentage amounts of compensation.
Analysis: Prohibited Transaction. Because of the TPAs affiliation with the investment
advisor, compensation for the TPA must be considered to be benefiting the investment
advisor as well. The only safe course therefore is to treat the combined revenues of the
two companies as being subject to the rules governing revenue-sharing. Since the
advisory firm is serving as an ERISA investment advisor, it is bound by the Frost letter
and is therefore obligated to return all revenue-sharing payments to the plan in the
form of direct credits or dollar-for-dollar fee offsets. Since this course of action is not
happening, the advisor/TPA may be engaging in prohibited transactions with its clients.
Solution: Follow the Frost Model. Study the details of DOL Advisory Opinion 97-15A
and implement them.
DOLS THREE FEE TRANSPARENCY INITIATIVES

The DOL has spoken frequently of three regulatory initiatives aimed at increasing transparency
and disclosure:
New disclosure rules for the Form 5500 which were released in late 2007;
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A point-of-sale disclosure in the form of amendments to the regulations under ERISA
408(b)(2), the exemption allowing vendors to do what would otherwise be prohibited
transactionsprovide services and get paid; and
A participant fee disclosure.
Taken together, these three initiatives have far-reaching consequences and may dramatically
change the face of 401(k) products and services.
Regulations on Service Providers Making Fee Disclosures to

Fiduciaries
(Information provided by ASPPA ASAP No. 10-26.)
On July 16, 2010, the DOL published its longawaited regulations on ERISA 408(b)(2). This
provides the statutory exemption that allows plan service providers to be compensated for their
services without engaging in a prohibited transaction. The final regulation was issued February
3, 2012 with an effective date of July 1, 2012.
THE REGULATION
In general, the final regulations require that covered service providers make certain fee
disclosures in writing to the fiduciaries of a covered plan within certain timeframes. The
regulations also clarify that, while the disclosures must be made in writing, the agreement or
arrangement does not require a formal written contract as was the case under the proposed
regulations.
Helpful Definitions
Covered plan: A covered plan is a defined contribution or defined benefit plan within the
meaning of ERISA that is not exempted from ERISA coverage under ERISA 4(b), i.e., church
plan. IRAs and SEPs are not covered under the regulations, and most significantly, welfare
plans are not covered either. The DOL is planning on addressing welfare plan fee disclosure
issues in separate regulations. Also excluded are vendors providing services for less than
$1,000.
Covered service providers:
There are three categories of covered service providers.
Category A: Includes three subcategories:
1. A fiduciary service provider or registered investment advisor providing services directly
to the plan.
2. A fiduciary providing services to an investment contract, product or entity that holds
plan assets in which the covered plan has a direct equity investment.
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3. Investment advice provided directly to the covered plan by a registered investment
advisor under either the Investment Advisers Act of 1940 or State law.
Category B: Recordkeepers or brokers providing services to participant directed plans if one or
more investment alternative is made available through an arrangement connected to the
recordkeeper or broker.
Category C: Services for indirect compensation. This category includes, among others, any
number of services such as accounting, appraisal, banking, legal, investment brokerage, or third
party administration for which the covered service provider, an affiliate, or subcontractor
reasonably expects to receive indirect compensation.
Covered service providers do not include an affiliate or subcontractor of a covered service
provider.
Participant Fee Disclosure

Information provided by ASPPA ASAP No. 10-36
A process that first began with a DOL Request for Information in April of 2007, was followed
by a proposed regulation on July 23, 2008, has now culminated in a final regulation published
on October 20, 2010 in the Federal Register.
(http://webapps.dol.gov/FederalRegister/PdfDisplay.aspx?DocId=24323). This long awaited
change in the rules will significantly affect what and when information is given to participants
who have the right to direct the investment of their account.
COVERED PLANS AND PARTICIPANTS

The regulation was released in final form and it is effective on its date of publication. However,
more importantly, its applicability date, which is the deadline by which plan administrators
must be in compliance, is the first day of the plan year beginning on or after November 1, 2011,
i.e., January 1, 2012 for calendar year plans. There is also a transitional rule that allows the initial
disclosure to be made to existing participants with the right to direct investments on the plans
applicability date, to be given the annual notice information any time up to 60 days after the
applicability date. The initial notice was required no later than August 30, 2012. The first
quarterly statement disclosure was required no later than November 14, 2012.
The new rule only applies to plans that are subject to ERISA and are individual account plans
over which the participant is given the right to direct the investment of his account. The rule
would not apply to nonERISA plans, e.g., nonERISA 403(b) arrangements, etc.) The rule was
written under authority found in the general fiduciary standards of ERISA 404(a) which are
mandatory responsibilities. That is different than the directed investment safe harbor provided
by ERISA 404(c), which is optional and not required of plan fiduciaries. Much of the new
required disclosures were previously made on an optional basis to conform to the ERISA
404(c) safe harbor. In many cases, some minor additional information is all that is necessary to
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meet ERISA 404(c). In general the information that must be provided is general plan
information, expense and fee information, investment information and annuity option
information.
Allocation and Delegation of Fiduciary Responsibility

DELEGATION OF DUTIES
The plan document must provide a procedure for allocation of fiduciary responsibility;
otherwise, it will not relieve the named fiduciary of liability for performance.
A plan or trust document must provide for the method of designating persons as fiduciaries. A
fiduciary who is not a named fiduciary may delegate fiduciary responsibilities to any person
other than a trustee. Only a named fiduciary can delegate trustee responsibilities and the
responsibilities may not be delegated to anyone other than a trustee.
Fiduciary duties can be delegated, but the person to whom the duties are delegated will become
a fiduciary. This is true even if the person to whom duties are delegated has a contract
provision stating that they are not a fiduciary.
Unless a trust instrument or plan document names a trustee, a named fiduciary must appoint a
trustee. Trustee responsibilities generally relate to the investment or disposition of plan assets. A
trustee is liable for following the named fiduciarys directions that are not contrary to ERISA and
within the terms of the plan. Trustees with dual capacities should exercise special caution to
avoid prohibited transactions.
In summary, a fiduciarys responsibilities may be allocated among named fiduciaries or

delegated from one fiduciary to another. Allocation of fiduciary responsibility can be
thought of as structural: it is a division of labor among named fiduciaries and is
specified in the plan document or in accordance with a procedure authorized in the
plan document. Delegation of fiduciary responsibility, on the other hand, is a decision
by a named fiduciary to give some portion of its responsibility to another fiduciary who
is not a named fiduciary.
RESPONSIBILITY THAT IS RETAINED

ERISA provides that a fiduciary is not liable for the acts and omissions of another fiduciary to
whom responsibilities have been properly allocated or delegated. While a fiduciary can delegate
decisions to others it only provides partial relief to the delegating fiduciary. They retain the
duty to monitor those to whom they have delegated and the review should be done in a manner
that may be reasonably expected to ensure that the performance of the responsible individuals
complies with the terms of the plan and all statutory standards, including ERISAs exclusivebenefit, prudence, diversification, and prohibited-transaction rules.
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ERISA 404(c)
ERISA 404(c) sets forth rules allowing plan fiduciaries to insulate themselves from
participants exercise of investment control in an individual account plan. The plan fiduciary is
responsible for selecting and monitoring performance of the investment alternatives available to
participants, but is not responsible for the investment performance as long as proper
procedures are followed in selecting the investment options and participant instructions are
implemented. Compliance with ERISA 404(c) helps provide fiduciary relief from that liability.
An ERISA 404(c) plan is an individual account plan that provides opportunity for participants
and beneficiaries to exercise control over assets in their individual accounts. The participant or
beneficiary must be provided with choices from a broad range of alternative investments, and
the plan must allow reasonable opportunity to give investment instruction to a plan fiduciary.
Election for a plan to be covered by ERISA 404(c) is voluntary, so plans are not required to
comply with ERISA 404(c). ERISA 404(c) can apply to a whole plan or only a part of a plan
(e.g., a participant directed 401(k) could be covered by ERISA 404(c) while the trustee directed
profit sharing portion is not).
TWO PRIMARY CONDITIONS FOR ERISA 404(C) RELIEF FROM LIABILITY

ERISA 404(c) relief applies when an individual account plan permits the exercise of
control and a participant in fact exercises control. The two primary conditions can
therefore be stated as:
The plan permits control; and
Participants exercise independent control in fact.
INVESTMENT REQUIREMENTS
To be considered an ERISA 404(c) plan, the plan must provide at least three investment
alternatives or funds that:
Invest in a diversified manner;
Have materially different risk and return; and
Enable a participant or beneficiary to choose among funds to establish a portfolio with
aggregate risk and return characteristics within a range appropriate for the participant
or beneficiary while minimizing overall risk through diversification.
Other requirements for ERISA 404(c) plans include the following:
The investment fund must allow transfers not less frequently than once every three
months among core funds and must generally be in the form of a pooled fund to allow
small investors adequate diversification.
Each core fund cannot be limited in the amount that can be placed in it.
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The participant must give affirmative investment decisions to protect the fiduciary
unless a QDIA is used as a default fund as explained below.
More frequent than quarterly transfers may be required if investments are considered
volatile. Transfers more frequently than quarterly require that core funds allow for
coinciding transfers or a low risk liquid fund to hold funds temporarily.
Investment in employer stock may be allowed in ERISA 404(c) plans if:
The stock is publicly traded but not thinly traded (traded infrequently and/or in low
volumes).
Participants must receive all information as otherwise would be provided to
stockholders.
Voting tender rights must be passed through to participants and beneficiaries.
Confidentiality must be preserved regarding stock trades.
Core funds must accept transfers from employer stock as frequently as transfers may be
made to employer stock.
A participant or beneficiary has exercised control over investments if the participant or
beneficiarys investment was the result of exercise of control or if the participant or beneficiary
was provided with reasonable opportunity to give instructions and has independent control.
Exercise of control will not be considered independent if the participant or beneficiary is subject
to improper influence by a plan fiduciary or plan sponsor; the fiduciary concealed material,
nonpublic facts regarding investments; or the participant or beneficiary is legally incompetent
and the fiduciary knows it. Plan sponsors are not required to provide education or advice to
participants.
An ERISA 404(c) plan may charge participants and beneficiaries for expenses associated with
carrying out investment instructions.
NOTICE REQUIREMENTS
To comply with ERISA 404(c) regulations, certain information must be supplied automatically
to participants and beneficiaries. Those items include:
Notice of limited liability;
Description of all investment alternatives;
Identification of investment managers;
Investment instructions and restrictions;
Transaction fee details;
Name and address of who to contact for additional information;
Details on confidentiality procedures; and
Pass-through proxy materials (if voting rights are passed through to participants).
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Certain other information must be furnished to the participant or beneficiary upon request. This
information includes:
Operating expenses of funds;
A listing of assets comprising the portfolio of each investment;
Overall investment performance; and
Value of shares or units of investments held by the participant.
EXCEPTIONS
A fiduciary may refuse to follow participant instructions if the transaction:
Would result in a prohibited transaction under ERISA or the IRC;
Would cause the plan to be subject to tax as unrelated business taxable income (UBTI);
Could cause losses greater than the amount of the participants account balance;
Would jeopardize the tax qualified status of the plan;
Would cause the plans asset to be held outside federal jurisdiction; or
Would violate the terms of the plan or other specified instructions set out in the plan.
PROTECTION FOR MAPPING AND BLACKOUTS

In the past, the consensus legal opinion was that ERISA 404(c) relief was not available
during a blackout or after a fund mapping because one of the ERISA 404(c)
requirementsexercise of controlis not met since the participant has not affirmatively
elected the new investment. This has always been an onerous point of view, because it
implies the following:
If ERISA 404(c) is not available, that means fiduciaries are responsible.
If fiduciaries are responsible for individuals investment choices, it means they
must ensure participant accounts are prudently invested.
As a practical matter, therefore, the only way a fiduciary could be assured of
protection is to manage the participants accounts for them, prudently, by
defaulting every single affected participant into a managed portfolio or lifestyle
fund. It would then be up to the participant to make a new affirmative election
after every single fund replacement.
Since in a well-managed 401(k) there might be two or three fund replacements
per year, this suggests that participants would be constantly taken out of the
investments they had elected and moved to a default portfolio. Several times per
year the participant would have to re-do his or her elections.
PPA 2006 addressed these concerns by amending ERISA 404(c)(1), providing relief for
fiduciaries during blackouts if certain rules are followed, and by adding ERISA
404(c)(4), with relief for fiduciaries concerning mapping during fund replacements.
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Blackouts
Beginning in 2008, PPA 2006 grants a limited safe harbor during blackouts that says, in
brief, that as long as the sponsor and fiduciaries have otherwise met their fiduciary
obligations with respect to the plan and incur a blackout, they will not be responsible
for losses suffered as a result of the blackout.
EXAMPLE: If a plan goes into blackout on January 20 and emerges on February 5, and the
market goes up 2% during that time, the participants have lost the 2% they would
have gained, theoretically. This PPA 2006 provision gives relief to the sponsor and
fiduciaries for such hypothetical losses so long as other fiduciary requirements are met.
The key here is that meeting fiduciary requirements is a big topic, and calls for a
comprehensive, written, rigorously applied and documented fiduciary process of the
sort sponsors may not have. But assuming the proper process is in place, this is a
welcome form of relief.
Mapping
As of 2008, ERISA 404(c) relief became available for plans using mapping so long as
certain requirements are met:
Funds are mapped to either like funds or a QDIA;
Notice requirements are met;
The participant does not otherwise elect not to be mapped (i.e., there must be a
clear-cut opt-out mechanism).
This provision is welcome and sorely needed since it answers the problem described
above, where participants could be defaulted and re-defaulted continuously as
investment managers or funds are replaced. When mapping the full account balance of
a participant it may be prudent to map to a QDIA as it could be difficult to find a like
fund for all investment options, on the other hand if only one or two funds are being
replaced for underperforming expectations it may be more prudent to map to a like
fund. A QDIA is generally designed to hold the entire balance of a participant and
provides diversification accordingly. If for example a bond fund is replaced in the plan
and a participants balance in that fund is moved to a target date fund with an
aggressive allocation the result may have increased the risk for the participant
substantially.
RELIEF PROVIDED
Relief is only provided to the extent the loss is the direct and necessary result of the
participants exercise of control. Relief is transactional, meaning that the application of ERISA
404(c) is determined separately with respect to each investment transaction. In other words, a
plans failure to satisfy ERISA 404(c) with respect to a particular investment transaction does
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not necessarily preclude reliance on ERISA 404(c) with respect to investment transactions that
were satisfied.
The fiduciary who is responsible for selecting the investment alternatives has a duty to act
prudently in constructing the investment menu that is being made available to participants, and
to prudently monitor those alternatives. The duty to make, review and monitor investment
selections, includes the review of an investment manager whom the fiduciary has selected as an
investment alternative to be made available to the plan participants.
No relief is available in the following instances:
For instructions that, if followed would be contrary to the documents or instruments of
the plan, unless such documents or instruments are contrary to ERISA.
For a transaction that causes the fiduciary to maintain ownership of the plan assets
outside the jurisdiction of the U.S. courts.
For a transaction that would jeopardize the qualification of the plan, or that could result
in a loss that exceeds the account balance.
Qualified Default Investment Alternatives (QDIA)

PPA 2006, signed by President Bush on August 17, 2006, removes several impediments to
automatic enrollment plans. A key one is amending ERISA to provide a safe harbor for plan
fiduciaries investing participant assets in certain types of default investment alternatives in the
absence of participant investment direction. Prior to the enactment of PPA 2006, ERISA 404(c)
protection was not available on any money placed in a default fund.
EBSA has issued a regulation implementing the default investment amendments made to
ERISA by PPA 2006. The regulation deems a participant to have exercised control over assets in
his or her account if, in the absence of investment direction from the participant, the plan
fiduciary invests the assets in a QDIA.
RELIEF PROVIDED
The relief provided to fiduciaries is the same as for ERISA 404(c), plus there is
no liability for decisions of an investment manager or fund manager over a
QDIA (comparable protection to existing law). Fiduciaries remain responsible for
prudently selecting and monitoring QDIAs and QDIA managers. Fiduciaries
remain responsible for fulfilling all of their other fiduciary responsibilities and no
relief from the prohibited transaction rules is provided.
CONDITIONS FOR RELIEF

The regulation establishes the following conditions for fiduciary relief:
Assets must be invested in a QDIA as defined in the regulations.
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Participants and beneficiaries must have been given an opportunity to provide
investment direction, but failed to do so.
A notice must be furnished to participants and beneficiaries 30 days in advance of the
first investment, and at least 30 days in advance of each subsequent plan year, and must
include:
o
A description of the circumstances under which assets will be invested in a

QDIA;
A description of the investment objectives of the QDIA; and
An explanation of the right of participants and beneficiaries to direct investment

of the assets out of the QDIA.
Any material, such as investment prospectuses and other notices, provided to the plan
by the QDIA must be furnished to participants and beneficiaries.
Participants and beneficiaries must have the opportunity to direct investments out of a
QDIA with the same frequency available for other plan investments but no less
frequently than quarterly, without financial penalty.
The plan must offer a broad range of investment alternatives as defined in ERISA
404(c).
Plan fiduciaries are not relieved of liability for the prudent selection and monitoring of a
QDIA.
REQUIREMENTS FOR A QDIA

There are five requirements for QDIAs; a QDIA:
Cannot invest in employer securities, with two exceptions those held by a mutual
fund, Collective Investment Fund (CIF), or insurance separate account; and those
acquired through matching contributions made in the form of employer stock, but only
if the QDIA manager has discretion over that stock;
Cannot impose financial penalties or restrict the availability of a participant or
beneficiary to transfer from the QDIA;
Must be either managed by an investment manager or trustee as defined by ERISA
3(38) or an investment company registered under the Investment Company Act of 1940;
Must be diversified so as to minimize risk of large losses through a mix of equity and
fixed income investments; and
Must be one of three types of investments, namely funds with characteristics usually
found in target date funds, balanced funds or managed accounts.
TYPES OF INVESTMENTS THAT QUALIFY AS A QDIA

Target Date Fund or Portfolio
An investment fund product or model portfolio that applies generally accepted

investment theories, is diversified so as to minimize the risk of large losses and that is
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designed to provide varying degrees of long-term appreciation and capital preservation

through a mix of equity and fixed income exposures based on the participants age,
target retirement date (such as normal retirement age under the plan) or life expectancy.
Such products and portfolios change their asset allocations and associated risk levels
over time with the objective of becoming more conservative (i.e., decreasing risk of
losses) with increasing age. Asset allocation decisions for such products and portfolios
are not required to take into account risk tolerances, investments or other preferences of
an individual participant. An example of such a fund or portfolio may be a life-cycle
or targeted-retirement-date fund or account.
Balanced Fund or Portfolio
An investment fund product or model portfolio that applies generally accepted

investment theories is diversified so as to minimize the risk of large losses and that is
designed to provide long-term appreciation and capital preservation through a mix of
equity and fixed income exposures consistent with a target level of risk appropriate for
participants of the plan as a whole. Asset allocation decisions for such products and
portfolios are not required to take into account the age, risk tolerances, investments or
other preferences of an individual participant. An example of such a fund or portfolio
may be a balanced fund.
Managed Account
An investment management service with respect to which a fiduciary, applying

generally accepted investment theories, allocates the assets of a participants individual
account to achieve varying degrees of long-term appreciation and capital preservation
through a mix of equity and fixed income exposures, offered through investment
alternatives available under the plan, based on the participants age, target retirement
date (such as normal retirement age under the plan) or life expectancy. Such portfolios
are diversified so as to minimize the risk of large losses and change their asset
allocations and associated risk levels for an individual account over time with the
objective of becoming more conservative (i.e., decreasing risk of losses) with increasing
age. Asset allocation decisions are not required to take into account risk tolerances,
investments or other preferences of an individual participant. An example of such a
service may be a managed account.
120 Day Money Market/Liquid Fund Exception
An investment product or fund designed to preserve principal and provide a

reasonable rate of return, whether or not such return is guaranteed, consistent with
liquidity qualifies as a QDIA, but only for the first 120 days after the participants first
investment. The purpose of this rule is to give sponsors the ability to protect initial
participant investments from fluctuation during the time that he or she might be
permitted to get the money back.
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Stable Value Exception for Prior Investments Only
For default investments made before December 24, 2007, and only for those prior
investments, a fixed account or stable value fund qualifies as a QDIA, but only if there
is no charge or penalty for withdrawals initiated by a participant. This provision was
the subject of tremendous debate and lobbying prior to enactment of the final
regulation.
SUMMARY
The DOL regulation makes three major decisions about QDIA investments:
Diversified portfolios with a mix of equity and fixed income are suitable QDIAs.
Fixed accounts such as money markets and stable value funds are not suitable
QDIAs (with minor exceptions), though they may nonetheless be suitable
defaults in the right circumstances (i.e., prudent defaults but not eligible for
QDIA relief).
With limited exceptions, employer securities are not an appropriate part of a
QDIA.
Fiduciaries are eligible for the same type of relief normally available under ERISA
404(c) with respect to the assets they invest on behalf of participants who fail to make
an investment election, but only if the fiduciaries comply with this regulation.
Fiduciaries do not have to qualify for ERISA 404(c) relief to qualify for QDIA reliefa
critical point since compliance with ERISA 404(c) is widely considered to be both
difficult and rarely accomplished.
Fiduciary Liability
Plan provisions may not relieve a fiduciary of breaching fiduciary liability. Plans cannot
indemnify a fiduciary against liability.
ERISA permits indemnification of a fiduciary by the plan sponsor or an employee organization
whose members are covered by a plan. This indemnification does not relieve the fiduciary of
responsibility or liability but allows another party to satisfy the liability.
A fiduciary sued for a breach may be able to sue a co-fiduciary that participated in the breach,
but may not sue a nonfiduciary that participates in a breach.
A nonfiduciary cannot be held liable for a breach of fiduciary duty. However, a nonfiduciary
may be held liable for a prohibited transaction, and penalties also may apply to nonfiduciaries
for a breach.
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FIDUCIARY BREACHES
A fiduciary breach is a failure to fulfill any of the obligations or responsibilities imposed on
fiduciaries under ERISA. This includes breaches of the four core duties of the fiduciary under
ERISA 404(a)loyalty, prudence, diversification, and following documentsbut also failures
to provide SPDs, file reports, ensure vesting and participation standards are met, and so on.
A fiduciary that breaches the fiduciary requirements of ERISA is personally liable for any losses
to the plan resulting from that breach. Any profits obtained by the fiduciary through the use of
plan assets must be restored to the plan. Civil action may be taken to enforce personal liability
of the fiduciary by the Secretary of Labor, a participant, a beneficiary or another fiduciary.
Generally, a fiduciary is not liable for breaches of his or her predecessor. However, a successor
fiduciary is liable for not taking reasonable steps to remedy the situation. Knowledge of a
possible breach obligates the successor fiduciary to notify the plan trustees or the DOL.
There are three ways a fiduciary can be held liable as a co-fiduciary under ERISA 405(a):
1. Knowingly participate in or conceal a breach which the fiduciary knows to be a breach;
2. Enable a breach to occur through failure to meet ones own fiduciary responsibilities
under ERISA 404(a); and
3. Fail to make reasonable efforts to correct a breach that the fiduciary knows has occurred.
An attorney ultimately represents the plan when advising the fiduciary. It is an unresolved
issue in the courts whether attorney-client privilege would protect communications between a
fiduciary and an attorney in an action involving plan participants and beneficiaries.
Attorney fees may be reimbursed by the plan for the fiduciarys legal expenses incurred in
defending a lawsuit for a breach. The fiduciary can be held liable for attorney fees if the court
finds the fiduciary guilty of the breach.
CIVIL AND CRIMINAL PENALTIES

Under ERISA 501, any person who willfully violates any provision of part 1 of this
subtitle, or any regulation or order issued under any such provision, shall upon
conviction be fined not more than $100,000 or imprisoned not more than 10 years, or
both; except that in the case of such violation by a person not an individual, the fine
imposed upon such person shall be a fine not exceeding $500,000.
The authority for suing someone under ERISA is provided by 502, the civil enforcement rules.
Participants, beneficiaries, fiduciaries, and the Secretary of Labor are all permitted to bring suit
under ERISA for the following purposes (though not all parties can sue for all of these
purposescertain actions are limited to certain parties):
To enforce participant rights;

To clarify future rights;
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To recover benefits that are due;

To provide relief as provided by ERISA 409;
To obtain an injunction stopping an act or practice that violates ERISA or the
terms of the plan;
To enforce ERISA and the terms of the plan; and
To collect civil penalties.
There are a variety of civil penalties for failure to provide notices and other information
as required by ERISA, such as:
$100 per day per participant for failure to provide certain notices with respect to
defined benefit plans;
$1000 per day from the date of failure to file a complete Form 5500;
$1000 per day for failure to file the annual notice required in an automatic
contribution arrangement;
$1000 per day for failure to file any additional information that is required to be
filed with DOL; and
$100 per day for failure to provide a blackout notice.
The plan may be sued as an entity, in which case the legal process is served upon the
trustee or administrator, but money judgments will only be enforceable against the plan
unless the responsible fiduciary is found liable.
U.S. district courts have exclusive authority over most actions, with the state courts
having jurisdiction over certain specified actions. The court has discretion to award
attorneys fees and court costs to either party. A copy of the complaint in any ERISA
law suit is sent to the Secretary of Labor or the Secretary of the Treasury as appropriate,
and the Secretaries may intervene.
There is a civil penalty for prohibited transactions with two tiersa 20% first tier
penalty (originally 5%) and a 100% second-tier penalty assessed if the transaction is not
timely corrected. The civil penalty for prohibited transactions is reduced by the amount
of any excise tax paid for the same transaction under IRC 4975.
There is a civil penalty for breach of fiduciary duty equal to 20% of the applicable
recovery amount, defined as the amount identified in a settlement with DOL or by a
court. DOL has discretion to waive the penalty if the fiduciary acted in good faith or
will be unable to restore the losses without severe financial hardship.
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CORRECTING A BREACH
ERISA may impose legal remedies, equitable remedies or both for a breach. Legal remedies
include money damages for restoration of plan losses or disgorgement of fiduciary profits.
Equitable remedies include injunctions, constructive trusts and removal of a fiduciary. Liability
is joint and several meaning that two or more fiduciaries can each individually be held
responsible for the full amount of liability. A fiduciarys own plan benefits may be attached
regardless of the spendthrift and anti-alienation clauses.
To measure the plans loss resulting from a breach for restoration purposes, compare what the
plan actually earned or lost as a result of fiduciary actions to what the plan would have earned
or lost had the breach not occurred. Gains generally do not offset losses to the plan as a result of
a fiduciary breach.
Fiduciary profits from a breach must be disgorged regardless of whether the plan suffers loss.
Participants and beneficiaries may not recover punitive damages for a breach, but a plan may
recover damages resulting from fiduciary breach.
The DOL may assess a 20% penalty based on the amount payable pursuant to a court order
settlement with the DOL. This penalty may be waived or reduced by the DOL if it is determined
the fiduciary acted in good faith or cannot pay without severe financial hardship. The penalty
imposed on the fiduciary is offset by any tax or penalty imposed as a result of the prohibited
transaction.
If a fiduciary breach also involves a prohibited transaction, the IRS 15% excise tax applies as
well. Additionally, criminal liability for a breach of fiduciary duty may be assessed for willful
violation of any reporting or disclosure provisions under Title I of ERISA. A fine of $5,000
($100,000 if a partnership or corporation) may be assessed; and use of force, violence, threat,
fraud and/or intimidation against a participant or beneficiary may result in $10,000 fine and/or
imprisonment for one year. Accepting kickbacks in connection with an ERISA plan is a federal
crime, as is knowingly making false statements concealing facts in connection with plan
documents.
Other equitable remedies available for a breach of fiduciary duties include removal of the
fiduciary, permanently enjoining the fiduciary from acting as a fiduciary (or providing services
to) an ERISA plan or suspending the fiduciary until correction of the transaction that caused the
breach.
Participants or beneficiaries may recover any lost benefits against any person who interferes
with the exercise or attainment of any right that they are entitled to under the plan or ERISA.
Liability is generally applied to employers that discharge employees shortly before retirement
with an intent to cut off vesting.
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FIDUCIARY OR FIDELITY BOND

Every fiduciary and plan official of a benefit plan must be bonded if involved in handling funds
or other property of the plan. The bond shall provide protection to the plan against loss by
reason of acts of fraud or dishonesty on the part of the plan official, directly, or through
connivance with others. The amount of the bond shall be fixed at the beginning of each fiscal
year of the plan. Such amount shall be not less than 10% of the amount of funds handled. The
bond may not be less than $1,000, nor more than $500,000, except that the Secretary may
prescribe an amount in excess of $500,000, subject to the 10% limitation of the preceding
sentence. Note that PPA 2006 amended IRC 412(a) to increase the maximum to $1 million for
plans holding employer securities.
Higher bonding amounts may apply in order for a plan to meet the small plan audit waiver
requirements. This is discussed later in this section.
No bond is required of a fiduciary that is a corporation doing business under U.S. law;
is authorized to exercise trust powers or to conduct an insurance business; is subject to
supervision of federal/state authority and at all times has combined capital and surplus
in excess of such minimum prescribed by the Secretary, which is at least one million
dollars.
The ERISA fiduciary bond is an employee dishonesty insurance policy with very
limited application, and both sponsors and advisors routinely misperceive that the
bond is a fiduciary insurance policy. Fiduciary insurance indemnifies fiduciaries for
losses suffered due to breaches of duty; the bond only covers embezzlement or other
direct threats to the assets themselves.
FIDUCIARY LIABILITY INSURANCE

Fiduciary liability insurance may be purchased by the plan for itself and fiduciaries to cover
losses from omissions. If purchased by the plan, the contract must allow the insurance company
to seek recourse from the fiduciaries. Fiduciaries may also purchase fiduciary liability insurance
for themselves.
Fiduciary liability insurance covers most breaches of fiduciary duty arising under ERISA;
negligence in connection with administration of a plan; and defense costs, settlements, and
judgments.
INDEMNIFICATION AGREEMENT
An indemnification agreement is also permitted, under which another party (e.g., the employer)
agrees to satisfy any liability incurred by a fiduciary. The agreement must leave the fiduciary
fully responsible and liable.
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REDUCE THE RISK OF A BREACH

To reduce risk of breach as a fiduciary, the following steps should be followed:
Document compliance with claims procedures;
Adopt forms and establish consistent operational policies;
Document when a fiduciary assumes duties, is dismissed, resigns or is recused;
Hold formal fiduciary meetings and keep minutes; and
Consult experts as needed.
Prohibited Transactions
ERISA and the IRC prohibit certain transactions between the plan and an individual or entity
that has a specific relationship to the plan known as a party-in-interest (under ERISA) and a
disqualified person (under the IRC).
PARTY-IN-INTEREST
The term party-in-interest encompasses anyone who is a fiduciary to the plan as well as
nonfiduciaries. A party-in-interest is defined as:
1. Any fiduciary of the plan, including any administrator, officer, trustee or custodian,
counsel or employee of the employee benefit plan;
2. A person providing services to the plan;
3. An employer whose employees are covered by the plan;
4. An employee organization whose members are covered by the plan;
5. A 50% owner (direct or indirect) of the employer whose employees are covered by plan;
6. A relative (i.e., a spouse, ancestor, lineal descendant, or spouse of a lineal descendant) of
any of the individuals in items 1, 2, 3, 4 or 5 (Note that the definition of relatives
excludes siblings);
7. An entity owned 50% by any individual listed in items 1, 2, 3, 4 or 5;
8. An employee, officer, director or 10% owner of the entities above or of the employee
benefit plan; and
9. A joint venturer or partner owning at least 10% interest in the entities above.
EXAMPLE: Luann and Monte are co-trustees of a profit sharing plan. The plan is maintained by
corporation X for the benefit of its employees. LuAnn owns 75% of the X stock and Monte owns
the other 25%. LuAnn has a husband, Louis. Louis, who is a doctor, owns 80% of a medical
practice, corporation P. The other 20% is owned by another doctor, Cyril. ERISA Corp provides
annual recordkeeping services for the plan. The annual 5500 is filed by Sidney, corporation Xs
accountant. Sidney has three children. LuAnn is also a 60% partner in Partnership XYZ, a real
estate company. The other two partners are Karen and Vincent, each of whom owns a 20%
partnership interest in XYZ. The following types of parties-in-interest are illustrated in this
example:
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LuAnn&Montearefiduciaries.
ERISACorp&Sidneyareserviceproviders.
CorporationXistheemployermaintainingtheplan.
Louis,becauseheisLuAnnsspouse,isconsideredanownerof50%ormoreofthe
employer.
Sidneyschildrenarefamilymembersofaserviceprovider.
Themedicalpractice,corporationP,becauseLouisowns80%ofthecorporation.
PartnershipXYZbecauseitisatleast50%isownedbyLuAnn.
Cyrilbecauseheownsatleast10%ofCorporationPwhichisapartyininterestbecauseitis
owned50%ormorebyLouis.
KarenandVincentbecauseeachisatleasta10%partnerofpartnershipXYZ,whichisa
partyininterestbecauseitisatleast50%ownedbyLuAnn.
ThedefinitionofthetermdisqualifiedpersonundertheIRCisnearlyidenticaltothatof
partyininterestunderERISA.Thereareafewdifferencesbetweenthetermsascontainedin
theprohibitedtransactionrulesunderERISAandtheIRC.Forexample,anemployeeofthe
plansponsorisapartyininterest,buttheIRCexcludessuchpersonfromthedefinitionofa
disqualifiedperson.
ERISA406(A)PROHIBITIONSFORPARTIESININTEREST
UnderERISA406(a),afiduciarymaynotknowinglycausetheplantoengageinthefollowing
transactionswithapartyininterestordisqualifiedperson:
Sale,exchangeorleaseofanyproperty;
o
Aprohibitedtransactionmayoccureventhoughnotransferofmoneyor
propertyoccursbetweentheplanandthepartyininterest.
Aprohibitedtransactionresultsfromthedirectorindirectsale,exchangeorlease
ofanypropertybetweentheplanandapartyininterestregardlessofwhoowns
theproperty.Apartyininterestmaynottransferrealorpersonalpropertytothe
planifthepropertyissubjecttoamortgageorlienthattheplanassumes,orifit
issubjecttoamortgageorlienthatapartyininterestplacedontheproperty
withina10yearperiodendingonthedateoftransfer.Theemployers
contributionofpropertytoaplanmayresultinaprohibitedtransaction.
Lendingorextendingcreditbetweentheplanandapartyininterest;
Furnishingofgoods,servicesand/orfacilitiestoapartyininterest;
o
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Thereisaprohibitionagainstfurnishinggoods,servicesand/orfacilitieswhether
directorindirectunlessareasonablecontractorarrangementisdetermined
basedonfactsandcircumstances.Theservicemustbeappropriateorhelpfulto
theplanforreasonablecompensation.Fiduciariesmayreceivecompensation
fromthesponsoringemployeriftheydonotreceivefulltimepayfromthe

sponsoring employer, employee association or union. A fiduciary may receive
reimbursement for direct expenses properly and actually incurred on behalf of
the plan.
o
ERISA 408(b)(2) contains the primary exemption available for transactions

involving the purchase of goods and services on the plans behalf. It provides
that a transaction between a plan and a party-in-interest for office space or legal,
accounting or other services is not prohibited if:
The arrangement or contract between the plan and the party-in-interest is
reasonable;
The services are necessary for the establishment or operation of the plan;
and
No more than reasonable compensation is paid for the services, goods or
lease.
The burden is on the fiduciary and participating party-in-interest to prove that

this exemption is available.
Transferring plan assets to a party-in-interest; and

Acquisition and/or holding of employer security or real property in excess of ERISA
limits.
o
Fiduciaries may not allow a plan to hold an employer security that is not
qualifying employer securities or employer real property that is not qualifying
employer real property. These terms are defined and further discussed in the
Investments Module.
ERISA 406(B) PROHIBITIONS AGAINST SELF-DEALING FOR FIDUCIARIES

Under ERISA 406(b) a fiduciary with respect to a plan shall not do any of the following:
Deal with the assets of the plan in his or her own interest or for his or her own account;
o
Fiduciaries may not deal with the assets of plans in their own interest or for their
own account (self-dealing). Additionally, fiduciaries are not allowed to engage in
potential conflicts of interest or receive kickbacks.
A fiduciary generally may not provide multiple services to a plan unless the
fiduciary does not exercise any authority, control or responsibility which would
cause the plan to pay a fee for services the fiduciary performs.
In his or her individual capacity or in any other capacity, act in a transaction involving
the plan on behalf or a party whose interests are adverse to the interests of the plan, its
participants or its beneficiaries; or
Receive any consideration from any party dealing with a plan in connection with a
transaction involving plan assets.
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Changes to a party-in-interest relationship subsequent to the occurrence of a prohibited
transaction do not alter the treatment of the prohibited transaction.
PROHIBITED TRANSACTION EXEMPTIONS

Administrative exemptions to prohibited transaction rules may be granted by DOL if the
exemption is:
Administratively feasible;
In the best interest of the plan and its participants and/or beneficiaries; and
Protective of the rights of participants and beneficiaries of the plan.
The DOL may grant retroactive approval of a prohibited transaction if the applicant acted in
good faith and no loss to the plan occurred.
Statutory Exemptions
There are several exemptions to prohibited transactions, including the following:
Statutory and administrative exemptions are available for loans to an ESOP if the loan is
primarily for the benefit of participants, made at a reasonable interest rate and used to
leverage the purchase of qualifying employer securities. [ERISA 408(b)(3)]
An exemption exists for an interest-free, unsecured loan to the plan by a party-ininterest for payment of ordinary operating expenses, including the payment of benefits.
[PTE 80-26 as amended in April of 2006 by the DOL]
o
There is a requirement that the terms of any interest-free, unsecured loan

covered by the exemption be set forth in writing if the loan is for a period of 60
days or longer.
Reliance on the exemption requires a clear demonstration that funds provided to

the plan by a party-in-interest are in the nature of a loan rather than a
contribution.
Loans secured by residential mortgages and entered into by a qualified real estate
manager are exempted. [PTCE 88-59]
Additional exemptions are permitted for parties-in-interest and plan investment funds
managed by a QPAM, and investments by a plan in an employer obligation if made for
adequate consideration and no commission is charged. [PTCE 84-14, ERISA 407(d)(5)
& 408(e)]
Loans from the plan to participants and beneficiaries are allowed if available to all participants
and beneficiaries who are active employees and certain vested terminees or beneficiaries who
are parties-in-interest. In order to qualify for the statutory exemption,
The loans must be available on a reasonably equivalent basis;
The minimum loan permitted may not exceed $1,000; (i.e., must be available on a
reasonably equivalent basis);
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The loan must be made in accordance with specific, written plan provisions with written
disclosure required to participants regarding the loan program;
The plan must charge a reasonable rate of interest;
The loan must be adequately secured. The portion of the participants vested interest
used to secure the loan may not exceed 50% unless additional security is given for the
portion that exceeds 50% of the vested balance; and
The loan may not exceed $50,000 reduced by the excess of the highest outstanding loan
balance during the one year period ending on the day before the date on which the loan
was made, over the outstanding balance of loans on the date on which the loan was
made. Though violating the $50,000 limit constitutes a deemed distribution violating this
limit does not cause a prohibited transaction.
Exemptions are not available for an employers contribution of employer debt obligations
(indirect loan) or investments of the plan in loans granted by a third party to a party-in-interest.
A prohibited transaction exemption may benefit the owner of a closely-held corporation.
Prohibited Transaction Class Exemptions (PTCE)
A PTCE applies to any party-in-interest within the class of party-in-interest specified in the
exemption. A prohibited transaction class exemption should be analyzed carefully to determine
if it applies. Some of the PTCEs are as follows:
PTCE 75-1 Permits certain types of dealings by plans with certain broker-dealers,
reporting dealers and bankers.
PTCE 76-1 Arrangements between multiple employer plans and contributing
employers involving delinquent employer contributions.
PTCE 77-3 and PTCE 79-13 Permits the acquisition or sale of shares of a registered
open-end investment (77-3) or closed-end (79-13) company by a plan covering only
employees of the mutual fund, the funds investment advisor, funds principal
underwriter or affiliate of those entities.
PTCE 77-4 Plans purchase or sale of shares of a registered open-end investment
company when the investment advisor is a plan fiduciary but not an employer of
employees covered by plan.
PTCE 77-10 Sharing and leasing of office space and administrative services and sale or
lease of goods by multiemployer plan to participating employee organization,
participating employer or another multiple-employer plan.
PTCE 80-26 Interest-free loans between plans and parties-in-interest.
PTCE 84-24 Transactions involving plans whose assets are managed by a qualified
professional asset manager (QPAM).
PTCE 92-6 The sale of an individual life insurance or annuity contract by a plan to a
plan participant insured by the policy; the participants relative who is the beneficiary
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under the policy; an employer whose employees are covered by the plan; or another
plan.
PTCE 96-23 Transactions between an in-house asset manager and persons who are
parties-in-interest to the plan solely by reason of being service providers to a plan or by
reason of a relationship to such service providers.
PTCE 96-62 Where transactions are similar to at least two individual prohibited
transaction exemptions (PTE), applicants can obtain a class exemption on an expedited
basis.
PTCE 96-63 Restoration of delinquent contributions to employee benefit plans without
penalties or excise tax.
PTCE 2003-39 Relief from ERISAs prohibited transaction provisions in connection
with settlement of litigation where the plan and the party-in-interest may have
negotiated a compromise in the amount for losses allegedly suffered by a plan.
PTCE 2006-06 Permits a qualified termination administrator (QTA) under an
abandoned defined contribution plan to select itself to provide services to the plan with
respect to the termination of the abandoned plan and to pay itself fees for those services
from the abandoned plans assets.
Individual PTEs are administrative exemptions that apply to specific parties-in-interest named
or defined in the exemption.
Most prohibited transaction exemptions are issued by the DOL. Exemptions for IRAs, directed
investments relating to ERISA 404(c), and ESOPs are issued by the IRS.
CORRECTIONS AND FORM 5330

Correction of a prohibited transaction requires the fiduciary to undo the prohibited transaction
to whatever extent possible, and must at least put the plan in a financial position no worse than
the position it would have been in had the transaction not occurred. In some cases, a prohibited
transaction may self-correct by becoming an extremely successful investment.
A fiduciary is personally liable for engaging in a prohibited transaction if the fiduciary knew or
should have known that he or she caused the plan to engage in a prohibited transaction (under
ERISA), or if the fiduciary caused the transaction to occur even without the knowledge that the
other party was a party-in-interest (under the IRC).
Under the IRC, Form 5330 must be filed to report prohibited transactions and submit payment
of an excise tax, which is the personal liability of a party-in-interest. The plan may not
indemnify a disqualified person or party-in-interest. The tax equals 15% of the amount involved
per year in the taxable period. Note that this means a separate 15% tax is imposed for each year
or partial year within the taxable period. An additional 100% excise tax may apply if the
prohibited transaction is not corrected within the taxable period.
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The amount involved is the greater of the fair market value of property and money
given for that property (prohibited purchase), or the greater of the fair market value of
the property and the money received for that property (prohibited sale).
Valuation date for determining the fair market value is the date on which the
prohibited transaction occurred.
Taxable period is the period beginning on the date of prohibited transaction and
ending on the earliest of 1) the date of notice of deficiency by the Secretary regarding the
15% tax; 2) the date the 15% tax is assessed; or 3) the date of correction.
Correction period is the period beginning on the date the prohibited transaction
occurs and ending 90 days after the mailing of the notice of deficiency with reference to
the 100% tax.
A single event can cause multiple prohibited transactions to occur. One excise tax is imposed
even if the transaction involves more than one disqualified person in the prohibited transaction.
ERISA imposes trust law remedies, while criminal or civil penalties are assessed by the DOL. A
plan may carry insurance to cover any losses resulting from a prohibited transaction. Some
prohibited transactions can also be corrected by using the Voluntary Fiduciary Correction (VFC)
Program.
Form 5500 and Plan Audit Requirements

Generally a return/report must be filed every year for every pension benefit plan, welfare
benefit plan, and for every entity that files as a direct filing entity (DFE). Plans with less than
$250,000 in assets and otherwise meeting the filing requirements for the form 5500-EZ are
exempt from the filing requirements.
ERISA permits the DOL to impose civil penalties of up to $1,100 per day for each annual return
that is not filed in a timely manner. The Form 5500 is due within 7 months after the close of the
plan year unless an extension is filed. The extension allows an additional 2 months to file the
Form 5500 beyond the first filing date. DOL administrative procedures provide that a plan
administrator who files a late Form 5500 may be assessed a civil penalty of $50 per day for each
day the return is late up to a maximum of $30,000. Also, the IRS can impose a penalty of $25 a
day up to a maximum of $15,000 per return.
Generally, a Form 5500 return/report filed for a pension benefit plan or welfare benefit plan that
covered fewer than 100 participants as of the beginning of the plan year should be completed
following the requirements for a small plan, and a Form 5500 return/report filed for a plan
that covered 100 or more participants as of the beginning of the plan year should be completed
following the requirements for a large plan. Plans with less than 100 participants may be able
to file Form 5500-SF beginning in 2009.
Under the 80-120 Participant Rule, if the number of participants reported on line 6 of the Form
5500 is between 80 and 120, and a Form 5500 was filed for the prior plan year, the plan sponsor
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may elect to complete the return/report in the same category (large plan or small plan) as
was filed for the prior return/report. Large plans are required to attach an audit report prepared
by an independent auditor.
SMALL PLAN AUDIT EXEMPTION

Small plans may be exempted from the annual audit requirement if the following conditions are
met:
As of the last day of the preceding plan year at least 95% of a small pension plans assets
must be qualifying plan assets or if less than 95% are qualifying plan assets, then any
person who handles assets of a plan that do not constitute qualifying plan assets must
be bonded in an amount that is at least equal to 100% of the value of the non-qualifying
plan assets he or she handles.
o
Qualifying plan assets means:

Qualifying employer securities;
Participant loans;
Any assets held by regulated institutions including a bank or similar
financial institution; an insurance company; a registered broker-dealer
under the Securities Exchange Act of 1934; or any other organization
authorized to act as a trustee for individual retirement accounts;
Shares issued by an investment company registered under the Investment
Company Act of 1940;
Investment and annuity contracts issued by any insurance company
qualified to do business under the laws of any state; and
Assets in the individual account of a participant or beneficiary over
which the participant or beneficiary has the opportunity to exercise
control and with respect to which the participant or beneficiary is
furnished, at least annually, a statement from a regulated financial
institution describing the assets held (or issued by) such institution
including the amount of such assets.
In response to a request from any participant or beneficiary, the plan administrator must
furnish without charge copies of statements the plan receives from the regulated
financial institutions holding or issuing the plans qualifying plan assets and evidence
of any required fiduciary bond.
Some of the material in this chapter was taken from 401(k) Fiduciary Governance: An Advisors
Guide, 3rd Edition, written by Pete Swisher, CFP, CPC. Special thanks to Pete for these
contributions.
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Chapter 7
Correction Programs and Ethics
This module addresses the various correction programs offered by the IRS and the DOL. The
IRS has a program called the Employee Plans Compliance Resolution System (EPCRS) that is an
avenue for correction of plan qualification issues.
The DOL has two programs that will also be discussed. The first one is the Voluntary Fiduciary
Compliance (VFC) Program that addresses the correction of specific prohibited transactions.
The second one is the Delinquent Filer Voluntary Compliance (DFVC) Program to handle late
filings of the Form 5500 series.
Lastly the ASPPA Code of Professional Conduct will be covered.
Employee Plan Compliance Resolution System (EPCRS)

Overview
The IRS established the EPCRS and it is maintained by the Employee Plans (EP) area of the TaxExempt and Government Entities Operating Division of the IRS.
Prior to 1998 there were several different correction programs. Rev. Proc. 98-22 consolidated all
IRS correction programs into a single program called EPCRS. The program was updated and
expanded with issuance of Rev. Proc. 2003-44 and subsequently by Rev. Proc. 2006-27 issued in
May, 2006. Most recently the IRS issued Rev. Proc. 2008-50 in August of 2008 which supersedes
Rev. Proc. 2006-27. The full text of Rev. Proc. 2008-50 is available on the IRS Web site,
www.irs.gov. The procedures addressed in Rev. Proc. 2008-50 are effective beginning January 1,
2009. However a plan sponsor may apply them on or after September 2, 2008.
This program covers the correction of qualification failures that are the result of plan document
failures, operational failures, demographic failures and employer eligibility failures. This
program does not cover funding deficiencies, prohibited transactions and failure to file the
Form 5500 series.
PLAN TYPES COVERED

EPCRS permits plan sponsors of qualified plans, 403(b) plans, SEPs and SIMPLE IRAs to correct
failures under the IRC and thereby continue to provide their employees with retirement
benefits on a tax-favored basis. Please note that while operational failures for 403(b) plans are
covered under EPCRS, document failures for 403(b) plans are not included in the program.
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GENERAL PRINCIPLES
The following are general principles underlying the EPCRS program:
Sponsors should establish and utilize administrative practices and procedures intended
to ensure their plans comply with applicable qualification requirements.
Sponsors should timely update their plan documents to comply with changes in
qualification requirements.
Sponsors should make voluntary and timely correction of any plan failures, whether
involving discrimination in favor of highly compensated employees (HCEs), plan
operations, terms of the plan document or adoption of the plan by an ineligible
employer.
Voluntary compliance by sponsors that proactively identify and correct operational and
form defects will be promoted by subjecting them to smaller sanctions or fees than the
sanctions and fees imposed on those who fail to voluntarily comply with regulations.
Fees and sanctions should be graduated in a series of steps often based on size of the
plan so there is always an incentive to correct promptly.
Sponsors that have qualification defects identified on audit can expect a reasonable
sanction, based upon nature, extent and severity of defect although self identification of
the problem prior to discovery on audit should be less costly.
EPCRS will be applied in a consistent and uniform manner.
Sponsors may rely on receiving relief under EPCRS when correcting qualification
defects.
THREE PROGRAMS
There are three programs within EPCRS:
Self-Correction Program (SCP) - Plan sponsors that have established practices and
procedures may, at any time without paying any fee or sanction, correct insignificant
operational failures under a qualified plan, 403(b) plan, SEP or SIMPLE IRA. A SEP or
SIMPLE IRA plan must be established and maintained on a document approved by IRS.
A qualified plan that is the subject of a favorable determination letter or a 403(b) plan
may generally correct even significant operational failures without payment of a fee or
sanction under SCP. Use of SCP does not require Service approval or notification.
However, SCP cannot be used to resolve egregious failures.
Voluntary Correction Program (VCP) At any time before audit, plan sponsors may pay
a limited fee and receive IRS approval for correction of a qualified plan, 403(b) plan, SEP
or SIMPLE IRA plan. VCP includes special procedures for anonymous submissions and
group submissions.
Audit Closing Agreement Program (Audit CAP) If a failure (other than a failure
corrected through SCP or VCP) is identified on audit, the plan sponsor may correct the
failure and pay a sanction that will bear a reasonable relationship to the nature, extent,
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and severity of the failure, taking into account the extent to which the correction
occurred before audit.
QUALIFICATION FAILURE
A qualification failure is any failure that adversely affects the qualification of a plan. There are
four types of qualification failures:
Plan Document Failure. This is a plan provision or absence of a plan provision that
violates the requirements of IRC 401(a) or IRC 403(a). An example would be the
failure of a plan to timely amend to reflect a new qualification requirement within the
plans remedial amendment period or a provision that is in the plan document that
incorrectly states the law.
Operational Failure. This occurs solely from the failure to follow the plan provisions.
This could also be an operation that is permitted by law but the plan document was not
written to operate in that manner. ADP and ACP testing failures would be operational
failures.
Demographic Failure. This is a failure to satisfy the requirements of nondiscrimination
testing under IRC 401(a)(4), minimum participation requirements under IRC
401(a)(26) or coverage requirements under IRC 410(b) that does not satisfy the
definition of an operational failure. These types of failures generally require a corrective
amendment to the plan adding more benefits or increasing existing benefits.
Employer Eligibility Failure. This occurs when an employer adopts a 401(k) plan or
403(b) plan and that employer is not eligible to adopt such a plan. An example might be
when certain governmental entities adopt a 401(k) plan.
RELIEF OFFERED UPON CORRECTION

EPCRS provides the following relief and reliance for sponsors that have satisfied the eligibility
and correction requirements of SCP, VCP and Audit CAP:
Qualified plans IRS will not treat a plan as failing to satisfy the requirements of IRC
401(a). The plan will be treated as qualified for FICA and FUTA purposes.
403(b) plans IRS will not treat a plan as failing to satisfy IRC 403(b). The plan will be
treated as qualified for FICA and FUTA purposes.
SEP and SIMPLE IRA plans IRS will not treat the plan as failing to satisfy the
requirements of IRC 408(k) or 408(p), as applicable. The plan will be treated as
qualified for FICA and FUTA purposes.
Generally, applicable excise taxes resulting from qualification failure are not waived merely
because the failure has been corrected. However, Rev. Proc. 2008-50 provides the following
exceptions:
As part of VCP and Audit CAP, if the failure was a failure to satisfy required minimum
distribution requirements, in appropriate cases, IRS will waive the excise tax under IRC
4974 applicable to plan participants. Plan sponsor must request waiver as part of the
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submission. If the affected participant is an owner-employee, the plan sponsor also must
provide supporting explanation.
As part of VCP, if the failure involves a correction that requires a nondeductible contribution
by the plan sponsor, in appropriate cases, IRS will waive the excise tax under IRC 4972
on such nondeductible contributions.
As part of VCP, if the failure results in excess contributions or excess aggregate
contributions, IRS will not pursue excise tax under IRC 4979 in appropriate cases, e.g.,
where the correction was made for an ADP test that was timely performed but due to
reliance on inaccurate data resulted in an insufficient amount of excess elective
contributions being distributed to HCEs.
As part of VCP, if the failure results in excess contributions being made to an IRA, IRS
will not pursue excise tax under IRC 4973 if relief is requested and either the recipient
removes the excess plus earnings and returns it to the plan or the recipient removes the
excess plus earnings and reports it as taxable.
As part of VCP, IRS may not pursue the 10% excise tax under IRC 72(t). However the
IRS may require the plan sponsor to pay an additional fee under VCP not in excess of
the 10% additional tax under IRC 72(t).
CORRECTION PRINCIPLES
To be eligible for EPCRS, IRS requires that a failure be corrected. Correction principles listed
below apply to all correction programs under EPCRS (more fully described in Section 6 of Rev.
Proc. 2008-50.)
Full correction is generally required with respect to all participants and for all taxable
years including closed years. Special exceptions to full correction exist regarding:
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Use of reasonable estimates. If either: (1) it is possible to make precise calculation

but the probable difference between approximate and precise restoration of
participants benefits is insignificant and the administrative cost of determining
the precise restoration would significantly exceed probable difference; or (2) it is
not possible to make precise calculation, reasonable estimates may be used in
calculating restoration of benefits. The plan may use a reasonable interest rate if it
is not feasible to make reasonable estimate of what actual investment results
would have been.
Delivery of small benefits. Sponsors are not required to make corrective

distributions of $75 or less if reasonable direct costs of processing and delivering
distribution to participant or beneficiary would exceed the amount of the
distribution.
Recovery of small overpayments. Generally, if the total amount of overpayment

to a participant or beneficiary is $100 or less, the sponsor is not required to seek
return of overpayment and is not required to notify the participant or beneficiary
that overpayment is not eligible for tax-free rollover.

o
Locating lost participants. The plan sponsor must take reasonable actions to find
lost participants to whom additional benefits are due. Generally, reasonable
actions include use of Social Security Administration Employer Reporting
Service. If the program is used and participants are still lost, the plan will not be
considered to have failed to correct a failure under EPCRS as long as additional
benefits due will be provided to participants if they are located at some future
time.
Small excess amounts. Generally, if the total amount of the underpayment to the
participant or beneficiary is $100 or less, the sponsor is not required to distribute
or forfeit the excess amount. Some notification requirements may apply.
Failures related to orphan plans. The IRS has discretion to determine under VCP
and Audit CAP whether full correction will be required under a terminating
orphan plan.
Correction method should restore the plan to the position it would have been in had the
failure not occurred, including restoration to current and former participants of the
benefits and rights they would have had if the failure had not occurred.
Correction should be reasonable and appropriate for the failure. There may be more
than one reasonable and appropriate correction for the failure. To determine whether
the method of correction is reasonable and appropriate, the following principles should
be considered:
o
Any correction method set forth in Appendix A or Appendix B of Rev. Proc.

2008-50 is deemed to be reasonable and an appropriate method for correcting the
related failure.
Correction method should, to the extent possible, resemble one already provided
for in the IRC, income tax regulations or other guidance of general applicability.
Correction method for failures relating to nondiscrimination should provide

benefits for nonhighly compensated employees (NHCEs). An IRS example
explains the correction of failure to satisfy actual deferral percentage (ADP)
and/or actual contribution percentage (ACP).
Generally, if SCP or VCP is used to correct a violation of the ADP/ACP test after
the statutory 12-month correction period (i.e., the 12-month period following the
close of the plan year), the employer is required to make QNECs for the NHCEs.
Under one corrective approach, the employer contributes enough QNECs to all
the NHCEs in order to raise the ADP of the NHCEs to a level necessary that
satisfies the ADP test. Another approach under EPCRS permits correction by
making distributions to the HCEs after the statutory correction period as long as
the employer makes a QNEC for the NHCEs that equals the total amount being
distributed.
Just distributing excess amounts to HCEs would not be an acceptable means of

correction under SCP and is unlikely to be approved under VCP.
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o
Correction method should keep plan assets in the plan.
Correction method should not violate another requirement of the IRC, (i.e., IRC
401(a), 403(b), 408(k) or 408(p), or parallel requirement in Part 2 of Title I of
ERISA for plans subject to ERISA).
Correction method should be consistently applied. Generally, where more than one
correction method is available to correct an operational failure, the correction method
should be applied consistently in correcting all operational failures of that type for that
plan year. Similarly, earnings adjustment methods should be applied consistently. In
group submissions the consistency requirement applies on a plan by plan basis.
Generally, corrective allocations and corrective distributions should be based on the
terms of the plan and other information available at the time of the failure.
o
Corrective allocations should be adjusted for earnings and forfeitures that would
have been allocated to participant accounts if the failure had not occurred.
Corrective allocations are considered an annual addition for the limitation year
to which the correction applies, rather than the year in which the correction is
made, although normal rules of IRC 404 regarding deductions still apply.
Corrective allocations should come only from employer contributions (or

forfeitures if the plan permits their use to reduce employer contributions).
Corrective distributions from a defined benefit plan should be increased to take

into account the delayed payment, consistent with the plans actuarial
assumptions.
Generally, the participant is responsible for paying the corrective payment in the case of
loan failures where loan amount exceeded IRC 72(p)(2)(A) or loan terms did not satisfy
IRC 72(p)(2)(B) or (C). However, if loan failure was due to a defaulted loan, the
employer should pay a portion of the correction payment equal to the interest that
accumulates as a result of the failure, generally determined at a rate equal to the greater
of the plans loan interest rate or the rate of return under the plan.
A correction principle applies solely to limited circumstance for a qualified plan with an
operational failure that excluded an employee who should have been eligible to make an
elective contribution under a cash or deferred arrangement or an after-tax employee
contribution. In this limited circumstance, the employer should contribute to the plan on
behalf of the excluded employee an amount that makes up for value of the lost
opportunity to the employee to have a portion of employees compensation contributed
to the plan accumulated with earnings tax free in future.
Under correction principles applicable to reporting, corrective distributions must be
properly reported.
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Self-Correction Program (SCP)

ELIGIBILITY
SCP is available only for qualification failures related to operational failures which must have
arisen from a failure to follow terms of plan document.
SCP is available to qualified plans and 403(b) plans for correction of significant and
insignificant operational failures. SCP is available only for insignificant operational failures in
SEP and SIMPLE IRA plans.
If plan is under IRS examination, SCP can be used only to correct insignificant operational
failures. However, if correction has been substantially completed before the sponsor is notified
of an IRS examination, SCP can still be used to correct significant operational failures.
FAILURES THAT CANNOT BE CORRECTED UNDER SCP

SCP is not available to correct:
Egregious operational failures (VCP or Audit CAP would be available);
Operational failure directly or indirectly related to abusive tax avoidance transaction
(ATAT);
Demographic failures;
Employer eligibility failures;
Terminated plan failures orphan or not;
Plan document failures;
Failures involving misuse or diversion of plan assets; and
Failures for which the plan sponsor corrects by a plan amendment that conforms the
terms of the plan to the plans prior operations (with limited exceptions discussed in
Section 4.05(2) of Rev. Proc. 2008-50).
SIGNIFICANT VS. INSIGNIFICANT FAILURES

Determination of whether a failure is significant or insignificant is done on a facts and
circumstances basis. Factors considered in determining whether an operational failure is
insignificant include:
Number of failures that occurred during the period being examined (a failure is not
considered to have occurred more than once just because more than one participant is
affected by failure);
Percentage of plan assets and contributions involved in the failures;
Number of years that the failures occurred;
Number of participants affected relative to the total number of participants;
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Number of participants affected relative to the number of participants that could have
been affected by the failures;
Whether corrections were made within a reasonable time after the failures were
discovered; and
Reason for the failures (e.g., data errors).
No single factor is determinative. The IRS will apply factors in a way so as not to preclude small
businesses from being eligible for SCP merely because of their size.
One of the key points in knowing when self correction is possible and when filing under VCP
will be required is to understand the difference between significant and insignificant failures.
Remember: with SEP and SIMPLE IRA plans only insignificant failures can be self corrected.
With SEP and SIMPLE IRA plans, all significant failures require submission under VCP. This
was stated in Rev Proc 2006-27 and repeated again in Rev Proc 2008-50.
The following examples illustrate the differences between significant and insignificant failures.
EXAMPLE: In 1994, Employer X established Plan A, a profit sharing plan that satisfies the
requirements of IRC 401(a) in form. In 2008, the benefits of 50 of the 250 participants in Plan A
were limited by IRC 415(c). However, when the IRS examined Plan A in 2011, it discovered
that, during the 2008 limitation year, the annual additions allocated to the accounts of 3 of these
employees exceeded the maximum limitations under IRC 415(c). Employer X contributed
$3,500,000 to the plan for the plan year. The amount of the excesses totaled $4,550. Under these
facts, because the number of participants affected by the failure relative to the total number of
participants who could have been affected by the failure, and the monetary amount of the
failure relative to the total employer contribution to the plan for the 2008 plan year, are
insignificant, the IRC 415(c) failure in Plan A that occurred in 2008 would be eligible for
correction under SCP.
EXAMPLE: The facts are the same as in the preceding example, except that the failure to satisfy
IRC 415 occurred during each of the 2008 and 2010 limitation years. In addition, the three
participants affected by the IRC 415 failure were not identical each year. The fact that the IRC
415 failures occurred during more than one limitation year and 6 participants were involved
did not cause the failures to be significant; accordingly, the failures are still eligible for
correction under SCP.
EXAMPLE: The facts are the same as in the example above, except that the annual additions of 18
of the 50 employees whose benefits were limited by IRC 415(c) nevertheless exceeded the
maximum limitations under IRC 415(c) during the 2008 limitation year, and the amount of the
excesses ranged from $1,000 to $9,000, and totaled $150,000. Under these facts, taking into
account the number of participants affected by the failure relative to the total number of
participants who could have been affected by the failure for the 2008 limitation year (and the
monetary amount of the failure relative to the total employer contribution), the failure is
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significant. Accordingly, the IRC 415(c) failure in Plan A that occurred in 2008 is ineligible for
correction under SCP as an insignificant failure.
EXAMPLE: Employer J maintains Plan C, a money purchase pension plan established in 1995.
The plan document satisfies the requirements of IRC 401(a). The formula under the plan
provides for an employer contribution equal to 10% of compensation, as defined in the plan.
During its examination of the plan for the 2008 plan year, the Service discovered that the
employee responsible for entering data into the employer's computer made minor arithmetic
errors in transcribing the compensation data with respect to 6 of the plan's 40 participants,
resulting in excess allocations to those 6 participants' accounts. Under these facts, the number of
participants affected by the failure relative to the number of participants that could have been
affected is insignificant, and the failure is due to minor data errors. Thus, the failure occurring
in 2008 would be insignificant and therefore eligible for correction under SCP.
EXAMPLE: Public School maintains a salary reduction 403(b) plan for its 200 employees that
satisfies the requirements of IRC 403(b). The business manager has primary responsibility for
administering the Plan, in addition to other administrative functions within the Public School.
During the 2008 plan year, a former employee should have received an additional minimum
required distribution of $278 under IRC 403(b)(10). Another participant received an
impermissible hardship withdrawal of $2,500. Another participant made elective deferrals of
which $1,000 was in excess of the IRC 402(g) limit. Under these facts, even though multiple
failures occurred in a single plan year, the failures will be eligible for correction under SCP
because in the aggregate the failures are insignificant.
PRACTICES AND PROCEDURES

If a qualified plan is correcting a significant operational failure, the plan must have received a
recent determination letter or must be relying on a current opinion or advisory letter pertaining
to a valid prototype or volume submitter plan.
A SEP must be utilizing either a valid Form 5305-SEP or 5305A-SEP, or be relying upon a
current opinion letter for a prototype SEP. A SIMPLE IRA must be utilizing either a valid Form
5305-SIMPLE or 5304-SIMPLE, or be relying upon a current opinion letter for a prototype
SIMPLE.
Currently there is not a program for a 403(b) to receive a determination letter or opinion
letter. The only IRS approval available is a private letter ruling (PLR). A PLR is not
required for a 403(b) to use SCP, but a 403(b) plan must have practices and procedures
in place to ensure compliance with 403(b). This will likely change in the next version of
EPCRS as the IRS prototype program for 403(b) plans is put into place in the future. In
late 2009, the IRS had announced that it would issue revenue procedures for obtaining
opinion letters for prototype 403(b) plans and for obtaining determination letters for
individual 403(b) plans. An employer that adopts a pre-approved plan with a favorable
277
opinion letter or that applies for an individual determination letter under these revenue
procedures will be able to retroactively correct any defects in its 403(b) plan.
Plans must have established practices and procedures (formal or informal) designed to promote
and facilitate overall compliance with the applicable regulatory requirements. Practices and
procedures must have been followed, and the failure arose due to oversight or mistake in
applying them, or due to inadequacy in procedures.
Under limited circumstances SCP may be used by a qualified plan to correct an operational
failure by plan amendment. The amendment would conform the plan document to the plans
prior operations. The amendment retroactively amends plan terms and is allowed only for
correction of IRC 401(a)(17) failures, hardship distribution and loan failures, and early
inclusion of an otherwise eligible employee failures. The amendment must comply with
requirements of IRC 401(a), including IRC 401(a)(4), 410(b) and 411(d)(6). The plan sponsor
must submit a determination letter application and identify the SCP amendment as part of
submission.
TIMING RULES
Correction of significant operational failures using SCP must be complete or substantially
complete by the end of the second plan year that follows the plan year in which the significant
operational failure occurred. If failures in the aggregate, after considering all facts and
circumstances, are insignificant operational failures, the two-year requirement does not apply
and correction may occur at any time up to and including the time the plan or plan sponsor
comes under IRS examination.
Note that for significant ADP and ACP failures, the plan year for which the operational failure
occurs is the plan year that includes the last day of the additional one-year statutory correction
period permitted under IRC 401(k)(8) and 401(m)(6). Thus, under the two-year correction
period, a plan sponsor may correct by the end of the 2013 plan year a failure of the ADP test
with respect to elective deferrals made during the plan year 2010.
Substantially complete is defined in EPCRS as either (i) the plan sponsor is reasonably prompt in
identifying the failure and initiating correction that demonstrates commitment to completing
correction as expeditiously as possible and correction is complete within 120 days after the end
of the second plan year; or (ii) before the end of the second plan year, correction is complete
with respect to 65% of all affected participants and correction is completed with respect to
remaining participants in a diligent manner.
No application or reporting requirements under SCP (other than the determination letter
requirement if corrected via plan amendment), but the plan sponsor should maintain adequate
records demonstrating correction in case of plan audit.
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Voluntary Correction Program (VCP)

ELIGIBILITY
VCP allows sponsors of qualified plans, 403(b) plans, SEP plans and SIMPLE IRA plans to
voluntarily correct qualification failures provided that neither the plan nor the plan sponsor (if
the plan sponsor is a tax-exempt organization) is under examination by the IRS. Corrections for
qualification failures can include those from operational failures, plan document failures,
demographic failures and employer eligibility. VCP is also available to correct participant loans
that do not comply with the requirements of IRC 72(p)(2).
VCP requires self-policing, voluntary disclosure and fee payment to IRS.
FAILURES THAT CAN BE CORRECTED UNDER VCP

VCP may be used to correct:
Significant operational failures not correctable under SCP or when method of correction
proposed by sponsor does not meet one of the standard methods of correction
prescribed under Rev. Proc. 2008-50 and sponsor desires confirmation that IRS approves
of the alternative correction method the plan sponsor proposed.
Plan document failures including failure to amend timely for law changes.
Demographic failures involving participation, coverage or nondiscrimination issues typically, the correction of a demographic failure requires an amendment that adds
more benefits or increases existing benefits.
Situations where the sponsor has adopted a plan that it is not eligible to adopt.
Permitted correction is cessation of all contributions beginning no later than the date the
application under VCP is filed. Assets in the ineligible plan remain in the trust, annuity
contract, or custodial account and are distributed upon the occurrence of a distributable
event.
Egregious failures - although egregious failures may be corrected under VCP, they are
subject to a different, higher fee schedule.
Qualification failures in a terminated plan, whether or not the plan trust is still in
existence (may also be corrected under Audit CAP).
Qualification failures in terminating an orphan plan, provided the party acting on behalf
of the plan is an eligible party under Section 5.03 of Rev. Proc. 2008-50 (also may be
corrected under Audit CAP).
In cases where the correction of a qualification failure includes correction of a plan document
failure, a demographic failure or an operational failure by plan amendment, a determination
letter application may be required as part of the VCP submission.
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FAILURES THAT CANNOT BE CORRECTED UNDER VCP

VCP is not available to resolve:
Failures that are not qualification failures;
Failures involving misuse or diversion of plan assets;
Failures for which the plan sponsor proposes correction by plan amendment that
conforms the terms of the plan document to the plans prior operations if the
amendment violates any other IRC requirement;
Failures where the plan or the plan sponsor is or was a party to an ATAT unless IRS
determines the failure is unrelated to the ATAT; and
In a 403(b) plan, failures related to the purchase of annuity contracts or contributions to
custodial accounts on behalf of individuals who are not employees of employer.
ANONYMOUS SUBMISSION
Sponsors (or their representatives) may use VCP on an anonymous basis using the anonymous
(John Doe) submission process. Submission does not initially identify the applicable plans, plan
sponsor or organization. Once the IRS and the plan representative reach agreement with respect
to the submission, full disclosure is required.
The use of the anonymous submission program is best reserved for plans with large failures
and many issues where there is a real concern that the plan will be disqualified.
GROUP SUBMISSION
Group VCP submissions may be made by eligible organizations that provide administrative
services to qualified plans, 403(b) plans, SEPs or SIMPLE IRA plans if the operational failure,
plan document failure or employer eligibility failure resulted from a systemic error involving
the eligible organization which results in at least 20 plans requiring correction.
Group submission uses the same submission procedures as any VCP submission except the
eligible organization is responsible for the procedural obligations normally imposed on the plan
sponsor. The eligible organization also must notify the affected plan sponsors of the submission.
An eligible organization is a sponsor of a master or prototype plan, a volume submitter sponsor,
an insurance company or other entity that has issued annuity contracts or an entity that
provides its clients with administrative services.
FEES FOR USAGE

Generally, use of VCP requires the plan sponsor to pay the IRS at the time of submission
(including anonymous submissions) a graduated fee based on the number of participants in
plan.
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Number of Participants
Fee
20 or fewer
$750
21 to 50
$1,000
51 to 100
$2,500
101 to 500
$5,000
501 to 1,000
$8,000
1,001 to 5,000
$15,000
5,001 to 10,000
$20,000
Over 10,000
$25,000
The applicable fee is reduced 50% for plans that have not been amended for tax legislation
changes within the plans remedial amendment period. The submission must be made under
VCP within the one-year period following expiration of the remedial amendment period.
Note that nonamender fees in conjunction with VCP applications are different from fees for
nonamender defects discovered during the determination letter application review process.
Generally, the VCP-related fees are lower and Audit CAP sanctions are higher than those that
apply if the defect is found during the determination letter review.
If the only failure under a VCP submission is a failure to meet the required minimum
distribution requirement for 50 or fewer participants and failure would result in excise tax
under IRC 974, the fee is $500 regardless of the number of participants in the plan.
If the plan sponsor elects to use the anonymous submission program and resolution with the
IRS cannot be reached, the IRS will refund one-half of the fee to the plan sponsor.
Generally, the fee for SEPs and SIMPLE IRA plans is $250. For SEPS and SIMPLE IRAs, an
additional fee equal to at least ten percent of the plans excess amounts may apply where such
excess amounts are retained in the plan and not distributed to the participant(s). Excess amount
generally means contributions or allocations that exceed certain IRC or plan limits on
contributions and allocations.
The IRS may waive the fee for terminating orphan plans. The submission should include a
request for the waiver.
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For egregious failures, the fee is equal to greater of the fee from the graduated table or a
negotiated amount limited to not more than 40 percent of the taxes the IRS could collect if the
plan were disqualified.
The group submission VCP fee is based on the number of plans affected by the failure. The
initial fee for the first 20 plans is $10,000. The additional fee is equal to the number of plans
affected in excess of 20 multiplied by $250 for each plan. The maximum fee is $50,000. If group
submission includes more than one master or prototype plan, the compliance fee is calculated
separately for each master or prototype plan.
VCP COMPARED TO SCP

There are several factors that determine whether a plan may file under VCP or can just self
correct under SCP, including:
Whether the plan or plan sponsor is under examination;
Type of failure involved and whether it is egregious;
Whether the plan or plan sponsor was or may have been a party to an ATAT;
Whether the plan has obtained a favorable determination letter;
Type of correction proposed (e.g., correction through plan amendment);
When correction is completed; and
Whether the failure involves misuse or diversion of plan assets.
VCP compared to SCP:
SCP allows voluntary identification and correction of failures without IRS notification,
while VCP requires submission of an application to the IRS.
No fee is required under SCP, while VCP requires a fixed fee payment dependent on the
number of participants or type of plan.
SCP relief is limited to operational failures that are not egregious, while VCP provides
relief for all qualification failures including egregious failures.
VCP provides assurance that the correction methods used by a plan sponsor are
acceptable to the IRS, while SCP does not provide guarantee of IRS acceptance.
(However, Appendices A and B of Rev. Proc. 2008-50 illustrate sample failures and
correction methods deemed to be reasonable and appropriate.)
If a failure is insignificant, SCP is available even if a plan or plan sponsor is under
examination by IRS.
If a failure is significant, SCP is not available for correction for SEPs and SIMPLE IRA
plans, while VCP is available for qualified plans, 403(b) plans, SEPs and SIMPLE IRA
plans.
Operational failures may be corrected by a plan amendment that conforms the terms of
the plan document to the plans prior operations (provided no other IRC section is
violated by such amendment) in more instances under VCP than SCP.
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Favorable determination, advisory or opinion letter is required to correct a significant
operational failure under SCP while such a letter is not required to submit an application
under VCP.
Plans submitted under VCP prior to the plan or plan sponsor coming under examination
by IRS will not be subject to examination until submission process is complete and plan
sponsor has been issued a signed compliance statement. A plan corrected under SCP is
subject to examination at any time during the correction process (exception for
substantial completion of correction).
Audit Closing Agreement Program (Audit CAP)

ELIGIBILITY
Audit CAP is available for qualified plans, 403(b) plans, SEPs and SIMPLE IRA plans. Plan
sponsors may utilize the Audit CAP program for correcting defects found upon IRS audit, if the
defect is not an insignificant failure that may be resolved using SCP. Audit CAP is also available
to correct participant loans that do not comply with the requirements of IRC 72(p)(2).
The plan sponsor effects correction prior to entering into a closing agreement with the IRS. The
closing agreement is then signed by the IRS and the plan sponsor, and the plan sponsor pays
the negotiated sanction.
If the IRS and the plan sponsor cannot reach an agreement with respect to the correction of the
failure or the amount of the sanction the plan will be disqualified.
FEES
The negotiated sanction imposed will bear a reasonable relationship to the nature, extent and
severity of failure, taking into account the extent to which the correction occurred before the
audit.
For plans that intended to be qualified, the sanction is a negotiated percentage of the
approximate amount of money the IRS could collect if the plan were to be disqualified
including taxes, penalties and interest.
For 403(b) plans, the sanction is a negotiated percentage of the approximate amount of money
the IRS could collect as result of the failure, including additional income tax resulting from
income inclusion for employees or participants, tax on distributions that have been rolled over
to other qualified trusts, interest or penalties applicable to participants tax returns and any
other tax resulting from 403(b) failures that would not be imposed as result of correction under
Rev. Proc. 2008-50.
For SEPs and SIMPLE IRA plans, the sanction is a negotiated percentage of the amount
approximately equal to the sum of: (1) the income tax resulting from the loss of employer
deductions for plan contributions including interest and penalties applicable to the employers
tax return; and (2) income tax resulting from income inclusion for participants in the plan.
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Sanctions under Audit CAP are typically significantly greater than VCP fees.
AUDIT CAP COMPARED TO OTHER CORRECTION PROGRAMS

Audit CAP compared to other correction programs:
Audit CAP is used when the plan is under examination by IRS. All other programs are
voluntary and, except for certain instances under SCP, may not be used when plan or
plan sponsor is under examination.
Like VCP, and when correcting insignificant failures under SCP, Audit CAP does not
require that a favorable determination, advisory or opinion letter be issued with respect
to the plan.
Unlike SCP, Audit CAP may be used for any type of qualification failure.
Fee (sanction) under Audit CAP should be greater than the fee under VCP (no fee
applies to SCP).
Correction Methods
Suggested correction methods that are approved by the IRS are included in Appendix A and B
of Revenue Procedure 2008-50. Such methods include those to correct for:
Failure to properly provide the minimum top-heavy benefit to non-key employees.
Failure to satisfy the ADP and or ACP test.
Failure to distribute elective deferrals in excess of the deferral limit.
Exclusion of an eligible employee for all employer contributions or accrual of benefits.
Exclusion of an eligible employee from making elective deferrals, after-tax employee
contributions, designated Roth contributions or catch-up contributions.
Exclusion of an eligible employee from receiving a match.
Failure to implement an employee election for a deferral, after-tax employee
contribution, or matching contribution.
Failure to timely pay the minimum required distribution.
Failure to obtain participant consent for a distribution subject to spousal consent.
Failure to satisfy the annual additions limit.
Failures that occur due to the plan being abandoned.
For a full understanding of all the correction methods, see Appendix A and B of Revenue
Procedure 2008-50.
CORRECTION FOR A FAILED ADP AND ACP TEST

The following is a general discussion of how to correct a failure of an ADP and/or ACP test
based on Appendix A and B of Revenue Procedure 2008-50. There are two correction methods
that may be used if the plan has exceeded the 12 month period.
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The first correction method allowed is for the plan sponsor to make a qualified nonelective
contribution (QNEC) on behalf of the HCEs in an amount necessary to raise the ADP or ACP of
the NHCEs to the percentage needed to pass the test. The percentage of compensation
contributed must be the same for all NHCEs and must be made for all eligible NHCEs.
The second correction method allowed is to use the one-to-one correction method. Under this
method an excess contribution or excess aggregate contribution is determined and assigned to
HCEs. It is then distributed along with earnings to the HCE or forfeited. That same dollar
amount is then contributed to the plan and allocated to NHCEs as a QNEC in a uniform
allocation (as a percentage of compensation).
It is important to note that processing refunds without a corresponding QNEC is not an
approved correction method under EPCRS.
Voluntary Fiduciary Compliance (VFC) Program

The DOL created the VFC Program to allow plan fiduciaries to identify and correct fully certain
specific fiduciary breaches and receive assurance in the form of a no-action letter from the
EBSA/DOL that no civil investigation will be conducted for ERISA Title I violations and no
excise taxes under ERISA 502(l) will be assessed. Please note that self correction is not an
option under VFC, submission to the DOL is always required.
Any fiduciary may take advantage of the program, as long as the fiduciary is not under
investigation, and the DOL determines that there is no evidence of potentially criminal
violations contained in the application.
VIOLATIONS THAT CAN BE CORRECTED

The program is only available to correct fiduciary violations resulting from 19 specific types of
transactions. This listing of fiduciary violations available for correction under the VFC program
was lengthened in April, 2006 under an update to the program intended to simplify and expand
the original program published in 2002 and revised in April, 2005.
The expanded program includes detailed guidance on how to correct each type of fiduciary
breach, examples, model application form, application checklist and an online calculator to
assist program filers with calculations of the correction amounts required. Instructions on how
to perform manual calculations also are included.
The 19 fiduciary violations available for correction are:
Delinquent participant contributions and participant loan repayments to pension plans;
Delinquent participant contributions to insured welfare plans;
Delinquent participant contributions to welfare plan trusts;
Fair market interest rate loans with parties-in-interest;
Below market interest rate loans with parties-in-interest;
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Below market interest rate loans with nonparties-in-interest;
Below market interest rate loans due to delay in perfecting security interest;
Participant loans failing to comply with plan provisions regarding amount, duration or
level amortization;
Defaulted participant loans;
Purchase of assets by plans from parties-in-interest;
Sale of assets by plans to parties-in-interest;
Sale and leaseback of property to sponsoring employers;
Purchase of assets from nonparties-in-interest at more than fair market value;
Sale of assets to nonparties-in-interest at less than fair market value;
Holding of an illiquid asset previously purchased by the plan;
Benefit payments based on improper valuation of plan assets;
Payment of duplicate, excessive or unnecessary compensation;
Improper payment of expenses by the plan; and
Payment of dual compensation to plan fiduciaries.
If a fiduciary violation is not fully corrected under the VFC program, the DOL may assess
penalties, take other civil or criminal enforcement actions or seek equitable relief.
If an applicant files a truthful and complete application (subject to DOL investigation),
compliance with the VFC program exempts the plan from ERISA 502(l) penalties. The DOL
may still impose penalties under ERISA 502(c) for failure to file a complete, timely and
accurate Form 5500. Additionally, no relief is provided regarding criminal investigations, and
VFC relief does not restrict the activities of other government agencies. For example, the EBSA
must refer evidence of criminal activity and prohibited transactions to the IRS. However, the
IRS has stated that generally correction under the VFC program constitutes a correction of the
prohibited transaction under the IRC, and a correction under the VFC program of an
operational failure is accepted as a correction for purposes of EPCRS.
In conjunction with the April, 2006 expansion of the VFC program, an amendment to PTE 200251 was completed to incorporate additional transactions relating to the VFC program. To be
eligible for relief under the PTE, the fiduciary must have completed all applicable requirements
of the VFC program and received a no-action letter from the EBSA. PTE 2002-51 now covers:
Failure to remit on a timely basis participant contributions including participant loan
repayments to the plan;
Loans made at fair market interest rate to parties-in-interest;
Purchases and sales of assets at fair market value between plans and parties-in-interest;
The sale of real property to the plan by an employer and leaseback of the property at fair
market value and fair market rental value;
Use of plan assets to pay settlor expenses; and
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Acquisition and/or subsequent sale by the plan of an asset that was determined to be
illiquid.
If a violation is identified, a determination should be made whether it is eligible for the VFC
program. The violation should be corrected using the DOLs prescribed process, including
restoration of any lost earnings and interest, or any additional benefits that need to be
distributed. The process must restore the plan, participants, and beneficiaries to the condition
they would have been in had the breach not occurred. All affected participants and beneficiaries
need to be notified of the correction. Only then should an application be filed with the
appropriate DOL regional office.
CORRECTION PRINCIPLES
The VFC program provides rules for making acceptable corrections involving the
transactions listed above. Applicants generally must:
Conduct valuations of plan assets using generally recognized markets for the assets
or obtain written appraisal reports from qualified professionals that are based on
generally accepted appraisal standards;
Restore to the plan the principal amount involved, plus the greater of lost earnings,
starting on the date of the loss and extending to the recovery date, or profits
resulting from the use of the principal amount, starting on the date of the loss and
extending to the date the profit is realized;
Pay the expenses associated with correcting transactions, such as appraisal costs or
fees associated with recalculating participant account balances; and
Make supplemental distributions when appropriate to former employees,
beneficiaries, or alternate payees, and provide proof of the payments.
REQUIREMENTS TO USE THE PROGRAM

To be eligible to use the VFC program:
Neither the plan nor the applicant can be under investigation by any federal agency at
the time of submission. The plan and the applicant would be considered under
investigation upon receipt of notification by any federal agency of its intent to conduct
an examination;
The VFC program application cannot contain any evidence of potential criminal
violations; and
The Employee Benefits Security Administration (EBSA) must not have notified any plan
fiduciary that the transaction covered by the VFC program application had been referred
to the IRS.
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CORRECTION FOR FAILURE TO MAKE TIMELY DEPOSIT OF DEFERRALS

When deferrals withheld from participant paychecks are not deposited timely a prohibited
transaction has occurred. The transaction is a prohibited transaction because it is considered to
be a prohibited loan to the employer from the plan. When this issue is found the deferrals
should be deposited into the trust as soon as possible. An amount equal to the earnings that the
participants would have received if the deposit was made timely (or the amount that the
employer profited, if greater) also needs to be deposited. The lost interest is calculated for the
period beginning on the date the deposit should have been made (as soon as administratively
feasible after the payroll date but in no case later than the 15th business day of the month
following the month that it was withheld) through the day that the deposit was actually made
at IRS approved rates. Note that if a small plan misses its safe harbor, the interest and penalties
are to be calculated from the benchmarked deposit date (usually 3 to 5 business days) and not
from the end of the 7-day safe harbor.
There is a VFCP online calculator available on the DOL website that uses IRC 6621(a)(2) and
(c)(1) underpayment rates. A Form 5330 must then be filed with the IRS to pay the 15% penalty
tax on the amount involved. The amount involved is the earnings on the delinquent
contributions and not the whole amount of the delinquent deposit. The sponsor can also file
under the VFCP to receive assurance that the PT has been corrected and that there will not be
penalties assessed at a future date.
Delinquent Filer Voluntary Compliance (DFVC) Program

The DFVC program enables sponsors that have failed to meet their annual filing requirements
under Title I of ERISA to file their delinquent returns without the imposition of severe penalties.
The program is designed to be easy to use and intended to encourage voluntary compliance
with the annual reporting requirements of ERISA.
Use of the DFVC program eliminates the DOL and IRS penalties with regard to the late filing of
Form 5500 on behalf of qualified retirement plans, welfare benefit plans, top hat plans,
apprenticeship plans or training plans. In addition, the PBGC has agreed not to assess a penalty
against a plan administrator if the DFVC program is used.
The relief provided under the DFVC program does not apply to one-participant qualified plans
or plans without employees that are required to file Form 5500-EZ or Form 5500 because these
plans are not subject to Title I of ERISA.
To be eligible to file under the DFVC program, the plan must not have received a Notice of
Intent to Assess a Penalty from the DOL, which is different from an IRS late-filer penalty letter.
DFVC PROCESS
The DFVC program requires completion of two steps:
First, the completed late form filing with all required schedules and attachments must be
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submitted to EBSA/DOL at the address and in the manner specified in the instructions to the
Form 5500 in conformance with the computerized ERISA Filing Acceptance System (EFAST).
Plan administrators may use the applicable Form 5500 for the year relief is sought or the most
current form available at the time of participation in the program with the applicable plan year
indicated. Box D on the Form 5500 should be checked, and a statement labeled DFVC Program
must be attached to the return. Simplified rules apply to apprenticeship, training and top hat
plan filings. It is important to visit the DOL website before preparing a submission to ensure
that you are informed of any updates to the program.
A copy of the Form 5500 only, without the schedules and attachments, must be submitted to the
DFVC program along with the applicable penalty amount.
PROGRAM FEES
Use of the DFVC program requires payment of a fee based on the type of plan for which
penalty relief is requested and the number of participants participating in the plan. The basic
penalty is $10 for each day the return is delinquent. For plans with fewer than 100 participants,
the $10 per day fee is subject to a maximum of $750 (i.e., the per filing cap). If multiple returns
for the same plan are delinquent, the maximum fee will be limited to $1,500, referred to as the
per plan cap. If the plan has more than 100 participants, the fee is $10 per day up to the per
filing maximum of $2,000 with the per plan maximum fee for multiple late returns limited to
$4,000. For purposes of calculating the number of days a return is delinquent, no extension is
considered. If the annual return is filed one-day after the extended deadline, the days
delinquent is determined by reference to the original due date. A special per plan cap of $750
applies to a plan sponsored by a tax-exempt organization under IRC 501(c)(3) provided that
the plan has always been a small plan filer. Apprenticeship, training, and top hat nonqualified
plans are required to pay a fee of $750 per plan.
The plan administrator is personally liable for payment of this fee, and therefore the fee cannot
be paid from plan assets.
ASPPA Code of Professional Conduct

ASPPA is committed to encouraging every retirement plan professional to achieve and
maintain the highest levels of technical competence and integrity. To this end, each member of
ASPPA must abide by the professional and ethical standards contained in the ASPPA Code of
Professional Conduct.
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CPC Study Guide:

RevenueProcedure200850AppendicesAandB
291
APPENDIX A
OPERATIONAL FAILURES AND CORRECTION METHODS
.01 General rule. This appendix sets forth Operational Failures and Correction
Methods relating to Qualified Plans. In each case, the method described corrects the
Operational Failure identified in the headings below. Corrective allocations and
distributions should reflect earnings and actuarial adjustments in accordance with section
6.02(4) of this revenue procedure. The correction methods in this appendix are
acceptable to correct Qualification Failures under VCP, and to correct Qualification
Failures under SCP that occurred notwithstanding that the plan has established practices
and procedures reasonably designed to promote and facilitate overall compliance with the
Code, as provided in section 4.04 of this revenue procedure. To the extent a failure listed
in this appendix could occur under a 403(b) Plan, a SEP, or a SIMPLE IRA Plan, the
correction method listed for such failure may similarly be used to correct the failure.
.02 Failure to properly provide the minimum top-heavy benefit under 416 to nonkey employees. In a defined contribution plan, the permitted correction method is to
properly contribute and allocate the required top-heavy minimums to the plan in the
manner provided for in the plan on behalf of the non-key employees (and any other
employees required to receive top-heavy allocations under the plan). In a defined benefit
plan, the minimum required benefit must be accrued in the manner provided in the plan.
.03 Failure to satisfy the ADP test set forth in 401(k)(3), the ACP test set forth in
401(m)(2), or, for plan years beginning on or before December 31, 2001, the multiple
use test of 401(m)(9). The permitted correction method is to make qualified nonelective
contributions (QNECs) (as defined in 1.401(k)-6) on behalf of the nonhighly
compensated employees to the extent necessary to raise the actual deferral percentage
or actual contribution percentage of the nonhighly compensated employees to the
percentage needed to pass the test or tests. The contributions must be made on behalf
of all eligible nonhighly compensated employees (to the extent permitted under 415)
and must be the same percentage of compensation. QNECs contributed to satisfy the
ADP test need not be taken into account for determining additional contributions (e.g., a
matching contribution), if any. For purposes of this section .03, employees who would
have received a matching contribution had they made elective deferrals must be counted
as eligible employees for the ACP test, and the plan must satisfy the ACP test. Under
this correction method, a plan may not be treated as two separate plans, one covering
otherwise excludable employees and the other covering all other employees (as permitted
in 1.410(b)-6(b)(3)), in order to reduce the number of employees eligible to receive
QNECs. Likewise, under this correction method, the plan may not be restructured into
component plans in order to reduce the number of employees eligible to receive QNECs.
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.04 Failure to distribute elective deferrals in excess of the 402(g) limit (in
contravention of 401(a)(30)). The permitted correction method is to distribute the
excess deferral to the employee and to report the amount as taxable in the year of
deferral and in the year distributed. The inclusion of the deferral and the distribution (for
both the excess deferral and earnings) in gross income applies whether or not any portion
of the excess deferral is attributable to a designated Roth contribution (see 402A(d)(3)).
In accordance with 1.402(g)-1(e)(1)(ii), a distribution to a highly compensated employee
is included in the ADP test; and a distribution to a nonhighly compensated employee is
not included in the ADP test.
.05 Exclusion of an eligible employee from all contributions or accruals under the
plan for one or more plan years. (1) Improperly excluded employees: employer provided
contributions or benefits. For plans with employer provided contributions or benefits
(which are neither elective deferrals under a qualified cash or deferred arrangement
under 401(k) nor matching or after-tax employee contributions that are subject to
401(m)), the permitted correction method is to make a contribution to the plan on behalf of
the employees excluded from a defined contribution plan or to provide benefit accruals for
the employees excluded from a defined benefit plan.
(2) Improperly excluded employees: contributions subject to 401(k) or 401(m).
(a) For plans providing benefits subject to 401(k) or 401(m), the corrective contribution
for an improperly excluded employee is described in the following paragraphs of this
section .05(2). (See Examples 3 through 12 of Appendix B.)
(b) If the employee was not provided the opportunity to elect and make elective
deferrals (other than designated Roth contributions) to a 401(k) plan that does not
satisfy 401(k)(3) by applying the safe harbor contribution requirements of 401(k)(12)
or 401(k)(13), the employer must make a QNEC to the plan on behalf of the employee
that replaces the missed deferral opportunity. The missed deferral opportunity is equal
to 50% of the employees missed deferral. The missed deferral is determined by
multiplying the actual deferral percentage for the year of exclusion (whether or not the
plan is using current or prior year testing) for the employee's group in the plan (either
highly compensated or nonhighly compensated) by the employees compensation for that
year. The employees missed deferral amount is reduced further to the extent necessary
to ensure that the missed deferral does not exceed applicable plan limits, including the
annual deferral limit under 402(g) for the calendar year in which the failure occurred.
Under this correction method, a plan may not be treated as two separate plans, one
covering otherwise excludable employees and the other covering all other employees (as
permitted in 1.410(b)-6(b)(3)) in order to reduce the applicable ADP, the corresponding
missed deferral, and the required QNEC. Likewise, restructuring the plan into component
plans is not permitted in order to reduce the applicable ADP, the corresponding missed
deferral, and the required QNEC. The QNEC required for the employee for the missed
deferral opportunity for the year of exclusion is adjusted for earnings to the date the
corrective QNEC is made on behalf of the affected employee.
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(c) If the employee should have been eligible for but did not receive an allocation of
employer matching contributions under a non-safe harbor plan because he or she was
not given the opportunity to make elective deferrals, the employer should make a QNEC
on behalf of the affected employee. The QNEC is equal to the matching contribution the
employee would have received had the employee made a deferral equal to the missed
deferral determined under section .05(2)(b). The QNEC must be adjusted for earnings to
the date the corrective QNEC is made on behalf of the affected employee.
(d) If the employee was not provided the opportunity to elect and make elective
deferrals (other than designated Roth contributions) to a safe harbor 401(k) plan that
uses a rate of matching contributions to satisfy the safe harbor requirements of
401(k)(12), then the missed deferral is deemed equal to the greater of 3% of
compensation or the maximum deferral percentage for which the employer provides a
matching contribution rate that is at least as favorable as 100% of the elective deferral
made by the employee. This estimate of the missed deferral replaces the estimate based
on the ADP test in a traditional 401(k) plan. The required QNEC on behalf of the
excluded employee is equal to (i) the missed deferral opportunity, which is an amount
equal to 50% of the missed deferral, plus (ii) the matching contribution that would apply
based on the missed deferral. If an employee was not provided the opportunity to elect
and make elective deferrals to a safe harbor 401(k) plan that uses nonelective
contributions to satisfy the safe harbor requirements of 401(k)(12), then the missed
deferral is deemed equal to 3% of compensation. The required QNEC on behalf of the
excluded employee is equal to (i) 50% of the missed deferral, plus (ii) the nonelective
contribution required to be made on behalf of the employee. The QNEC required to
replace the employees missed deferral opportunity and the corresponding matching or
nonelective contribution is adjusted for earnings to the date the corrective QNEC is made
on behalf of the affected employee.
(e) If the employee should have been eligible to elect and make after-tax employee
contributions (other than designated Roth contributions), the employer must make a
QNEC to the plan on behalf of the employee that is equal to the missed opportunity for
making after-tax employee contributions. The missed opportunity for making after-tax
employee contributions is equal to 40% of the employees missed after-tax
contributions. The employees missed after-tax contributions are equal to the actual
contribution percentage (ACP) for the employees group (either highly compensated or
nonhighly compensated) times the employees compensation, but with the resulting
amount not to exceed applicable plan limits. If the ACP consists of both matching and
after-tax employee contributions, then, in lieu of basing the employees missed after-tax
employee contributions on the ACP for the employees group, the employer is permitted
to determine separately the portion of the ACP that is attributable to after-tax employee
contributions for the employees group (either highly compensated or nonhighly
compensated), multiplied by the employees compensation for the year of exclusion. The
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QNEC must be adjusted for earnings to the date the corrective QNEC is made on behalf
of the affected employee.
(f) If the employee was improperly excluded from an allocation of employer
matching contributions because he or she was not given the opportunity to make after-tax
employee contributions (other than designated Roth contributions), the employer must
make a QNEC on behalf of the affected employee. The QNEC is equal to the matching
contribution the employee would have received had the employee made an after-tax
employee contribution equal to the missed after-tax employee contribution determined
under section .05(2)(e). The QNEC must be adjusted for earnings to the date the
corrective QNEC is made on behalf of the affected employee.
(g) The methods for correcting the failures described in this section .05(2) do not
apply until after the correction of other qualification failures. Thus, for example, if, in
addition to the failure of excluding an eligible employee, the plan also failed the ADP or
ACP test, the correction methods described in section .05(2)(b) through (f) cannot be
used until after correction of the ADP or ACP test failures. For purposes of this section
.05(2), in order to determine whether the plan passed the ADP or ACP test, the plan may
rely on a test performed with respect to those eligible employees who were provided with
the opportunity to make elective deferrals or after-tax employee contributions and receive
an allocation of employer matching contributions, in accordance with the terms of the plan
and may disregard the employees who were improperly excluded.
(3) Improperly excluded employees: designated Roth contributions. For employees
who were improperly excluded from plans that (i) are subject to 401(k) (as described in
section .05(2)) and (ii) provide for the optional treatment of elective deferrals as
designated Roth contributions, the correction is the same as described under section
.05(2). Thus, for example, the corrective employer contribution required to replace the
missed deferral opportunity is made in accordance with the method described in section
.05(2)(b) in the case of a 401(k) plan that is not a safe harbor 401(k) plan or .05(2)(d)
in the case of a safe harbor 401(k) plan. However, none of the corrective contributions
made by the employer may be treated as designated Roth contributions (and may not be
included in an employees gross income) and thus may not be contributed or allocated to
a designated Roth account (as described in 402A(b)(2)). The corrective contribution
must be allocated to an account established for receiving a QNEC or any other employer
contribution in which the employee is fully vested and subject to the withdrawal
restrictions that apply to elective deferrals.
(4) Improperly excluded employees: catch-up contributions only. (a) Correction for
missed catch-up contributions. If an eligible employee was not provided the opportunity to
elect and make catch-up contributions to a 401(k) plan, the employer must make a
QNEC to the plan on behalf of the employee that replaces the missed deferral
opportunity attributable to the failure to permit an eligible employee to make a catch-up
contribution pursuant to 414(v). The missed deferral opportunity for catch-up
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contributions is equal to 50% of the employees missed deferral attributable to catch-up

contributions. For this purpose, the missed deferral attributable to catch-up contributions
is one half of the applicable catch-up contribution limit for the year in which the employee
was improperly excluded. Thus, for example if an eligible employee was improperly
precluded from electing and making catch-up contributions in 2006, the missed deferral
attributable to catch-up contributions is $2,500, which is one half of $5,000, the 2006
catch-up contribution limit for a 401(k) plan. The eligible employees missed deferral
opportunity is $1,250 (i.e., 50% of the missed deferral attributable to catch-up
contributions of $2,500). The QNEC required to replace the missed deferral opportunity
for the year of exclusion is adjusted for earnings to the date the corrective QNEC is made
on behalf of the affected employee. For purposes of this correction, an eligible employee,
pursuant to 414(v)(5), refers to any participant who (i) would have attained age 50 by
the end of the plans taxable year and (ii) in the absence of the plans catch-up provision,
could not make additional elective deferrals on account of the plan or statutory limitations
described in 414(v)(3) and 1.414(v)-1(b)(1).
(b) Correction for missed matching contributions. If an employee was precluded
from making catch-up contributions under this section .05(4), the Plan Sponsor should
ascertain whether the affected employee would have been entitled to an additional
matching contribution on account of the missed deferral. If the employee would have
been entitled to an additional matching contribution, then the employer must make a
QNEC for the matching contribution on behalf of the affected employee. The QNEC is
equal to the additional matching contribution the employee would have received had the
employee made a deferral equal to the missed deferral determined under paragraph (a)
of this section .05(4). The QNEC must be adjusted for earnings to the date the corrective
QNEC is made on behalf of the affected employee. If in addition to the failure to provide
matching contributions under this section .05(4)(b) , the plan also failed the ACP test, the
correction methods described in this section cannot be used until after correction of the
ACP test failure. For purposes of this section, in order to determine whether the plan
passed the ACP test the plan may rely on a test performed with respect to those eligible
employees who were provided with the opportunity to make elective deferrals or after-tax
employee contributions and receive an allocation of employer matching contributions, in
accordance with the terms of the plan and may disregard any employer matching
contribution that was not made on account of the plans failure to provide an eligible
employee with the opportunity to make a catch up contribution.
(5) Failure to implement an employee election. (a) Missed opportunity for elective
deferrals. For eligible employees who filed elections to make elective deferrals under the
Plan which the Plan Sponsor failed to implement on a timely basis, the Plan Sponsor
must make a QNEC to the plan on behalf of the employee to replace the missed deferral
opportunity. The missed deferral opportunity is equal to 50% of the employees missed
deferral. The missed deferral is determined by multiplying the employees elected
deferral percentage by the employees compensation. If the employee elected a dollar
amount for an elective deferral, the missed deferral would be the specified dollar amount.
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The employees missed deferral amount is reduced further to the extent necessary to
ensure that the missed deferral does not exceed applicable plan limits, including the
annual deferral limit under 402(g) for the calendar year in which the failure occurred.
(b) Missed opportunity for after-tax employee contributions. For eligible employees
who filed elections to make after-tax employee contributions under the Plan which the
Plan Sponsor failed to implement on a timely basis, the Plan Sponsor must make a
QNEC to the plan on behalf of the employee to replace the employees missed
opportunity for after-tax employee contributions. The missed opportunity for making aftertax employee contributions is equal to 40% of the employees missed after-tax
contributions. The missed after-tax employee contribution is determined by multiplying
the employees elected after-tax employee contribution percentage by the employees
compensation.
(c) Missed opportunity affecting matching contributions. In the event of failure
described in section (a) or (b) of this section .05(5), if the employee would have been
entitled to an additional matching contribution had either the missed deferral or after-tax
employee contribution been made, then the employer must make a QNEC for the
matching contribution on behalf of the affected employee. The QNEC is equal to the
matching contribution the employee would have received had the employee made a
deferral equal to the missed deferral determined under this paragraph. The QNEC must
be adjusted for earnings to the date the corrective QNEC is made on behalf of the
affected employee.
(d) Coordination with correction of other Qualification Failures. The method for
correcting the failures described in this section .05(5) does not apply until after the
correction of other qualification failures. Thus, for example, if in addition to the failure to
implement an employees election, the plan also failed the ADP test or ACP test, the
correction methods described in section .05(5)(a), (b) or (c) cannot be used until after
correction of the ADP or ACP test failures. For purposes of this section .05(5), in order to
determine whether the plan passed the ADP or ACP test the plan may rely on a test
performed with respect to those eligible employees who were not impacted by the Plan
Sponsors failure to implement employee elections and received allocations of employer
matching contributions, in accordance with the terms of the plan and may disregard
employees whose elections were not properly implemented.
.06 Failure to timely pay the minimum distribution required under 401(a)(9). In a
defined contribution plan, the permitted correction method is to distribute the required
minimum distributions (with earnings from the date of the failure to the date of the
distribution). The amount required to be distributed for each year in which the initial
failure occurred should be determined by dividing the adjusted account balance on the
applicable valuation date by the applicable distribution period. For this purpose, adjusted
account balance means the actual account balance, determined in accordance with
1.401(a)(9)-5 Q&A-3, reduced by the amount of the total missed minimum distributions
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for prior years. In a defined benefit plan, the permitted correction method is to distribute
the required minimum distributions, plus an interest payment representing the loss of use
of such amounts.
.07 Failure to obtain participant or spousal consent for a distribution subject to the
participant and spousal consent rules under 401(a)(11), 411(a)(11), and 417. (1) The
permitted correction method is to give each affected participant a choice between
providing informed consent for the distribution actually made or receiving a qualified joint
and survivor annuity. In the event that participant or spousal consent is required but
cannot be obtained, the participant must receive a qualified joint and survivor annuity
based on the monthly amount that would have been provided under the plan at his or her
retirement date. This annuity may be actuarially reduced to take into account distributions
already received by the participant. However, the portion of the qualified joint and
survivor annuity payable to the spouse upon the death of the participant may not be
actuarially reduced to take into account prior distributions to the participant. Thus, for
example, if, in accordance with the automatic qualified joint and survivor annuity option
under a plan, a married participant who retired would have received a qualified joint and
survivor annuity of $600 per month payable for life with $300 per month payable to the
spouse for the spouses life beginning upon the participant's death, but instead received a
single-sum distribution equal to the actuarial present value of the participant's accrued
benefit under the plan, then the $600 monthly annuity payable during the participant's
lifetime may be actuarially reduced to take the single-sum distribution into account.
However, the spouse must be entitled to receive an annuity of $300 per month payable
for life beginning at the participant's death.
(2) An alternative permitted correction method is to give each affected participant
a choice between (i) providing informed consent for the distribution actually made, (ii)
receiving a qualified joint and survivor annuity (both (i) and (ii) of this section .07(2) are
described in section .07(1) of this Appendix A), or (iii) a single-sum payment to the
participants spouse equal to the actuarial present value of that survivor annuity benefit
(calculated using the applicable interest rate and mortality table under 417(e)(3)). For
example, assuming the actuarial present value of a $300 per month annuity payable to
the spouse for the spouses life beginning upon the participant's death were $7,837
(calculated using the applicable interest rate and applicable mortality table under
417(e)(3)), the single-sum payment to the spouse under clause (iii) of this section .07(2)
is equal to $7,837. If the single-sum payment is made to the spouse, then the payment is
treated in the same manner as a distribution under 402(c)(9) for purposes of rolling over
the payment to an IRA or other eligible retirement plan.
.08 Failure to satisfy the 415 limits in a defined contribution plan. For limitation
years beginning before January 1, 2009, the permitted correction for failure to limit annual
additions (other than elective deferrals and after-tax employee contributions) allocated to
participants in a defined contribution plan as required in 415 (even if the excess did not
result from the allocation of forfeitures or from a reasonable error in estimating
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compensation) is to place the excess annual additions into an unallocated account,

similar to the suspense account described in 1.415-6(b)(6)(iii) (as it appeared in the
April 1, 2007 edition of 26 CFR part 1) prior to amendments made by the recently
finalized regulations under 415, to be used as an employer contribution, other than
elective deferrals, in the succeeding year(s). While such amounts remain in the
unallocated account, the employer is not permitted to make additional contributions to the
plan. The permitted correction for failure to limit annual additions that are elective
deferrals or after-tax employee contributions (even if the excess did not result from a
reasonable error in determining compensation, the amount of elective deferrals or aftertax employee contributions that could be made with respect to an individual under the
415 limits) is to distribute the elective deferrals or after-tax employee contributions using
a method similar to that described under 1.415-6(b)(6)(iv) (as it appeared in the April 1,
2007 edition of 26 CFR part 1) prior to amendments made by the recently finalized
regulations under 415. Elective deferrals and after-tax employee contributions that are
matched may be returned to the employee, provided that the matching contributions
relating to such contributions are forfeited (which will also reduce excess annual additions
for the affected individuals). The forfeited matching contributions are to be placed into an
unallocated account to be used as an employer contribution, other than elective deferrals,
in succeeding periods. For limitation years beginning on or after January 1, 2009, the
failure to limit annual additions allocated to participants in a defined contribution plan as
required in 415 is corrected in accordance with section 6.06(2) and (3).
.09 Abandoned Orphan Plans; orphan contracts and other abandoned plan
assets. (1) Abandoned plans. If (a) a plan has one or more failures (whether a
Qualification Failure or a 403(b) Failure) that result from either the employer having
ceased to exist, the employer no longer maintaining the plan, or similar reasons and (b)
the plan is an Orphan Plan, as defined in section 5.03 (i.e., is not a plan to which ERISA
applies), the permitted correction is to terminate the plan and distribute plan assets to
participants and beneficiaries. This correction must satisfy four conditions. First, the
correction must comply with conditions, standards, and procedures substantially similar to
those set forth in section 2578.1 of the Department of Labor Regulations (relating to
abandoned plans). Second, the qualified termination administrator, based on plan
records located and updated in accordance with the Department of Labor Regulations,
must have reasonably determined whether, and to what extent, the survivor annuity
requirements of 401(a)(11) and 417 apply to any benefit payable under the plan and
takes reasonable steps to comply with those requirements (if applicable). Third, each
participant and beneficiary must have been provided a nonforfeitable right to his or her
accrued benefits as of the date of deemed termination under the Department of Labor
Regulations, subject to income, expenses, gains, and losses between that date and the
date of distribution. Fourth, participants and beneficiaries must receive notification of their
rights under 402(f). In addition, notwithstanding correction under this revenue
procedure, the Service reserves the right to pursue appropriate remedies under the
Internal Revenue Code against any party who is responsible for the plan, such as the
Plan Sponsor, plan administrator, or owner of the business, even in its capacity as a
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participant or beneficiary under the plan. However, with respect to the first through third
conditions above, notice need not be furnished to the Department of Labor, and notices
furnished to the Plan Sponsor, participants, or beneficiaries need not indicate that the
procedures followed or notices furnished actually comply with, or are required under,
Department of Labor regulations.
(2) Orphan contracts or other assets. In any case in which a 403(b) Failure results
from the employer having ceased involvement with respect to specific assets (including
an insurance annuity contract) held under a defined contribution plan on behalf of a
participant who is a former employee or on behalf of a beneficiary, a permitted correction
is to distribute those plan assets to the participant or beneficiary. Compliance with the
distribution rules of section 2578.1(d)(2)(vii) of the Department of Labor Regulations
satisfies this paragraph .09(2).
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APPENDIX B
CORRECTION METHODS AND EXAMPLES;
EARNINGS ADJUSTMENT METHODS AND EXAMPLES
SECTION 1. PURPOSE, ASSUMPTIONS FOR EXAMPLES AND SECTION
REFERENCES
.01 Purpose. (1) This appendix sets forth correction methods relating to
Operational Failures under Qualified Plans. This appendix also sets forth earnings
adjustment methods. In each case, the method described corrects the Operational Failure
identified in the headings below. Corrective allocations and distributions should reflect
earnings and actuarial adjustments in accordance with section 6.02(4) of this revenue
procedure. The correction methods in this appendix are acceptable to correct
Qualification Failures under VCP, and to correct Qualification Failures under SCP that
occurred notwithstanding that the plan has established practices and procedures
reasonably designed to promote and facilitate overall compliance with the Code, as
provided in section 4.04 of this revenue procedure. .
(2) To the extent a failure listed in this appendix could occur under a 403(b)
Plan, SEP, or a SIMPLE IRA Plan, the correction method listed for such failure may
similarly be used to correct the failure.
.02 Assumptions for Examples. Unless otherwise specified, for ease of
presentation, the examples assume that:
(1) the plan year and the 415 limitation year are the calendar year;
(2) the employer maintains a single plan intended to satisfy 401(a) and
has never maintained any other plan;
(3) in a defined contribution plan, the plan provides that forfeitures are used
to reduce future employer contributions;
(4) the Qualification Failures are Operational Failures and the eligibility and
other requirements for SCP, VCP or Audit CAP, whichever applies, are satisfied; and
(5) there are no Qualification Failures other than the described Operational
Failures, and if a corrective action would result in any additional Qualification Failure,
appropriate corrective action is taken for that additional Qualification Failure in
accordance with EPCRS.
.03 Designated Roth contributions. The examples in this Appendix B generally do
not identify whether the plan offers designated Roth contributions. The results in the
examples, including corrective contributions, would be the same whether or not the plan
offered designated Roth contributions.
.04 Section references. References to section 2 and section 3 are references to
the section 2 and 3 in this appendix.
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SECTION 2. CORRECTION METHODS AND EXAMPLES

.01 ADP/ACP Failures.
(1) Correction Methods. (a) Appendix A Correction Method. Appendix A,
section .03 sets forth a correction method for a failure to satisfy the actual deferral
percentage ("ADP"), actual contribution percentage ("ACP"), or, for plan years beginning
on or before December 31, 2001, multiple use test set forth in 401(k)(3), 401(m)(2),
and 401(m)(9), respectively.
(b) One-to-One Correction Method. (i) General. In addition to the
correction method in Appendix A, a failure to satisfy the ADP test, ACP test, or, for plan
years beginning on or before December 31, 2001, the multiple use test may be corrected
by using the one-to-one correction method set forth in this section 2.01(1)(b). Under the
one-to-one correction method, an excess contribution amount is determined and assigned
to highly compensated employees as provided in paragraph (1)(b)(ii) below. That excess
contribution amount (adjusted for earnings) is either distributed to the highly compensated
employees or forfeited from the highly compensated employees' accounts as provided in
paragraph (1)(b)(iii) below. That same dollar amount (i.e., the excess contribution amount,
adjusted for earnings) is contributed to the plan and allocated to nonhighly compensated
employees as provided in paragraph (1)(b)(iv) below. Under this correction method, a
plan may not be treated as two separate plans, one covering otherwise excludable
employees and the other covering all other employees (as permitted in 1.410(b)6(b)(3)). Likewise, restructuring the plan into component plans is not permitted.
(ii) Determination of the Excess Contribution Amount. The excess contribution
amount for the year is equal to the excess of (A) the sum of the excess contributions (as
defined in 401(k)(8)(B)), the excess aggregate contributions (as defined in
401(m)(6)(B)), and for plan years beginning on or before December 31, 2001 the
amount treated as excess contributions or excess aggregate contributions under the
multiple use test for the year, as assigned to each highly compensated employee in
accordance with 401(k)(8)(C) and 401(m)(6)(C), over (B) previous corrections that
complied with 401(k)(8), 401(m)(6), and, for plan years beginning on or before
December 31, 2001, the multiple use test.
(iii) Distributions and Forfeitures of the Excess Contribution Amount. (A) The
portion of the excess contribution amount assigned to a particular highly compensated
employee under paragraph (1)(b)(ii) is adjusted for earnings from the end of the plan year
of the year of the failure through the date of correction. The amount assigned to a
particular highly compensated employee, as adjusted, is distributed or, to the extent the
amount was forfeitable as of the close of the plan year of the failure, is forfeited. If the
amount is forfeited, it is used in accordance with the plan provisions relating to forfeitures
that were in effect for the year of the failure. If the amount so assigned to a particular
highly compensated employee has been previously distributed, the amount is an Excess
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Amount within the meaning of section 5.01(3) of this revenue procedure. Thus, pursuant
to section 6.06 of this revenue procedure, the employer must notify the employee that the
Excess Amount is not eligible for favorable tax treatment accorded to distributions from
qualified plans (and, specifically, is not eligible for tax-free rollover).
(B) If any matching contributions (adjusted for earnings) are forfeited in
accordance with 411(a)(3)(G), the forfeited amount is used in accordance with the plan
provisions relating to forfeitures that were in effect for the year of the failure.
(C) If a payment was made to an employee and that payment is a forfeitable
match described in either paragraph (1)(b)(iii)(A) or (B), then it is an Overpayment defined
in section 5.01(6) of this revenue procedure that must be corrected (see sections 2.04
and 2.05 below).
(iv) Contribution and Allocation of Equivalent Amount. (A) The employer makes
a contribution to the plan that is equal to the aggregate amounts distributed and forfeited
under paragraph (1)(b)(iii)(A) (i.e., the excess contribution amount adjusted for earnings,
as provided in paragraph (1)(b)(iii)(A), which does not include any matching contributions
forfeited in accordance with 411(a)(3)(G) as provided in paragraph (1)(b)(iii)(B)). The
contribution must satisfy the vesting requirements and distribution limitations of
401(k)(2)(B) and (C).
(B)(1) This paragraph (1)(b)(iv)(B)(1) applies to a plan that uses the current year
testing method described in 1.401(k)-2(a)(2), 1.401(m)-2(a)(2) and, for periods prior to
the effective date of those regulations, Notice 98-1, 1998-1 C.B. 327. The contribution
made under paragraph (1)(b)(iv)(A) is allocated to the account balances of those
individuals who were either (I) the eligible employees for the year of the failure who were
nonhighly compensated employees for that year or (II) the eligible employees for the year
of the failure who were nonhighly compensated employees for that year and who also are
nonhighly compensated employees for the year of correction. Alternatively, the
contribution is allocated to account balances of eligible employees described in (I) or (II)
of the preceding sentence, except that the allocation is made only to the account
balances of those employees who are employees on a date during the year of the
correction that is no later than the date of correction. Regardless of which of these four
options (described in the two preceding sentences) the employer selects, eligible
employees must receive a uniform allocation (as a percentage of compensation) of the
contribution. (See Examples 1 and 2.) Under the one-to-one correction method, the
amount allocated to the account balance of an employee (i.e., the employee's share of
the total amount contributed under paragraph (1)(b)(iv)(A)) is not further adjusted for
earnings and is treated as an annual addition under 415 for the year of the failure for
the employee for whom it is allocated.
(2) This paragraph (1)(b)(iv)(B)(2) applies to a plan that uses the prior year
testing method described in 1.401(k)-2(a)(2) and 1.401(m)-2(a)(2) and, for periods prior
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to the effective date of those regulations, Notice 98-1. Paragraph (1)(b)(iv)(B)(1) is

applied by substituting "the year prior to the year of the failure" for "the year of the failure".
(2) Examples.
Example 1:
Employer A maintains a profit-sharing plan with a cash or deferred arrangement that is intended to
satisfy 401(k) using the current year testing method. The plan does not provide for matching
contributions or after-tax employee contributions. In 2007, it was discovered that the ADP test for
2005 was not performed correctly. When the ADP test was performed correctly, the test was not
satisfied for 2005. For 2005, the ADP for highly compensated employees was 9% and the ADP for
nonhighly compensated employees was 4%. Accordingly, the ADP for highly compensated
employees exceeded the ADP for nonhighly compensated employees by more than two percentage
points (in violation of 401(k)(3)). There were two highly compensated employees eligible under
the 401(k) plan during 2005, Employee P and Employee Q. Employee P made elective deferrals
of $10,000, which is equal to 10% of Employee P's compensation of $100,000 for 2005. Employee
Q made elective deferrals of $9,500, which is equal to 8% of Employee Q's compensation of
$118,750 for 2005.
Correction:
On June 30, 2007, Employer A uses the one-to-one correction method to correct the failure to
satisfy the ADP test for 2005. Accordingly, Employer A calculates the dollar amount of the excess
contributions for the two highly compensated employees in the manner described in 401(k)(8)(B).
The amount of the excess contribution for Employee P is $4,000 (4% of $100,000) and the amount
of the excess contribution for Employee Q is $2,375 (2% of $118,750), or a total of $6,375. In
accordance with 401(k)(8)(C), $6,375, the excess contribution amount, is assigned $3,437.50 to
Employee P and $2,937.50 to Employee Q. It is determined that the earnings on the assigned
amounts through June 30, 2007 are $687 and $587 for Employees P and Q, respectively. The
assigned amounts and the earnings are distributed to Employees P and Q. Therefore, Employee P
receives $4,124.50 ($3,437.50 + $687) and Employee Q receives $3,524.50 ($2,937.50 + $587). In
addition, on the same date, Employer A makes a corrective contribution to the 401(k) plan equal
to $7,649 (the sum of the $4,124.50 distributed to Employee P and the $3,524.50 distributed to
Employee Q). The corrective contribution is allocated to the account balances of eligible nonhighly
compensated employees for 2005, pro rata based on their compensation for 2005 (subject to 415
for 2005).
Example 2:
The facts are the same as in Example 1, except that for 2005 the plan also provides for (1) after-tax
employee contributions and (2) matching contributions equal to 50% of the sum of an employee's
elective deferrals and after-tax employee contributions that do not exceed 10% of the employee's
compensation. The plan provides that matching contributions are subject to the plan's 20% per
year of service vesting schedule and that matching contributions are forfeited and used to reduce
employer contributions if associated elective deferrals or after-tax employee contributions are
distributed to correct an ADP or ACP test failure. For 2005, nonhighly compensated employees
made after-tax employee contributions and no highly compensated employee made any after-tax
employee contributions. Employee P received a matching contribution of $5,000 (50% of $10,000)
and Employee Q received a matching contribution of $4,750 (50% of $9,500). Employees P and Q
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were 100% vested in 2005. It was determined that the plan satisfied the requirements of the ACP
test for 2005.
Correction:
The same corrective actions are taken as in Example 1. In addition, in accordance with the plan's
terms, corrective action is taken to forfeit Employee P's and Employee Q's matching contributions
associated with their distributed excess contributions. Employee P's distributed excess
contributions and associated matching contributions are $3,437.50 and $1,718.75, respectively.
Employee Q's distributed excess contributions and associated matching contributions are
$2,937.50 and $1,468.75, respectively. Thus, $1,718.75 is forfeited from Employee P's account
and $1,468.75 is forfeited from Employee Q's account. In addition, the earnings on the forfeited
amounts are also forfeited. It is determined that the respective earnings on the forfeited amount for
Employee P is $250 and for Employee Q is $220. The total amount of the forfeitures of $3,657.50
(Employee P's $1,718.75 + $250 and Employee Q's $1,468.75 + $220) is used to reduce
contributions for 2007 and subsequent years.
.02 Exclusion of Otherwise Eligible Employees.

(1) Exclusion of Eligible Employees in a 401(k) or (m) Plan. (a) Correction
Method. (i) Appendix A Correction Method for Full Year Exclusion. Appendix A section
.05(2) sets forth the correction method for the exclusion of an eligible employee from
electing and making elective deferrals (other than designated Roth contributions) and
after-tax employee contributions to a plan that provides benefits that are subject to the
requirements of 401(k) or 401(m) for one or more full plan years. (See Example 3.)
Appendix A section .05(2) also specifies the method for determining missed elective
deferrals and the corrective contributions for employees who were improperly excluded
from electing and making elective deferrals to a safe harbor 401(k) plan for one or more
full plan years. (See Examples 8, 9 and 10.) Appendix A section .05(3) sets forth the
correction method for the exclusion of an eligible employee from electing and making
elective deferrals in a plan that (i) is subject to 401(k) and (ii) provides employees with
the opportunity to make designated Roth contributions. Appendix A section .05(4) sets
forth the correction method for the situation where an eligible employee was permitted to
make an elective deferral, but was not provided with the opportunity to make catch-up
contributions under the terms of the plan and 414(v), and correction is being made by
making a QNEC on behalf of the excluded employee. (See Example 11.) Appendix A
section .05(5) sets forth the correction method for the failure by a plan to implement an
employees election with respect to elective deferrals (including designated Roth
contributions) or after-tax employee contributions. (See Example 12.) In section
2.02(1)(a)(ii) below, the correction methods for (I) the exclusion of an eligible employee
from all contributions (including designated Roth contributions) under a 401(k) or (m) plan
for a full year, as described in Appendix A sections .05(2) and .05(3), (II) the exclusion of
an eligible employee who was permitted to make elective deferrals, but was not permitted
to make catch-up contributions for a full plan year as described in Appendix A section
.05(4), and (III) the exclusion of an eligible employee on account of the failure to
implement an employees election to make elective deferrals or after-tax employee
contributions to the plan as described in Appendix A section .05(5) are expanded to
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include correction for the exclusion from these contributions (including designated Roth
contributions) under a 401(k) or (m) plan for a partial plan year. This correction for a
partial year exclusion may be used in conjunction with the correction for a full year
exclusion.
(ii) Expansion of Correction Method to Partial Year Exclusion. (A) In General.
The correction method in Appendix A, section .05 is expanded to cover an employee who
was improperly excluded from electing and making elective deferrals (including
designated Roth contributions) or after-tax employee contributions for a portion of a plan
year or from receiving matching contributions (on either elective deferrals or after-tax
employee contributions) for a portion of a plan year. In such case, a permitted correction
method for the failure is for the Employer to satisfy this section 2.02(1)(a)(ii). The
Employer makes a QNEC on behalf of the excluded employee. The method and
examples described to correct the failure to include otherwise eligible employees do not
apply until after correction of other qualification failures. Thus, for example, in the case of
a 401(k) plan that does not apply the safe harbor contribution requirements of
401(k)(12) or 401(k)(13) the correction for improperly excluding an employee from
making elective deferrals, as described in the narrative and the examples in this section
cannot be used until after correction of the ADP test failure. (See Appendix A .05(2)(g).)
(B) Elective Deferral Failures. (1) The appropriate QNEC for the failure to allow an
employee to elect and make elective deferrals (including designated Roth contributions)
for a portion of the plan year is equal to the missed deferral opportunity which is an
amount equal to 50% of the employees missed deferral. The employees missed deferral
is determined by multiplying the ADP of the employee's group (either highly or nonhighly
compensated), determined prior to correction under this section 2.02(1)(a)(ii), by the
employee's plan compensation for the portion of the year during which the employee was
improperly excluded. In a safe harbor 401(k) plan, the employees missed deferral is
determined by multiplying 3% (or, if greater, whatever percentage of the participants
compensation which, if contributed as an elective deferral, would have been matched at a
rate of 100% or more) by the employees plan compensation for the portion of the year
during which the employee was improperly excluded. The missed deferral for the portion
of the plan year during which the employee was improperly excluded from being eligible
to make elective deferrals is reduced to the extent that (i) the sum of the missed deferral
(as determined in the preceding two sentences of this paragraph) and any elective
deferrals actually made by the employee for that year would exceed (ii) the maximum
elective deferrals permitted under the plan for the employee for that plan year (including
the 402(g) limit). The corrective contribution is adjusted for earnings. For purposes of
correcting other failures under this revenue procedure (including determination of any
required matching contribution) after correction has occurred under this section
2.02(1)(a)(ii)(B), the employee is treated as having made pre-tax elective deferrals equal
to the employees missed deferral for the portion of the year during which the employee
was improperly excluded. (See Examples 4 and 5.)
307
(2) The appropriate corrective contribution for the plans failure to implement an
employees election with respect to elective deferrals is equal to the missed deferral
opportunity which is an amount equal to 50% of the employees missed deferral.
Corrective contributions are adjusted for earnings. The missed deferral is determined by
multiplying the employees deferral percentage by the employee's plan compensation for
the portion of the year during which the employee was improperly excluded. If the
employee elected a fixed dollar amount that can be attributed to the period of exclusion,
then the flat dollar amount for the period of exclusion may be used for this purpose. If the
employee elected a fixed dollar amount to be deferred for the entire plan year, then that
dollar amount is multiplied by a fraction. The fraction is equal to the number of months,
including partial months where applicable, during which the eligible employee was
excluded from making catch-up contributions divided by 12. The missed deferral for the
portion of the plan year during which the eligible employee was improperly excluded from
making elective deferrals is reduced to the extent that (i) the sum of the missed deferral
(as determined in the preceding three sentences) and any elective deferrals actually
made by the employee for that year would exceed (ii) the maximum elective deferrals
permitted under the plan for the employee for that plan year (including the 402(g) limit).
The corrective contribution is adjusted for earnings. The requirements relating to the
passage of the ADP test before this correction method can be used, as described in
Appendix A section .05(5)(d) still apply.
(C) After-tax Employee Contribution Failures. (1) The appropriate corrective
contribution for the failure to allow employees to elect and make after-tax employee
contributions for a portion of the plan year is equal to the missed after-tax employee
contributions opportunity, which is an amount equal to 40% of the employees missed
after-tax employee contributions. The employees missed after-tax employee
contributions is determined by multiplying the ACP of the employee's group (either highly
or nonhighly compensated), determined prior to correction under this section
2.02(1)(a)(ii)(C), by the employee's plan compensation for the portion of the year during
which the employee was improperly excluded. If the ACP consists of both matching and
after-tax employee contributions, then for purposes of the preceding sentence, in lieu of
basing the missed after-tax employee contributions on the ACP for the employee's group
(either highly compensated or nonhighly compensated), the Employer is permitted to
determine separately the portions of the ACP that are attributable to matching
contributions and after-tax employee contributions and base the missed after-tax
employee contributions on the portion of the ACP that is attributable to after-tax employee
contributions. The missed after-tax employee contribution is reduced to the extent that (i)
the sum of that contribution and the actual total after-tax employee contributions made by
the employee for the plan year would exceed (ii) the sum of the maximum after-tax
employee contributions permitted under the plan for the employee for the plan year. The
corrective contribution is adjusted for earnings. The requirements relating to the passage
of the ACP test before this correction method can be used, as described in Appendix A
section .05(2)(g) still apply.
308
(2) The appropriate corrective contribution for the plans failure to implement an
employees election with respect to after-tax employee contributions for a portion of the
plan year is equal to the missed after-tax employee contributions opportunity, which is an
amount equal to 40% of the employees missed after-tax employee contributions.
Corrective contributions are adjusted for earnings. The missed after-tax employee
contribution is determined by multiplying the employees elected after-tax employee
contribution percentage by the employee's plan compensation for the portion of the year
during which the employee was improperly excluded. If the employee elected a flat dollar
amount that can be attributed to the period of exclusion, then the flat dollar amount for the
period of exclusion may be used for this purpose. If the employee elected a flat dollar
amount to be contributed for the entire plan year, then that dollar amount is multiplied by
a fraction. The fraction is equal to the number of months, including partial months where
applicable, during which the eligible employee was excluded from making after-tax
employee contributions divided by 12. The missed after-tax employee contribution is
reduced to the extent that (i) the sum of that contribution and the actual total after-tax
employee contributions made by the employee for the plan year would exceed (ii) the
sum of the maximum after-tax employee contributions permitted under the plan for the
employee for the plan year. The requirements relating to the passage of the ACP test
before this correction method can be used, as described in Appendix A section .05(5)(d)
still apply.
(D) Matching Contribution Failures. (1) The appropriate corrective contribution for
the failure to make matching contributions for an employee because the employee was
precluded from making elective deferrals (including designated Roth contributions) or
after-tax employee contributions for a portion of the plan year is equal to the matching
contribution that would have been made for the employee if (1) the employees elective
deferrals for that portion of the plan year had equaled the employees missed deferrals
(determined under section 2.02(1)(a)(i)(B)) or (2) the employees after-tax contribution for
that portion of the plan year had equaled the employees missed after-tax employee
contribution (determined under section 2.02(1)(a)(ii)(C)). This matching contribution is
reduced to the extent that (i) the sum of this contribution and other matching contributions
actually made on behalf of the employee for the plan year would exceed (ii) the maximum
matching contribution permitted if the employee had made the maximum matchable
contributions permitted under the plan for the plan year. The corrective contribution is
adjusted for earnings. The requirements relating to the passage of the ACP test before
this correction method can be used, as described in Appendix A section .05(2)(g) still
apply.
(2) The appropriate corrective contribution for the failure to make matching
contributions for an employee because of the failure by the plan to implement an
employees election with respect to elective deferrals (including designated Roth
contributions) or, where applicable, after-tax employee contributions for a portion of the
plan year is equal to the matching contribution that would have been made for the
employee if the employee made the elective deferral as determined under section
309
2.02(1)(a)(ii)(B)(2), or where applicable, the after-tax employee contribution determined

under section 2.02(1)(a)(ii)(C)(2). This matching contribution is reduced to the extent that
(i) the sum of this contribution and other matching contributions actually made on behalf
of the employee for the plan year would exceed (ii) the maximum matching contribution
permitted if the employee had made the maximum matchable contributions permitted
under the plan for the plan year. The corrective contribution is adjusted for earnings. The
requirements relating to the passage of the ACP test before this correction method can be
used, as described in Appendix A section .05(5)(d), still apply.
(E) Use of Prorated Compensation. For purposes of this paragraph (1)(a)(ii), for
administrative convenience, in lieu of using the employee's actual plan compensation for
the portion of the year during which the employee was improperly excluded, a pro rata
portion of the employee's plan compensation that would have been taken into account for
the plan year, if the employee had not been improperly excluded, may be used.
(F) Special Rule for Brief Exclusion from Elective Deferrals and After-Tax
Employee Contributions. An employer is not required to make a corrective contribution
with respect to elective deferrals (including designated Roth contributions) or after-tax
employee contributions, as provided in sections 2.02(1)(a)(ii)(B) and (C), but is required to
make a corrective contribution with respect to any matching contributions, as provided in
section 2.02(1)(a)(ii)(D) for an employee for a plan year if the employee has been
provided the opportunity to make elective deferrals or after-tax employee contributions
under the plan for a period of at least the last 9 months in that plan year and during that
period the employee had the opportunity to make elective deferrals or after-tax employee
contributions in an amount not less than the maximum amount that would have been
permitted if no failure had occurred. (See Examples 6 and 7.)
(b) Examples.
Example 3:
Employer B maintains a 401(k) plan. The plan provides for matching contributions for eligible
employees equal to 100% of elective deferrals that do not exceed 3% of an employee's
compensation. The plan allows employees to make after-tax employee contributions up to a
maximum of the lesser of 2% of compensation or $1,000. The after-tax employee contributions are
not matched. The plan provides that employees who complete one year of service are eligible to
participate in the plan on the next designated entry date. The entry dates are January 1, and July 1.
In 2007, it is discovered that Employee V, a NHCE with compensation of $30,000, was excluded
from the plan for the 2006 plan year even though she satisfied the plans eligibility requirements as
of January 1, 2006.
For the 2006 plan year, the relevant employee and contribution information is as follows:
Compensation Elective deferral
Match
Highly Compensated Employees (HCEs):
310
After-Tax Employee
Contribution
R
S
$200,000
150,000
$ 6,000
$12,000
$6,000
$4,500
0
$1,000
Nonhighly Compensated Employees (NHCEs):

T
U
80,000
50,000
$12,000
$ 500
$2,400
$ 500
$1,000
0
HCEs:
ADP - 5.5%
ACP - 3.33%
ACP attributable to matching contributions - 3%
ACP attributable to after-tax employee contributions - 0.33%
NHCEs:
ADP - 8%
ACP -2.63%
ACP attributable to matching contributions - 2%
ACP attributable to after-tax employee contributions - 0.63%
Correction:
Employer B uses the correction method for a full year exclusion, described in Appendix A section
.05(2), to correct the failure to include Employee V in the plan for the full plan year beginning
January 1, 2006. Employer B calculates the corrective QNEC to be made on behalf of Employee V
as follows:
Elective deferrals: Employee V was eligible to, but was not provided with the opportunity to, elect
and make elective deferrals in 2006. Thus, Employer B must make a QNEC to the plan on behalf of
Employee V equal to the missed deferral opportunity for Employee V, which is 50% of Employee
Vs missed deferral. The QNEC is adjusted for earnings. The missed deferral for Employee V is
determined by using the ADP for NHCEs for 2006 and multiplying that percentage by Employee Vs
compensation for 2006. Accordingly, the missed deferral for Employee V on account of the
employees improper exclusion from the plan is $2,400 (8% x $30,000). The missed deferral
opportunity is $1,200 (i.e., 50% x $2,400). Thus, the required corrective contribution for the failure
to provide Employee V with the opportunity to make elective deferrals to the plan is $1,200 (plus
earnings). The corrective contribution is made to a pre-tax QNEC account for Employee V (not to a
designated Roth contributions account even if the plan offers designated Roth contributions, as
provided in section .05(3) of Appendix A).
Matching contributions: Employee V should have been eligible for, but did not receive, an allocation
of employer matching contributions because Employee V was not provided the opportunity to make
elective deferrals in 2006. Thus, Employer B must make a QNEC to the plan on behalf of
Employee V that is equal to the matching contribution Employee V would have received had the
missed deferral been made. The QNEC is adjusted for earnings. Under the terms of the plan, if
Employee V had made an elective deferral of $2,400 or 8% of compensation ($30,000), the
employee would have been entitled to a matching contribution equal to 100% of first 3% of
Employee Vs compensation ($30,000) or $900. Accordingly, the contribution required to replace
the missed employer matching contribution is $900 (plus earnings).
311
After-tax employee contributions: Employee V was eligible to, but was not provided with the
opportunity to, elect and make after-tax employee contributions in 2006. Employer B must make a
QNEC to the plan equal to the missed opportunity for making after-tax employee contributions for
Employee V, which is 40% of Employee Vs missed after-tax employee contribution. The QNEC is
adjusted for earnings. The missed after-tax employee contribution for Employee V is estimated by
using the ACP for NHCEs (to the extent that the ACP is attributable to after-tax employee
contributions) for 2006 and multiplying that percentage by Employee Vs compensation for 2006.
Accordingly, the missed after-tax employee contribution for Employee V, on account of the
employees improper exclusion from the plan is $189 (0.63% x $30,000). The missed opportunity to
make after-tax employee contributions to the plan is $76 (40% x $189). Thus, the required
corrective contribution for the failure to provide Employee V with the opportunity to make the $189
after-tax employee contribution to the plan is $76 (plus earnings).
The total required corrective QNEC, before adjustments for earnings, on behalf of Employee V is
$2,176 ($1,200 for the missed deferral opportunity plus $900 for the missed matching contribution
plus $76 for the missed opportunity to make after-tax employee contributions). The required
corrective QNEC is further adjusted for earnings.
Example 4:
Employer C maintains a 401(k) plan. The plan provides for matching contributions for each
payroll period that are equal to 100% of an employee's elective deferrals that do not exceed 2% of
the eligible employee's plan compensation during the payroll period. The plan provides for after-tax
employee contributions. The after-tax employee contribution cannot exceed $1,000 for the plan
year. The plan provides that employees who complete one year of service are eligible to participate
in the plan on the next January 1 or July 1 entry date. Employee X, a nonhighly compensated
employee, who met the eligibility requirements and should have entered the plan on January 1,
2006, was not offered the opportunity to participate in the plan. In August of 2006, the error was
discovered and Employer C offered Employee X the opportunity to make elective deferrals and
after-tax employee contributions as of September 1, 2006. Employee X made elective deferrals
equal to 4% of the employee's plan compensation for each payroll period from September 1, 2006
through December 31, 2006 (resulting in elective deferrals of $400). Employee Xs plan
compensation for 2006 was $36,000 ($26,000 for the first eight months and $10,000 for the last
four months). Employer C made matching contributions equal to $200 on behalf of Employee X,
which is 2% of Employee Xs plan compensation for each payroll period from September 1, 2006
through December 31, 2006 ($10,000). After being allowed to participate in the plan, Employee X
made $250 of after-tax employee contributions for the 2006 plan year. The ADP for nonhighly
compensated employees for 2006 was 3% and the ACP for nonhighly compensated employees for
2006 was 2.3%. The ACP attributable to matching contributions for nonhighly compensated
employees for 2003 was 1.8%. The ACP attributable to employee contributions for nonhighly
compensated employees for 2006 was 0.5%.
Correction:
In accordance with section 2.02(1)(a)(ii), Employer C uses the correction method described in
Appendix A section .05 to correct for the failure to provide Employee X the opportunity to elect and
make elective deferrals and after-tax employee contributions, and, as a result, not receiving
matching contributions for a portion of the plan year (January 1, 2006 through August 31, 2006).
Thus, Employer C makes a corrective contribution on behalf of Employee X that satisfies the
requirements of section 2.02(1)(a)(ii). Employer C elects to utilize the provisions of section
2.02(1)(a)(ii)(E) to determine Employee Xs compensation for the portion of the year in which
312
Employee X was not provided the opportunity to make elective deferrals and after-tax employee
contributions. Thus, for administrative convenience, in lieu of using actual plan compensation of
$26,000 for the period Employee X was excluded, Employee Xs annual plan compensation is
prorated for the 8-month period that the employee was excluded from participating in the plan. The
corrective contribution is determined as follows:
(1) Corrective contribution for missed deferral: Employee X was eligible to, but was not provided
with the opportunity to, elect and make elective deferrals from January 1 through August 31 of
2006. Employer C must make a corrective contribution to the plan on behalf of Employee X
equal to Employee Xs missed deferral opportunity for that period, which is 50% of Employee
Xs missed deferral. From January 1 through August 31, 2006. The corrective contribution is
adjusted for earnings. Employee Xs missed deferral is determined by multiplying the 3% ADP
for nonhighly compensated employees by $24,000 (8/12ths of the employees 2006
compensation of $36,000). Accordingly, the missed deferral is $720. The missed deferral is
not reduced because when this amount is added to the amount already deferred, no plan limit
(including 402(g)) was exceeded. Accordingly, the required corrective contribution is $360
(i.e. 50% multiplied by the missed deferral amount of $720). The required corrective
contribution is adjusted for earnings.
(2) Corrective contribution for missed matching contribution: Under the terms of the plan, if
Employee X had made an elective deferral of $720 or 3% of compensation for the period of
exclusion ($24,000), the employee would have been entitled to a matching contribution equal to
2% of $24,000 or $480. The missed matching contribution is not reduced because no plan limit
is exceeded when this amount is added to the matching contribution already contributed for the
2006 plan year. Accordingly, the required corrective contribution is $480. The required
corrective contribution is adjusted for earnings.
(3) Corrective contribution for missed after-tax employee contribution: Employee X was eligible to,
but was not provided with the opportunity to elect and make after-tax employee contributions
from January 1 through August 31 of 2006. Employer C must make a corrective contribution to
the plan on behalf of Employee X equal to the missed opportunity to make after-tax employee
contributions. The missed opportunity to make after-tax employee contributions is equal to 40%
of Employee Xs missed after-tax employee contributions. The corrective contribution is
adjusted for earnings. The missed after-tax employee contribution amount is equal to the 0.5%
ACP attributable to employee contributions for nonhighly compensated employees multiplied by
$24,000 (8/12ths of the employees 2006 plan compensation of $36,000). Accordingly, the
missed after-tax employee contribution amount is $120. The missed after-tax employee
contribution is not reduced because the sum of $120 and the previously made after-tax
employee contribution of $250 is less than the overall plan limit of $1,000. Therefore, the
required corrective contribution is $48 (i.e., 40% multiplied by the missed after-tax employee
contribution of $120). The corrective contribution is adjusted for earnings.
The total required QNEC on behalf of the employee is $888 ($360 for the missed deferral
opportunity plus $480 for the missed matching contribution plus $48 for the missed opportunity to
make after-tax employee contributions).
Example 5:
The facts (including the ADP and ACP results) are the same as in Example 4, except that it is now
determined that Employee X, after being included in the plan in 2006, made after-tax employee
contributions of $950.
Correction:
313
The correction is the same as in Example 4, except that the corrective contribution required to
replace the missed after-tax employee contribution is re-calculated to take into account applicable
plan limits in accordance with the provisions of section 2.02(1)(a)(ii)(C). The required corrective
contribution is determined as follows:
Corrective contribution for missed after-tax employee contribution: The missed after-tax employee
contribution amount is equal to the 0.5% ACP attributable to after-tax employee contributions for
nonhighly compensated employees multiplied by $24,000 (8/12ths of the employees 2006 plan
compensation of $36,000). The missed after-tax employee contribution amount, based on this
calculation, is $120. However, the sum of this amount ($120) and the previously made after-tax
employee contribution ($950) is $1,070. Because the plan limit for after-tax employee contributions
is $1,000, the missed after-tax employee contribution needs to be reduced by $70, to ensure that
the total after-tax employee contributions comply with the plan limit. Accordingly, the missed aftertax employee contribution is $50 ($120 minus $70) and the required corrective contribution is $20
(i.e. 40% multiplied by the missed after-tax employee contribution of $50). The corrective
Example 6:
Employer D sponsors a 401(k) plan. The plan has a one year of service eligibility requirement
and provides for January 1 and July 1 entry dates. Employee Y, who should have been provided
the opportunity to elect and make elective deferrals on January 1, 2006, was not provided the
opportunity to elect and make elective deferrals until July 1, 2006. The employee made $5,000 in
elective deferrals to the plan in 2006. The employee was a highly compensated employee with
compensation for 2006 of $200,000. Employee Ys compensation from January 1 through June 30,
2006 was $130,000. The ADP for highly compensated employees for 2006 was 10%. The ADP for
nonhighly compensated employees for 2006 was 8%. The 402(g) limit for deferrals made in 2006
was $15,000.
Correction:
Corrective contribution for missed deferral: Employee Ws missed deferral is equal to the 10% ADP
for highly compensated employees multiplied by $130,000 (compensation earned for the portion of
the year in which Employee W was erroneously excluded, i.e., January 1 through June 30, 2006).
The missed deferral amount, based on this calculation is $13,000. However, the sum of this
amount ($13,000) and the previously made elective contribution ($5,000) is $18,000. The 2006
402(g) limit for elective deferrals is $15,000. In accordance with the provisions of section
2.02(1)(a)(ii)(B), the missed deferral needs to be reduced by $3,000, to ensure that the total
elective contribution complies with the applicable 402(g) limit. Accordingly, the missed deferral is
$7,000 ($10,000 minus $3,000) and the required corrective contribution is $3,500 (i.e., 50%
multiplied by the missed deferral of $7,000). The corrective contribution is adjusted for earnings.
Example 7:
Employer E maintains a 401(k) plan. The plan provides for matching contributions for each
payroll period that are equal to 100% of an employee's elective deferrals that do not exceed 2% of
the eligible employee's plan compensation during the payroll period. The plan also provides that
the annual limit on matching contributions is $750. The plan provides for after-tax employee
contributions. The after-tax employee contribution cannot exceed $1,000 during a plan year. The
plan provides that employees who complete one year of service are eligible to participate in the
plan on the next January 1 or July 1 entry date. Employee Z, a nonhighly compensated employee
314
who met the eligibility requirements and should have entered the plan on January 1, 2006 was not
offered the opportunity to participate in the plan. In March of 2006, the error was discovered and
Employer E offered the employee an election opportunity as of April 1, 2006. Employee Z had the
opportunity to make the maximum elective deferrals and/or after-tax employee contributions that
could have been made under the terms of the plan for the entire 2006 plan year. The employee
made elective deferrals equal to 3% of the employee's plan compensation for each payroll period
from April 1, 2006 through December 31, 2006 (resulting in elective deferrals of $960). The
employee's plan compensation for 2006 was $40,000 ($8,000 for the first three months and
$32,000 for the last nine months). Employer E made matching contributions equal to $640 for the
excluded employee, which is 2% of the employee's plan compensation for each payroll period from
April 1, 2006 through December 31, 2006 ($32,000). After being allowed to participate in the plan,
the employee made $500 in after-tax employee contributions. The ADP for nonhighly compensated
employees for 2006 was 3% and the ACP for nonhighly compensated employees for 2006 was
2.3%. The portion of the ACP attributable to matching contributions for nonhighly compensated
employees for 2006 was 1.8%. The portion of the ACP attributable to after-tax employee
contributions for nonhighly compensated employees for 2006 was 0.5%.
Correction:
Employer E uses the correction method for partial year exclusions, pursuant to section
2.02(1)(a)(ii), to correct the failure to include an eligible employee in the plan. Because Employee Z
was given an opportunity to make elective deferrals and after-tax employee contributions to the
plan for at least the last 9 months of the plan year (and the amount of the elective deferrals or aftertax employee contributions that the employee had the opportunity to make was not less than the
maximum elective deferrals or after-tax employee contributions that the employee could have made
if the employee had been given the opportunity to make elective deferrals and after-tax employee
contributions on January 1, 2006), under the special rule set forth in section 2.02(1)(a)(ii)(F),
Employer E is not required to make a corrective contribution for the failure to provide the employee
with the opportunity to make either elective deferrals or after-tax employee contributions. The
employer only needs to make a corrective contribution for the failure to provide the employee with
the opportunity to receive matching contributions on deferrals that could have been made during
the first 3 months of the plan year. The calculation of the corrective contribution required to correct
this failure is shown as follows:
The missed matching contribution is determined by calculating the matching contribution that the
employee would have received had the employee been provided the opportunity to make elective
deferrals during the period of exclusion, i.e., January 1, 2006 through March 31, 2006. Assuming
that the employee elected to defer an amount equal to 3% of compensation (which is the ADP for
the nonhighly compensated employees for the plan year), then, under the terms of the plan, the
employee would have been entitled to a matching contribution of 2% of compensation. Pursuant to
the provisions of section 2.02(1)(a)(ii)(E), Employer E determines compensation by prorating
Employee Zs annual compensation for the portion of the year that Employee Z was not given the
opportunity to make elective deferrals or after-tax employee contributions. Accordingly, the
required matching contribution for the period of exclusion is obtained by multiplying 2% by
Employee Zs compensation of $10,000 (3/12ths of the employees 2006 plan compensation of
$40,000). Based on this calculation, the missed matching contribution is $200. However, when this
amount is added to the matching contribution already received ($640), the total ($840) exceeds the
$750 plan limit on matching contributions by $90. Accordingly, pursuant to section 2.02(1)(a)(ii)(D),
the missed matching contribution figure is reduced to $110 ($200 minus $90). The required
corrective contribution is $110. The corrective contribution is adjusted for earnings.
Example 8:
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Employer G maintains a safe harbor 401(k) plan that requires matching contributions that satisfy
the requirements of 401(k)(12), which are equal to: 100% of elective deferrals that do not exceed
3% of an employee's compensation and 50% of elective deferrals that exceed 3% but do not
exceed 5% of an employees compensation. Employee M, a nonhighly compensated employee
who met the eligibility requirements and should have entered the plan on January 1, 2006, was not
offered the opportunity to defer under the plan and was erroneously excluded for all of 2006.
Employee M's compensation for 2006 was $20,000.
Correction:
In accordance with the provisions of section 2.02(1)(a)(ii)(B), Employee Ms missed deferral on
account of exclusion from the safe harbor 401(k) plan is 3% of compensation. Thus, the missed
deferral is equal to 3% multiplied by $20,000, or $600. Accordingly, the required QNEC for
Employee Ms missed deferral opportunity in 2006 is $300, i.e., 50% of $600. The required
matching contribution, based on the missed deferral of $600, is $600. The required corrective
contribution for Employee Ms missed matching contribution is $600. The total required corrective
contribution, before adjustments for earnings, on behalf of Employee M is $900 (i.e., $300 for the
missed deferral opportunity, plus $600 for the missed matching contribution). The corrective
Example 9:
Same facts as Example 8, except that the plan provides for matching contributions equal to 100%
of elective deferrals that do not exceed 4% of an employees compensation.
Correction:
account of exclusion from the safe harbor 401(k) plan is 4% of compensation. The missed
deferral is 4% of compensation because the plan provides for a 100% match for deferrals up to that
level of compensation. (See Appendix A .05(2)(d).) Therefore, in this case, Employee Ms missed
deferral is equal to 4% multiplied by $20,000, or $800. The required corrective contribution for
Employee Ms missed deferral opportunity in 2006 is $400, i.e., 50% multiplied by $800. The
required matching contribution, based on the missed deferral of $800, is $800. Thus, the required
corrective contribution for Employee Ms missed matching contribution is $800. The total required
corrective contribution, before adjustments for earnings, on behalf of Employee M is $1,200 (i.e.,
$400 for the missed deferral opportunity plus $800 for the missed matching contribution). The
corrective contribution is adjusted for earnings.
Example 10:
Same facts as Example 8, except that the plan uses a rate of nonelective contributions to satisfy
the requirements of 401(k)(12) and provides for a QNEC equal to 3% of compensation.
Correction:
account of exclusion from the safe harbor 401(k) plan is 3% of compensation. Thus, the missed
deferral is equal to 3% multiplied by $20,000, or $600. Thus, the required corrective contribution for
Employee Ms missed deferral opportunity in 2006 is $300 (50% of $600). The required nonelective
contribution, based on the plans formula of 3% of compensation for nonelective contributions, is
$600. The total required QNEC, before adjustments for earnings, on behalf of Employee M is $900
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(i.e., $300 for the missed deferral opportunity, plus $600 for the missed nonelective contribution).
The corrective contribution is adjusted for earnings.
Example 11:
Employer H maintains a 401(k) plan. The plan limit on deferrals is the lesser of the deferral limit
under 401(a)(30) or the limitation under 415. The plan also provides that eligible participants (as
defined in 414(v)(5) may make contributions in excess of the plans deferral limits, up to the
limitations on catch-up contributions for the year. The plan also provides for a 60% matching
contribution on elective deferrals. The deferral limit under 401(a)(30) for 2006 is $15,000. The
limitation on catch-up contributions under the terms of the plan and 414(v)(2)(B)(i) is $5,000.
Employee R, age 55, was provided with the opportunity to make elective deferrals up to the plan
limit, but was not provided the option to make catch-up contributions. Employee R is a nonhighly
compensated employee who earned $60,000 in compensation and made elective deferrals totaling
$15,000 in 2006.
Correction:
In accordance with the provisions of Appendix A section .05(4), Employee Rs missed deferral on
account of the plans failure to offer the opportunity to make catch-up contributions is $2,500 (or
one half of the limitation on catch-up contributions for 2006). The missed deferral opportunity is
$1,250 (or 50% of $2,500). Thus, the required QNEC for Employee Rs missed deferral opportunity
relating to catch-up contributions in 2006 is $1,250 adjusted for earnings.
In addition, Employee R was entitled to an additional matching contribution, under the terms of the
plan, equal to 60% of the missed deferral that is attributable to the catch-up contribution that the
employee would have made had the failure not occurred. In this case, the missed deferral is $2,500
and the corresponding matching contribution is $1,500 (i.e., 60% of $2,500). Thus, the required
corrective contribution for the additional matching contribution that should have been made on
behalf of Employee R is $1,500 adjusted for earnings.
Example 12:
Employer K maintains a 401(k) plan. The plan provides for matching contributions for eligible
employees equal to 100% of elective deferrals that do not exceed 5% of an employee's
compensation. On January 1, 2006, Employee T made an election to contribute 10% of
compensation for the 2006 plan year. However, Employee Ts election was not processed, and the
required amounts were not withheld from Employee Ts salary in 2006. Employee Ts salary was
$30,000 in 2006.
Correction:
Employer K uses the correction method described in Appendix A section .05(5), to correct the
failure to implement Employee Ts election to make elective deferrals under the plan for the full plan
year beginning January 1, 2006. Employer K calculates the corrective QNEC to be made on behalf
of Employee T as follows:
(1) Elective deferrals:
Employee Ts election to make elective deferrals, pursuant to an election, in 2006 was not
implemented. Thus, pursuant to section .05(5)(a) of Appendix A, Employer K must make a QNEC
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to the plan on behalf of Employee T equal to the missed deferral opportunity for Employee T, which
is 50% of Employee Ts missed deferral. The QNEC is adjusted for earnings. The missed deferral
for Employee T is determined by using Ts elected deferral percentage (10%) for 2006 and
multiplying that percentage by Employee Ts compensation for 2006 ($30,000). Accordingly, the
missed deferral for Employee V, on account of the employees improper exclusion from the plan is
$3,000 (10% x $30,000). The missed deferral opportunity is $1,500 (i.e., 50% x $3,000). Thus, the
required corrective contribution for the failure to provide Employee V with the opportunity to make
elective deferrals to the plan is $1,500 (plus earnings).
(2) Matching contributions:
Employee T should have been eligible for but did not receive an allocation of employer matching
contributions because no elective deferrals were made on behalf of Employee T in 2006. Thus,
pursuant to section .05(5)(c) of Appendix A, Employer K must make a QNEC to the plan on behalf
of Employee T that is equal to the matching contribution Employee T would have received had the
missed deferral been made. The QNEC is adjusted for earnings. Under the terms of the plan, if
Employee T had made an elective deferral of $3,000 or 10% of compensation ($30,000), the
employee would have been entitled to a matching contribution equal to 100% of first 3% of
Employee Ts compensation ($30,000) or $900. Accordingly, the contribution required to replace
the missed employer matching contribution is $900 (plus earnings).
The total required corrective QNEC, before adjustments for earnings, on behalf of Employee T is
$2,400 ($1,500 for the missed deferral opportunity plus $900 for the missed matching contribution)
(2) Exclusion of Eligible Employees In a Profit-Sharing Plan.

(a) Correction Methods. (i) Appendix A Correction Method. Appendix A,
section .05 sets forth the correction method for correcting the failure to make a
contribution on behalf of the employees improperly excluded from a defined contribution
plan or to provide benefit accruals for the employees improperly excluded from a defined
benefit plan. In the case of a defined contribution plan, the correction method is to make a
contribution on behalf of the excluded employee. Section 2.02(2)(a)(ii) of this Appendix B
clarifies the correction method in the case of a profit-sharing or stock bonus plan that
provides for nonelective contributions (within the meaning of 1.401(k)-6).
(ii) Additional Requirements for Appendix A Correction Method as applied to
Profit-Sharing Plans. To correct for the exclusion of an eligible employee from nonelective
contributions in a profit-sharing or stock bonus plan under the Appendix A correction
method, an allocation amount is determined for each excluded employee on the same
basis as the allocation amounts were determined for the other employees under the
plan's allocation formula (e.g., the same ratio of allocation to compensation), taking into
account all of the employee's relevant factors (e.g., compensation) under that formula for
that year. The Employer makes a corrective contribution on behalf of the excluded
employee that is equal to the allocation amount for the excluded employee. The
corrective contribution is adjusted for earnings. If, as a result of excluding an employee,
an amount was improperly allocated to the account balance of an eligible employee who
shared in the original allocation of the nonelective contribution, no reduction is made to
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the account balance of the employee who shared in the original allocation on account of
the improper allocation. (See Example 15.)
(iii) Reallocation Correction Method. (A) In General. Subject to the limitations set
forth in section 2.02(2)(a)(iii)(F) below, in addition to the Appendix A correction method,
the exclusion of an eligible employee for a plan year from a profit-sharing or stock bonus
plan that provides for nonelective contributions may be corrected using the reallocation
correction method set forth in this section 2.02(2)(a)(iii). Under the reallocation correction
method, the account balance of the excluded employee is increased as provided in
paragraph (2)(a)(iii)(B) below, the account balances of other employees are reduced as
provided in paragraph (2)(a)(iii)(C) below, and the increases and reductions are
reconciled, as necessary, as provided in paragraph (2)(a)(iii)(D) below. (See Examples
16 and 17.)
(B) Increase in Account Balance of Excluded Employee. The account balance of
the excluded employee is increased by an amount that is equal to the allocation the
employee would have received had the employee shared in the allocation of the
nonelective contribution. The amount is adjusted for earnings.
(C) Reduction in Account Balances of Other Employees. (1) The account balance
of each employee who was an eligible employee who shared in the original allocation of
the nonelective contribution is reduced by the excess, if any, of (I) the employee's
allocation of that contribution over (II) the amount that would have been allocated to that
employees account had the failure not occurred. This amount is adjusted for earnings
taking into account the rules set forth in section 2.02(2)(a)(iii)(C)(2) and (3) below. The
amount after adjustment for earnings is limited in accordance with section
2.02(2)(a)(iii)(C)(4) below.
(2) This paragraph (2)(a)(iii)(C)(2) applies if most of the employees with account
balances that are being reduced are nonhighly compensated employees. If there has
been an overall gain for the period from the date of the original allocation of the
contribution through the date of correction, no adjustment for earnings is required to the
amount determined under section 2.02(2)(a)(iii)(C)(1) for the employee. If the amount for
the employee is being adjusted for earnings and the plan permits investment of account
balances in more than one investment fund, for administrative convenience, the reduction
to the employee's account balance may be adjusted by the lowest earnings rate of any
fund for the period from the date of the original allocation of the contribution through the
date of correction.
(3) If an employee's account balance is reduced and the original allocation was
made to more than one investment fund or there was a subsequent distribution or transfer
from the fund receiving the original allocation, then reasonable, consistent assumptions
are used to determine the earnings adjustment.
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(4) The amount determined in section 2.02(2)(a)(iii)(C)(1) for an employee after

the application of section 2.02(2)(a)(iii)(C)(2) and (3) may not exceed the account balance
of the employee on the date of correction, and the employee is permitted to retain any
distribution made prior to the date of correction.
(D) Reconciliation of Increases and Reductions. If the aggregate amount of the
increases under section 2.02(2)(a)(iii)(B) exceeds the aggregate amount of the reductions
under section 2.02(2)(a)(iii)(C), the Employer makes a corrective contribution to the plan
for the amount of the excess. If the aggregate amount of the reductions under section
2.02(2)(a)(iii)(C) exceeds the aggregate amount of the increases under section
2.02(2)(a)(iii)(B), then the amount by which each employee's account balance is reduced
under section 2.02(2)(a)(iii)(C) is decreased on a pro rata basis.
(E) Reductions Among Multiple Investment Funds. If an employee's account
balance is reduced and the employee's account balance is invested in more than one
investment fund, then the reduction may be made from the investment funds selected in
any reasonable manner.
(F) Limitations on Use of Reallocation Correction Method. If any employee would
be permitted to retain any distribution pursuant to section 2.02(2)(a)(iii)(C)(4), then the
reallocation correction method may not be used unless most of the employees who would
be permitted to retain a distribution are nonhighly compensated employees.
(b) Examples.
Example 13:
Employer D maintains a profit-sharing plan that provides for discretionary nonelective employer
contributions. The plan provides that the employer's contributions are allocated to account balances
in the ratio that each eligible employee's compensation for the plan year bears to the compensation
of all eligible employees for the plan year and, therefore, the only relevant factor for determining an
allocation is the employee's compensation. The plan provides for self-directed investments among
four investment funds and daily valuations of account balances. For the 2006 plan year, Employer
D made a contribution to the plan of a fixed dollar amount. However, five employees who met the
eligibility requirements were inadvertently excluded from participating in the plan. The contribution
resulted in an allocation on behalf of each of the eligible employees, other than the excluded
employees, equal to 10% of compensation. Most of the employees who received allocations under
the plan for the year of the failure were nonhighly compensated employees. No distributions have
been made from the plan since 2006. If the five excluded employees had shared in the original
allocation, the allocation made on behalf of each employee would have equaled 9% of
compensation. The excluded employees began participating in the plan in the 2007 plan year.
Correction:
Employer D uses the Appendix A correction method to correct the failure to include the five eligible
employees. Thus, Employer D makes a corrective contribution to the plan. The amount of the
corrective contribution on behalf of the five excluded employees for the 2006 plan year is equal to
10% of compensation of each excluded employee, the same allocation that was made for other
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eligible employees, adjusted for earnings. The excluded employees receive an allocation equal to
10% of compensation (adjusted for earnings) even though, had the excluded employees originally
shared in the allocation for the 2006 contribution, their account balances, as well as those of the
other eligible employees, would have received an allocation equal to only 9% of compensation.
Example 14:
The facts are the same as in Example 13.
Correction:
Employer D uses the reallocation correction method to correct the failure to include the five eligible
employees. Thus, the account balances are adjusted to reflect what would have resulted from the
correct allocation of the employer contribution for the 2006 plan year among all eligible employees,
including the five excluded employees. The inclusion of the excluded employees in the allocation of
that contribution would have resulted in each eligible employee, including each excluded employee,
receiving an allocation equal to 9% of compensation. Accordingly, the account balance of each
excluded employee is increased by 9% of the employee's 2006 compensation, adjusted for
earnings. The account balance of each of the eligible employees other than the excluded
employees is reduced by 1% of the employee's 2006 compensation, adjusted for earnings.
Employer D determines the adjustment for earnings using the earnings rate of each eligible
employee's excess allocation (using reasonable, consistent assumptions). Accordingly, for an
employee who shared in the original allocation and directed the investment of the allocation into
more than one investment fund or who subsequently transferred a portion of a fund that had been
credited with a portion of the 2006 allocation to another fund, reasonable, consistent assumptions
are followed to determine the adjustment for earnings. It is determined that the total of the initially
determined reductions in account balances exceeds the total of the required increases in account
balances. Accordingly, these initially determined reductions are decreased pro rata so that the total
of the actual reductions in account balances equals the total of the increases in the account
balances, and Employer D does not make any corrective contribution. The reductions from the
account balances are made on a pro rata basis among all of the funds in which each employee's
account balance is invested.
Example 15:
Correction:
The correction is the same as in Example 14, except that, because most of the employees whose
account balances are being reduced are nonhighly compensated employees, for administrative
convenience, Employer D uses the earnings rate of the fund with the lowest earnings rate for the
period of the failure to adjust the reduction to each account balance. It is determined that the
aggregate amount (adjusted for earnings) by which the account balances of the excluded
employees is increased exceeds the aggregate amount (adjusted for earnings) by which the other
employees' account balances are reduced. Accordingly, Employer D makes a contribution to the
plan in an amount equal to the excess. The reduction from account balances is made on a pro rata
basis among all of the funds in which each employee's account balance is invested.
.03 Vesting Failures.
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(1) Correction Methods. (a) Contribution Correction Method. A failure in a defined

contribution plan to apply the proper vesting percentage to an employee's account
balance that results in forfeiture of too large a portion of the employee's account balance
may be corrected using the contribution correction method set forth in this paragraph.
The Employer makes a corrective contribution on behalf of the employee whose account
balance was improperly forfeited in an amount equal to the improper forfeiture. The
corrective contribution is adjusted for earnings. If, as a result of the improper forfeiture, an
amount was improperly allocated to the account balance of another employee, no
reduction is made to the account balance of that employee. (See Example 16.)
(b) Reallocation Correction Method. In lieu of the contribution correction method,
in a defined contribution plan under which forfeitures of account balances are reallocated
among the account balances of the other eligible employees in the plan, a failure to apply
the proper vesting percentage to an employee's account balance which results in
forfeiture of too large a portion of the employee's account balance may be corrected
under the reallocation correction method set forth in this paragraph. A corrective
reallocation is made in accordance with the reallocation correction method set forth in
section 2.02(2)(a)(iii), subject to the limitations set forth in section 2.02(2)(a)(iii)(F). In
applying section 2.02(2)(a)(iii)(B), the account balance of the employee who incurred the
improper forfeiture is increased by an amount equal to the amount of the improper
forfeiture and the amount is adjusted for earnings. In applying section
2.02(2)(a)(iii)(C)(1), the account balance of each employee who shared in the allocation
of the improper forfeiture is reduced by the amount of the improper forfeiture that was
allocated to that employee's account. The earnings adjustments for the account balances
that are being reduced are determined in accordance with sections 2.02(2)(a)(iii)(C)(2)
and (3) and the reductions after adjustments for earnings are limited in accordance with
section 2.02(2)(a)(iii)(C)(4). In accordance with section 2.02(2)(a)(iii)(D), if the aggregate
amount of the increases exceeds the aggregate amount of the reductions, the Employer
makes a corrective contribution to the plan for the amount of the excess. In accordance
with section 2.02(2)(a)(iii)(D), if the aggregate amount of the reductions exceeds the
aggregate amount of the increases, then the amount by which each employee's account
balance is reduced is decreased on a pro rata basis. (See Example 17.)
(2) Examples.
Example 16:
Employer E maintains a profit-sharing plan that provides for nonelective contributions. The plan
provides for self-directed investments among four investment funds and daily valuation of account
balances. The plan provides that forfeitures of account balances are reallocated among the
account balances of other eligible employees on the basis of compensation. During the 2006 plan
year, Employee R terminated employment with Employer E and elected and received a single-sum
distribution of the vested portion of his account balance. No other distributions have been made
since 2006. However, an incorrect determination of Employee R's vested percentage was made
resulting in Employee R receiving a distribution of less than the amount to which he was entitled
under the plan. The remaining portion of Employee R's account balance was forfeited and
322
reallocated (and these reallocations were not affected by the limitations of 415). Most of the
employees who received allocations of the improper forfeiture were nonhighly compensated
employees.
Correction:
Employer E uses the contribution correction method to correct the improper forfeiture. Thus,
Employer E makes a contribution on behalf of Employee R equal to the incorrectly forfeited amount
(adjusted for earnings) and Employee R's account balance is increased accordingly. No reduction
is made from the account balances of the employees who received an allocation of the improper
forfeiture.
Example 17:
Correction:
Employer E uses the reallocation correction method to correct the improper forfeiture. Thus,
Employee R's account balance is increased by the amount that was improperly forfeited (adjusted
for earnings). The account of each employee who shared in the allocation of the improper forfeiture
is reduced by the amount of the improper forfeiture that was allocated to that employee's account
(adjusted for earnings). Because most of the employees whose account balances are being
reduced are nonhighly compensated employees, for administrative convenience, Employer E uses
the earnings rate of the fund with the lowest earnings rate for the period of the failure to adjust the
reduction to each account balance. It is determined that the amount (adjusted for earnings) by
which the account balance of Employee R is increased exceeds the aggregate amount (adjusted
for earnings) by which the other employees' account balances are reduced. Accordingly, Employer
E makes a contribution to the plan in an amount equal to the excess. The reduction from the
account balances is made on a pro rata basis among all of the funds in which each employee's
account balance is invested.
.04 415 Failures.

(1) Failures Relating to a 415(b) Excess.
(a) Correction Methods. (i) Return of Overpayment Correction Method.
Overpayments as a result of amounts being paid in excess of the limits of 415(b) may
be corrected using the return of Overpayment correction method set forth in this
paragraph (1)(a)(i). The Employer takes reasonable steps to have the Overpayment (with
appropriate interest) returned by the recipient to the plan and reduces future benefit
payments (if any) due to the employee to reflect 415(b). To the extent the amount
returned by the recipient is less than the Overpayment, adjusted for earnings at the plan's
earnings rate, then the Employer or another person contributes the difference to the plan.
In addition, in accordance with section 6.05 of this revenue procedure, the Employer must
notify the recipient that the Overpayment was not eligible for favorable tax treatment
accorded to distributions from qualified plans (and, specifically, was not eligible for taxfree rollover). (See Examples 20 and 21.)
323
(ii) Adjustment of Future Payments Correction Method. (A) In General. In addition

to the return of overpayment correction method, in the case of plan benefits that are being
distributed in the form of periodic payments, Overpayments as a result of amounts being
paid in excess of the limits in 415(b) may be corrected by using the adjustment of future
payments correction method set forth in this paragraph (1)(a)(ii). Future payments to the
recipient are reduced so that they do not exceed the 415(b) maximum limit and an
additional reduction is made to recoup the Overpayment (over a period not longer than
the remaining payment period) so that the actuarial present value of the additional
reduction is equal to the Overpayment plus interest at the interest rate used by the plan to
determine actuarial equivalence. (See Examples 18 and 19.)
(B) Joint and Survivor Annuity Payments. If the employee is receiving payments
in the form of a joint and survivor annuity, with the employee's spouse to receive a life
annuity upon the employee's death equal to a percentage (e.g., 75%) of the amount being
paid to the employee, the reduction of future annuity payments to reflect 415(b) reduces
the amount of benefits payable during the lives of both the employee and spouse, but any
reduction to recoup Overpayments made to the employee does not reduce the amount of
the spouse's survivor benefit. Thus, the spouse's benefit will be based on the previous
specified percentage (e.g., 75%) of the maximum permitted under 415(b), instead of the
reduced annual periodic amount payable to the employee.
(C) Overpayment Not Treated as an Excess Amount. An Overpayment corrected
under this adjustment of future payment correction method is not treated as an Excess
Amount as defined in section 5.01(3) of this revenue procedure.
(b) Examples.
Example 18:
Employer F maintains a defined benefit plan funded solely through employer contributions. The
plan provides that the benefits of employees are limited to the maximum amount permitted under
415(b), disregarding cost-of-living adjustments under 415(d) after benefit payments have
commenced. At the beginning of the 2006 plan year, Employee S retired and started receiving an
annual straight life annuity of $185,000 from the plan. Due to an administrative error, the annual
amount received by Employee S for 1998 included an Overpayment of $10,000 (because the
415(b)(1)(A) limit for 2006 was $175,000). This error was discovered at the beginning of 2007.
Correction:
Employer F uses the adjustment of future payments correction method to correct the failure to
satisfy the limit in 415(b). Future annuity benefit payments to Employee S are reduced so that
they do not exceed the 415(b) maximum limit, and, in addition, Employee S's future benefit
payments from the plan are actuarially reduced to recoup the Overpayment. Accordingly,
Employee S's future benefit payments from the plan are reduced to $175,000 and further reduced
by $1,000 annually for life, beginning in 2007. The annual benefit amount is reduced by $1,000
annually for life because, for Employee S, the actuarial present value of a benefit of $1,000
annually for life commencing in 2007 is equal to the sum of $10,000 and interest at the rate used by
324
the plan to determine actuarial equivalence beginning with the date of the first Overpayment and
ending with the date the reduced annuity payment begins. Thus, Employee S's remaining benefit
payments are reduced so that Employee S receives $174,000 for 2007, and for each year
thereafter.
Example 19:
Correction:
Employer F uses the adjustments of future payments correction method to correct the 415(b)
failure, by recouping the entire excess payment made in 2006 from Employee S's remaining benefit
payments for 2007. Thus, Employee S's annual annuity benefit for 2007 is reduced to $164,400 to
reflect the excess benefit amounts (increased by interest) that were paid from the plan to Employee
S during the 2006 plan year. Beginning in 2008, Employee S begins to receive annual benefit
payments of $175,000.
Example 20:
The facts are the same as in Example 18, except that the benefit was paid to Employee S in the
form of a single-sum distribution in 2006, which exceeded the maximum 415(b) limits by
$110,000.
Correction:
Employer F uses the return of overpayment correction method to correct the 415(b) failure. Thus,
Employer F notifies Employee S of the $110,000 Overpayment and that the Overpayment was not
eligible for favorable tax treatment accorded to distributions from qualified plans (and, specifically,
was not eligible for tax-free rollover). The notice also informs Employee S that the Overpayment
(with interest at the rate used by the plan to calculate the single-sum payment) is owed to the plan.
Employer F takes reasonable steps to have the Overpayment (with interest at the rate used by the
plan to calculate the single-sum payment) paid to the plan. Employee S pays the $110,000 (plus
the requested interest) to the plan. It is determined that the plan's earnings rate for the relevant
period was 2 percentage points more than the rate used by the plan to calculate the single-sum
payment. Accordingly, Employer F contributes the difference to the plan.
Example 21:
Correction:
Employer F uses the return of overpayment correction method to correct the 415(b) failure. Thus,
Employer F notifies Employee S of the $110,000 Overpayment and that the Overpayment was not
eligible for favorable tax treatment accorded to distributions from qualified plans (and, specifically,
was not eligible for tax-free rollover). The notice also informs Employee S that the Overpayment
(with interest at the rate used by the plan to calculate the single-sum payment) is owed to the plan.
Employer F takes reasonable steps to have the Overpayment (with interest at the rate used by the
plan to calculate the single-sum payment) paid to the plan. As a result of Employer F's recovery
efforts, some, but not all, of the Overpayment (with interest) is recovered from Employee S. It is
determined that the amount returned by Employee S to the plan is less than the Overpayment
325
adjusted for earnings at the plans earnings rate. Accordingly, Employer F contributes the
difference to the plan.
(2) Failures Relating to a 415(c) Excess.

(a) Correction Methods. (i) Appendix A Correction Method. Appendix A, section
.08 sets forth the correction method for correcting the failure to satisfy the 415(c) limits
on annual additions.
(ii) Forfeiture Correction Method. In addition to the Appendix A correction method,
the failure to satisfy 415(c) with respect to a nonhighly compensated employee (A) who
in the limitation year of the failure had annual additions consisting of both (I) either
elective deferrals or after-tax employee contributions or both and (II) either matching or
nonelective contributions or both, (B) for whom the matching and nonelective
contributions equal or exceed the portion of the employee's annual addition that exceeds
the limits under 415(c) (" 415(c) excess") for the limitation year, and (C) who has
terminated with no vested interest in the matching and nonelective contributions (and has
not been reemployed at the time of the correction), may be corrected by using the
forfeiture correction method set forth in this paragraph. The 415(c) excess is deemed to
consist solely of the matching and nonelective contributions. If the employee's 415(c)
excess (adjusted for earnings) has previously been forfeited, the 415(c) failure is
deemed to be corrected. If the 415(c) excess (adjusted for earnings) has not been
forfeited, that amount is placed in an unallocated account, as described in section 6.06(2)
of this revenue procedure, to be used to reduce employer nonelective contributions in
succeeding year(s) (or if the amount would have been allocated to other employees who
were in the plan for the year of the failure if the failure had not occurred, then that amount
is reallocated to the other employees in accordance with the plan's allocation formula).
Note that while this correction method will permit more favorable tax treatment of elective
deferrals for the employee than the Appendix A correction method, this correction method
could be less favorable to the employee in certain cases, for example, if the employee is
subsequently reemployed and becomes vested. (See Examples 22 and 23.)
(iii) Return of Overpayment Correction Method. A failure to satisfy 415(c) that
includes a distribution of the 415(c) excess attributable to nonelective contributions and
matching contributions may be corrected using the return of Overpayment correction
method set forth in section 6.06(3) of this revenue procedure.
(b) Examples.
Example 22:
Employer G maintains a 401(k) plan. The plan provides for nonelective employer contributions,
elective deferrals, and after-tax employee contributions. The plan provides that the nonelective
contributions vest under a 5-year cliff vesting schedule. The plan provides that when an employee
terminates employment, the employee's nonvested account balance is forfeited five years after a
326
distribution of the employee's vested account balance and that forfeitures are used to reduce
employer contributions. For the 1998 limitation year, the annual additions made on behalf of two
nonhighly compensated employees in the plan, Employees T and U, exceeded the limit in 415(c).
For the 1998 limitation year, Employee T had 415 compensation of $60,000, and, accordingly, a
415(c)(1)(B) limit of $15,000. Employee T made elective deferrals and after-tax employee
contributions. For the 1998 limitation year, Employee U had 415 compensation of $40,000, and,
accordingly, a 415(c)(1)(B) limit of $10,000. Employee U made elective deferrals. Also, on
January 1, 1999, Employee U, who had three years of service with Employer G, terminated his
employment and received his entire vested account balance (which consisted of his elective
deferrals). The annual additions for Employees T and U consisted of:
T
Nonelective
Contributions
Elective
Deferrals
After-tax
Contributions
Total Contributions
415(c) Limit
415(c) Excess
$ 7,500
$ 4,500
10,000
5,800
500
_______
0
_______
$18,000
$15,000
$ 3,000
$ 10,300
$ 10,000
$
300
Correction:
Employer G uses the Appendix A correction method to correct the 415(c) excess with respect to
Employee T (i.e., $3,000). Thus, a distribution of plan assets (and corresponding reduction of the
account balance) consisting of $500 (adjusted for earnings) of after-tax employee contributions and
$2,500 (adjusted for earnings) of elective deferrals is made to Employee T. Employer G uses the
forfeiture correction method to correct the 415(c) excess with respect to Employee U. Thus, the
415(c) excess is deemed to consist solely of the nonelective contributions. Accordingly,
Employee U's nonvested account balance is reduced by $300 (adjusted for earnings) which is
placed in an unallocated account, as described in section 6.06(2) of this revenue procedure, to be
used to reduce employer contributions in succeeding year(s). After correction, it is determined that
the ADP and ACP tests for 1998 were satisfied.
Example 23:
Employer H maintains a 401(k) plan. The plan provides for nonelective employer contributions,
matching contributions and elective deferrals. The plan provides for matching contributions that are
equal to 100% of an employee's elective deferrals that do not exceed 8% of the employee's plan
compensation for the plan year. For the 1998 limitation year, Employee V had 415 compensation
of $50,000, and, accordingly, a 415(c)(1)(B) limit of $12,500. During that limitation year, the
annual additions for Employee V totaled $15,000, consisting of $5,000 in elective deferrals, a
$4,000 matching contribution (8% of $50,000), and a $6,000 nonelective employer contribution.
Thus, the annual additions for Employee V exceeded the 415(c) limit by $2,500.
Correction:
327
Employer H uses the Appendix A correction method to correct the 415(c) excess with respect to
Employee V (i.e., $2,500). Accordingly, $1,000 of the unmatched elective deferrals (adjusted for
earnings) are distributed to Employee V. The remaining $1,500 excess is apportioned equally
between the elective deferrals and the associated matching employer contributions, so Employee
V's account balance is further reduced by distributing to Employee V $750 (adjusted for earnings)
of the elective deferrals and forfeiting $750 (adjusted for earnings) of the associated employer
matching contributions. The forfeited matching contributions are placed in an unallocated account,
as described in section 6.06(2) of this revenue procedure, to be used to reduce employer
contributions in succeeding year(s). After correction, it is determined that the ADP and ACP tests
for 1998 were satisfied.
.05 Correction of Other Overpayment Failures.

An Overpayment, other than one described in section 2.04(1) (relating to a
415(b) excess) or section 2.04(2) (relating to a 415(c) excess), may be corrected in
accordance with this section 2.05. An Overpayment from a defined benefit plan is
corrected in accordance with the rules in section 2.04(1). An Overpayment from a
defined contribution plan is corrected in accordance with the rules in section
2.04(2)(a)(iii).
.06 401(a)(17) Failures.
(1) Reduction of Account Balance Correction Method. The allocation of
contributions or forfeitures under a defined contribution plan for a plan year on the basis
of compensation in excess of the limit under 401(a)(17) for the plan year may be
corrected using the reduction of account balance correction method set forth in section
6.06(2) of this revenue procedure.
(2) Example.
Example 24:
Employer J maintains a money purchase pension plan. Under the plan, an eligible employee is
entitled to an employer contribution of 8% of the employee's compensation up to the 401(a)(17)
limit ($220,000 for 2006). During the 2006 plan year, an eligible employee, Employee W,
inadvertently was credited with a contribution based on compensation above the 401(a)(17) limit.
Employee W's compensation for 2006 was $250,000. Employee W received a contribution of
$20,000 for 2006 (8% of $250,000), rather than the contribution of $17,600 (8% of $220,000)
provided by the plan for that year, resulting in an improper allocation of $2,400.
Correction:
The 401(a)(17) failure is corrected using the reduction of account balance method by reducing
Employee W's account balance by $2,400 (adjusted for earnings) and crediting that amount to an
unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to
reduce employer contributions in succeeding year(s).
.07 Correction by Amendment.
328
(1) 401(a)(17) Failures. (a) Contribution Correction Method. In addition to the

reduction of account balance correction method under section 6.06(2) of this revenue
procedure, an employer may correct a 401(a)(17) failure for a plan year under a defined
contribution plan by using the contribution correction method set forth in this paragraph.
The Employer contributes an additional amount on behalf of each of the other employees
(excluding each employee for whom there was a 401(a)(17) failure) who received an
allocation for the year of the failure, amending the plan (as necessary) to provide for the
additional allocation. The amount contributed for an employee is equal to the employee's
plan compensation for the year of the failure multiplied by a fraction, the numerator of
which is the improperly allocated amount made on behalf of the employee with the largest
improperly allocated amount, and the denominator of which is the limit under 401(a)(17)
applicable to the year of the failure. The resulting additional amount for each of the other
employees is adjusted for earnings. (See Example 25.)
(b) Examples.
Example 25:
Correction:
Employer J corrects the failure under VCP using the contribution correction method by (1)
amending the plan to increase the contribution percentage for all eligible employees (other than
Employee W) for the 2003 plan year and (2) contributing an additional amount (adjusted for
earnings) for those employees for that plan year. To determine the increase in the plan's
contribution percentage (and the additional amount contributed on behalf of each eligible
employee), the improperly allocated amount ($2,400) is divided by the 401(a)(17) limit for 2006
($220,000). Accordingly, the plan is amended to increase the contribution percentage by 1.09
percentage points ($2,400/$220,000) from 8% to 9.09%. In addition, each eligible employee for the
2006 plan year (other than Employee W) receives an additional contribution of 1.09% multiplied by
that employee's plan compensation for 2006. This additional contribution is adjusted for earnings.
(2) Hardship Distribution Failures and Plan Loan Failures. (a) Plan Amendment
Correction Method. The Operational Failure of making hardship distributions to
employees under a plan that does not provide for hardship distributions may be corrected
using the plan amendment correction method set forth in this paragraph. The plan is
amended retroactively to provide for the hardship distributions that were made available.
This paragraph does not apply unless (i) the amendment satisfies 401(a), and (ii) the
plan as amended would have satisfied the qualification requirements of 401(a)
(including the requirements applicable to hardship distributions under 401(k), if
applicable) had the amendment been adopted when hardship distributions were first
made available. (See Example 26.) The Plan Amendment Correction Method is also
available for the Operational Failure of permitting plan loans to employees under a plan
that does not provide for plan loans. The plan is amended retroactively to provide for the
plan loans that were made available. This paragraph does not apply unless (i) the
329
amendment satisfies 401(a), and (ii) the plan as amended would have satisfied the
qualification requirements of 401(a) (and the requirements applicable to plan loans
under 72(p)) had the amendment been adopted when plan loans were first made
available.
(b) Example.
Example 26:
Employer K, a for-profit corporation, maintains a 401(k) plan. Although plan provisions in 2005
did not provide for hardship distributions, beginning in 2005 hardship distributions of amounts
allowed to be distributed under 401(k) were made currently and effectively available to all
employees (within the meaning of l.401(a)(4)-4). The standard used to determine hardship
satisfied the deemed hardship distribution standards in 1.401(k)-1(d). Hardship distributions were
made to a number of employees during the 2005 and 2006 plan years, creating an Operational
Failure. The failure was discovered in 2007.
Correction:
Employer K corrects the failure under VCP by adopting a plan amendment, effective January 1,
2005, to provide a hardship distribution option that satisfies the rules applicable to hardship
distributions in 1.401(k)-1(d). The amendment provides that the hardship distribution option is
available to all employees. Thus, the amendment satisfies 401(a), and the plan as amended in
2005 would have satisfied 401(a) (including 1.401(a)(4)-4 and the requirements applicable to
hardship distributions under 401(k)) if the amendment had been adopted in 2005.
(3) Early Inclusion of Otherwise Eligible Employee Failure. (a) Plan Amendment
Correction Method. The Operational Failure of including an otherwise eligible employee
in the plan who either (i) has not completed the plans minimum age or service
requirements, or (ii) has completed the plans minimum age or service requirements but
became a participant in the plan on a date earlier than the applicable plan entry date, may
be corrected by using the plan amendment correction method set forth in this paragraph.
The plan is amended retroactively to change the eligibility or entry date provisions to
provide for the inclusion of the ineligible employee to reflect the plans actual operations.
The amendment may change the eligibility or entry date provisions with respect to only
those ineligible employees that were wrongly included, and only to those ineligible
employees, provided (i) the amendment satisfies 401(a) at the time it is adopted, (ii) the
amendment would have satisfied 401(a) had the amendment been adopted at the
earlier time when it is effective, and (iii) the employees affected by the amendment are
predominantly nonhighly compensated employees.
(b) Example
Example 27:
Employer L maintains a 401(k) plan applicable to all of its employees who have at least six
months of service. The plan is a calendar year plan. The plan provides that Employer L will make
330
matching contributions based upon an employees salary reduction contributions. In 2007, it is

discovered that all four employees who were hired by Employer L in 2006 were permitted to make
salary reduction contributions to the plan effective with the first weekly paycheck after they were
employed. Three of the four employees are nonhighly compensated. Employer L matched these
employees salary reduction contributions in accordance with the plans matching contribution
formula. Employer L calculates the ADP and ACP tests for 2006 (taking into account the salary
reduction and matching contributions that were made for these employees) and determines that the
tests were satisfied.
Correction:
Employer L corrects the failure under SCP by adopting a plan amendment, effective for employees
hired on or after January 1, 2006, to provide that there is no service eligibility requirement under the
plan and submitting the amendment to the Service for a determination letter.
331
SECTION 3. EARNINGS ADJUSTMENT METHODS AND EXAMPLES

.01 Earnings Adjustment Methods. (1) In general. (a) Under section 6.02(4)(a) of
this revenue procedure, whenever the appropriate correction method for an Operational
Failure in a defined contribution plan includes a corrective contribution or allocation that
increases one or more employees' account balances (now or in the future), the
contribution or allocation is adjusted for earnings and forfeitures. This section 3 provides
earnings adjustment methods (but not forfeiture adjustment methods) that may be used
by an employer to adjust a corrective contribution or allocation for earnings in a defined
contribution plan. Consequently, these earnings adjustment methods may be used to
determine the earnings adjustments for corrective contributions or allocations made under
the correction methods in section 2 and under the correction methods in Appendix A. If
an earnings adjustment method in this section 3 is used to adjust a corrective contribution
or allocation, that adjustment is treated as satisfying the earnings adjustment requirement
of section 6.02(4)(a) of this revenue procedure. Other earnings adjustment methods,
different from those illustrated in this section 3, may also be appropriate for adjusting
corrective contributions or allocations to reflect earnings.
(b) Under the earnings adjustment methods of this section 3, a corrective
contribution or allocation that increases an employee's account balance is adjusted to
reflect an "earnings amount" that is based on the earnings rate(s) (determined under
section 3.01(3)) for the period of the failure (determined under section 3.01(2)). The
earnings amount is allocated in accordance with section 3.01(4).
(c) The rule in section 6.02(5)(a) of this revenue procedure permitting reasonable
estimates in certain circumstances applies for purposes of this section 3. For this
purpose, a determination of earnings made in accordance with the rules of administrative
convenience set forth in this section 3 is treated as a precise determination of earnings.
Thus, if the probable difference between an approximate determination of earnings and a
determination of earnings under this section 3 is insignificant and the administrative cost
of a precise determination would significantly exceed the probable difference, reasonable
estimates may be used in calculating the appropriate earnings.
(d) This section 3 does not apply to corrective distributions or corrective reductions
in account balances. Thus, for example, while this section 3 applies in increasing the
account balance of an improperly excluded employee to correct the exclusion of the
employee under the reallocation correction method described in section 2.02(2)(a)(iii)(B),
this section 3 does not apply in reducing the account balances of other employees under
the reallocation correction method. (See section 2.02(2)(a)(iii)(C) for rules that apply to
the earnings adjustments for such reductions.) In addition, this section 3 does not apply
in determining earnings adjustments under the one-to-one correction method described in
section 2.01(1)(b)(iii).
332
(2) Period of the Failure. (a) General Rule. For purposes of this section 3, the
"period of the failure" is the period from the date that the failure began through the date of
correction. For example, in the case of an improper forfeiture of an employee's account
balance, the beginning of the period of the failure is the date as of which the account
balance was improperly reduced. See section 6.02(4)(e) of this revenue procedure.
(b) Rules for Beginning Date for Exclusion of Eligible Employees from Plan. (i)
General Rule. In the case of an exclusion of an eligible employee from a plan
contribution, the beginning of the period of the failure is the date on which contributions of
the same type (e.g., elective deferrals, matching contributions, or discretionary
nonelective employer contributions) were made for other employees for the year of the
failure. In the case of an exclusion of an eligible employee from an allocation of a
forfeiture, the beginning of the period of the failure is the date on which forfeitures were
allocated to other employees for the year of the failure.
(ii) Exclusion from a 401(k) or (m) Plan. For administrative convenience, for
purposes of calculating the earnings rate for corrective contributions for a plan year (or
the portion of the plan year) during which an employee was improperly excluded from
making periodic elective deferrals or after-tax employee contributions, or from receiving
periodic matching contributions, the Employer may treat the date on which the
contributions would have been made as the midpoint of the plan year (or the midpoint of
the portion of the plan year) for which the failure occurred. Alternatively, in this case, the
Employer may treat the date on which the contributions would have been made as the
first date of the plan year (or the portion of the plan year) during which an employee was
excluded, provided that the earnings rate used is one half of the earnings rate applicable
under section 3.01(3) for the plan year (or the portion of the plan year) for which the
failure occurred.
(3) Earnings Rate. (a) General Rule. For purposes of this section 3, the earnings
rate generally is based on the investment results that would have applied to the corrective
contribution or allocation if the failure had not occurred.
(b) Multiple Investment Funds. If a plan permits employees to direct the
investment of account balances into more than one investment fund, the earnings rate is
based on the rate applicable to the employee's investment choices for the period of the
failure. For administrative convenience, if most of the employees for whom the corrective
contribution or allocation is made are nonhighly compensated employees, the rate of
return of the fund with the highest earnings rate under the plan for the period of the failure
may be used to determine the earnings rate for all corrective contributions or allocations.
If the employee had not made any applicable investment choices, the earnings rate may
be based on the earnings rate under the plan as a whole (i.e., the average of the rates
earned by all of the funds in the valuation periods during the period of the failure weighted
by the portion of the plan assets invested in the various funds during the period of the
failure).
333
(c) Other Simplifying Assumptions. For administrative convenience, the earnings

rate applicable to the corrective contribution or allocation for a valuation period with
respect to any investment fund may be assumed to be the actual earnings rate for the
plan's investments in that fund during that valuation period. For example, the earnings
rate may be determined without regard to any special investment provisions that vary
according to the size of the fund. Further, the earnings rate applicable to the corrective
contribution or allocation for a portion of a valuation period may be a pro rata portion of
the earnings rate for the entire valuation period, unless the application of this rule would
result in either a significant understatement or overstatement of the actual earnings during
that portion of the valuation period.
(4) Allocation Methods. (a) In General. For purposes of this section 3, the
earnings amount generally may be allocated in accordance with any of the methods set
forth in this paragraph (4). The methods under paragraph (4)(c), (d), and (e) are intended
to be particularly helpful where corrective contributions are made at dates between the
plan's valuation dates.
(b) Plan Allocation Method. Under the plan allocation method, the earnings
amount is allocated to account balances under the plan in accordance with the plan's
method for allocating earnings as if the failure had not occurred. (See, Example 28.)
(c) Specific Employee Allocation Method. Under the specific employee allocation
method, the entire earnings amount is allocated solely to the account balance of the
employee on whose behalf the corrective contribution or allocation is made (regardless of
whether the plan's allocation method would have allocated the earnings solely to that
employee). In determining the allocation of plan earnings for the valuation period during
which the corrective contribution or allocation is made, the corrective contribution or
allocation (including the earnings amount) is treated in the same manner as any other
contribution under the plan on behalf of the employee during that valuation period.
Alternatively, where the plan's allocation method does not allocate plan earnings for a
valuation period to a contribution made during that valuation period, plan earnings for the
valuation period during which the corrective contribution or allocation is made may be
allocated as if that employee's account balance had been increased as of the last day of
the prior valuation period by the corrective contribution or allocation, including only that
portion of the earnings amount attributable to earnings through the last day of the prior
valuation period. The employee's account balance is then further increased as of the last
day of the valuation period during which the corrective contribution or allocation is made
by that portion of the earnings amount attributable to earnings after the last day of the
prior valuation period. (See Example 29.)
(d) Bifurcated Allocation Method. Under the bifurcated allocation method, the
entire earnings amount for the valuation periods ending before the date the corrective
contribution or allocation is made is allocated solely to the account balance of the
334
employee on whose behalf the corrective contribution or allocation is made. The earnings
amount for the valuation period during which the corrective contribution or allocation is
made is allocated in accordance with the plan's method for allocating other earnings for
that valuation period in accordance with section 3.01(4)(b). (See Example 30.)
(e) Current Period Allocation Method. Under the current period allocation method,
the portion of the earnings amount attributable to the valuation period during which the
period of the failure begins ("first partial valuation period") is allocated in the same
manner as earnings for the valuation period during which the corrective contribution or
allocation is made in accordance section 3.01(4)(b). The earnings for the subsequent full
valuation periods ending before the beginning of the valuation period during which the
corrective contribution or allocation is made are allocated solely to the employee for
whom the required contribution should have been made. The earnings amount for the
valuation period during which the corrective contribution or allocation is made ("second
partial valuation period") is allocated in accordance with the plan's method for allocating
other earnings for that valuation period in accordance with section 3.01(4)(b). (See
Example 31.)
.02 Examples.
Example 28:
Employer L maintains a profit-sharing plan that provides only for nonelective contributions. The
plan has a single investment fund. Under the plan, assets are valued annually (the last day of the
plan year) and earnings for the year are allocated in proportion to account balances as of the last
day of the prior year, after reduction for distributions during the current year but without regard to
contributions received during the current year (the "prior year account balance"). Plan contributions
for 1997 were made on March 31, 1998. On April 20, 2000 Employer L determines that an
operational failure occurred for 1997 because Employee X was improperly excluded from the plan.
Employer L decides to correct the failure by using the Appendix A correction method for the
exclusion of an eligible employee from nonelective contributions in a profit-sharing plan. Under this
method, Employer L determines that this failure is corrected by making a contribution on behalf of
Employee X of $5,000 (adjusted for earnings). The earnings rate under the plan for 1998 was
+20%. The earnings rate under the plan for 1999 was +10%. On May 15, 2000, when Employer L
determines that a contribution to correct for the failure will be made on June 1, 2000, a reasonable
estimate of the earnings rate under the plan from January 1, 2000 to June 1, 2000 is +12%.
Earnings Adjustment on the Corrective Contribution:
The $5,000 corrective contribution on behalf of Employee X is adjusted to reflect an earnings
amount based on the earnings rates for the period of the failure (March 31, 1998 through June 1,
2000) and the earnings amount is allocated using the plan allocation method. Employer L
determines that a pro rata simplifying assumption may be used to determine the earnings rate for
the period from March 31, 1998 to December 31, 1998, because that rate does not significantly
understate or overstate the actual earnings for that period. Accordingly, Employer L determines
that the earnings rate for that period is 15% (9/12 of the plan's 20% earnings rate for the year).
Thus, applicable earnings rates under the plan during the period of the failure are:
Time Periods
3/31/98 - 12/31/98 (First Partial Valuation Period)
Earnings Rate
+15%
335
1/1/99 - 12/31/99
1/1/00 - 6/1/00 (Second Partial Valuation Period)
+10%
+12%
If the $5,000 corrective contribution had been contributed for Employee X on March 31, 1998, (1)
earnings for 1998 would have been increased by the amount of the earnings on the additional
$5,000 contribution from March 31, 1998 through December 31, 1998 and would have been
allocated as 1998 earnings in proportion to the prior year (December 31, 1997) account balances,
(2) Employee X's account balance as of December 31, 1998 would have been increased by the
additional $5,000 contribution, (3) earnings for 1999 would have been increased by the 1999
earnings on the additional $5,000 contribution (including 1998 earnings thereon) allocated in
proportion to the prior year (December 31, 1998) account balances along with other 1999 earnings,
and (4) earnings for 2000 would have been increased by the earnings on the additional $5,000
(including 1998 and 1999 earnings thereon) from January 1 to June 1, 2000 and would be allocated
in proportion to the prior year (December 31, 1999) account balances along with other 2000
earnings. Accordingly, the $5,000 corrective contribution is adjusted to reflect an earnings amount
of $2,084 ($5,000[(1.15)(1.10)(1.12)-1]) and the earnings amount is allocated to the account
balances under the plan allocation method as follows:
(a) Each account balance that shared in the allocation of earnings for 1998 is increased, as of
December 31, 1998, by its appropriate share of the earnings amount for 1998, $750 ($5,000(.15)).
(b) Employee X's account balance is increased, as of December 31, 1998, by $5,000.
(c) The resulting December 31, 1998 account balances will share in the 1999 earnings, including
the $575 for 1999 earnings included in the corrective contribution ($5,750(.10)), to determine the
account balances as of December 31, 1999. However, each account balance other than Employee
X's account balance has already shared in the 1999 earnings, excluding the $575. Accordingly,
Employee X's account balance as of December 31, 1999 will include $500 of the 1999 portion of
the earnings amount based on the $5,000 corrective contribution allocated to Employee X's
account balance as of December 31, 1998 ($5,000(.10)). Then each account balance that
originally shared in the allocation of earnings for 1999 (i.e., excluding the $5,500 additions to
Employee X's account balance) is increased by its appropriate share of the remaining 1999 portion
of the earnings amount, $75.
(d) The resulting December 31, 1999 account balances (including the $5,500 additions to Employee
X's account balance) will share in the 2000 portion of the earnings amount based on the estimated
January 1, 2000 to June 1, 2000 earnings included in the corrective contribution equal to $759
($6,325(.12)). (See Table 1.)
______________________________________________________________________
TABLE 1
CALCULATION AND ALLOCATION OF THE
CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS
Earnings Rate
Corrective Contribution
Amount
Allocated to:
$5,000
Employee X
First Partial Valuation

Period Earnings
15%
7501
All 12/31/1997 Account

Balances4
1999 Earnings
10%
5752
Employee X ($500)/ All
336
12/31/1998 Account
Balances ($75)4
Second Partial
Valuation Period
Earnings
12%
Total Amount
Contributed
7593
All 12/31/1999 Account

Balances (including
Employee X's $5,500)4
$7,084
$5,000 x 15%
$5,750($5,000 +750) x 10%
3
$6,325($5,000 +750 +575) x 12%
4
After reduction for distributions during the year for which earning are being determined but without regard
to contributions received during the year for which earnings are being determined.
____________________________________________________________________
2
Example 29:
The earnings amount on the corrective contribution is the same as in Example 30, but the earnings
amount is allocated using the specific employee allocation method. Thus, the entire earnings
amount for all periods through June 1, 2000 (i.e., $750 for March 31, 1998 to December 31, 1998,
$575 for 1999, and $759 for January 1, 2000 to June 1, 2000) is allocated to Employee X.
Accordingly, Employer L makes a contribution on June 1, 2000 to the plan of $7,084
($5,000(1.15)(1.10)(1.12)). Employee X's account balance as of December 31, 2000 is increased
by $7,084. Alternatively, Employee X's account balance as of December 31, 1999 is increased by
$6,325 ($5,000(1.15)(1.10)), which shares in the allocation of earnings for 2000, and Employee X's
account balance as of December 31, 2000 is increased by the remaining $759. (See Table 2.)
______________________________________________________________________
TABLE 2
Earnings Rate
Amount
Allocated to:
$5,000
Employee X

Period Earnings
15%
7501
Employee X
1999 Earnings
10%
5752
Employee X
Second Partial
Valuation Period
Earnings
12%
7593
Employee X
Total Amount
Contributed
$7,084
337
$5,000 x 15%
$5,750($5,000 +750) x 10%
3
$6,325($5,000 +750 +575) x 12%
______________________________________________________________________
2
Example 30:
amount is allocated using the bifurcated allocation method. Thus, the earnings for the first partial
valuation period (March 31, 1998 to December 31, 1998) and the earnings for 1999 are allocated to
Employee X. Accordingly, Employer L makes a contribution on June 1, 2000 to the plan of $7,084
($5,000(1.15)(1.10)(1.12)). Employee X's account balance as of December 31, 1999 is increased
by $6,325 ($5,000(1.15)(1.10)); and the December 31, 1999 account balances of employees
(including Employee X's increased account balance) will share in estimated January 1, 2000 to
June 1, 2000 earnings on the corrective contribution equal to $759 ($6,325(.12)). (See, Table 3.)
______________________________________________________________________
TABLE 3
Earnings Rate
Amount
Allocated to:
$5,000
Employee X

Period Earnings
15%
7501
Employee X
1999 Earnings
10%
5752
Employee X
Second Partial
Valuation Period
Earnings
12%
7593
12/31/99 Account
Balances (including
Total Amount
Contributed
$7,084
$5,000 x 15%
$5,750($5,000 +750) x 10%
3
$6,325($5,000 +750 +575) x 12%
4
After reduction for distributions during the 2000 year but without regard to contributions received during the
2000 year.
______________________________________________________________________
2
Example 31:
338

amount is allocated using the current period allocation method. Thus, the earnings for the first
partial valuation period (March 31, 1998 to December 31, 1998) are allocated as 2000 earnings.
Accordingly, Employer L makes a contribution on June 1, 2000 to the plan of $7,084 ($5,000
(1.15)(1.10)(1.12)). Employee X's account balance as of December 31, 1999 is increased by the
sum of $5,500 ($5,000(1.10)) and the remaining 1999 earnings on the corrective contribution equal
to $75 ($5,000(.15)(.10)). Further, both (1) the estimated March 31, 1998 to December 31, 1998
earnings on the corrective contribution equal to $750 ($5,000(.15)) and (2) the estimated January 1,
2000 to June 1, 2000 earnings on the corrective contribution equal to $759 ($6,325(.12)) are
treated in the same manner as 2000 earnings by allocating these amounts to the December 31,
2000 account balances of employees in proportion to account balances as of December 31, 1999
(including Employee X's increased account balance). (See, Table 4.) Thus, Employee X is
allocated the earnings for the full valuation period during the period of the failure.
______________________________________________________________________
TABLE 4
Earnings Rate
Amount
Allocated to:
$5,000
Employee X

Period Earnings
15%
7501
12/31/99 Account
Balances (including
1999 Earnings
10%
5752
Employee X
Second Partial
Valuation Period
Earnings
12%
7593
12/31/99 Account
Balances (including
Total Amount
Contributed
$7,084
$5,000 x 15%
$5,750($5,000 +750) x 10%
3
$6,325($5,000 +750 +575) x 12%
4
After reduction for distributions during the year for which earnings are being determined but without regard
to contributions received during the year for which earnings are being determined.
2
339
340
CPC Study Guide:

ASPPACodeofProfessionalConduct
341
ASPPA Code of Professional Conduct

Professional standards that set the standard for the industry.
ASPPA is committed to encouraging every retirement plan professional to achieve and maintain
the highest levels of technical competence and integrity. To this end, each member of ASPPA must abide
by these professional and ethical standards.
Compliance
Conicts of Interest
An ASPPA member shall be knowledgeable about this Code

of Professional Conduct, keep current with Code revisions
and abide by its provisions. Laws and regulations may impose
binding obligations on a benets professional. Where the
requirements of law or regulation conict with this Code, the
requirements of law or regulation take precedence.
An ASPPA member shall not perform professional services

involving an actual or potential conict of interest unless:
a. the members ability to act fairly is unimpaired;
b. there has been full disclosure of the conict to the
principal(s); and
c. all principals have expressly agreed to the performance of
the services by the member.
If the member is aware of any signicant conict between the
interests of a principal and the interests of another party, the
member should advise the principal of the conict and should
also include appropriate qualications or disclosures in any
related communication.
Professional Integrity
An ASPPA member shall perform professional services with
honesty, integrity, skill and care. A member has an obligation
to observe standards of professional conduct in the course
of providing advice, recommendations and other services
performed for a principal. For purposes of this Code, the
term principal means any present or prospective client or
employer. A member who pleads guilty to or is found guilty
of any misdemeanor related to nancial matters or any felony
shall be presumed to have contravened this Code and shall be
subject to ASPPAs counseling and disciplinary procedures.
A members relationship with a third party shall not be used
to obtain illegal or improper treatment from such third party
on behalf of a principal.
Qualication Standards
An ASPPA member shall render opinions or advice, or
perform professional services only when qualied to do
so based on education, training or experience.
Disclosure
An ASPPA member shall make full and timely disclosure to
a principal of all sources of compensation or other material
consideration that the member or the members rm may
receive in relation to an assignment for such principal.
A member who is not nancially and organizationally
independent concerning any matter related to the performance of professional services shall disclose to the principal
any pertinent relationship which is not apparent.
Control of Work Product

An ASPPA member shall not perform professional services
when the member has reason to believe that they may be used
to mislead or to violate or evade the law. Material prepared
by a member could be used by another party to inuence the
actions of a third party. The member should recognize the
risks of misquotation, misinterpretation or other misuse of
such material and should take reasonable steps to ensure that
the material is clear and presented fairly and that the sources
of the material are clearly identied.
Condentiality
An ASPPA member shall not disclose to another party any
condential information obtained through a professional
assignment performed for a principal unless authorized to do
so by the principal or required to do so by law. Condential
information refers to information not in the public domain
of which the member becomes aware during the course of
rendering professional services to a principal. It may include
information of a proprietary nature, information which is
legally restricted from circulation, or information which the
member has reason to believe that the principal would not
wish to be divulged.
343
Courtesy and Cooperation
Advertising
An ASPPA member shall perform professional services with

courtesy and shall cooperate with others in the principals
interest. Differences of opinion among benets professionals may arise. Discussion of such differences, whether directly
between benets professionals or in observations made to a
client by one benets professional on the work of another,
should be conducted objectively and with courtesy. A member
in the course of an engagement or employment may encounter
a situation such that the best interest of the principal would be
served by the members setting out a differing opinion to one
expressed by another benets professional, together with an
explanation of the factors which lend support to the differing
opinion. Nothing in this Code should be construed as preventing the member from expressing such differing opinion to
the principal. A principal has an indisputable right to choose
a professional advisor. A member may provide service to any
principal who requests it even though such principal is being
or has been served by another benets professional in the
same matter.
If a member is invited to advise a principal for whom
the member knows, or has reasonable grounds to believe,
that another benets professional is already acting in a
professional capacity with respect to the same matter or has
recently so acted, it would normally be prudent to consult
the other benets professional both to prepare adequately
for the assignment and to make an informed judgement
whether there are circumstances as to potential violations of
this Code which might affect acceptance of the assignment.
The prospective new or additional benets professional
should request the principals consent to such consultation.
An ASPPA member shall not engage in any advertising or

business solicitation activities with respect to professional
services that the member knows or should know are false or
misleading. Advertising encompasses all communications by
whatever medium, including oral communications, which may
directly or indirectly inuence any person or organization to
decide whether there is a need for professional services or to
select a specic person or rm to perform such services.
344
Titles and Credentials

An ASPPA member shall make use of the membership titles
and credentials of ASPPA only where that use conforms to the
practices authorized by ASPPA.
Collateral Obligations
An ASPPA member who is an actuary shall also abide by
the Code of Professional Conduct for Actuaries. A member
or representative shall respond promptly in writing to any
letter received from a person duly authorized by ASPPA to
obtain information or assistance regarding possible violations
of this Code. To nd out more, visit www.asppa.org or call
703.516.9300.
Chapter 8
Plan Design
Plan Types
The following retirement arrangements are typically tested by the plan design section of the
examination:
1.
SIMPLE IRA
2.
SIMPLE 401(k)
3.
Traditional 401(k) plan
4.
Individual 401(k) plan
5.
Automatic enrollment 401(k) plan
6.
Safe harbor 401(k) plan with matching contributions
7.
Safe harbor 401(k) plan with nonelective contribution
8.
QACA safe harbor 401(k) plan with matching contributions
9.
QACA safe harbor 401(k) plan with nonelective contribution
10.
Traditional profit sharing plan
11.
Age-weighted profit sharing plan
12.
Cross-tested profit sharing plan
13.
Floor-offset plan
14.
Cash balance defined benefit plan
15.
Defined benefit plan
16.
DB-K
17.
IRC 412(e)(3) plan
18.
403(b) plan
19.
Governmental 457(b) plan
20.
Simplified Employee Pension (SEP)
21.
Employee Stock Ownership Plan (ESOP)
22.
Nonqualified plan
Things to Consider
There are many important items to consider when consulting on plan design including the plan
sponsors needs and desires, the employer and employee demographics, and the plan features
that best fit the situation.
345
PLAN SPONSORS NEEDS

Any plan design must take into consideration the needs and desires of the employer including
the contributions that they are willing and able to make and the level of administrative
complexity and expense the employer is able to handle.
Flexibility
Is the employer able to make regular required contributions?
Does the employer need flexibility in contribution levels from year to year?
Desired Contributions
Is the plan intended to benefit the owners and/or HCEs while controlling costs for rankand-file employees?
Is creating retirement security for employees a primary goal?
Do the owners and/or HCEs want to maximize contributions?
Does the plan sponsor want to make contributions or will contributions be made by
employees only?
How much can the plan sponsor afford to contribute?
How much volatility can the plan sponsor handle in the amount of the contribution each
year?
Administrative Complexity and Expenses
Is the plan sponsor willing and able to pay for plan administration?
Is the plan sponsor willing and able to pay for necessary nondiscrimination and
coverage testing?
Does the employer have payroll systems in place to handle withholding for employee
contributions?
Does the employer have systems in place to provide accurate data in a timely manner for
employer contribution calculations and nondiscrimination testing?
Will the plan sponsor appreciate the tax advantages of a complex design along with
corresponding higher costs or will a simpler design be more easily handled?
Does the plan sponsor have a person administering the plan that can understand and
correctly administer the recommended provisions?
EMPLOYER AND EMPLOYEE DEMOGRAPHICS

Employer and employee demographics have a large impact in determining the best plan for the
situation.
Entity Type
What type of entity is the employer?
Are there controlled group or affiliated service group issues to consider?
346

Is it a noncorporate entity that will require a circular calculation on owner contributions
to determine the deductible limit?
What kinds of retirement arrangements may this type of entity sponsor?
Employee Demographics
What is the total number of employees?
What is the age demographic of the employee group?
How many years of service do employees of the employee group have?
Does the employee group have a history of high turnover, and if so, when does the
turnover tend to happen?
Are all employees working full-time or does the employer also use part-time/seasonal
employees?
Does the employer make use of leased employees?
Do any of the employees belong to a union?
Are any employees non-resident aliens or foreign employees?
What is the compensation range of the employee population?
Is there a certain group of employees that the employer may want to favor?
Plan Features
Will employer contributions be made to the plan?
Will employee contributions be made to the plan?
Which employees will benefit under the plan?
What will the plan eligibility requirements and entry dates be?
Is there a goal to exclude any particular group of employees?
Will the plan have safe harbor features or will nondiscrimination testing be necessary?
Does the plan have mandatory or voluntary contributions?
What deduction limits are associated with the desired plan type?
Will the plan be top-heavy?
Are participant loans or the ability to receive in-service withdrawals desired?
What restrictions or conditions concerning plan design are created by existing or prior
plans sponsored by the employer?
If there is an existing plan that is being amended, what IRC 411(d)(6) cutback issues
exist?
Have any other plans been merged into this plan previously?
Plan Types in Detail

SIMPLE IRA
General facts about a SIMPLE IRA include:
347

Deferral limit of $11,500 for 2012 and $12,000 for 2013.
Catch-up limit of $2,500 for both 2012 and 2013.
Required annual employer contribution in the form of either:
o
100% match on deferrals up to 3% of compensation; or
2% nonelective contribution.
In two out of five plan years, the match may be reduced to 100% on the first 1% of
compensation deferred.
Can only be sponsored by employers who have less than 100 eligible employees.
All employees who have earned more than $5,000 in any two prior years and are
expected to earn at least $5,000 in the current year must be covered by the plan.
Advantages
No Form 5500 is required.
Fiduciary liability is limited because the plan is funded through individual participant
IRAs.
Compensation limits of IRC 401(a)(17) do not apply to the matching contribution
calculation so the matching would be based on total compensation. The IRC 401(a)(17)
compensation limits do apply to the nonelective contribution calculation if that is the
method selected for meeting the SIMPLE contribution requirements.
Disadvantages
Employees can withdraw funds from the individual IRAs at anytime.
No loans are available.
A SIMPLE IRA is not technically a qualified plan under ERISA.
Balances in a SIMPLE IRA cannot be rolled over to another plan or IRA until two years
after the first contribution was made to the account or a 25% early withdrawal penalty
will apply.
Employer contributions must be 100% vested.
No additional contributions are permitted beyond the required matching or nonelective
contributions.
Employer sponsoring a SIMPLE cannot sponsor any other plan including a SEP during a
plan year in which SIMPLE contributions are made.
Best Uses
Small employers who are looking to implement their first plan.
Employers looking to avoid the administrative burden and cost of annual filings and
nondiscrimination testing.
In situations where the HCEs do not desire to fund more than $12,000 ($14,500 if catchup eligible) plus a 3% match for themselves.
348
SIMPLE 401(K) AS COMPARED TO SIMPLE IRA

A SIMPLE 401(k) is another plan type that is similar to a SIMPLE IRA in many ways but does
have some key differences that may make one more attractive than the other in a particular
situation.
What is the Same?
Elective deferral and catch-up limits;
Employers eligible to sponsor;
Employer contributions required (except that IRC 401(a)(17) compensation limit does
apply and the reduced matching is not available); and
Employer contributions are 100% vested.
What is Different?
A SIMPLE 401(k) is a qualified plan;
Qualified plan fiduciary requirements apply;
IRC 401(a)(17) compensation limit does apply to the calculation of matching
contributions;
A Form 5500 must be filed annually;
Plan is funded through a trust;
Loans are permitted; and
Regular qualified plan rules for eligibility of 1 year of service with 1,000 hours, and age
21 apply.
Best Uses
Small employers who are looking to implement their first plan.
In situations where the HCEs do not desire to fund more than $12,000 ($14,500 if catchup eligible) plus a 3% match for themselves currently but may want to increase
contributions in the not too distant future as a simple amendment is required to become
a traditional or safe harbor 401(k).
In situations where a SIMPLE IRA would meet many needs but the desire to offer loans,
exclude employees who have compensation of over $5,000 but do not have a year of
service and/or concern about the employees having continual access to the money in the
plan exists.
SEP
General facts about a SEP are:
Funded through IRAs;
Only employer contributions can be made (with the exception of a SARSEP established
prior to 1997);
Contributions are discretionary from year to year;
349

Contributions are generally allocated pro rata but can be integrated with social security if
a document other than the Form 5305-SEP is used;
Another plan can be maintained if a document other than the Form 5305-SEP is used;
All contributions are 100% vested;
Maximum contribution for each employee is determined under IRC 415;
All employees who worked at least three of the last five years with compensation of at
least $550 in 2013 must be covered by the plan.
Advantages
No Form 5500 is required.
Fiduciary liability is limited because the plan is funded through individual participant
IRAs.
Disadvantages
Employees can withdraw funds from the individual IRAs at anytime.
No loans are available.
Employer contributions must be 100% vested.
No employee contributions are permitted which also precludes the HCEs from making
catch-up contributions.
Best Uses
Employers without nonowner employees or who do not have long term employees that
would have to be covered by the plan.
Employers looking to avoid the administrative burden and cost of annual filings,
nondiscrimination testing and payroll withholding.
Employers who dont mind making large contributions for the employees.
INDIVIDUAL 401(K)
A 401(k) adopted by an employer with only owners as employees and often just a single owner
employee.
Advantages
Complete funding flexibility.
Elective deferral limit of $17,000 for 2012 and $17,500 for 2013.
Catch-up limit of $5,500 for both 2012 and 2013.
Profit sharing can be discretionary each year.
Deduction is limited to 25% of compensation (circular reduction for sole proprietors and
partnerships) without regard to deferrals.
Total contributions are limited to the IRC 415 limit of the lesser of 100% of
compensation or $50,000 for 2012 or $51,000 for 2013 plus catch-up contributions.
Loans are available.
350

Disadvantages
A Form 5500 or 5500-EZ must be filed annually.
Plan document, set-up, Form 5500, and plan amendments add to the cost and
complexity.
Best Uses
Ideal for a sole proprietor or one person corporation who:
Is looking to fund more than a SIMPLE IRA or SEP would allow;
Has compensation low enough that the 25% of compensation (circularly reduced to 20%
for sole proprietors) SEP limit does not get them to the IRC 415 limit;
Has an owner over age 50 that would enable them to take advantage of catch-up
contribution availability;
Desires a great deal of flexibility in annual contributions making a defined benefit plan
impractical; or
Is happy with funding no more than the IRC 415 limit for defined contribution plans,
plus any catch-up contributions.
TRADITIONAL 401(K)
Advantages
Elective deferral limit of $17,000 for 2012 or $17,500 for 2013.
Catch-up limit of $5,500 for 2012 and 2013.
Generally, employer contributions are not required and most employer contributions can
be discretionary each year.
Employer contributions can be in the form of matching or nonelective contributions.
Employer contributions can be subject to a vesting schedule.
Employees working under 1,000 hours can be excluded as well as employees who have
been employed less than one year or are under age 21.
Loans and hardships can be offered.
Disadvantages
ADP/ACP testing may substantially limit HCE contributions if there is not adequate
NHCE participation.
Fiduciary responsibilities.
Adds administrative burden and cost with payroll complexity, frequent plan deposits,
testing and reporting costs.
Best for Companies Who:
Dont want to commit to employer contributions.
Have HCEs that are willing to live with ADP imposed deferral limits.
Expect good NHCE participation.
351

Have payroll systems in place to handle withholding and are able to provide data for
testing in a timely manner.
401(K) WITH AN AUTOMATIC CONTRIBUTION ARRANGEMENT

A 401(k) with an automatic contribution arrangement (ACA) can take several forms. In its
simplest form it can be implemented to automatically enroll all new participants at a given level.
Participation can be further expanded by enrolling all participants who have not made an
election previously, or even all participants who are not currently deferring at or above the
designated level. In any form the plan is designed to increase participation. Additional
information about automatic contribution arrangements can be found in the 401(k) plans
chapter of this study guide. The advantages and disadvantages below assume the plan is an
ACA or EACA and not a QACA safe harbor 401(k) plan.
Advantages
Increased participation by NHCEs will improve ADP results.
If the plan qualifies as an EACA and the EACA is applied to all employees, the ADP
refund deadline will be extended to 6 months from 2 months.
As in other plans, the QDIA is available to invest the contributions in the absence of an
election from the participant.
If the plan qualifies as an EACA, a provision is available to refund the automatically
withheld deferrals within 90-days of the first withholding.
Increases savings by the employee population thereby increasing the likelihood that
employees will have sufficient funds at retirement.
Disadvantages
While ADP/ACP testing will likely improve, it is still possible for the tests to fail.
Added administrative burden ensuring that the automatic contributions are applied
correctly and consistently and that all notices are provided in a timely manner.
An EACA cannot begin mid-year, so while automatic contributions may be started midyear, 90-day distributions and extended ADP/ACP testing time would not be available
until the following year.
Small account balances in the plan may increase costs.
Some employees may not have wanted to participate resulting in bad will with
employees or administrative hassle with processing 90-day distributions.
Matching contribution, if any, will likely be higher due to increased participation.
Dont want to commit to employer contributions.
Want to increase participation among NHCEs to help ADP test but cannot afford to
commit to a safe harbor plan.
Want to encourage a culture of savings.
352

Have payroll systems in place to handle withholding, tracking enrollment amounts and
dates and are able to provide data for testing in a timely manner (either 2 months or 6
months if the EACA applies to all employees).
SAFE HARBOR 401(K) WITH MATCH

A fully vested matching contribution of at least 100% on the first 3% of compensation deferred
and 50% on the next 2% of compensation deferred must be made. An enhanced match is also
available as long as it is at least as generous as the basic formula at all levels of deferral and does
not increase in percentage as deferrals increase. When using an enhanced match careful
attention should be paid to the ACP safe harbor requirements which would be violated if
deferrals in excess of 6% of compensation are matched.
Advantages
HCEs are not limited by ADP if there is poor NHCE participation.
Only have to contribute to employees who actually defer.
Automatic pass for top-heavy if no other allocations are made to employees and
eligibility provisions for deferrals and matching contributions are the same.
Additional profit sharing or matching may be made in good years and the additional
contributions can be subject to a vesting schedule and sometimes allocation
requirements.
Safe harbor matching contributions can be ceased upon proper notification to employees
and plan amendment.
Disadvantages
Matching contribution is required.
Additional notices must be provided.
Safe harbor contribution must be 100% vested.
No allocation requirements are permitted on the safe harbor contribution.
Have HCEs that want to make maximum deferrals.
Can afford to make the required contributions.
Dont mind contributing to employees who defer.
Expect poor NHCE participation.
May want to make additional contributions in good years.
Are concerned about top-heavy and dont want to contribute to employees who dont
defer.
SAFE HARBOR 401(K) WITH NONELECTIVE

A fully vested nonelective contribution of at least 3% of compensation must be made to all
eligible employees.
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Advantages
Provides some savings for all employees.
Nonelective acts as a base for additional profit sharing, top-heavy or new comparability
allocation, but cannot be taken into account as a base for social security integration.
Additional profit sharing or match may be made in good years and the additional
requirements.
A maybe notice can be issued to delay a final decision until closer to the end of the year.
Disadvantages
Safe harbor contribution of at least 3% is required for all employees.
Once elected, the safe harbor contribution can be stopped mid-year due to a financial
hardship but then ADP testing will be required for the full plan year. In addition, the
safe harbor contribution would still be required for the period of the year that the plan
was a safe harbor plan.
No allocation conditions are permitted.
Want to contribute at least something for all employees.
Do not have high turnover after one year of service (important because of vesting).
Likely want to make additional contributions in good years.
QACA SAFE HARBOR 401(K) WITH MATCH

A QACA safe harbor contains an automatic contribution arrangement that must enroll all
participants who have not made an election in the plan previously at a rate between 3% and
10%. If the automatic enrollment rate is under 6% then it must be increased annually by at least
1% until a 6% level is reached. A matching contribution of at least 100% on the first 1% of
compensation deferred and 50% on the next 5% of compensation deferred must be made. This
provides a maximum match of 3.5% of compensation. An enhanced match is also available as
long as it is at least as generous as the basic formula at all levels of deferral and does not
increase in percentage as deferrals increase. When using an enhanced match careful attention
should be paid to the ACP safe harbor requirements which would be violated if deferrals in
excess of 6% of compensation are matched.
Advantages
354

NHCE participation rates for plans with automatic enrollment features tend to be higher
than for plans without automatic enrollment which means more employees are saving
for retirement.
Only have to contribute to employees who participate.
Automatic pass for top-heavy if no other allocations are made to the employees.
Can be subject to a vesting schedule as long as participants are 100% vested after two
years. This is an advantage over the traditional safe harbor for companies that
experience significant turnover in the first two years of an employees of employment.
Maximum match is 3.5% as compared to 4% for traditional safe harbor so the cost is
lower per employee, but the increased participation achieved under the automatic
enrollment provision may result in increased total cost.
requirements.
Disadvantages
Matching contribution is required.
Increase in participation with the automatic enrollment feature may increase
administrative burden.
Dont mind contributing to employees who defer.
Want to encourage saving by their employees and do not mind the additional match cost
associated with the savings increase.
May want to make additional contributions in good years.
Are concerned about top-heavy and dont want to contribute to employees who dont
defer.
QACA SAFE HARBOR 401(K) WITH NONELECTIVE

A QACA safe harbor contains an automatic contribution arrangement that must enroll all
participants who have not made an election in the plan previously at a rate between 3% and
10%. If the automatic enrollment rate is under 6% then it must be increased annually until a 6%
level is reached. A nonelective contribution of at least 3% must be made to all eligible
employees. The nonelective contribution can be subject to a two year cliff vesting schedule.
Advantages
355

NHCE participation rates for plans with automatic enrollment features tend to be higher
than for plans without automatic enrollment, which means more employees are savings
for retirement.
Provides some savings for all employees through the nonelective contribution and
encourages employees to contribute to their own retirement.
Nonelective contribution acts as a base for additional profit sharing, top-heavy or new
comparability allocation.
Two-year cliff vesting can save a considerable amount over the traditional safe harbor
with nonelective contributions if the employer experiences high turnover in the first two
years of an employees employment.
requirements.
Disadvantages
Safe harbor contribution is required.
Unlike the traditional safe harbor 401(k) with nonelective, a maybe notice is not
available.
Contributions must be made to all eligible employees including those who are not
deferring.
Want to contribute at least something for all employees and encourage saving by
employees.
Have high turnover in the first two years of employment making the fully vested
traditional safe harbor less attractive.
Likely to make additional contributions in good years.
PROFIT SHARING ONLY PLANS

Advantages
Less administrative cost and complexity than a plan with deferrals.
Contributions are discretionary each year.
Contributions can be subject to a vesting schedule.
Can have allocation conditions subject to passing IRC 410(b).
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Several types of allocation formulas are available including pro rata, integrated, ageweighted and new comparability.
Can require two years of service to participate if contributions are 100% vested after two
years.
Disadvantages
Depending on demographics, it may be significantly more expensive to maximize the
contributions to HCEs than other plan types.
Employees arent able to contribute to their own retirement.
Pro Rata Allocation is Best for Companies Who:
Want to keep things simple.
Are okay with contributing the same percentage of compensation to NHCEs as to HCEs.
Integrated Allocation is Best for Companies Who:
Want some disparity tilted towards employees with higher compensation without
additional testing. Attention should be paid to where the integration level is set. If
NHCE compensation is significantly below the taxable wage base (TWB) an integration
level below the TWB may provide superior results.
Have HCE compensation that is quite a bit more than the rank-and-file employees.
Have owners with high compensation but are younger than some or most of the NHCEs.
New Comparability Allocation is Best for Companies Who:
Have HCEs who are quite a bit older than at least a few of the NHCEs.
Have fairly stable workforce demographics, as changes in demographics could result in
substantially higher contributions.
Have HCEs that want to receive IRC 415 maximum contributions with as little as
possible contributed to the NHCEs.
Dont mind making gateway contributions of the lesser of 5% of compensation or 1/3 of
the highest HCE contribution for NHCEs.
Want flexibility to provide different contribution levels to different employees (i.e.,
maximize one partner and not another or give higher contributions to the office manager
than the rest of the staff).
Things to Keep in Mind When Using a New Comparability Allocation:
Cost of administration and administrative complexity are greater than for other profit
sharing contribution types.
Demographic changes can have a huge impact on contribution levels.
Allocation conditions are permitted but should be carefully considered because
sometimes imposing a last day or 1,000 hour rule on one participant can increase the
overall NHCE cost significantly. This is because the participant being excluded from the
contribution is then a zero in the test and they might have otherwise had a fairly high
357

EBAR. Gateway contributions should also be considered as they may make allocation
conditions irrelevant.
Age-Weighted Allocation is Best for Companies Who:
Have all HCEs who are quite a bit older than all of the NHCEs.
Have a very stable workforce.
Have HCEs that want to maximize contributions for themselves with as little as possible
to NHCEs.
Have demographics to support contributions of less than the gateway to NHCEs.
TRADITIONAL DEFINED BENEFIT PLAN

Advantages
Can have a higher deductible contribution than is available in a defined contribution
plan.
Older HCEs can accumulate large benefits much more quickly than in a defined
contribution plan.
Can have contributions in excess of the IRC 415 limit for defined contribution plans.
Provides a predictable benefit to employees.
De minimis benefits can be provided to spouses working part-time if the employer has
never sponsored a defined contribution plan.
Provides larger benefits for older/longer service employees.
Generally insured by the PBGC.
Disadvantages
Can be hard to understand so the benefits may not be fully appreciated by employees.
Required contributions must be made annually and the requirements can fluctuate
significantly from year to year based on investment performance and demographic
changes.
The employer bears the investment risk.
Employees generally cannot contribute to their own retirement.
Administrative cost and complexity is higher than for many other plan types.
Have stable long term profits to make required contributions.
Have HCEs who are older and have more years of service than the NHCEs.
Want to fund a large benefit for older owners in a short period of time.
Want to make sure their employees are taken care of in retirement.
Want to make deductible contributions exceeding 25% of eligible compensation.
Want to contribute more than the IRC 415 limit available to defined contribution plans
for some employees.
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DB-K
Advantages
Advantages of a Traditional Defined Benefit Plan still apply.
An eligible combined plan is permitted to also contain a 401(k) component in the plan.
Formula of typical DB-K may be easier to understand for the average participant (The
applicable percentage is the lesser of (1) 1% multiplied by the number of years of service
with the employer or (2) 20%).
The 401(k) component of the DB-K is deemed to pass ADP testing.
Matching contributions are eligible for the ACP safe harbor.
DB-K is deemed to satisfy the top heavy rules.
Disadvantages
May only be established by a small employer (defined as an employer that employed an
average of at least 2 and no more than 500 employees on all business day during the
preceding year and that employs at least 2 employees on the first day of the year).
Requires special recordkeeping so that the defined contribution portion of the plan is
recorded separately, but all assets are held in a single trust.
401(k) portion must be an automatic contribution arrangement (ACA) at a default rate of
4%, including all notice requirements.
The employer is required to make a matching contribution in an amount equal to at least
50% of up to 4% of elective deferrals contributed.
Matching contributions are automatically 100% immediately vested.
CASH BALANCE PLAN

Advantages
Benefits are more understandable and therefore more likely to be appreciated than a
traditional defined benefit plan.
Can have a higher deductible contribution than is available in a defined contribution
plan.
Older HCEs can accumulate large benefits much more quickly than in a defined
contribution plan.
Can have contributions in excess of the IRC 415 limit for defined contribution plans.
Provides a predictable benefit to employees.
More attractive to younger employees who have longer to accumulate pay and interest
credits.
Can provide different pay credit levels to different employees.
Generally insured by the PBGC.
359

Disadvantages
Required contributions must be made annually and the requirements can fluctuate some
from year to year based on investment performance and demographic changes.
The employer bears the investment risk.
Employees generally cannot contribute to their own retirement.
Administrative cost and complexity is higher than for many other plan types.
Individually designed document is required.
Must provide a vesting schedule that is at least as generous as a three-year cliff.
Want to target benefits to certain owners and employees.
Have stable long term profits to make required contributions.
Have HCEs who are older and have higher compensation than NHCEs.
Want to fund a large benefit for older owners in a short period of time.
Want to provide benefits than are more easily understood than a traditional defined
benefit plan.
Want to be able to track benefits separately among partners in a partnership or owners
in a corporation.
Want to make deductible contributions exceeding 25% of eligible compensation.
Want to contribute more than the IRC 415 limit available to defined contribution plans.
NONQUALIFIED ARRANGEMENTS
Advantages
Not subject to most qualified plan rules.
Can benefit some employees and not others.
Can provide deferral of compensation in excess of the qualified plan limits such as IRC
402(g) and IRC 415 limits.
Disadvantages
Complex rules must be followed to avoid current taxation for employees.
Generally no employer deduction is available until the deferred amounts become taxable
to the employee.
Deferred amounts are often subject to employer creditors so deferred income may be lost
altogether if the sponsoring company goes bankrupt.
Want to provide substantial deferral of income to nonowners.
Are financially stable, increasing the likelihood that deferred amounts will be available at
a later date.
360
EMPLOYEE STOCK OWNERSHIP PLANS (ESOPS)

Advantages
Provides ownership mentality for employees, which can result in increased productivity.
Possible business succession tool.
Can provide tax advantages to the selling owner through an IRC 1042 exchange if
requirements are met.
Can be leveraged.
Creates a market for the stock of a closely held company.
Interest and dividends may be deductible in excess of the 25% of compensation limit that
generally applies to defined contribution plans.
Disadvantages
Complicated, with high start-up and administration costs as compared to other plan
types.
Loan payments for a leveraged ESOP essentially create an annual contribution
requirement.
Only allocation method permitted is pro rata or in groups passing IRC 401(a)(4) on a
contributions basis (integration and cross-testing are not available).
Owner must adjust to sharing ownership with the employees or completely transferring
ownership to employees. Management and oversight committees may need to be
established to ensure the companys survival.
Increased fiduciary liability associated with having company stock in the plan.
External annual valuation of stock is required and this adds cost to the plan.
If the company goes bankrupt, the ESOP accounts may become worthless meaning all of
the participants retirement assets in the plan could be lost.
Have stable long term profits.
Want to transfer ownership to the employees.
Want to create a market for the shares of a privately held company.
Want to deduct more than 25% of eligible compensation.
Already have structures in place to assume a leadership role with the transition of
ownership interest.
SAFE HARBOR 401(K) WITH NONELECTIVE AND NEW COMPARABILITY

A fully vested nonelective contribution of at least 3% must be made to all eligible employees. An
additional cross-tested contribution can be made that is discretionary from year to year.
Advantages
361

Employer contributions can be significantly targeted towards HCEs or other specific
employees if the employer has the right employee demographics.
A maybe notice can be issued to delay a final decision about the safe harbor contribution
until closer to the end of the year making all employer contributions relatively
discretionary.
Disadvantages
Safe harbor contribution is required.
Safe harbor notices must be provided.
Gateway requirements must be met in years where the new comparability contribution
is made.
No allocation conditions are permitted on safe harbor and may adversely impact testing
if allocation conditions are placed on the new comparability allocation.
Have HCEs that want to maximize their contributions at or near the IRC 415 limit plus
any catch-up contributions.
Can afford to make the required contributions and often additional contributions.
Want to contribute at least something for all employees.
Have stable employee demographics.
Have some NHCEs who are significantly younger than the HCEs who want to maximize
their contributions
401(K) SAFE HARBOR WITH NEW COMPARABILITY AND CASH BALANCE PLAN
A fully vested nonelective contribution of at least 3% must be made to all eligible employees. An
additional cross-tested nonelective contribution can be made that is discretionary from year to
year. Contributions in excess of the IRC 415 limit for defined contribution plans can be made to
the cash balance plan, but cash balance contributions will be required annually and may
fluctuate from year to year.
Advantages
Employer contributions can be significantly targeted towards HCEs or other specific
employees if the employer has the right employee demographics.
Employer nonelective contributions provide some discretion that would not be available
if all benefits were provided through a defined benefit plan.
362

The combination of plans offers HCEs the opportunity for contributions that far exceed
the IRC 415 limit applicable to a defined contribution alone.
Deductions may exceed 25% of compensation if the plan is covered by the PBGC or if
employer contributions to the defined contribution plan are not more than 6% of
compensation.
Disadvantages
Safe harbor contribution and cash balance contributions are required.
Gateway requirements must be met and may be higher than what is required for a
defined contribution plan on its own.
Changes in employee demographics can impact testing which in turn impacts benefit
accruals. In the extreme case an employee demographic change may require
amendment of the cash balance plan.
Set-up and administration costs will be higher due to the need for an actuary on the cash
balance plan, additional testing and document requirements.
No allocation conditions are permitted on safe harbor and may adversely impact testing
if allocation conditions are placed on other allocations.
Have HCEs that want to maximize their contributions significantly in excess of the IRC
415 limit applicable to defined contribution plans.
Want to contribute at least something for all NHCEs.
Have stable employee demographics.
Have some NHCEs who are significantly younger than the HCEs who want to maximize
their contributions
363
Case Study #1
Early in 2013, you get a call from Derek, who is interested in establishing a retirement plan.
Derek has a business acquaintance, Dennis, who uses your firm for his plans administration.
Derek tells you he wants a plan like Dennis plan. Dennis plan does not make him contribute
for all employees. He further tells you he is a small business man and doesnt have a lot of
employees yet, but his business is growing. He wants to get started saving for retirement. And
he wants his contributions to be pre-tax.
In reviewing your files, you determine Dennis has a profit sharing only plan that has 1,000 hour
and last day allocation requirements. It may or may not be appropriate for Dereks company.
We need to know more about Dereks company and his needs and expectation with regard to a
qualified plan.
Dereks company has been around for three years. There are five workers, including Derek.
Dereks wife, Dina, owns an equal share and works for the business. Dereks brother David
works there too but he has no ownership. He has two other employees, Abigail and Anna.
Everyone is under the age of 30. The first two years, Derek and Dina were the only two
employees. The other employees were hired as the business grew over the last year.
Derek explains that his is a small business and they arent getting rich yet, but hes working
hard and wants to reward his employees. He is concerned about having to contribute if they
have a slow period. He wants to contribute as much as he can afford for himself and Dina,
which at this point is $20,000. His only current retirement savings are IRAs that he and Dina
established a few years ago.
2013 Projected
Name
DOB
DOH
Compensation
Derek
7/18/1982
1/1/2010
$55,000
Dina
10/12/1984
1/1/2010
$45,000
David
1/12/1985
7/1/2012
$40,000
Abigail
6/27/1992
1/1/2012
$20,000
Anna
4/15/1990
8/15/2012
$15,000
GENERAL ANALYSIS:
Derek is a small business so cash flow and administrative burden are on-going concerns.
Derek has an IRA so he wants to contribute more than the IRA annual limit.
Derek doesnt have many employees and all employees are young and lower paid.
364
PLAN OPTIONS:
Individual IRAs
Derek and Dina can each contribute $5,500 per year to a traditional or Roth IRA (subject to
income limitations) for a total of $11,000 annually. They already have IRAs and they arent able
to contribute as much as they would like to. This also does not provide any benefit to their
employees, which is a goal, so it is not a suitable retirement strategy for them.
This type of plan does not allow employees to defer. So Dereks personal benefit is limited by
the business ability to contribute on behalf of the employees. The maximum contribution to a
SEP would be 25% of compensation for eligible employees. Because the eligibility for a SEP can
be longer than for a qualified plan (worked at least three of the last five years with
compensation exceeding $450 as indexed) he would be able to exclude some employees for the
next year or two but that does not address his desire to reward his employees. Also because he
expects continued growth in his business it is not a good long term solution. A SEP would be a
possible short term solution in that it could be put in place for 2012 if implemented prior to their
tax filing deadline.
SIMPLE IRA
A projection is done showing the maximum that can be contributed for the owners with the
maximum cost for the employees.
Name
DOB
DOH
2013 Comp
Deferral
Match
Derek
7/18/1982
1/1/2010
$55,000
$12,000
$1,650
Dina
10/12/1984
1/1/2010
$45,000
12,000
1,350
David
1/12/1985
7/1/2012
$40,000
1,200
1,200
Abigail
6/27/1992
1/1/2012
$20,000
600
600
Anna
4/15/1990
8/15/2012
$15,000
450
450
$25,250
$5,250
Total
Under this scenario the owners have the opportunity to fund up to $27,000 for themselves
through deferral and match at a maximum cost for the employees of $2,250. The cost for the
employees could also be lower if some chose not to defer or defer at a rate of less than 3%.
Advantages:
The administrative burden and cost is greatly reduced compared to a 401(k) plan.
It is very easy to establish.
No annual government reporting.
365

Derek and Dina could contribute up to $27,000 to a SIMPLE IRA plan at a maximum cost
for the employees of $2,250. That is not as much as the 401(k) plan, but it is adequate
given Derek and Dinas young ages and still exceeds the $20,000 they are looking to
fund.
There is very little fiduciary liability associated with a SIMPLE IRA because there is no
trust or reporting requirements and participants have control over their own
investments.
Disadvantages:
There is a required contribution of a 2% nonelective contribution or a 3% matching
contribution. However, the match could be reduced to as little as 1% for two out of five
years if proper notice is given.
All contributions are fully vested.
Employees can take their contributions out, thereby short-circuiting Dereks desire to set
something aside for their retirement.
Final analysis is that a SIMPLE IRA meets their goals and would be a great fit for their company
at this time. A 401(k) could be established in future years if Derek and Dina wanted to
contribute in excess of the SIMPLE deferral limit. A SIMPLE 401(k) is another possibility but it
carries with it much of the administrative and fiduciary burden of a traditional 401(k) with only
very limited benefits (i.e., loan availability) in the near term.
Traditional 401(k) Plan with an Automatic Contribution Arrangement
A projection for a traditional 401(k) with an automatic contribution arrangement is done.
Assuming an automatic enrollment at 3% Derek and Dina could defer 5%. The plan could
provide for a discretionary match that would not have a required contribution. Under this
scenario the contributions would be as follows:
Name
DOB
DOH
2013 Comp
Deferral
Derek
7/18/1982
1/1/2010
$55,000
$2,750
Dina
10/12/1984
1/1/2010
$45,000
2,250
David
1/12/1985
7/1/2012
$40,000
1,200
Abigail
6/27/1992
1/1/2012
$20,000
600
Anna
4/15/1990
8/15/2012
$15,000
450
Total
$7,250
through deferral without any cost for the employees.
366

Advantages:
No employer contribution is necessary.
If they have a great year, Derek can contribute employer money into the plan.
The plan can require 1,000 hours and last day employment for employer allocations. This
would allow employer contributions to benefit current employees.
Disadvantages:
The administrative burden for a 401(k) plan is very high for a small employer like Derek.
Given ADP considerations, with a young workforce, its unlikely Derek and Dina could
defer as much as they would like.
Government reporting and the associated cost and burden are additional administrative
issues.
Derek and Dina will have fiduciary liability.
Final analysis is that a 401(k) plan with an automatic contribution arrangement is not a good fit
for Dereks needs. There is a strong likelihood that the ADP test would substantially curtail the
benefits available to Derek and Dina.
Safe Harbor 401(k) Plan
A projection is done showing the maximum that can be contributed for the owners with the
maximum cost for the employees.
Name
DOB
DOH
2013 Comp
Deferral
Match
Derek
7/18/1982
1/1/2010
$55,000
$17,500
$2,200
Dina
10/12/1984
1/1/2010
$45,000
17,500
1,800
David
1/12/1985
7/1/2012
$40,000
2,000
1,600
Abigail
6/27/1992
1/1/2012
$20,000
1,000
800
Anna
4/15/1990
8/15/2012
$15,000
750
600
$36,750
$7,000
Total
through deferral and match at a maximum cost for the employees of $3,000. The cost for the
employees could also be lower if some chose not to defer or defer at a rate of less than 5%. As an
alternative a 3% nonelective contribution could be provided at a cost to the employees of $2,250
and provide the owners the opportunity to fund up to $38,000.
367

Advantages:
Derek and Dina can contribute up to the IRC 402(g) limit of $17,500 for 2013 without
concern of failing the ADP test, which far exceeds their goals.
The cost for the employee contributions is small relative to the amount that could be
contributed for the owners.
This plan design could grow with them as they added additional employees in the
future.
If they have a great year, Derek can contribute employer money into the plan subject to
any top-heavy issues that the additional contribution would create.
Disadvantages:
There is a required annual contribution that is fully vested and cannot have a 1,000 hour
or last day requirement.
The administrative burden for a 401(k) plan is very high for a small employer like Derek.
Set-up and annual administration costs could be significant in contrast to the benefit
provided to the employees.
Government reporting and the associated cost and burden are additional administrative
issues.
Derek and Dina will have fiduciary liability.
Final analysis is that a safe harbor 401(k) plan meets their goals but may not be the best fit for
Dereks current needs.
SOLUTION:
The SIMPLE IRA is the best solution for Derek and Dinas immediate need. If the business
grows and a more sophisticated plan is needed, it can be established later. A safe harbor 401(k)
plan would be the next best alternative but since they are only looking to fund approximately
$20,000 a year at this point the SIMPLE limits are adequate to meet their goal without adding
significant set-up and administration costs to the mix.
368
Case Study #2
You are asked to do a plan design for Cactus Flower Dental Center. You meet with Dr. Johnson,
the owner of Cactus Flower Dental Center, who tells you that he and his wife want to start
saving for retirement. His wife acts as the office manager and comes into the office every other
week to do payroll, which she does on Quickbooks.
Dr. Johnson indicates that flexibility in contributions is key as he is going to need to buy some
new equipment over the next couple of years and may even buy a building for his practice as he
currently rents office space. He is also concerned about adding administrative burden for his
wife with this plan. He wants a keep-it-simple approach. His staff is older than he is and hed
like to take care of them. He has no objections to making contributions on their behalf as long as
he can subject them to vesting. One of his goals is to keep the staff he has. He anticipates his
office remaining at its current size for at least the next 5 years.
The census information is as follows:
DOB
DOH
Comp
Dr. Johnson
10/18/79
1/1/2011
$ 80,000
Mrs. Johnson
6/8/82
1/1/2011
$ 40,000
Hygienist Heidi
3/5/68
1/8/2011
$ 80,000
Receptionist Randi
11/2/78 1/16/2011
$ 38,000
GENERAL ANALYSIS:
Dr. Johnson doesnt have the payroll and HR capabilities to handle a 401(k) plan. He indicated
that he wanted to keep the plan simple. He doesnt mind providing benefits for the employees.
The NHCEs are older than the HCEs and at least one makes the same wage as the doctor.
PLAN OPTIONS:
401(k) plan
Advantages:
The contribution level for Dr. Johnson and his wife is $35,000 plus any safe harbor or
other employer contributions.
Employees would have the option to save for themselves if they so desired.
Disadvantages:
It is unlikely the employees would save at a high enough rate to satisfy the ADP test due
to the low salaries of the owners. This would likely have to be a safe harbor plan.
The safe harbor contributions to the employees are not subject to vesting.
369

There is a high administrative burden for this plan design as deferrals must be remitted
each pay date.
There is no flexibility on making the safe harbor contributions.
The $35,000 in salary deferral contribution is subject to employment tax even though it is
not subject to income tax.
Final analysis is that a 401(k) plan is not a good fit for this group.
New Comparability Profit Sharing Plan
This wont work as the NHCEs are older than the HCEs.
Integrated Profit Sharing Plan
Advantages:
Contributions are skewed to employees who earn more compensation.
There is flexibility in contributions.
The contributions are all subject to vesting.
The contributions are all exempt from employment tax as well as income tax.
Disadvantages:
At least one of the employees makes the same as the doctor. The other employee makes
only slightly less than the wife. There isnt going to be much leveraging available.
Final analysis is that an integrated profit sharing plan is not a good fit for this group.
Pro Rata Profit Sharing Plan
Advantages:
The administrative burden is substantially less than the 401(k) plan.
Disadvantages:
The cost for the employees is substantial although Dr. Johnson indicated that he didnt
mind providing substantial benefits to the staff.
SOLUTION:
The best solution is for the Dr. Johnson to establish a profit sharing plan that allocates
contributions on a pro rata basis.
370
Case Study #3
You are meeting with Saguaro Medical Center to discuss possible designs for their new
retirement plan. Dr. Stewart, the owner of Saguaro Medical Center, tells you that he and his
partner each want to start saving roughly $50,000 a year for retirement. His wife acts as the
office manager and comes into the office every other week to do payroll, which she does on an
internal payroll application.
Dr. Stewart indicates that flexibility in contributions is essential as he and his partner are going
to do some real estate investing and they may need the cash. He is concerned about adding
administrative burden as this really isnt his strong suit. He wants to keep it simple. His staff is
older than he is and hed like to take care of them. He has no objections to making contributions
on their behalf as long as he can subject them to vesting. One of his goals is to keep the staff he
has. He anticipates the office remaining at its current size for at least the next 3 years.
DOB
DOH
Wages
Dr. Stewart
10/18/79
1/1/2010
$850,000
Mrs. Stewart
6/1/82
1/1/2010
$100,000
Dr. Thomas
9/7/80
1/1/2010
$850,000
Nurse Nancy
3/6/68
1/8/2010
$ 60,000
Admin Anne
11/9/78 1/16/2010
$ 35,000
GENERAL ANALYSIS:
Dr. Stewart doesnt have the payroll and HR capabilities to handle a 401(k) plan. He indicated
that he wanted to keep the plan simple. He doesnt mind providing benefits for the employees.
The employees are older than he, his partner and his wife.
PLAN OPTIONS:
New Comparability Profit Sharing Plan
This wont work as the NHCEs are older than the HCEs.
Advantages:
Contributions are skewed to employees who earn more compensation so the Drs. and
the wife will receive more of the contributions as a percentage of pay than the two
employees.
371

Disadvantages:
The cost of the employees contributions is substantial although Dr. Stewart indicated
that he didnt mind providing substantial benefits to the staff.
Final analysis is that an integrated profit sharing plan is a good fit for this group. The
integration level could be set at the taxable wage base or at some level between Nurse Nancys
compensation and the taxable wage base.
Advantages:
Disadvantages:
The cost of the employees is substantial although Dr. Stewart indicated that he didnt
mind providing substantial benefits to the staff.
There is no leveraging on the salary differential in this plan design.
SOLUTION:
The best solution is for the Dr. Stewart to establish a profit sharing plan that allocates
contributions on an integrated basis. The next step would be to choose the integration level. The
integration level is often the taxable wage base, which allows for an excess percentage of 5.7%.
Another possible integration level would be 81% of the taxable wage base, which allows for an
excess percentage of 5.4%. A third possibility would be to set it slightly above the compensation
of the highest NHCE, in this case $65,000. Because $65,000 is approximately 57% of the taxable
wage base, the excess contribution percentage would be 4.3%. These options are illustrated
below:
Wages
TWB
81% of TWB
$65,000
Dr. Stewart
$850,000
$51,000
$51,000
$51,000
Mrs. Stewart
$100,000
$16,842
$16,977
$18,301
Dr. Thomas
$850,000
$51,000
$51,000
$51,000
Nurse Nancy
$ 60,000
$10,105
$9,930
$10,078
372

Admin Anne
Total for HCEs
Total for NHCEs
Total Contribution
% to HCEs
$ 35,000
$5,895
$5,793
$5,879
$118,842
$118,977
$120,301
$16,000
$15,723
$15,956
$134,842
$134,700
$136,257
88.13%
88.33%
88.28%
In this particular case there is not a significant difference in the percentage of the contribution
given to HCEs at each of the possible integration levels, though the difference may be more
significant with different demographics.
373
Case Study #4
You receive a call to look at the plan design options for Nancy Smith. She tells you that she
wants to start saving for retirement. Her mother works as an assistant for her and does the
payroll and HR functions.
Nancy indicates that flexibility in contributions is essential as she isnt certain how her practice
will hold up in this new economy. She is concerned about adding administrative burden
because payroll takes away from the practice. Her one staff member is younger than she is and
she is willing to provide her with substantial benefits. She would also like to provide maximum
benefits to her mother, Janice. She has no objections to making contributions on her employees
behalf as long as she can subject them to vesting. One of her goals is to keep Amy around. She
anticipates her office remaining at its current size indefinitely.
DOB
DOH
Wages
Nancy Smith
8/18/63 1/1/2009
$630,000
Janice Smith
7/10/39 1/1/2009
$115,000
Assistant Amy 11/9/85 1/8/2009
$ 38,000
GENERAL ANALYSIS:
Nancy indicated that she wanted to keep the plan simple and does her payroll in house so she is
concerned about the complexity of adding a 401(k). She doesnt mind providing benefits for the
employees.
There are two older HCEs and one younger NHCE. There is considerable disparity in salaries
with the HCEs making substantially more money.
PLAN OPTIONS:
Advantages:
The contributions are all subject to a vesting schedule.
Disadvantages:
The cost of the employees is substantial although Nancy indicated that she didnt mind
providing substantial benefits to the staff.
374

There is no leveraging on the age difference and no leveraging on the compensation
difference.
Advantages:
Contributions are skewed to employees who earn more compensation.
Disadvantages:
There is no leveraging on the age differential. Age-weighted or new comparability
would consider both the salary and the age.
Final analysis is that an integrated profit sharing plan is not a good fit for this group.
New Comparability or an Age-Weighted Profit Sharing Plan
Advantages:
This type of profit sharing plan will consider both the age and a salary differential
providing large benefits to the HCEs at a cost for the NHCE that is much lower than
would be available using other formulas.
Disadvantages:
The employee may receive a substantial contribution depending on the testing.
Any turnover in staff will greatly impact the plan design.
More administratively expensive than the other designs considered.
SOLUTION:
An age-weighted formula does not require the satisfaction of the gateway contribution. If, when
the cross testing is completed, the allocation required for Amy is less than 5% of pay, consider
age-weighted. The primary factor here would be the stability of the group as the hiring of an
older employee could considerably increase costs in the future.
A new comparability formula would be appropriate if the cross testing developed a contribution
of at least 5% of pay for Amy. This would also allow future demographic changes to impact the
contribution allocation as little as possible.
An analysis will need to be run. The analysis results are as follows:
Nancy
Contribution
Percent of Comp
EBAR
$51,000
20.0%
8.6%
375

Janice
$51,000
44.3%
7.1%
Amy
$ 1,265
3.3%
8.6%
Nancy and Janice are maximized to the IRC 415 limit. Amy needs only 3.3% of pay as a
contribution to make the nondiscrimination testing pass (both average benefits and rate segment
testing) as well as satisfy the top-heavy requirements. If this plan was set up as a new
comparability plan, gateway contributions would need to be made which would increase her
contribution percentage to 5%. If the plan was set up as an age-weighted plan, she could receive
as little as 3.3% of pay as the contribution. As a result, the best plan design for Nancys
company is an age-weighted profit sharing allocation. Nancy may want to consider adding a
401(k) feature to allow Janice and her to defer $5,500 each for 2013. The deferrals will be
classified as catch-up contributions since the profit sharing contributions equal the IRC 415
limit, so there will be no ADP testing. She would need to consider whether she wants to add the
administrative burden and added costs of a 401(k) feature in order to save these extra dollars.
376
Case Study #5
During 2013, you get a call from James who is interested in establishing a retirement plan. James
is a retired teacher that does consulting for several educational organizations and expects that
his 2013 income will be approximately $120,000 after the reduction of of the self-employment
taxes. He did some consulting part-time in the three years prior to retiring, giving him a three
year average of $72,000. He doesnt have any employees and has no plans to ever hire another
person. James is 60 years old and because he has a pension from his prior teaching career he
would like to defer income from current taxation. He plans to continue consulting for about five
more years. His income will be fairly stable though he may cut back some as he gets closer to
retirement.
GENERAL ANALYSIS:
The organizations James consults for always have additional projects they would like
him to work on so cash flow is not really a concern.
James doesnt have any plans to hire employees so the plan can be designed simply to
meet his objectives.
James would like to defer a significant amount of his income, but would be open to
having some left over for travel and home improvements.
PLAN OPTIONS:
This type of plan would allow James to contribute the lesser of 25% of his eligible compensation
or $51,000. Since Jamess net Schedule C income will be $120,000 for 2013 after reduction of of
the self-employment taxes, the maximum SEP contribution would be $24,000. Because each
dollar of employer contribution to the plan reduces Jamess income in a circular fashion the
maximum deduction ends up being 20% of the net schedule C prior to reduction for pension
contributions.
Advantages:
The administrative burden and cost is greatly reduced compared to a traditional
qualified plan.
It is very easy to establish and can be established even after the end of the year.
Disadvantages:
Jamess contribution is limited to $24,000 which still leaves him with a substantial tax
burden.
Individual 401(k) Plan
Since James is age 60, the advantage of the individual 401(k) is that in addition to the $24,000
employer nonelective contribution allowed under the SEP, he could make deferrals up to the
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IRC 402(g) limit of $17,500 and a catch-up contribution of $5,500. This would increase his
maximum contribution to a total of $47,000.
Advantages:
Provides the opportunity to save $23,000 more each year than a SEP.
Contributions would allow him to shelter up to $46,000 for the year which equates to
almost 40% of his income and leaves a good amount to travel on.
Contributions are completely flexible each year.
Disadvantages:
While there are no nondiscrimination issues since James is the only employee, annual
government reporting would be required.
Administrative cost and complexity is significantly more than a SEP.
Defined Benefit Plan
A defined benefit plan is the only plan that would allow James to make annual contributions of
more than $46,000 based on his current compensation. Since he has a 3-year average
compensation of $72,000, James can establish a defined benefit plan with an annual benefit of
$57,600 (100% of 3-year average compensation reduced by 8/10 due to years of service at
retirement of less than 10) starting at age 65. Using the following assumptions: interest: 6% preretirement, 5.5% post-retirement, and mortality 94 GAR post-retirement only, the annual
contribution would be approximately $109,000.
Advantages:
The annual contribution of $109,000 is significantly greater that what could be made to
an individual 401(k) Plan.
After the first plan year, there will be a fairly large range of contributions between the
minimum required and the maximum deductible. This will provide James with some
flexibility to contribute more in good years and less in bad years.
Disadvantages:
Because of the requirement for an enrolled actuary to annually certify both the
contributions and the funded status of the plan, the administrative costs are higher in
defined benefit plans.
While there are no nondiscrimination issues since James is the only employee, annual
Unlike the SEP or 401(k) plan, there are minimum required contributions in defined
benefit plans. Changes in income can significantly impact the required contribution.
While there are ways to make the contributions somewhat flexible, defined benefit plan
sponsors should understand that contributions are required each year.
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James would need to invest the portfolio conservatively to ensure no large swings in
contribution levels as he cant deduct more than his net Schedule C income.
As an alternative to a traditional defined benefit plan a cash balance could be established with a
formula that provided for a pay credit of 100% of compensation over a certain floor allowing
him to keep some for travel and provide some flexibility if his income decreases in future years
as he nears retirement.
SOLUTION:
James would likely benefit the most from an individual 401(k) because it provides a substantial
deferral of income while retaining ultimate flexibility. It would, however, be worth discussing
the defined benefit plan options with him as it would allow him to defer a significant amount
more if he is comfortable with the contribution amount and the fact that it may fluctuate from
year to year. If he decides to move forward with a defined benefit plan he will need to keep in
close contact with the actuary to make sure that any changes in his income are dealt with
proactively.
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Case Study #6
During 2013, you get a call from George who is interested in establishing a retirement plan.
George is an independent insurance agent and doesnt have any employees and has no plans to
ever hire another person. George is 50 years old and has not really made any plans for his
retirement other than annual contributions to a traditional IRA. He would like to retire at age 62
and wants to be able to continue his current standard of living. He is also very interested in
reducing his tax burden.
George explains that he has built up a substantial group of clients that are very loyal to him. His
income has grown over the last 20 years at an annual rate of 7% to 10% and he foresees this
continuing into the future. His 2012 net Schedule C income was $350,000 and he has a high 3year average of over $255,000.
GENERAL ANALYSIS:
George has built up a steady clientele so cash flow and administrative burden are not
really concerns.
George has an IRA so he wants to contribute more than the IRA annual limit.
George doesnt have any plans to hire employees so the plan can be designed simply to
meet his objectives.
George needs to build up a substantial retirement account over the next 12 years.
PLAN OPTIONS:
This type of plan would allow George to contribute the lesser of 25% of his eligible
compensation or $51,000. Since Georges net Schedule C income, even after reduction for FICA
taxes and the maximum SEP contribution, is well over the IRC 401(a)(17) limit of $255,000 for
2013, his maximum contribution would be $51,000.
Advantages:
The administrative burden and cost is greatly reduced compared to a traditional
qualified plan.
It is very easy to establish.
Disadvantages:
Georges contribution is limited to $51,000 which will not provide the funds needed for
his planned retirement at age 62.
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Individual 401(k) Plan
Since George is age 50, the advantage of the individual 401(k) is that in addition to the regular
contribution limit of $51,000, he could make a catch-up contribution of $5,500. This would
increase his maximum contribution to at total of $56,500.
Advantages:
The only real advantage over the SEP is the ability to contribute an additional $5,500 in
catch-up contributions.
Disadvantages:
Georges contribution is limited to $56,500 which will not provide the funds needed for
his planned retirement at age 62.
While there are no nondiscrimination issues since George is the only employee, annual
A defined benefit plan is the only plan that would allow George to make annual contributions of
more than $56,500. Since he has already established a high 3-year average compensation of over
$255,000, George can establish a defined benefit plan with an annual benefit of $205,000 starting
at age 62. This equates to a lump sum benefit at age 62 of approximately $2,545,454. Using plan
segment interest rate and mortality assumptions, this would produce an annual minimum
contribution requirement of approximately $128,000.
Advantages:
The lump sum at age 62 of $2,545,454 is significantly greater that what could reasonably
expected to be accumulated in a 401(k) plan using a balanced portfolio for a 12 year
period.
A defined benefit plan is the only retirement plan that can automatically keep up with
inflation. While the maximum contributions to a defined contribution plan are increased
each year to reflect inflation, there is no catch up available for past years. In a defined
benefit plan, the maximum benefit is increased for inflation and therefore the
contributions can be automatically increased to pay for the increased benefits.
After the first plan year, there will be a fairly large range of contributions between the
minimum required and the maximum deductible. This will provide George with some
flexibility to contribute more in good years and less in bad years.
Disadvantages:
While there are no nondiscrimination issues since George is the only employee, annual
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Unlike the SEP or 401(k) plan, there are minimum required contributions in defined
benefit plans. While there are ways to make the contributions somewhat flexible, defined
benefit plan sponsors should understand that contributions are required each year.
George would need to invest the portfolio conservatively to ensure no large swings in
contribution levels as he cant deduct more than his net Schedule C income.
SOLUTION:
The defined benefit is the best solution for George. If he desires even more retirement savings,
he could add an individual 401(k) plan to the defined benefit plan. This would allow him to
make deferrals of $24,000 plus a profit sharing contribution of 6%. Based on his 2012 net
Schedule C income, this would allow him to make a profit sharing contribution of
approximately $15,300. Therefore, his total retirement contribution in the first year of the plans
could be approximately $167,300.
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Case Study #7
Early in 2013, you get a call from Harold who interested in establishing a retirement plan.
Harold has heard about this new type of plan that allows him to accumulate substantial dollars
for his retirement while providing more modest benefits for his employees. He further tells you
he is a dentist with 8 other employees including his wife who is the office manager. He wants to
get started saving for retirement and he wants his contributions to be pre-tax.
Harold purchased the dental practice 20 years ago after having worked as an associate for the
prior owner for several years. The practice is incorporated and has elected Sub-chapter S status.
There are 7 other employees who have all been with Harold for over 2 years. The practice has
built a solid base of clients and the income is fairly steady.
Although Harold has sponsored a 401(k) plan for a number of years and has been able to
contribute close to the maximum allowable amounts, his account has suffered substantial losses
during the recent market downturn. He is concerned about having enough funds to live
comfortably on what he has accumulated at his planned retirement age of 65. His daughter is
currently attending dental school and the plan is for her to join the practice upon graduation in
3 years. When he retires she will take over the practice and therefore he is not planning on
receiving a significant buyout.
Harold states that he would like to see some proposals that would provide him with a
contribution of $150,000 while keeping the contributions for the employees in the range of 5% to
10% of compensation. He cannot afford more than $180,000 in employer contributions. He also
does not want to provide different contribution percentages for different employees as he fears
that would lead to personnel problems.
Harold provides you with the following census information:
Name
Age
Projected 2013
Compensation
Harold
55
$230,000
Teresa
40
$42,500
Patricia
54
$34,000
Pam
42
$29,000
Kate
25
$28,000
Mary
60
$27,000
Hanna
55
$25,000
Sara
29
$24,000
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GENERAL ANALYSIS:
The practice has a stable cash flow and income so required contributions are not a major
concern.
Harold has been contributing the maximum to the 401(k) plan but he wants to contribute
more than the defined contribution annual limit.
Because of the significant disparity in the ages of the employees, Harold is concerned
that a defined benefit plan might cause personnel problems.
There are several employees the same age or older than Harold, so a traditional defined
benefit plan might be too costly for them.
PLAN OPTIONS:
Current 401(k) Plan
Harold could contribute $56,500 to the existing 401(k) plan this year. This would only require a
company contribution of 5% for the employees. However, this does not come close to meeting
his goal of $150,000 for his retirement. However, consideration must be given to keeping this
plan in combination with either a defined benefit or cash balance plan.
2013
Comp.
Salary
Deferral
Profit
Sharing
Total
Contribution
Percentage
Name
Age
Harold
55
$230,000
$24,000
$32,500
$56,500
23.70%
Hanna
55
$25,000
$0
$1,180
$1,180
4.72%
Teresa
40
$42,500
$0
$2,006
$2,006
4.72%
Patricia
54
$34,000
$0
$1,605
$1,605
4.72%
Sara
29
$24,000
$0
$1,133
$1,133
4.72%
Mary
60
$27,000
$0
$1,274
$1,274
4.72%
Pam
42
$29,000
$0
$1,369
$1,369
4.72%
Kate
25
$28,000
$0
$1,322
$1,322
4.72%
$439,500
$24,000
$42,389
$66,389
Totals
Contribution
Traditional Defined Benefit Plan (DB)

This type of plan would allow Harold to contribute $150,000 for his own benefit. Based on this
he could fund toward the maximum allowable benefit at age 65 of $205,000 per year. The
problem is the cost for the other employees, especially those over age 50. As shown in the
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following chart this plan would require contributions of over 60% of compensation for the three
older employees:
2013
Comp.
Contribution
Percentage
Name
Age
Harold
55
$230,000
$150,000
65.22%
Hanna
55
$25,000
$16,299
65.20%
Teresa
40
$42,500
$11,562
27.20%
Patricia
54
$34,000
$26,912
79.15%
Sara
29
$24,000
$3,440
14.33%
Mary
60
$27,000
$23,556
87.24%
Pam
42
$29,000
$8,864
30.57%
Kate
25
$28,000
$3,179
11.35%
$439,500
$243,812
Totals
Contribution
Advantages:
The plan provides Harold with his desired contribution level.
Disadvantages:
The contributions for the employees are all in excess of his desired maximum
contribution percentage.
The contributions for the employees vary from 11.35% to 87.24%.
The total contribution of $243,812 is over $60,000 more than his budget.
Unlike the current 401(k) plan, there are minimum required contributions in defined
benefit plans. Defined benefit plan sponsors should understand that contributions are
required each year and that they may fluctuate significantly from year to year.
Traditional defined benefit plans are very hard to explain to employees and they tend to
not appreciate the benefits being provided.
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Final analysis is that a traditional defined benefit plan simply will not work on its own.
Stand Alone Cash Balance Plan
A stand alone cash balance plan might be a better solution as it would allow each of the
employees to receive the same percentage contribution, subject to the requirement to provide
top-heavy minimum benefits. There would be two groups of participants, Harold and all others.
2013
Comp.
Contribution
Percentage
Name
Age
Harold
55
$230,000
$150,000
65.22%
Hanna
55
$25,000
$5,625
22.50%
Teresa
40
$42,500
$9,563
22.50%
Patricia
54
$34,000
$7,650
22.50%
Sara
29
$24,000
$5,400
22.50%
Mary
60
$27,000
$6,075
22.50%
Pam
42
$29,000
$6,525
22.50%
Kate
25
$28,000
$6,300
22.50%
$439,500
$197,138
Totals
Contribution
Advantages:
The plan provides Harold with his desired contribution level.
The contribution for each employee is the same, 22.50% of compensation. This eliminates
the concern about personnel problems.
Cash balance plans are much easier to explain and therefore employees tend to
appreciate them much more than traditional defined benefit plans.
Disadvantages:
The total contribution of $197,138 is still about $37,000 more than the budget.
cash balance plans.
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Unlike the current 401(k) plan, there are minimum required contributions in cash
balance plans. Plan sponsors should understand that contributions are required each
year and that the contributions may fluctuate some from year to year.
Combination of Current 401(k) and Cash Balance Plans
By adding a cash balance plan to the current 401(k) plan, Harold can achieve the objective of
higher contributions for him while mitigating most of the negatives of a standalone cash balance
plan. Also, by taking advantage of the current rules regarding testing for nondiscrimination
when aggregating a cash balance with a 401(k) plan, he can actually lower the required
contributions for the other employees.
2013
Comp.
Salary
Deferral
Profit
Sharing
Cash
Balance
Combined
Contribution
Percentage
Name
Age
Harold
55
$230,000
$24,000
$11,500
$116,500
$150,000
65.22%
Hanna
55
$25,000
$0
$1,563
$500
$2,063
8.25%
Teresa
40
$42,500
$0
$2,656
$850
$3,506
8.25%
Patricia
54
$34,000
$0
$2,125
$680
$2,805
8.25%
Sara
29
$24,000
$0
$1,500
$480
$1,980
8.25%
Mary
60
$27,000
$0
$1,688
$540
$2,228
8.25%
Pam
42
$29,000
$0
$1,812
$580
$2,392
8.25%
Kate
25
$28,000
$0
$1,750
$560
$2,310
8.25%
$439,500
$24,000
$24,594
$120,690
$167,284
Totals
Contribution
Advantages:
Harold can receive total contributions of $150,000.
The cost for the employee contributions is only $17,284, which is only $7,395 more than
under the current 401(k) plan.
The contribution for each employee is the same, 8.25% of compensation. This eliminates
the concern about personnel problems.
Cash balance plans are much easier to explain and therefore employees tend to
appreciate them much more than traditional defined benefit plans.
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If the cash balance plan is designed properly, it is not subject to IRC 417(e). Therefore,
lump sums are equal to the hypothetical account balances. In a traditional DB plan lump
sums are usually subsidized, especially for younger employees.
The 401(k) plan provides Harold with the flexibility to reduce his contributions by
$35,500 in a bad year. In addition the current funding rules for cash balance and defined
benefit plans also provide some flexibility, especially in future years.
Disadvantages:
There are required annual contributions for the employees in the 401(k) plan of at least
5% to satisfy the top-heavy minimum requirement.
There are also minimum required contributions in cash balance plans. While there are
ways to make the contributions somewhat flexible, cash balance plan sponsors should
understand that contributions are required each year.
The administrative burden and cost for the combined plans is higher than for a single
plan.
defined benefit and cash balance plans.
The requirement for an individually designed plan document for cash balance plans
makes the cash balance option more expensive.
SOLUTION:
The combination of the existing 401(k) plan and a new cash balance plan is the best solution for
Harold. It meets his objectives of contribution $150,000 annually for his retirement while
keeping the cost for employees in his desired range. The additional benefits are well worth the
increased administrative burden and costs.
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Case Study #8
You have been invited to attend a meeting with the Finance Director, the Human Resources
Manager and the President of the Fire and Police Union for the City of MainStreet. This group is
the Executive Leadership Committee for the Retirement Plan Council for the City of MainStreet.
The purpose of the meeting is to discuss options for additional supplemental retirement plans
for two employee groups: the fire and police and the management of MainStreet. The following
information is provided about the two groups as it pertains to their current retirement plan:
Fire and Police
Participate in the state pension system that is offered to fire and police only
Normal Retirement age within the pension plan is age 55
The member contribution percentage is 8.83%
Salaries for the employees range from $40,000 to $65,000
Although retirement is at age 55, due to stressful occupations, some employees choose to
leave service at an earlier age to pursue another occupation
Management Group
Participate in the state pension system that is offered to state employees (not fire and
police)
Normal Retirement age within the pension plan is age 65
The member contribution percentage is 5.45%
Salaries for the employees range from $50,000 to $120,000
The Executive Leadership team has been asked by the Committee to explore additional
supplemental retirement plans since it is felt that employees should save as much as possible for
retirement given the increasing life expectancy and increases in health care costs and overall cost
of living. The following retirement plans are being considered: 457 deferred compensation plan,
401(a) money purchase plan, 401(k) plan, and Payroll Roth IRA. Due to the current economic
environment, the City must assess how much they can contribute on behalf of the employees.
Each type of plan will be evaluated and recommendations will be made to the Executive
Leadership Committee. They will then seek final approval through the Retirement Plan Council.
457 Deferred Compensation Plan
Advantages:
No 10% penalty if funds are withdrawn prior to age 59
If the Council wants to add a loan feature, this is available
Participants may stop or start contributions
IRC 457 Limits are $17,500 for 2013
IRC 415(c) limits do not apply to 457 plans so amounts to other defined contribution
plans do not affect amount contributed in 457 deferred compensation plan
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Age 50 catch-up limit of additional $5,500 in contributions
Additional pre-retirement catch-up limit of $16,500 available for amounts not
contributed in earlier years. This is applicable for 3 years prior to declared retirement age
under catch-up provision
Emergency withdrawals are allowed under specified circumstances as defined by the
IRS code
Does not require employer contributions
Disadvantages:
Cannot contribute additional after-tax contributions
Compared to the 401(a) plan, the annual limits are lower
IRC 401(a) Money Purchase Plan
Advantages:
If the Council wants to add a loan feature, this is available
IRC 415(c) limits are $51,000 for employer and employee contributions (other defined
contribution plans are not offered to employees so the $51,000 is applicable totally to the
IRC 401(a) plan)
If after-tax employee contributions are permitted, in-service withdrawals of after-tax
contributions are allowed
If voluntary after-tax employee contributions are allowed, the employee can increase,
decrease or stop contributing
Can establish a small fixed employer contribution to keep the employer costs down
Can require vesting
Disadvantages:
Catch-up provisions are not available
If employee contributions are required, they will be mandatory, which means that the
employee cannot increase, decrease or stop contributing while in service (one-time
irrevocable decision)
No emergency/hardship withdrawal provisions except for disability situation
Compared to the 457 deferred compensation, there is a 10% IRS penalty for withdrawal
unless certain circumstances are achieved
Payroll Roth IRA
Advantages:
Automatic payroll deduction provides discipline in contributing for employees
Not subject to required minimum distribution rules
Contributions allowed after age 70 if still employed
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Earnings not taxed if held for 5 years and qualifying event met (such as first home
purchase, age 59)
Disadvantages:
Eligibility is based upon adjusted gross income levels not favorable to some of the
management.
Contributions are limited to $5,500.
401(k) Plans
Governmental entities are not permitted to open up a 401(k) plan under the Tax Reform Act of
1986. This type of plan cannot be considered for the City of MainStreet.
SOLUTION
Based upon the various pros and cons and the demographics of the two groups, the following
recommendations were made:
Since the fire and police pay a higher percentage to the defined benefit plan, requiring an
additional retirement plan with mandatory contributions would not be feasible for most
of the employees. Therefore, the IRC 401(a) plan is not appropriate.
The 457 deferred compensation plan offers an opportunity for the Fire and Police group
since the participation is voluntary, and there is no 10% penalty prior to age 59. There
is no employer contribution required.
The IRC 401(a) plan would be an appropriate option for the management group. With
the employer contribution, along with the increased limits available to the management
team, this would be a viable retirement vehicle. A vesting schedule is recommended for
5 years, 20% per year.
Since there is no cost to the City to offer the Payroll IRA and it has several advantages,
this can be offered to both groups.
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Case Study # 9
You have been contacted by the HR Department of a large public university about your interest
in responding to an RFP (request for proposal) for plan design and plan administration services
for one or possibly two new supplemental defined contribution type of plans. These plan(s)
should give all employees the opportunity to make maximum elective deferrals and act as an
attractive recruiting and retention tool for deans, provosts and the University presidents. You
begin your plan design analysis as soon as you receive the RFP.
GENERAL ANALYSIS:
State University X has over 10,000 regular employees and faculty and all employees are
covered under Social Security.
The University does not currently have any kind of a qualified or other tax favored
defined contribution plan.
All employees are required to contribute 6% of their pre-tax salary as an IRC 414(h)
pick-up contribution to the State retirement systems defined benefit plan. The
University is required to contribute 8% of each employees salary to the defined benefit
plan.
The University wants optimal design flexibility. For example, it would like to be able to
make nonelective contributions for certain employees and employee groups but not for
all employees. All employees should have the option to make pre and post tax
contributions.
The University may want to automatically enroll participants in plan(s) at some future
date.
Employees have expressed interest in a plan that would let them use their account
balances while they are still working to purchase additional service credits or repay
forfeited employee contributions in the State defined benefit plan.
Many employees terminate employment with large amounts of unused sick and vacation
pay which they receive in cash when they terminate employment. The University would
like to give employees the option to defer some or all of the value of their unused sick
and vacation pay to the supplemental plan(s), and provide plan loans and hardship
distributions.
The University may want to include certain independent contractors providing services
to its medical school in its plan.
Employees will pay all administration and investment fees associated with the plan.
Successful bidders will provide all necessary administration forms, employee education
and communication materials and work with the Universitys attorneys in preparing
plan documents.
An outside investment consultant will select plan investments from which employee will
choose for their own accounts.
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PLAN OPTIONS:
401(k) Plan
A 401(k) plan is not an option for the University because the University is a public sector
employer cannot adopt a new 401(k) plan.
403(b) Plan
A 403(b) plan can be designed to accept employee salary reduction contributions (elective
deferrals) and employer matching, non elective and discretionary contributions. 403(b) plans are
subject to the IRC 401(a)(17), 402(g) and 415 limits.
Advantages:
Pre- and post-tax elective deferrals and after-tax employee contributions can be part of
the plan design.
Contributions are not subject to nondiscrimination/coverage testing because the
University is a governmental employer and exempt from these requirements.
403(b) deferrals are not reduced by contributions to a 457(b) plan and vice versa.
Plan can be designed to provide for special 403(b) catch-up contributions for employees
with at least 15 years of service with the University who under deferred to the plan in
prior years and include the age 50+ catch-up provision.
Age 50 catch-up can be used at the same time as long service catch-up.
Employer can make nonelective contributions for up to 5 years after an employee
terminates employment with the employer.
In service distributions of elective deferrals permitted at age 59.
In service direct transfers can be made to the states defined benefit plan to purchase
service credits.
Separate IRC 415 limits from any of the employers IRC 401(a) plans.
Plan design can permit deferral of the value of sick and unused vacation pay to plan.
Loan and hardship distributions can be permitted.
Automatic enrollment available.
Disadvantages:
Salary reduction contributions still subject to universal availability requirement.
Universal availability violations are one of the most frequent violations found on an IRS
exam.
Funding options are limited to annuities and custodial accounts containing mutual fund
shares.
Potential conflicts between plan provisions and funding contracts. If contact permits
loans and hardship but plan does not, there can be no loans and hardship and vice versa.
Investment consultant may not be aware of potential conflicts with plan design.
393

Governmental 457(b) Plan
This type of plan has limited design possibilities because of the relatively low amounts that can
be contributed ($17,500 for 2013), the types of contributions the plan can offer and the
application of FICA taxes to both employer and employee deferral contributions. These plans,
however, have several special features that are not available under other plans.
Advantages:
Contributions not reduced by deferrals to 403(b)/401(k) or other plans subject to IRC
402(g) limits.
Contributions not subject to nondiscrimination testing.
Independent contracts can defer into the plan.
Participants can defer value of unused sick and vacation pay in to plan.
Unforeseeable emergency distributions do not require a suspension of elective deferrals
for 6 months.
Plan investments not limited to annuities and custodial accounts
Participants can transfer funds from the 457 plan to purchase service credits in the
government defined benefit plan.
Distributions are not subject to 10% early distribution tax unless distribution comes
from a rollover account that holds non 457 rollover contributions
Plan defects can be corrected by the beginning of the 1 st plan year that begins 180 days
after notification by the IRS and past deferrals will still be treated as 457(b) deferrals
even if plan mistakes are not corrected.
Disadvantages:
All contributions, including employer contributions, are subject to FICA taxes and
reduce the deferral limits when they vest.
Contribution limits, excluding catch-ups, are limited to the 457 deferral limit ($17,500 for
2013).
Designated Roth deferrals or employee after tax contributions are not permitted.
Participants cannot use age 50 catch-up and 457 special catch-up in the same year.
In-service withdrawals of elective deferrals not permitted at age 59.
Future deferrals treated as 457(f) deferrals if plan administration errors are not timely
corrected.
SOLUTION:
The ideal solution would be for the University to adopt both a 403(b) and 457(b) plan. Adopting
both a 457(b) and 403(b) plan will offer employees the greatest opportunity for making
maximum elective deferrals, provide the design flexibility the employer seeks and can be an
attractive retention and recruiting tool. This scenario has the following benefits:
394

Employees making maximum elective deferrals to both plans could defer as much as
$35,000 in 2013 because deferral limits between 403(b) and 457(b) plans are not
coordinated.
Employees age 50 and older participating in both plans could defer a total of $46,000 for
2013 for the same reason.
Employer could make 403(b) nonelective contributions for up to 5 years after certain
employees terminate employment ($251,000 based on 2013 maximum IRC 415 limits).
Plan administration, employee communications and education will be complex and require
special effort and possibly extra expense to help participants understand their options.
If, however, the University can adopt only one plan at this time, the 403(b) plan will better serve
its needs and those of its employees than a 457(b) plan. The 403(b) will offer greater contribution
flexibility, less exposure to FICA taxation, and is a more effective retention and recruitment tool
than a 457(b) plan.
395
Case Study #10

The Director of a local animal shelter that provides care and adoption services for homeless
dogs and cats invited you to attend the next Board meeting to discuss possible retirement plans
for its employees. The Shelter is a tax-exempt organization under IRC 501(c)(3).
At the meeting, a member of the Shelters Board of Directors asked you to discuss the various
retirement plans that might be suitable for its employees. The Board would like to offer a
retirement plan in which all the employees could make pre-tax contributions. Employees have
expressed an interest in having some sort of retirement plan.
Board members emphasized that the Shelter, because of severe budget constraints is unable to
make any contributions to the plan or pay for plan administration services.
GENERAL ANALYSIS:
The Shelter has 3 part-time employees, 5 full-time employees as well as a number of
volunteers who donate their time to help run the shelter and care for the animals.
The Shelter is totally dependent on donations, grants and fundraisers for the revenue
needed to fulfill its mission of providing care and placement for homeless animals.
Difficult economic times have put greater stress on its limited resources.
The Shelter cannot make any matching or non-elective contributions to this or any other
plan or pay for any plan administration expenses, other than for a plan document.
The Shelter wants to avoid coverage under ERISA.
Full time employees are paid between $25,000 - $35,000 annually and part time
employees average between $4,000 and $10,000 annually. The two full time employees,
including, the Director, have enough other income that they could contribute most of
their Shelter salary to the retirement plan.
PLAN OPTIONS:
SIMPLE IRA and SIMPLE/Safe Harbor 401(k) Plans:
Simple IRA and 401(k) plans require employer contributions which the Shelter cannot afford to
make or commit to.
403(b) Plan
A 403(b) plan can be designed as a salary reduction only (elective deferrals) plan without a lot of
bells and whistles allowing those who with sufficient salaries to defer up to $17,500 for 2013.
Advantages:
Employee pre-tax salary reduction contributions available
No conflict with 403(b) universal availability requirement because employer will make
the plan available to all employees regardless of age and employment status (full-time
and part-time).
Salary reduction contributions are not subject to ADP testing.
396

Plan can be designed to exclude optional provisions such as loans, hardships, contract
exchanges and transfers that increase plan complexity.
IRS prototype documents are now available.
Employer responsible for 403(b) compliance, but may be able to delegate it to a third
party/vendor.
Disadvantages:
Plan design options are limited because of cost and ERISA concerns
Investment options limited to annuities and custodial accounts
Plan may have to offer products from several vendors to stay within DOL ERISA safe
harbor making plan administration more complex
Staying within the ERISA safe harbor will depend on employers actions, which are still
not very clear.
Payroll Deducted IRAs
Employees may be able to contribute up to $5,500 per year to their IRAs or more if age 50 or
older. Payroll deduct IRAs, both traditional and Roth IRAs, are a convenient way for employees
to save for retirement if an employer is unable to provide any other sort of retirement plan.
Advantages:
IRA funds may be withdrawn at any time.
IRA trustee/ custodian administers the IRA, provides required IRA documents, account
statements and tax reporting.
Employer is not responsible for IRA compliance.
IRAs are exempt from ERISA.
IRAs can be invested in a variety of investment products.
Employer merely remits contributions to various IRA providers.
Employer can limit the number of IRA providers.
Roth IRA distributions may be tax-free.
IRS Publication 590 which is updated every year has a wealth of IRA information and is
available on the IRS website.
Disadvantages:
Maximum IRA contributions have smaller limits than 403(b) plan or other retirement
plans.
IRA contributions are not pre-tax contributions.
Employees may not always be able to deduct traditional IRA contributions from their
federal income tax returns.
Roth IRA contributions are never tax deductible.
397

Employer responsible for remitting employee contributions to IRA provider.
IRA rules can be complex and employee will need access to good IRA information and
resources.
SOLUTION:
Payroll deduction IRAs may the best solution for the Shelter in the short term until more explicit
safe harbor 403(b) guidance is available from the DOL on the effect of implementing the final
403(b) regulations on the safe harbor. At some point in the future when its finances improve, the
Shelter could adopt a 403(b) or other retirement plan. Employees could roll their IRA balances
into a 403(b) plan or another retirement plan, except a SIMPLE IRA, that the employer adopts
without terminating employment.
398
Case Study #11

A new Sole Proprietor, Sam, has been operating his sports training facility for about 18 months.
He feels comfortable with the revenue stream and business growth that he would like to expand
the benefits currently offered to full-time employees. In the initial meeting with his consultant,
he mentions that he would like to offer a retirement plan option, but doesnt have either the
time or expertise to really put a lot into the ongoing maintenance.
GENERAL ANALYSIS:
The sports facility currently has 15 full-time employees, plus the owner and 5 part-time
staff members.
The owner cannot make any matching or non-elective contributions at this time, but
hopes to have the option should there be additional profits at year end.
Sam will be age 50 in the coming year and would like to put as much away as possible.
None of the employees would be considered Highly Compensated Employees.
They are currently using an outside payroll vendor that also provides a platform for
their health benefits.
PLAN OPTIONS:
401(k) Plan
Since Sam is nearly age 50, the advantage of the 401(k) is that in addition to the regular
contribution limit of $50,000, he could make a catch-up contribution of $5,500. This would
increase his maximum contribution to at total of $55,500.
Advantages:
The employees can make deferrals into the plan. Sam would be eligible to make a catchup contribution of $5,500.
A discretionary matching contribution option can be put into the document giving Sam
the option at year end to put money into the plan.
Disadvantages:
Given that Sam is the only HCE, his deferrals may be very restricted based on the ADP
testing results.
The administrative burden of operating a 401(k) plan may be too much for Sam to
manage.
Multiple Employer Plan (MEP) Adopter
Since Sam is currently using an outside payroll vendor that also provides health benefits, it is
possible that this same vendor offers access to an MEP. This would be another form of a
traditional 401(k) Plan.
399

Advantages
The same advantages exist as listed above for the 401(k) Plan as most MEPs offer the
design flexibility that would allow for discretionary match and non-matching
contribution options.
The MEP sponsor is often responsible for submitting all census data and completing
necessary annual testing.
The MEP sponsor will be responsible for all annual filings.
Since the payroll vendor is providing the plan, deferrals should be pulled and submitted
without any intervention from Sam.
Disadvantages
MEP may not offer Sam as much flexibility with plan design as he would like.
Pricing may be higher than Sam would like to pay.
SIMPLE 401(k) Plan
The SIMPLE 401(k) is good for small employers who are looking to implement their first plan
and have a limited amount of financial and administrative support resources.
Advantages
Administrative requirements are less than a traditional 401(k).
Disadvantages
Annual filing requirements apply.
Employer contribution is mandatory.
Limits for deferrals and catch-up contributions are less than traditional 401(k) plans.
SOLUTION:
Looking to join a Multiple Employer Plan may be the most efficient administrative solution for
Sam. Whether the cost is appropriate would have to be determined by Sam. While his deferrals
would be limited by ADP testing results, he could still contribute at least the catch-up
contributions. Depending on the suite of services offered by the payroll company/MEP sponsor,
Sam may be able to add Automatic Enrollment to help boost participation and have the payroll
company take care of the notice requirements.
400
CPC Study Guide:

HowtoChooseBetween403(b)and401(k)forNonprofits
GinnyBoggs,CPC,QPA,QKA,QPFC
2008ASPPAAnnualConference,October20,2008
401
Workshop 32: How to Choose Between

403(b) and 401(k) for Nonprofits
Presented By: Ginny Boggs, CPC, QPA, QKA, QPFC
October 20, 2008
Overview
403
Overview
Private sector 401(k) plans most

prevalent type of DC plan
Public & Nonprofit sectors other

types of DC plans exist
403(b)
457(b)
Overview
Certain Nonprofit Organizations are in

the unique position of being able to
sponsor both 403(b) and 401(k)
Applies to only a subset of nonprofits
Must have 501(c)(3) charitable status to
sponsor 403(b)
Any tax-exempt can sponsor 401(k)
4
404
Overview
New final 403(b) regulations increase the

similarity of 403(b) and 401(k) plans
But still some important differences
403(b) vs. 401(k)

Similarities and differences
Pros and cons of sponsoring one over the
other
Final 403(b) Regulations Review
405
Final 403(b) Regulations - Review
First updated guidance since the original

1964 403(b) regulations
Issued July 23, 2007 (published in the

Federal register July 26, 2007)
Effective date - January 1, 2009 (with a later

effective date for certain church-related and
collective bargaining plans)
7

Reflect updates for changes in the law, the Internal Revenue
Code and IRS interpretive guidance over the past 43
years, including:
1974 - ERISA
1982 - TEFRA
1986 - TRA86
1996 - SBJPA
2001- EGTRRA
2006 - PPA 06
Many of the provisions in the new regulations are existing rules.

In many instances, the new regulations simply reflect prior
changes in the law since the old 1964 regulations were issued.
406

The final 403(b) regulations include:
Written plan document requirement
Stricter contract exchange and transfer rules
Nondiscrimination requirements universal

availability rule
Timing of deposits of employee deferrals
Plan termination

Written plan must include all material provisions:
eligibility
benefits
contribution limits
available investment vehicles
loans
hardship withdrawals
distributions
fund transfers
rollovers
allocation of compliance responsibilities between the

employer and service providers
10
407

Prior 403(b) Rules Revenue Ruling 90-24
Exchanges
Participant could exchange his 403(b)

contract or account to another vendor, even
one not offered through the employer
Essentially created individual plans of each

employee that the employer is unable to
monitor for compliance with the various IRS
limitations and distribution rules
After September 24, 2007, this Revenue

Ruling becomes obsolete
11

New Exchange Rules
Intended to eliminate participants ability to move

403(b) funds independent of employer
involvement
Any contract exchanges outside the employers

normal vendors require an agreement between
the employer and vendor establishing the means
to share employment and plan benefit
information
Ensures compliance with the employers plan

provisions, IRS limitations and IRS rules
governing loans, distributions and withdrawals
12
408

New Plan-to-Plan Transfer Rules
Permitted if the plan participant is an employee

or former employee of the employer whose plan
is receiving the assets
Must retain the same (or stricter) distribution

restrictions
Both plans must allow the transfer
13

New Plan-to-Plan Transfer Rules
Employers may not transfer 403(b) plan assets

to non-403(b) plans
Thus, employers that freeze or terminate a

403(b) plan cannot merge or transfer 403(b) plan
assets into a 401(k) or 457(b) plan
Via the rollover process, a plan participant

receiving a distribution may transfer 403(b)
monies to a 401(k) or 457(b) plan or an IRA
14
409

Universal Availability Rule Basics
If any employee is permitted to make 403(b) elective

deferrals (including Roth contributions, if offered
under the plan), then all employees must be
permitted to do so
Allowable exclusions: non-resident aliens, certain

students, employees who normally work less than 20
hours per week, employees eligible for another salary
deferral plan of the employer (403(b), 401(k) or
457(b) governmental)
$200 annual minimum contribution requirement

allowed
Employees also must have an effective opportunity

to contribute at least annually
15

Universal Availability Under New Rules
Allowed employee exclusions provided by IRS Notice
89-23 are repealed (subject to certain transitional
relief, generally through 2010)
collectively bargained employees
visiting professors
government employees who make one-time
elections
employees working under a vow of poverty
16
410

Previously no bright-line test for the less than

20 hours per week exception
The new regulations provide a bright-line test of

1,000 hours of service
New employees who are hired with the

expectation of working less than 1,000 hours in
their first year of employment may be initially
excluded
17

Will have to be included if they ever complete

1,000 hours in the preceding one-year
measurement period (as defined in the plan)
Note: there is no change in ERISA plans, which

may not use the 20 hours per week exclusion
and may only exclude part-time employees
under the 1,000 hours rule described above
18
411

For the plan to be effectively available, a

meaningful notice must be provided to all
eligible employees at least annually
The meaningful notice must inform employees

of their right to participate in the 403(b) plan and
provide an effective method for making and
changing their deferral elections
19

Elective deferrals to 403(b) plans remain free from

ADP testing
Employer contributions and after-tax employee

contributions continue to be subject to ACP testing
(government and certain church plans are exempt)
20
412

Deposit Requirements Under New Rules
Employers must transmit the salary deferrals

to the 403(b) plans investment vehicle as
soon as is reasonable for proper plan
administration
The regulations provide an example of no

later than 15 business days after the month
in which the amounts would have been paid
to the employee
The new rule has applicability only for nonERISA plans

21

Deposit Requirements Under New Rules
There is no change for plans that are subject to

ERISA
403(b) plans that are subject to ERISA are

already subject to similar, yet somewhat stricter,
DOL rules requiring deposit of employee
deferrals
on the earliest date the employer can
reasonably segregate and transmit them,

but not later than 15 business days after the
month the deferrals are made
22
413

403(b) Plan Termination
Prior rules did not allow for plan termination
An employers only option was to freeze the

plan and cease contributions
The new regulations allow 403(b) plans to be

terminated, provided
all plan benefits are distributed to participants
as soon as practicable after termination, and

the employer does not contribute to another
403(b) plan for 12 months

23

Participants have the right to roll over plan

termination distributions to another eligible retirement
plan (i.e., a 403(b), 401(k), 457(b) governmental
plan, or IRA)
As stated above under the transfer rules, employers

that freeze or terminate a 403(b) plan cannot merge
or transfer 403(b) plan assets into a 401(k) or 457(b)
plan
Therefore, an employer may not make plan-level

transfers of 403(b) plan assets to its 401(k) plan,
although it may encourage participant-level rollovers
24
414

403(b) plan terminations are allowed earlier than

the effective date of the new regulations
However, the plan must also apply and comply

with all applicable requirements of the new
regulations at that time
One notable exception - the written plan

document requirement
25
403(b) ERISA vs. Non-ERISA

Non-ERISA
Government and Church

plans not subject to ERISA
Otherwise
Participation- completely
voluntary
Deferrals only
No employer contributions
Limited employer
involvement- payroll
remittance only
No 5500/audit; no testing; no
DOL rules or disclosures
ERISA
Deferrals and employer dollars

Subject to more than limited
employer involvement
Pre-2009 -minimal 5500, no
audit
Beginning 2009 plan year- full
5500 reporting, including audit
for large plans
26
415
ERISA Exemption - DOL 1979

safe harbor [29 CFR 2510.3-2(f)
Requires
limited employer
involvement in the operation of
their 403(b) plan
27

DOL FAB 2007-02 clarified under the new
403(b) regs and employer may still do the
following and still be non-ERISA:
adopt a 403(b) plan
perform duties to ensure tax compliance
(e.g., nondiscrimination testing)
ensure maximum contribution limits not
exceeded
collect and compile plan-related information
terminate a 403(b) plan
28
416

DOL FAB 2007-02 clarified an employer may not, however,
make any discretionary determinations in administering the
403(b) plan; examples:
authorize plan-to-plan transfers
process distributions
satisfy J&S annuity requirements
Determine hardship withdrawal eligibility
make QDRO determinations
determine participant loan eligibility
enforce participant loans
negotiate with plan vendors to change the terms of their
products (e.g., setting conditions for hardship withdrawals)
29
DOL FAB 2007-02 and the

new 403(b) regs make
being a non-ERISA 403(b)
plan more difficult to
achieve
30
417
New 403(b) rules (requiring written plan

document extensive information sharing with
plan vendors) made many wonder if the DOL
safe harbor would still be available
DOL issued Field Assistance Bulletin (FAB)

2007-02 right after the new IRS regulations
to clarify safe harbor is still available
31
Eligible Plan Sponsor
418
Who Can Have What Plan?

Entity Type
401(k)
403(b)
Taxable Entity
(For Profit) Entities
Yes
No
State or Local
Governmental Entities
No
Yes if educational
organizations (i.e., public
schools and universities)
(but see exceptions

list)
(but see exceptions list)

Tax Exempt
(Nonprofit) Entities
Yes after 1996
Federal government;
Yes
Indian tribal government
Yes if 501(c)(3)
charitable organization
No
33
501(c)(3) Tax-Exempt Status

A 501(c)(3) nonprofit is exempt from federal income tax
if it has one of these purposes:
charitable
religious
educational
scientific
literary
testing for public safety
fosters amateur sports competition
prevents cruelty to children or animals
34
419

Examples:
old-age homes
parent-teacher associations
charitable hospitals
alumni associations
schools
chapters of the Red Cross or Salvation Army
Boys' or Girl's clubs
churches
35
May receive grants from foundations
Donations to them are tax-deductible for the

donors
IRS publication 557 contains information on

qualifying for and applying for 501(c)(3) status
Exempt from federal and state taxes

36
420
403(b) vs. 401(k)
Which Plan?
Starting in 2009, 403(b) plans look and

feel a lot like 401(k) plans
Choosing between the two for any

given 501(c)(3) nonprofit will depend
on:
the plan features and investments the
employer wants to offer to employees

whether the perceived advantages of
one outweigh the disadvantages
38
421
Written Document Requirements
401(k)
403(b)
Required beginning Jan. 1,
2009 under new regs.
Required
Currently required for plans
subject to ERISA
39
IRS Approval
401(k)
403(b)
Private letter ruling
Formal determination letter

process
(IRS has announced it will

launch a pre-approved plan
program and a determination
letter program after the final
403(b) regs take effect)
40
422
Trust/Funding Vehicle
Requirements
401(k)
Trust
is required, unless fully

insured
Group
annuity without loans
403(b)
Must invest in
Annuity
contract 403(b)(1)
Custodial
account with mutual

funds only * 403(b)(7)
Retirement
income accounts
(churches only) 403(b)(9)
Exclusive
benefit rule applies
plans exclusive benefit

rule applies. Non-ERISA state
law applies
ERISA
* 403(b) plan cannot invest in a collective trust. No life insurance.
41
Annual Limits
401(k)
403(b)
402(g) Deferral Limit

(shared)
402(g) Deferral Limit

(shared)
Age 50 catch-up
(shared)
Age 50 catch-up *
(shared)
Section 415
(separate)
Section 415
(separate)
401(a)(17) compensation limit

applies
401(a)(17) compensation limit

applies
* special 403(b) 15-year catch-up

comes first, if applicable
42
423
403(b) Special Catch-Up
Up to $3,000
15 years of service
Only employees of qualified organizations

Educational organizations
Hospitals
Health and welfare service agencies (including
home health service)

Church-related agencies
Tax-exempt organizations controlled by /
associated with a church
43
Exception to Separate 415 Limits
Must aggregate a participants 403(b) and 401(a)/(k)

415 annual additions if he/she also controls 50% or
more of an employer who sponsors a qualified plan.
Example must aggregate a physicians
403(b) account with his private practice

qualified plan
Same 415 corrections available to 403(b)s that
are available for 401(k)s
44
424
Excludable Employees
401(k)
Minimum Age & Service
Union
Non-resident alien
403(b)
Employees who cannot defer >
$200
Employees eligible for another
salary deferral plan of the
employer (403(b), 401(k) or 457
plan)
Non-resident aliens
Student performing work/study
service for school
Normally work less then 20
hours per week
Employer contribution only:
Same as 401(a) / (k)
45
Nondiscrimination / Coverage Tests

401(k)
ADP, ACP, 410(b),
401(a)(4) for employer
nonelective
403(b)
No ADP - universal
availability rule
If not governmental or
church:
ACP and 410(b) for aftertax and match
401(a)(4), 410(b) for
employer nonelective
46
425
Distributable Events
401(k)
403(b)
403(b)(1) contracts and

Deferrals:
403(b)(9) retirement income
Age 59
Severance from employment accounts:
Deferral same as 401(k)
Death
Disability
Hardship
Employer:
If in-service, must be due to a
stated event, passage of a
number of years or a
specified age
Employer same as 401(k)

plan
403(b)(7)
401(k) deferral restrictions
apply to all contributions
(except hardship dist. events
on deferrals only)
47
Hardship Requirements
401(k)
Safe harbor hardship
requirements:
403(b)
Same
1. Eviction/foreclosure
2. Medical
3. Purchase residence
4. Post-secondary
education
5. Burial / funeral
6. Principal residence
casualty loss
48
426
Hardship Requirements
(Availability Of Earnings)
401(k)
Deferral only plus
earnings accrued through
December 31, 1988
available for hardship
403(b)
Same
49
Premature 10% Distribution

Penalty
401(k)
Yes
403(b)
Yes
50
427
Distribution Reporting
401(k)
403(b)
1099-R
Same
Rollover eligible
(401(a)/(k), 403(b),
457(b) governmental)
Same
20% Mandatory
withholding on rollover
eligible distributions
Same
51
Other Comparisons
401(k)
403(b)
Deemed IRAs
Yes
Yes
Can include
Roth
Yes
Yes
Participation
affects IRA
Deduction
Limits
Yes
Yes
Life Insurance
Yes incidental
Prohibited under new final

regs after Sept. 24, 2007
52
428
Other Comparisons
401(k)
403(b)
Automatic
enrollment
Yes
Yes
10% Excise Tax

ADP/ACP refunds
made after 2
months
(6 months for PPA
EACAs)
Yes
If ACP test required, excess

applies
Top heavy rules
Yes
No
Return of Excess
Deferral
By April 15
By April 15
Minimum
distributions
401(a)(9) apply
Yes
Yes
Loans
Yes
Yes
53
Other Comparisons
401(k)
403(b)
Popularity /
Understandability
Yes- Overwhelming popularity

makes 401(k) plans a
recognizable commodity to
most individuals;
No- 403(b) plans are not really

understood as a 401(k)
equivalent;
Platform
Tend to be one cohesive plan

on single platform
Tend to be multiple vendors /

investment providers
Good Software
Availability
Yes- Good software and

support materials are widely
available
No- Good 403(b) software and

support materials not as
available
Understanding in
Vendor / Service
Provider Community
Yes- Better understanding in

vendor community
No- Vendor understanding of

403(b) plans more limited
54
429
Exception to Separate 415 Limits
Must aggregate a participants 403(b) and 401(a)/(k)

415 annual additions if he/she also controls 50% or
more of an employer who sponsors a qualified plan.
Example must aggregate a physicians
403(b) account with his private practice

qualified plan
Same 415 corrections available to 403(b)s that
are available for 401(k)s
55
403(b) Main Advantages
Exempt from ADP testing

(universal availability instead
Still possible (though more

difficult) to still have a nonERISA 403(b) plan
56
430
401(k) Main Advantages
Overwhelming popularity /
recognizable commodity to most
individuals
Tend to be one cohesive plan /

single platform
Greater purchasing power possibly lower fees
(improved investment performance; better

investment choices
Easier to communicate unified program to
employees
57
Questions and Discussion
431
432
CPC Study Guide:

CashBalancePlansforDefinedContributionAdministrators
LorraineDorsa,DCA,MAAA,MSPA,EA,CEBS
433
Presented by
LORRAINE DORSA, DCA,MAAA,MSPA, EA, CEBS
Dorsa Consulting, Inc.
www.dorsaconsulting.com
435
Using Maximum Deduction Limits
436
437
For business owners receiving an inheritance or with other income from

assets other than his business
As Part of a Buyout
438
Focusing Significant Benefits on the Principal
Focusing Significant Benefits on the Principals

Same Benefit Level to Principals
439

with Different Benefit Levels for the Principals

440

441
442
CASH BALANCE PLANS

FOR DEFINED CONTRIBUTION ADMINISTRATORS
Presented By
Lorraine Dorsa, FCA, MAAA, MSPA, EA, CEBS
822 Hwy A1A North, Suite 211

Ponte Vedra Beach, FL 32082
(904) 249-9171 (800) 361-4635
IRS Circular 230 Disclosure: IRS regulations require us to notify you that
this communication was not intended or written to be used, and cannot be
used, by you as the taxpayer, for the purpose of avoiding penalties the IRS
might impose on you.
Copyright Dorsa Consulting, Inc. 2008
443
A. Things You Already Know About Cash Balance Plans
444
entry dates
vesting
statutory eligibility
year of service
coverage [IRC 410(b)]
normal retirement age
qualified joint & survivor rules
5500 filing requirements
qualification requirements
normal retirement age
hour of service
401(a)(17) compensation
top-heavy vesting
plan year
contribution due date
break in service rules
non-discrimination [IRC 401(a)((4)]
trustee
permanency requirements
limitation year
fiduciary responsibility
affiliated service group rules
highly compensated employee
forfeitures
highly compensated employee
key employee
415(c) compensation
QDROs
414(s) compensation
rollover
bonding requirements
anti-alienation rules
controlled group rules
determination letter
affiliated service group rules
minimum distributions
ERISA
sole proprietor
Pension Protection Act
S corporation
Enrolled Actuary
C corporation
lump sum distribution
third party administrator
terminee
plan sponsor
B. Overview and Basic Terminology

A defined benefit plan is a plan in which the monthly benefit to be provided at
retirement is defined in the plan. Contributions are not defined in the plan, but are
actuarially computed as the amount necessary to provide the benefit.
Benefits are usually defined in terms of the participants compensation and service
or participation and are expressed in terms of a monthly benefit commencing at the
participants normal retirement date.
In many cases, the actual payment of the benefit is in a form other than the plans
normal form. These other forms of benefit are called alternate forms and are
generally actuarially equivalent (of an equal value, using the actuarial equivalent
factors defined in the plan).
A cash balance plan is a variation in which benefits are defined in terms of a
notional account, called a cash balance account, rather than monthly retirement
benefits.
The participants notional account is credited with pay credits and interest credits
each year and his benefit at retirement is the account balance. Pay credits are
generally a function of compensation and interest credits are based on a fixed rate
or index.
Actual payment of the benefit may be the account balance or an actuarially
equivalent alternate form.
C. When is a Defined Benefit or Cash Balance Plan Appropriate?

Employers often adopt defined benefit plans so they can provide full retirement
benefits to employees who are older at plan commencement.
Since defined benefit plans provide specified benefits, rather than just the benefit
can be provided by the participants account balance at retirement, defined benefit
plans are well suited to situations in which the employer establishes the plan late in
an employees career and wants to provide a significant retirement benefit.
A cash balance plan is often selected in situations where the employer wishes to
provide benefits based on compensation rather than a combination of age and
compensation. In a cash balance plan, employees with the same compensation
receive the same pay credit regardless of age. This is particularly useful in the
situation in which the plan sponsor wishes to provide the same benefit to partners
who are different ages.
In general, a defined benefit plan or cash balance is most effective if the favored
employee is age 45 or older. This is because the compression of the funding of
the favored employees benefit into the relatively short period immediately prior to
his retirement produces the largest contributions.
445
For a younger participant, funding may also be compressed into a 10 15 year

period, but the contributions will be less because the participant is many years from
retirement. This may be an appropriate and tax-effective design if a young
principal expects his highest earnings years will be the 10 15 year period after
the defined benefit or cash balance plan is established or if he wishes to make the
bulk of his contributions to the defined benefit or cash balance plan in these years.
However, for plans of professional service employers or small businesses with no
rank and file employees, adopting a cash balance plan will require giving up the
opportunity to make current contributions in excess of 6% of compensation to the
defined contribution plan, an opportunity which cannot be recaptured, in order to
make contributions to the defined benefit plan or cash balance plan.
If the employer chooses to wait until a future year to establish a defined benefit or
cash balance plan, contributions will be larger as the principal will be older and
thus the foregone contributions in earlier years can be recaptured.
D. How Does a Defined Benefit Plan Work?

The amount of benefit payable at retirement is defined and therefore the
contribution must be the variable. This is unlike a defined contribution plan in
which the contribution or allocation is fixed and the benefit the participant will
receive at retirement is the variable.
Benefits are generally defined in terms of a monthly benefit payable at retirement in
the form of an annuity, although many plans allow participants to receive their
benefit in another form, such as a lump sum.
The amount of the contribution depends on the level of benefits, the ages and
compensations of the participants and expectations regarding salary increases,
turnover and other factors.
Annual contributions are required, not discretionary.
Contributions are not a
percentage of payroll, but are computed by the plans actuary.
Due to the different rules applied by IRC 430 (which defines the minimum
required contributions) and IRC 404 (which defines the maximum deductible
contributions), it is likely that the contribution to the plan is not a single amount, but
rather a range.
Each year, the actuary will provide a range of contributions to the defined plan
including the minimum required contribution, a recommended contribution and the
maximum deductible contribution. The recommended contribution is the amount
that should be contributed in order to properly fund the plan such that all benefits
can be paid when due. The minimum contribution will satisfy IRS requirements,
but will likely result in the need for increased contributions in future years. The
maximum deductible contribution includes the maximum allowable advance
446
funding and will likely result in lower contributions in some future years.
Contributions are determined for the plan as a whole, not as individual amounts for
each participant.
Some plan sponsors, familiar with defined contribution plans and used to seeing a
contribution amount for each individual, ask for individual participant contributions
in a defined benefit plan. In response, actuaries and administrators sometimes
provide the amount attributable to each individuals participation in the plan in a
given year. It is important to understand that these amounts are not allocated to
individual participant accounts and are not to be used to determine amounts which
will be payable upon termination of employment.
E. How Does a Cash Balance Plan Work?

In a cash balance plan, each participant has a hypothetical account, called a cash
balance account, which is credited with annual pay credits and interest credits.
Pay credits can be a percentage of compensation, a flat dollar amount or other
amount defined in the plan. Pay credits can be different for different groups
(similar to a cross-tested or new comparability plan).
Interest credits must also be defined in the plan. The interest crediting rate may be
determined by reference to an index or published rates (such as the 30 year
Treasury rates). The Pension Protection Act allows the use of a market related
rate but additional guidance is required to determine how such rate is to be
computed and how it will impact plan funding and non-discrimination testing.
With regard to its funding, a cash balance plan works the same as a defined
benefit plan except that the defined amount is the participants cash balance
account balance rather than a monthly benefit. The contribution is the variable and
is determined by the plans actuary each year.
Each year, the actuary will provide a range of contributions to the defined plan
including the minimum required contribution, a recommended contribution and the
maximum deductible contribution. The recommended contribution is the amount
that should be contributed in order to properly fund the plan such that all benefits
can be paid when due. The minimum contribution will satisfy IRS requirements but
will likely result in the need for increased contributions in future years. The
maximum deductible contribution includes the maximum allowable advance
funding and will likely result in lower contributions in some future years.
The amount of the contribution depends on the level of benefits, the ages and
compensations of the participants and expectations regarding salary increases,
turnover and other factors.
Generally, the sum of the contribution credits will be within the range of
contributions provided by the actuary. While the contribution attributable to
447
funding a participants benefit is not exactly equal to his contribution credit, it

is generally close enough for plan sponsors to be comfortable in using it to
understand the cost of the plan.
Barring relief from technical corrections or IRS regulations, there is an
inconsistency between the funding rules of IRC 430 and the rules regarding
crediting interest to cash balance accounts (sometimes referred to as funding
whipsaw) which may limit contributions in the first year of the plan to an amount
less than the sum of the contribution credits. If this is the case, the range of
contributions available in the second and subsequent years is expected to be
sufficient to allow for larger contributions in these years to make up for the first year
limitation.
In a cash balance plan, annual contributions are required, not discretionary. While
it may look like a profit sharing plan, it is a defined benefit plan and subject to the
funding requirements applicable to defined benefit plans.
Contributions are determined for the plan as a whole, not as individual amounts for
each participant.
While the contribution is provided for the plan as a whole, the portion of the total
contribution attributable to each individuals participation in the plan in a given year
is usually estimated by reference to the cash balance contribution credits.
F. Funding the Plan

The process of making contributions to a defined benefit (or cash balance) plan is
called funding the plan.
Each year, the plans actuary determines the amount of contributions required to
fund the plan and certifies to the appropriateness of this amount on Schedule B or
Schedule SB of Form 5500.
Prior to the effective date of the Pension Protection Act (PPA) rules in 2008, the
actuary applied a specific set of actuarial calculations, called a funding method,
and selected the actuarial assumptions (rates of return on plan assets, mortality
and interest rates expected to settle plan benefits, turnover, retirement rates and
forms of payment, etc) used in the calculations.
Under PPA, the actuary must use the funding method and the interest and
mortality rates prescribed by PPA to determine the minimum required and
maximum deductible contributions. The actuary must still select the assumptions
regarding other factors such as form of payment, turnover, etc.
The funding rules of PPA first apply in 2008. However, the IRS has issued only
limited guidance regarding how the rules are to be applied and such guidance is
not effective until the 2009 plan year.
448
In the absence of hard guidance, actuaries and plan sponsors are directed to look
to the statutes and use a reasonable interpretation of the statutes. Actuaries are
working through the implications of these rules and the most appropriate practices
to compute and communicate these new funding requirements to plan sponsors.
Plan sponsors need to understand that this may mean that methodologies and
assumptions may again need to be changed in the 2009 and future years as more
guidance is issued.
Some of the significant changes made by PPA to the funding rules are:
Requirement that a specified funding method be used to compute minimum

and maximum contributions
Requirement that specified interest and mortality factors be used to value

liabilities and costs for funding and benefit restriction purposes
Replacement of the Funding Standard Account Credit Balances with

Carryover and Prefunding Balances
Restrictions on the use of Carryover and Prefunding Balances to reduce

minimum contributions in years in which the plan is less than 80% funded
As a whole, these calculations and their results are called the actuarial valuation.
G. Benefit Restrictions and Timing Issues

Benefit Restrictions
Under PPA, benefit restrictions apply to defined benefit and cash balance plans
which have an AFTAP (adjusted funding target attainment percentage) of less than
80%.
The AFTAP is the plans assets (reduced by carryover balances [formerly called
credit balances]) divided by plan liabilities (computed using mandated
assumptions).
For plans with AFTAPs less than 80% but at least 60%, payment of benefits in the
form of lump sum is restricted to of the benefit with the balance delayed or paid
in the form of an annuity.
For plans with AFTAPs of less than 60%, no lump sum payments are permitted
and all future benefit accruals are frozen.
Restrictions become effective when the actuary certifies the AFTAP for the year.
In cases where the certification has not been completed, the prior years AFTAP
continues to apply with the following adjustments:
On the first day of the 4th month of the year (April 1 for calendar year plans) the
449
AFTAP is presumed to be the prior years AFTAP decreased by 10 percentage

points (e.g. 92% becomes 82%)
On the first day of the 10th month of the year (October 1 for calendar year plans)
the AFTAP is presumed to be less than 60%
If the plans AFTAP would be greater than one of the restriction levels (80% or
60%) if the plan assets were not reduced by the carryover balances, a plan
sponsor must waive that portion of the carryover balance which will remove the
restriction (e.g. if waiver of a portion of the carryover balance would bring the plans
AFTAP to 80%, that portion must be waived).
If restrictions apply, participants must be notified of the applicable restrictions
within 30 days. Thus, for calendar year plans which became subject to either of
these restrictions on April 1, notices must be provided to participants by April 30.
Restrictions on Payouts to Restricted Employees
IRC 401(a)(4) provides that distributions to restricted employees must be limited to
the amount payable annually in the form of a life annuity unless certain conditions
are met. These conditions are:
After the distribution to the restricted employee, Plan assets equal or

exceed 110% of the Plans current liabilities as defined in IRC 412(l)(7)
The value of the benefit distributed to the restricted employee is less than
1% of the Plans assets
The value of the benefit distributed to the restricted employee does not
exceed $5,000
If none of the conditions above are met, the participant may:
establish an escrow account of at least 125% of the restricted amount
Provide a letter of credit for 100% of restricted amount
Post a bond for 100% of restricted amount
Restricted employees are generally the 25 Highly Compensated Employees with

the highest compensation although the plan may by its terms provide that all
HCEs, not just the top 25, are restricted.
The IRS has not yet issued guidance regarding how the 110% of Current Liability is
to be determined since under PPA, Current Liability is no longer a defined term for
single employer plans so it is not clear exactly how this restriction should be
applied.
In the absence of such guidance, some actuaries are using target liability or the
pre-PPA definition of current liability, or in the case of cash balance plans, cash
balance account balance, as a stand in for current liability.
450
H. Pooled Investment Account

Assets are not individually directed, but are held in a pooled account.
Contributions are paid into the pool and benefits are paid from the pool. The plan
sponsor and/or trustee is responsible for managing the plans assets and usually
works with a broker or financial institution to manage the investments.
In a cash balance plan, accounts are notional and do not reflect the actual return
on plan assets. Plan assets are managed as described above--individual accounts
are not established and participant direction is not permitted.
I. Maximum Benefit/Contribution Limits for Qualified Plans

The IRC 415 maximum benefit/contribution limit for a participant in a defined
benefit plan is defined in terms of the maximum benefit that can be provided at
retirement, not in terms of a maximum contribution.
Contributions are not limited to the lesser of 100% of pay or $46,000 as they are in
a defined contribution plan.
Instead, the maximum benefit that can be provided is limited to a benefit equal to
the lesser of 100% of 3 year high average compensation or $185,000 (as indexed,
with adjustments for retirement prior to age 62 or after age 65). The percentage of
pay limitation is reduced for participants with less than 10 years of service at
retirement and the dollar limit is reduced for participants with less than 10 years of
participation.
This method of determining the maximum benefit/contribution applies to cash
balance plans as well. Pay credits are not limited. Instead, the actuarially
equivalent benefit is limited as stated above. Thus, a participant can receive a pay
credit in excess of the $46,000 defined contribution limit.
J. Benefit Payments and Distributions

Benefits may be paid in any of the alternate forms of distribution allowed by the
plangenerally annuities payable monthly or in a lump sum. While plans are not
required to offer a lump sum, most small and medium size plans do. Larger plans
may not offer a lump sum option, but rather will pay annuity benefits to terminated
employees when they reach retirement age. In the case of cash balance plans, a
lump sum is almost always offered.
As a practical matter, most terminees in plans that offer lump sum distributions
elect to receive their benefits in the form of a lump sum and, in many cases, roll the
lump sum over into an IRA to preserve its tax-deferred status and then draw down
funds as needed.
451
Prior to PPA, cash balance plans which used other than a limited set of interest
crediting rates were subject to a whipsaw in which the lump sum distribution to a
participant would not equal the balance in his cash balance account. Most small
plans were designed to avoid this whipsaw but PPA granted relief from whipsaw for
a broader range of plans.
K. PBGC Coverage
Defined benefit plans (and cash balance plans), with certain exceptions, are
required to be covered by the Pension Benefit Guaranty Corporation, which
provides a guarantee of certain plan benefits to participants.
Plans which are covered by the PBGC must pay annual premiums to the PBGC.
The amount of the premium is computed on Form PBGC-1. The form must be filed
and the premium paid by 8 after the beginning of the plan year. Plans with more
than 500 participants must pay an estimated premium earlier in the year and a final
amount by the regular due date.
The annual PBGC premium is $33 per participant (as indexed to 2008) plus an
additional variable amount based on the funded status of the plan.
Plans which are exempt from PBGC coverage and premiums include plans which
cover only substantial owners and plans of professional service employers with
less than 26 employees.
L. Administration Issues
Administration Procedures
Prior to PPA, annual administration of a defined benefit plan has two distinct
partsthe actuarial valuation and the Schedule SB contribution reconciliation.
PPA has added dates during the plan year by which AFTAP certifications are due
and as of which benefit restrictions may apply.
The actuarial valuation may be prepared either at the beginning of the plan year (if
the valuation date is first day of the plan year) or at the end of the plan year (if the
valuation date is the last day of the plan year).
The Schedule SB contribution reconciliation is always performed after the end of
the plan year after all contributions have been made.
If the actuarial valuation is prepared before the due dates of the AFTAP
certifications, it may be possible to prepare these certifications at the same time as
the actuarial valuation is prepared. If not, a separate certification processing may
be necessary.
452
Valuation Date
PPA provides that the actuarial valuation date is the first day of the plan year but
allows plans with less than 100 participants to elect to use an end of the year
valuation date.
However, the description of the AFTAP percentage and its application assumes a
beginning of the year valuation date and only limited guidance with limited
applicability has been provided regarding how an AFTAP may be computed for a
plan using an end of the year valuation date.
Communication with Plan Sponsors and Participants
The rules of IRC 436 regarding benefit restrictions require that the plan sponsor be
prepared to take action to restrict benefits immediately upon either receipt of an
AFTAP certification that the plan is less than 80% funded or, in the absence of a
certification, the dates by which the AFTAP is presumed. Required actions may
include modification of plan administration procedures, notices to plan participants
and amendments to the plan.
Accordingly, plan administrators may need to communicate with plan sponsors
several times during the plan year rather than just once or twice a year as they do
now when the actuarial valuation and Schedule B are prepared.
Working with the Enrolled Actuary
Some administrative firms have an Enrolled Actuary on staff, while others retain
the services of an outside actuary.
Regardless of whether the actuary is on staff or not, he/she is still responsible for
determining actuarial assumptions, certifying the actuarial valuation and signing the
Schedule SB.
453
CASE STUDY 1
The owner of small business would like to accumulate significant retirement savings over
the next 10 years with the goal of retiring at age 62.
In addition to the owner, the staff includes a key associate and several employees. The
goal of the plan is to benefit the owner and provide the staff with whatever benefits are
necessary to support the owners benefit.
A traditional defined benefit plan, designed to maximize the benefits to the principals and
minimize the cost of other employees, is selected.
The benefit formula is 7.32% of compensation, multiplied by years of participation plus 1
past year of service to a maximum of 11 years. (This formula provides the principal with
his maximum benefit permitted under IRC 415 at retirement age 62.)
Name
Owner
Associate
Staffer1
Staffer2
Staffer3
Staffer4
Age Compensation
52
47
40
35
30
25
$ 230,000
120,000
40,000
30,000
20,000
20,000
Monthly Bft
Contribution*
$15,416
8,052
2,684
2,013
1,342
1,342
$ 150,120
68,680
15,720
9,250
4,890
3,920
$460,000
$252,580
* Contributions are not allocated to each participant, but represent the annual cost of providing the monthly
retirement benefit. Projected level annual contributions are illustrated; actual contributions for each year
must be actuarially computed and may vary.
This plan satisfies the safe harbors. Non-discrimination testing is not required.
454
CASE STUDY 2
Cash Balance Plan
A medical practice with 5 physicians with no staff would like to adopt a defined benefit
plan to take advantage of the higher benefits/contributions. All physicians earn the same
amount ($230,000+) and want to continue this pattern with any additional benefits the
firm provides.
In a traditional defined benefit plan, contributions are skewed towards the older
physicians since the cost of funding a given benefit for an older participant is higher than
for a younger participant.
In a cash balance plan, the benefit can be defined as the accumulation of a specific
contribution (actually a pay credit, not a contribution) to each participant each year
credited with a defined rate of interest each year (called an interest credit). The notional
account in which these pay credits and interest credits are accumulated is called the
participants cash balance account.
The contribution to the plan, while actuarially determined, will approximate the amount of
the pay credit to each participant for the year. Thus, a cash balance plan can meet the
needs of this medical practice.
[Note: a cash balance plan is a defined benefit plan and thus subject to all the rules
applicable to a defined benefit plan, including the rules of IRC 415]
Physician1
Physician2
Physician3
Physician4
Physician5
Age
Compensation
Cash Balance
Pay Credit*
60
54
48
45
41
$ 230,000
230,000
230,000
230,000
225,000
$ 70,000
70,000
70,000
70,000
70,000
$1,150,000
$ 350,000
* Actual plan contributions are actuarially determined and thus may not exactly equal pay credits provided.
455
CASE STUDY 3
Defined Benefit Plan + Profit Sharing Plan
This example expands Case Study 1 to add a discretionary profit sharing plan to take
advantage of the maximum deduction limits available to an employer who sponsors both
a defined benefit and a defined contribution plan such as a profit sharing plan.
Since defined benefit or cash balance plans of medical practices are exempt from PBGC
coverage, the maximum deduction is the amount necessary to fund the defined benefit
plan plus a profit sharing contribution equal to 6% of total compensation.
An advantage of this design is that it provides a range of contributionsthe defined
benefit contribution is required, but the profit sharing contribution is discretionary. Thus,
the employer has the option to contribute and deduct the maximum amount in good
years and contribute only the defined benefit amount in less favorable years.
Name
Principal
Associate
Staffer1
Staffer2
Staffer3
Staffer4
Age Compensation
52
47
40
35
30
25
DB Plan
Contribution*
Profit Sharing
Contribution
Total
$ 230,000
120,000
40,000
30,000
20,000
20,000
$ 150,120
68,680
15,720
9,250
4,890
3,920
$ 13,800
7,200
2,400
1,800
1,200
1,200
$ 163,920
75,880
18,120
11,050
6,090
5,120
$460,000
$ 252,580
$ 27,600
$ 280,180
456
CASE STUDY 4
Cash Balance Plan + Profit Sharing Plan
This example expands Case Study 2 to add a discretionary profit sharing plan to take
advantage of the maximum deduction limits available to an employer who sponsors both
a defined benefit/cash balance and a defined contribution plan.
Since defined benefit or cash balance plans of medical practices are not subject to the
PBGC, the maximum deduction is the amount necessary to fund the defined benefit plan
plus an amount equal to 6% of total compensation as a contribution to the defined
contribution plan.
Following the desire of the practice to provide equal benefits to all partners, a nonintegrated profit sharing allocation is used.
The contribution to the plan, while actuarially determined, will approximate the amount o
of the pay credit to each participant for the year. Thus, a cash balance plan can meet
the needs of this medical practice.
Physician1
Physician2
Physician3
Physician4
Physician5
Age
Compensation
Cash Balance
Pay Credit*
Profit Sharing
Contribution
Total
60
54
48
45
41
$ 230,000
230,000
230,000
230,000
230,000
$ 70,000
70,000
70,000
70,000
70,000
$ 13,800
13,800
13,800
13,800
13,800
$ 83,800
83,800
83,800
83,800
83,800
$1,150,000
$ 350,000
$ 69,000
$ 419,000
457
CASE STUDY 5
Cash Balance Plan + Profit Sharing Plan
This example modifies Case Study 4 to change the employer from a medical practice to
a retail business with 2 owners and 3 highly paid salesmen.
The cash balance plan, since it does not meet any of the exceptions, is covered by the
PBGC and must pay PBGC premiums ($33 per participant plus a variable premium
based on the plans funded status).
However, since it is PBGC covered, the combined plan maximum deduction limits of IRC
404(a)(7) do not apply. Thus, the contribution to the profit sharing plan is not limited to
6% and the total contribution between both plans is not limited to 25% of total
compensation.
The contribution to the cash balance plan, while actuarially determined, will approximate
the amount of the pay credit to each participant for the year.
Owner1
Owner2
Salesman1
Salesman2
Salesman3
Age
Compensation
Cash Balance
Pay Credit*
Profit Sharing
Contribution
Total
60
54
48
45
41
$ 230,000
230,000
230,000
230,000
230,000
$ 70,000
70,000
70,000
70,000
70,000
$ 46,000
46,000
46,000
46,000
46,000
$ 116,000
116,000
116,000
116,000
116,000
$1,150,000
$ 350,000
$ 230,000
$ 580,000
458
CASE STUDY 6
For Business Owner Receiving an Inheritance
Or With Income from Assets Other Than His Business
Since benefits can be based on a participants average compensation over a specified

number of years (3 or 5 is most common), it is not necessary for a participant to have
current compensation to participate in a defined benefit plan and have contributions
made on his behalf.
For example, a business owner who has received W-2 compensation from his business
for the last 5 years has now come into an inheritance. He has sufficient assets from the
inheritance such that he does not need his income from the business for current
expenses and would prefer to minimize his current taxable income from his business.
By establishing a defined benefit plan, the business owner can reduce his compensation
to a small amount and can make large contributions to the plan on his behalf with the
money he would have paid himself.
To do this, he pays some or all of his living expenses from the inherited monies, takes
little compensation from the business and puts the monies he would have paid himself
as compensation into the plan as contributions on his behalf.
The net result is the same as if the business owner had moved his taxable assets (the
inherited money) to tax-deferred assets (the qualified plan).
(If there are employees who would also benefit under the plan, their costs must also be
considered in determining the effectiveness of this plan design.)
Name
Current
Age Compensation
Business Owner 55
$ 43,000
3 Yr High Monthly Bft

Average At Retirement
Compensation
(age 65)
$ 200,000
$ 15,416
Contribution*
$ 157,000
459
CASE STUDY 7
As Part of a Buyout
A small business is owned by 2 shareholders. The older shareholder is age 59 and

plans to retire when he reaches age 65 six years from now. The younger shareholder is
age 47 and would like to buy out his partner when he retires.
The company decides to adopt a defined benefit plan, both to provide retirement benefits
to the shareholders and employees and to help the younger shareholder fund the buyout
of the older shareholder when he retires.
The compensation of the shareholders is $230,000. However, due to the age of the
older shareholder, the contribution made to the plan on his behalf over the next 6 years
will be significantly higher than that made on behalf of the younger shareholder.
The plans normal retirement age is 65 and the benefit formula is 6.89% of
compensation, multiplied by years of plan participation plus 1 past year of service,
maximum 7 years. (This formula is designed to provide the Older Principal the
maximum allowable benefit at age 65 based on 6 years of participation.)
The shareholders agree that a portion of the lump sum retirement benefit payable to the
older shareholder when he retires will be used to offset the value of his portion of the
business and therefore the price the younger shareholder pays to buy him out. (Buyouts
are complex and may be structured in a number of ways. The clients attorney should
be involved in the design and drafting of such agreements.)
Name
Monthly Bft
At Retirement
(age 65) Contribution*
Age
Compensation
Older Principal
Younger Principal
59
47
$ 230,000
230,000
$9,250
9,250
$ 192,000
106,000
Staffer1
Staffer2
39
39
36,500
20,500
1,467
824
9,650
4,425
$ 517,000
$ 312,075
460
CASE STUDY 8
401(k) Plan and Cash Balance Plan
Focusing Significant Benefits on the Principal
A single practitioner dental practiceone dentist and 2 staff membershas had a

401(k) plan for a number of years. The dentist now wants to increase his contribution
but also wants to continue the 401(k) plan because it is important to his staff.
The current design of the 401(k) plan includes salary deferrals, a safe harbor matching
contribution and a profit sharing contribution and the dentists total contribution each
year is the maximum allowable contribution ($46,000 in 2008).
The 401(k) plan was redesigned to discontinue the safe harbor matching contribution
and replace it with the flat 3% safe harbor contribution. The deferral and profit sharing
features are continued.
A cash balance plan is added in which pay credits are a percentage of compensation
based on employee class43.5% for dentist and 2% for staff.
The contribution to the cash balance plan, while actuarially determined, will approximate
the amount of the pay credit to each participant for the year.
In the 401(k) profit sharing plan, each participant is allocated the 3% safe harbor
contribution plus a 3% regular profit sharing contribution for a total of 6% of
compensation.
This design is not a safe harbor and requires annual non-discrimination testing.
Age Compensation
Dentist
Staff1
Staff2
50
40
30
Salary
Deferral
$ 230,000
40,000
30,000
$ 20,500
$300,000
Profit Cash Balance

Sharing
Pay Credit*
Total
as elected
$13,800
2,400
1,800
$100,000
800
600
$134,300
3,200
2,400
$ 20,500
$18,000
$101,400
$139,900
as elected
Non-discrimination testing under 401(a)(4) is satisfied.
461
CASE STUDY 9
Same Benefit Level to Principals
A small law firm with 2 attorneys and 5 staff members would like to establish a plan in
which the attorneys each receive an annual contribution of about $120,000.
To do this in a defined contribution design would require 2 plansa qualified plan in
which the contribution for each would be limited to the maximum defined contribution
limit ($46,000 in 2008) and a non-qualified plan for the balance of the contribution.
A defined benefit plan was considered, but the attorneys are not the same age and
therefore the contributions attributable to both of them would not be equal.
A cash balance plan was established in which pay credits are a percentage of
compensation based on employee class40% for attorneys and 8% for staff.
The contribution to the plan, while actuarially determined, will approximate the amount of
the pay credit to each participant for the year. Thus, a cash balance plan can meet the
needs of this firm.
In addition, a safe harbor 401(k) was added. This was considered a benefit for the staff,
and the safe harbor provisions allow the attorneys to maximize their salary deferrals
regardless of the level of deferrals made by the staff.
Age Compensation
Attorney1
Attorney2
Staff1
Staff2
Staff3
Staff4
Staff5
55
50
41
38
35
28
24
Salary Safe Harbor Cash Balance

Deferral
PS (3%)
Pay Credit*
$ 230,000
230,000
80,000
65,000
47,000
42,000
25,000
$ 20,500
20,500
$719,000
Total
as elected
$6,900
6,900
2,400
1,950
1,410
1,260
750
$92,000
92,000
6,400
5,200
3,760
3,360
2,000
$119,400
119,400
8,800
7,150
5,170
4,620
2,750
$ 41,000
$21,570
$204,720
$267,290
as elected
as elected
as elected
as elected
462
CASE STUDY 10
Different Benefit Levels to the Principals
A medical practice with 2 physicians and 18 staff members would like to establish a plan
in which one physician receives a contribution of about $120,000 and the other receives
a contribution of about $70,000.
compensation based on employee class$91,000 for Physician A, $41,000 for
Physician B and 4.75% of compensation for staff.
A safe harbor 401(k) was also established. This plan provides for a non-elective safe
harbor contribution of 3% of compensation plus additional profit sharing allocations
based on employee classPhysician A, Physician B and staff.
Profit sharing allocations are designed to bring the physicians to their desired level of
funding and to allow both plans to satisfy the non-discrimination testing rules on an
aggregated basis. Thus, in this design, the amount of the profit sharing contribution is
not fully discretionary, but must be at least the amount necessary to satisfy the nondiscrimination testing.
In this year, a 6% profit sharing contribution (including the 3% safe harbor) is allocated.
Age Compensation
Physician1 46
Physician2 36
Staff1 - 18 22-49

Deferral + PS (6%)
Pay Credit*
Total
$ 230,000
230,000
$ 15,500
15,500
$13,800
13,800
$91,000
41,000
$120,300
70,300
607,900
as elected
36,474
28,875
65,349
$ 31,000
$64,074
$160,875
$255,949
Cash balance and profit sharing plans are aggregated for non-discrimination testing under 401(a)(4) and the
test is satisfied.
463
CASE STUDY 11
Different Benefit Levels to Principals
A mid-sized business with 2 owners and 33 staff members would like to establish a plan
in which the principals each receive annual contributions of about $120,000.
They currently sponsor a cross-tested 401(k) plan which includes a 3% non-elective safe
harbor contribution to the staff. They have generally contributed about 8-10% of
compensation for the staff and the maximum amount for the principals.
A defined benefit plan was considered, but the attorneys are not the same age and
therefore the contributions attributable to each of them would not be equal. They do not
wish to reduce profit sharing plan contributions as the staff has come to expect them.
compensation based on employee class80% for attorneys and 2% for staff.
The cross-tested safe harbor 401(k) plan was continued using the same classes as the
cash balance plan. The non-elective safe harbor contribution is provided to the staff only
to allow flexibility in the profit sharing allocation.
The plans are aggregated for testing and thus the profit sharing contributions to the staff
can support the large cash balance contribution credits to the staff. As in the above
Case Study, profit sharing contribution is not fully discretionary, but must be at least the
amount necessary to satisfy the non-discrimination testing.
In this year, a profit sharing allocation of 1.64% was provided to the Owners and an
allocation of 13% to the staff.
The cash balance plan is covered by the PBGC. Therefore, the combined plan
maximum deduction limits of IRC 404(a)(7) do not apply and the contributions to the
profit sharing plan need not be limited.
Age Compensation

Deferral
+ PS
Pay Credit*
Total
Owner1
Owner2
52
49
$ 130,000
130,000
$ 20,500
15,500
$2,132
2,132
$104,000
104,000
$126,632
121,632
Staff1 - 33
24
1,833,000
as elected
238,290
36,660
274,950
$ 36,000
$242,554
$244,660
$523,214
464
CASE STUDY 12
Flat Dollar Allocations
A physician whose wife works for the practice as his office manager and has 11 staff
members would like to establish a plan in which the physician and his wife together
receive contributions totaling about $145,000.
The practice currently sponsors a cross-tested 401(k) plan which includes a 3% nonelective safe harbor contribution. They would like to continue the same basic design
(different levels of contribution to owners and staff).
A cash balance plan was established in which pay credits are a specified dollar
amounts$60,000 for the physician, $22,000 for the office manager and $1,000 to the
staff.
The safe harbor 401(k) plan is continued using the same classes as the cash balance
plan. In this year, allocations of 6% are made to all classes.
The plans are aggregated for testing and thus the profit sharing contributions to the staff
can support the large cash balance contribution credits to the staff. As in the above
Case Study, profit sharing contribution is not fully discretionary, but must be at least the
amount necessary to satisfy the non-discrimination testing.
The cash balance plan is not covered by the PBGC. Therefore, the combined plan
maximum deduction limits of IRC 404(a)(7) apply and thus the profit sharing
contribution must be limited to 6% of aggregate compensation.
Age Compensation
Physician
Office Mgr
52
50
Staff1 - 11 21-59

Deferral + PS (6%)
Pay Credit*
Total
$ 225,000
105,000
$ 20,500
20,500
$13,500
6,300
$60,000
25,000
$ 94,000
51,800
253,000
as elected
15,180
11,000
26,180
$583,000
$ 41,000
$34,980
$96,000
$171,980
465
466
CPC Study Guide:

SuccessfulDCPlanDesignCaseStudies
EricC.Droblyen,CPC,QPAandJJMcKinney,CPC,QPA,QKA
467
Workshop 61:
Successful DC Plan Design Case Studies
Eric C. Droblyen, CPC, QPA \ JJ McKinney, CPC, QPA, QKA
Aegis Retirement Plan Services LLC \ Retirement Strategies, Inc.
Session Agenda
`
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`
`
`
`
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`
`
Importance of Plan Design

Employer and Employee Considerations
Eligibility
Compensation
Contribution Options
Vesting
Distributions
Loans
Case Studies
Q&A
469
Importance of Plan Design

`
`
`
There is no such thing as the one size fits all DC* plan
The plan design process matches plan specifications to
employer goals and employee demographics
Benefits of understanding good design principles include:
`
`
`
A plan that meets needs of employer and is valued by

employees
Competitive advantage
Greater client retention
*Although appropriate regarding design, we will neither address DB plans

nor investment products as part of this discussion
Employer Considerations
`
`
Understanding employer ownership is CRITICAL

Related employers are considered a single employer
for Qualified plan purposes
`
`
`
`
`
`
470
Does any owner of the employer have an ownership interest

in another company? Any affiliated service relationships?
Failure to permit a related employer to participate in the plan
can result in plan disqualification
Does employer sponsor another qualified plan?

What are plan objectives?
Employer contribution budget
Profitability expectations
Employee Considerations
`
`
`
`
`
`
`
Number of employees
Union/non-union
Leased or staffing co. employees
Average Age of Employees
Turnover Frequency and Behavior
Sophistication
Compensation
Eligibility
`
Maximum eligibility conditions allowed by law

`
`
`
`
`
`
401(k) Deferrals age 21 and 1 year of service

Employer Contributions age 21 and 2 years of service
Year of service can be defined as 12 months in which

employee works 1,000 hours
Can impose different eligibility conditions for different
contribution types
Employers with high turnover likely to want longer
service requirement
Employers not required to cover all employees, but
Coverage requirements must be satisfied
471
Compensation
`
`
Contribution allocations are based on plans definition of

compensation
Plan definition of compensation may be different than
definition necessary for other purposes (e.g., top heavy,
HCE determination)
If plan compensation satisfies requirements of IRC
414(s), definition can also be used for nondiscrimination
testing purposes
If definition contains non-safe harbor exclusions (e.g.,
bonuses, overtime, etc.), special testing rules apply
`
401(k) deferrals
`
`
`
Roth 401(k) deferrals

`
`
After-tax contributions
Subject to same limits as pre-tax 401(k) deferrals
Voluntary contributions
`
`
472
Made pursuant to salary reduction agreement

Limited to IRC 402(g) limit annually ($15,500 for 2008)
Participants over age 50 able to defer catch-up deferrals
After-tax contributions
Less common than Roth
`
Employer matching contributions

`
`
`
`
Allocated only to participants making elective deferrals

Allocation formula based on % of deferrals up to % of
compensation (e.g., 50% of 401(k) up to 6% of comp)
Important to understand how match will be funded/allocated
(e.g., annually, per payroll, etc.)
Allocations can be subject to allocation conditions (e.g., last
day rule, 1,000 hour requirement)
`
Employer matching contributions

`
Why employers choose matching contributions:

`
`
`
Reduced cost since employee participation is required

Existence of match generally increases plan participation
Contributions can be discretionary
473
`
Employer nonelective contributions

`
`
`
A.K.A. profit sharing contributions

Allocated to participants regardless of elective deferrals
There are three principle profit sharing allocation formulas:
`
`
`
Pro rata participants allocated same percentage of comp or $$

Permitted Disparity participants receive greater benefit on
compensation earned over plans integration level
New Comparability permits multiple allocation groups, with each
allocated the same percentage or $$ (special testing applies)
Allocations can be subject to allocation conditions (e.g., last

day rule, 1,000 hour requirement)
`
Employer nonelective contributions

`
Why employers choose nonelective contributions:

`
`
`
`
`
474
New comparability design is often the least expensive way to

maximize owner/key employee contributions at lowest cost
Pro-rata and permitted disparity designs not subject to
nondiscrimination testing
Permitted disparity formula provides greater highly-compensated
benefit
Provides retirement benefit regardless of employee participation
Contributions can be discretionary
`
Safe harbor 401(k) plans

`
`
`
Plans deemed to pass nondiscrimination and top heavy

testing if certain requirements are satisfied
Subject to special participant notice requirements
Must contain one of the following contribution formulas:
`
`
`
Basic safe harbor match 100% up to 3% of comp + 50% on the next

2% of compensation (4%) contribution
Enhanced safe harbor match formula must equal or exceed basic
formula at each level of 401(k) deferral
Safe harbor nonelective contribution must equal at least 3% of
compensation
`
Safe harbor 401(k) plans

`
Why employers choose a safe harbor 401(k) plan design:

`
`
Trouble passing nondiscrimination and/or top heavy testing

Safe harbor nonelective contributions, when combined with new
comparability contributions, is often great way to cost-effectively
maximize owner/key employee contributions
Safe harbor matching contributions can be stacked with additional
matching contributions and still automatically satisfy
nondiscrimination and top heavy testing rules
Disadvantages include:
`
`
`
Safe harbor contributions are required (i.e. non-discretionary)

Safe harbor contributions must be immediately 100% vested
Safe harbor contributions cannot contain allocation conditions
475
`
Automatic enrollment arrangements

`
`
`
Allows an employer to enroll employees in a 401(k) plan

without an affirmative deferral election
Feature generally increases employee participation
There are 3 basic automatic enrollment plan designs
`
`
`
Automatic Contribution Arrangement (ACA)

Eligible Automatic Contribution Arrangement (EACA)
Qualified Automatic Contribution Arrangement (QACA)
QACA is new safe harbor 401(k) plan design

`
`
Default deferral rate must at least 3% for year 1; 4% for year 2; 5% for
year 3 and 6% for year 4 and beyond (must never exceed 10%)
The employer must make: (a) an annual matching contribution of 100% of
the first percent deferred and 50% of the next five percent deferred, or
(b) a profit sharing contribution of 3%
`
Automatic enrollment arrangements

`
Why employers choose an automatic enrollment feature:

`
`
`
`
`
`
476
Feature incents employee participation

Generally improves 401(k) nondiscrimination test results
Under EACA, employer will have up to six months after the end of
the plan year to perform nondiscrimination tests
QACA safe harbor contributions can be subject to 2 year cliff vesting
schedule
QACA match less costly than regular safe harbor match
Note: The employer must be equipped to handle the increased
administrative requirements of ACA designs
Vesting
`
`
`
A participant has a non-forfeitable right to their vested

account balance
Employer contributions vest subject to plans vesting
schedule
Maximum vesting schedules permitted by law:
`
`
`
`
6 year graded 0/0%, 1/0%, 2/20%, 3/40%, 4/60%, 5/80%,

6/100%
3 year cliff 0/0%, 1/0%, 2/0%, 3/100%
Year of service can be defined as 12 months in which

employee works 1,000 hours
Employers with high turnover likely to want vesting
schedule so forfeitures can be used by plan
Distributions
` Distributions upon separation from service
` Forms available
` Lump Sum distribution of participants entire account balance
` Partial payments distribution of a portion of the participants account
balance
` Installments equal payments made until account is depleted
` Annuity guaranteed payments made over the life of a participant (and
possibly a survivor)
A Qualified Joint and Survivor Annuity (QJSA) is special type of annuity
required under a pension plan, but optional under non-pension DC plan.
If plan contains QJSA, special notice and consent rules apply
` Lump sum option frequently the only option available under DC plan
` Plan can permit the involuntary cash-out of small balances
477
Distributions
`
In-service Distributions
`
Special restrictions apply to 401(k) and safe harbor sources

`
Employer contributions can be available sooner

`
`
`
Only available upon age 59 or hardship (401(k) only)

At a stated event, Years of Service and/or Age
Rollover source may be available at any time

Hardship distributions
`
`
Only available when a participant has an immediate and heavy

financial need
Distribution cannot be in excess of the amount of the immediate and
heavy financial need
Participant Loans
`
A DC plan can permit participants to take a loan from

the plan using their account balance as security
`
Design considerations:
`
`
`
`
`
478
Number of loans permissible

Interest rate
Minimum amount available
Immediately payable upon termination
Extended term for the purchase of primary residence
Case
Study
Case
Study
#1
#1 Real Estate Firm
Employer Type & Demographics
Real Estate Development Firm taxed as a partnership

9 partners with 24 Staff
2 Senior partners over 50; 7 Junior partners
Decision Maker Desires
Senior partners want max

Younger partners want more flexibility many not participating
Want to reward savers but would like to provide profit sharing
Other Considerations
Plan is generally Top Heavy

Want to grant service for prior real estate experience
Monthly draw for partners; Semi-monthly pay for staff
Case Study #1 Plan Design A

Traditional
with New
Comparability
Case
Study Match
#1 Plan
Design
Analysis-A
`
`
`
`
Eligibility statute max

(add provision to grant
real estate service)
Monthly Entry
Vesting 6 year graded
(count real estate service)
EE Sources: 401(k) with
Roth provision
ER Sources: Match
formula 50% up to 6%;
New Comp PS (focus on
Senior Partners)
Eligibility & Vesting does

not hand the plan to new
hires, but allows
competitive edge to
attract experienced talent
Sources: 401(k) & Roth
allow personal savings
options while matching
rewards savers. New
Comp allocation can focus
on partner savings goals
479

Traditional
with New
Comparability
Case
Study Match
#1 Plan
Design
Analysis-A
`
Allocation requirements:
End of year only both
match and non-elective
ADP/ACP Considerations:
Safe Harbor not necessary
as younger partners not
likely to participate
Top heavy minimums to
employed only; avoid
unnecessary gateway
allocations to termed
Other Notes: Use of
forfeitures can lower
costs

Traditional Match with New Comparability
480

`
Strengths
`
`
Senior partners reach

high level of savings
Junior partners have
flexibility with deferrals
and match, but save
something through
profit sharing
Forfeitures can reduce
cost
Weaknesses
` Senior partner with
lower comp does not
reach 415 limit
` Plan design is fairly
expensive
Case Study #1 Plan Design B

Safe Harbor
New Comparability
Case
StudyNonelective
#1 Planwith
Design
Analysis-B
`
`
`
`

(add provision to credit
Monthly Entry
Vesting 3 year cliff
Roth provision
ER Sources: Safe Harbor
and Discretionary
Nonelective
Eligibility & Vesting

Allows competitive edge
to attract experienced
talent; Vesting has less
impact since Safe Harbor
is immediate
Sources: 401(k) allows
individual savings; Safe
Harbor helps testing
481

Safe Harbor
New Comparability
Case
StudyNonelective
#1 Planwith
Design
Analysis-A
`
`
End of Year; 1,000 Hour
N/A - Safe Harbor
Not useful with Safe
Harbor
Other Notes: Safe Harbor
Noneletive Triple Coupon
= Pass ADP; Satisfy Top
Heavy Minimums; Use
towards Gateway
Minimums

Safe Harbor Nonelective with New Comparability
482

`
Strengths
`
`
`
`
Senior partners reach

high level of savings
flexibility with deferrals
Predictable and lower
cost than A
Triple Coupon Safe
Harbor
Weaknesses
` Senior partner with
lower comp does not
reach 415 limit
` Does not reward
savers
` Alloc Requirements
do not stop gateway
minimums
` Notice requirements
Case Study #1 Plan Design C

Age-weighted
Matching
Contribution
Case Study
#1 Plan
Design
Analysis-B
`
`
`
`

(add provision to credit
Monthly Entry
Roth provision
ER Sources: Age-weighted
Match (BRF Testing)
Eligibility & Vesting does

not hand the plan to new
hires, but allows
competitive edge to
attract experienced talent
individual savings; elective
match rewards deferring
Top heavy minimums
provide token for nondeferring
483

Age-weighted
Matching
Contribution
Case Study
#1 Plan
Design
Analysis-A
`
`
End of year; 1,000 hour
Must monitor the
ADP/ACP test as
participation changes
Other Nondiscrimination:
Match tested as Benefit,
Right or Feature to satisfy
Top heavy minimums to
employed;
Other Notes: Allows
match to have vesting and
end of year requirement
Cost: Very unpredictable
depending on participation
401(a)(4)

Age-weighted Matching Contribution
Age 21 to 35 35 to less 45 to less 55 or

Years of
Age
Match
Formula
484
than 45
Years of
Age
25% of
50% of
Deferrals Deferrals
than 55
Years of
Age
100% of
Deferrals
older
197% of
Deferrals


`
Strengths
`
`
`
`
`
`
Both senior partners

reach 415 limit
complete flexibility
Staff cost is lowest
based on current
participation
cost
Creative alternative
Helps older workers
Weaknesses
` ADP/ACP test
` Top heavy minimum
` Cost unpredictable
potentially very
expensive
` Complex prospect
might not understand
485
Case
Study
Case
Study
#1
#2 Utility Company
Utility Company (owned by resident customers)

No HCE, No Key (Board votes on decisions employed executive
director involved in decisions)
62 Currently Eligible Average Service is 7.5 Years
Executive Director (ED) Desires
Contribution for employees that cannot be removed by board vote

Provide incentive for individual savings
Enhance benefit for service and nearing retirement
ED is very paternal and wants employees to see value in plan

Bi-weekly pay periods
All company benefits have 1 month wait

Case
#1 and
Plan
Design
Analysis-B
401(k) Study
with Fixed Match
New Comparability
Group
by Individual
`
`
`
`
486
Eligibility One Month;

Entry on following pay
period
Roth provision
ER Sources: Fixed $1/$1
up to 4% Match; Flexible
New Comparability
Eligibility & Vesting High

average service
considered; brings them in
quickly
match rewards deferring
(not too high); can target
older / longer service EEs
with New Comp

Case
Study
#1 and
Plan
Design
Analysis-A
401(k) with Fixed Match
New Comparability
Group
by Individual
`
`
`
None
N/A No HCE
Other: Adding a loan
feature might enhance
participation limit to
one
Allows all participants to
benefit at some level
Other Notes: Vesting
allows for forfeitures
which can be allocated in
addition to board
determined allocation

401(k) with Fixed Match and New Comparability Group by Individual
487

401(k) with Fixed Match and New Comparability Group by Individual
Strengths
`
`
`
`
Has a fixed match

New comparability can
be used to target
certain employees flexibility
Incentive to save plus
nonelective
Forfeitures can allocate
as additional
Weaknesses
` Match is the only fixed
piece
` Nonelective is
completely
discretionary

401(k) with Fixed Match and Nonelective plus Points Allocation Weighted
Case Study #1 withPlan

Analysis-B
Service Design
& Age
`
`
`
`
488
Eligibility One Month;

Entry on following pay
date
Roth provision
ER Sources: Fixed $1/$1
up to 3% Match; 5% Fixed
Nonelective; Service/Age
Points Profit Sharing
Eligibility & Vesting High

average service
considered; brings them in
quickly
match rewards deferring;
fixed nonelective requires
amendment to stop; profit
sharing rewards service &
age

401(k) with Fixed Match and Nonelective plus Points Allocation Weighted
Case Study #1 with

Plan
Design
Analysis-A
Service &
Age
`
`
`
None
N/A No HCE
Other: Adding a loan
feature might enhance
participation limit to
one
All eligible receive ER
nonelective contributions
allows for forfeitures
which can be allocated in
addition to board
determined allocation

401(k) with Fixed Match and Nonelective plus Points Allocation Weighted with
Service & Age
Points Allocation Breakdown

` 3 Points for each year of service
` 1 point for each year of age over 20 not to exceed 45
points
489

Service & Age

Service & Age
Strengths
`
`
`
`
490
2 fixed components
nonelective
Forfeitures can allocate
as additional
Meaningful benefit for
employees
Weaknesses
` Cost
Case
Study
Case
Study
#1
#3 Dental Practice
Dental Practice
Two Owners Experienced Dentist age 62 (ED); New Dentist 34 (ND)
9 Eligible
Owner Desires
ED needs to increase saving nearing retirement

ND paying off debt (includes buying ED out); Also wants to save
Provide a decent retirement plan for all staff
ED spouse (61) and ND spouse (36) are co-office managers

Average age of staff is 32
$150,000 available for contributions
Currently have a SIMPLE 401(k)

Case
Study
#1Match
Plan
Design
Analysis-B
401(k) with
Safe Harbor
and Social
Security Integrated
Allocation
`
`
`
`

Dual Entry
Roth provision
Match with Social Security
Integrated Profit Sharing
Allocation

Fairly typical will not
benefit short timers
Harbor satisfies ADP/ACP
testing; integrated
allocation allows comp
based savings
491

Case
Study
#1Match
Plan
Design
Analysis-A
401(k) with Safe Harbor
and Social
Security Integrated
Allocation
`
End of year for profit
sharing
N/A-safe harbor
Top heavy will only be
paid to employed
Other Notes: No
additional testing required
for integrated allocation;

401(k) with Safe Harbor Match and Social Security Integrated Allocation
492

401(k) with Safe Harbor Match and Social Security Integrated Allocation
Strengths
`
`
`
`
High savings level for

dentists & spouses
nonelective
profit sharing
Integration allows safe
harbor allocation with
some disparity
Weaknesses
` Cost may be more
than they are willing
to spend
` ND may need the
cash flow for other
purposes
` Top heavy min
triggered with
nonelective

Case401(k)
Study
#1
Plan
Design
Analysis-B
with Safe
Harbor
Nonelective
and New Comparability
`
`
`
`

Dual Entry
Roth provision
Nonelective with New
Comparability Profit
Sharing

benefit short timers
Harbor satisfies ADP
testing; enhanced
contribution for ED and
none for ND help
493

Case401(k)
Study
Plan
Design
Analysis-A
with Safe#1
Harbor
Nonelective
and New Comparability
`
`
`
End of year & 1,000 hour
for New Comp above
gateway
N/A-safe harbor
Other: Drop ND New
Comp in early Years to
help testing enhance
benefit for ED and spouse
Allows practice to save on
amounts above gateway
minimums
allows for forfeitures to
reduce future allocations

401(k) with Safe Harbor Nonelective and New Comparability
Owners Share:
494
83.06%

401(k) with Safe Harbor Nonelective and New Comparability
Strengths
`
`
`
`
Targets ED
ND has flexibility
Cost significantly lower
than A
Predictable cost
Weaknesses
` Does not reward
savers

401(k)
Safe Harbor
with Triple
Stacked
Match
Case
Study
#1 Plan
Design
Analysis-B
`
`
`
`

Dual Entry
Roth provision
ER Sources: Enhanced Safe
Harbor Match to 4%;
Fixed Match based on 6%
of comp; Discretionary
Match to 4%

benefit short timers;
Allows vesting on Fixed &
Discretionary
Harbor satisfies ADP/ACP
testing; max contribution
for ED and ND; Avoid
discretionary match in
lean years
495

401(k)
Safe Harbor
with Triple
Stacked
Match
Case
Study
#1 Plan
Design
Analysis-A
`
`
N/A
N/A-safe harbor;
Additional Matches do not
require ACP testing
Other: ND has complete
flexibility
Eligible participating
receive all matching
allows for forfeitures to
reduce future allocations;
plan could be expensive
or cheap depending on
participation

401(k) Safe Harbor with Triple Stacked Match
Owners Share:
496
83.57%

401(k) Safe Harbor with Triple Stacked Match
`
Strengths
`
`
`
`
`
ED & spouse can pump

up savings
ND has complete
flexibility
Vesting on fixed and
discretionary match
No ACP test
Satisfies top heavy
Weaknesses
` Expensive and
unpredictable
Questions?
497
498
499
$118,117.41
Partners/Key
Staff
cost:
$41,858.16
50% to 6%
Match
19,951.69
21,906.47
79.09%
56,444.04
Partners' Share:
Staff Cost: $
$118,117.41
Partners/Key
Staff
cost:
$76,128.24
Safe Harbor
Nonelective
45,832.14
30,296.10
82.11%
44,636.25
Partners' Share:
Staff Cost: $
$118,117.41
Partners/Key
Staff
cost:
$9,634.88
Top Heavy
Minimum
0.00
9,634.88
77.95%
40,518.25
Partners' Share:
Staff Cost: $
Notes and Plan Assumptions
$233,385.66
$105,633.37
Total
143,250.00
90,135.66
Age:
21 - 35 YOA
75% of all
Age
Match Formula
100% of all
35 - < 45 YOA
Match: Age Tiers for Determining Matching Formula
125% of all
45 - < 55 YOA
Age-weighted Match
Strengths: Both senior partners reach 415 max
Junion partners have complete flexibility with match
Staff cost is lowest based on current participation
Forfeitures can reduce cost
Creative
Weaknesses: Must test Match in ACP as well as Benefit, Right or Feature
Top Heavy minimums must be paid
Costs will dramatically increase with participation - unpredictable
Complex - Prospect might not understand
197% of all
55 + YOA
Eligibility: Must be employed on the last day of the plan year to receive an employer contribution
Deferrals
68,500.00
49,617.41
Age
Weighted
Match
74,750.00
30,883.37
Safe Harbor Nonelective with New Comp

Strengths: Senior partners reach high level of savings
Junion partners have flexibility with 401(k), but have some savings through
nonelective contributions
Staff cost is lower than Plan Design A - costs predictable
Safe Harbor Nonelective triple use (pass ADP, satisfy TH min, GW count)
Weaknesses: Does not reward savers
Senior partner with lower comp does not reach 415 max
Allocation conditions - safe harbor nonelective automatically
grants Gateway minimum (may still have condition for amounts above)
Notice Requirements
Plan Design C
$299,170.07
Total
204,916.41
94,253.66
$104,924.42
Age-weighted Match
Deferrals
68,500.00
49,617.41
New
Comparability
Profit-Sharing
90,584.27
14,340.15
Weaknesses: Senior partner with lower comp does not reach 415 max
Plan is fairly expensive
Plan Design B
$319,558.31
Total
213,496.86
106,061.45
Traditional Match with New Comp

Strengths: Senior partners reach high level of savings
Junion partners have flexibility with match, but have some savings through
profit sharing piece
Forfeitures can reduce cost
Plan Design A
$159,582.74
Safe Harbor Nonelective with New Comp
Deferrals
68,500.00
49,617.41
New
Comparability
Profit-Sharing
125,045.17
34,537.57
Case Study #1 Real Estate Development Firm

Defined Contribution Retirement Plan Designs
Summary of Totals
500
Senior
Senior
Junior
Junior
Junior
Junior
Junior
Junior
Junior
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
First Name
Partner 1
Partner 2
Partner 1
Partner 2
Partner 3
Partner 4
Partner 5
Partner 6
Partner 7
Staff HCE 1
Staff HCE 2
Staff NHCE 1
Staff NHCE 2
Staff NHCE 3
Staff NHCE 4
Staff NHCE 5
Staff NHCE 6
Staff NHCE 7
Staff NHCE 8
Staff NHCE 9
Staff NHCE 10
Staff NHCE 11
Staff NHCE 12
Staff NHCE 13
Staff NHCE 14
Staff NHCE 15
Staff NHCE 16
Staff NHCE 17
Staff NHCE 18
Staff NHCE 19
Staff NHCE 20
Staff NHCE 21
Staff NHCE 22
Last Name
07/27/49
02/20/45
04/13/66
09/10/69
06/03/62
03/25/66
07/04/59
05/30/66
11/11/66
11/09/70
09/15/73
08/19/81
04/26/72
12/16/67
08/10/83
06/15/68
02/22/80
07/23/67
09/29/44
05/18/66
08/22/79
12/20/76
11/13/77
12/13/67
12/10/70
10/07/62
03/10/86
09/14/82
06/26/70
04/29/67
03/23/64
08/12/54
07/26/63
DOB
01/01/84
01/01/84
01/01/92
06/01/98
10/01/96
01/01/06
03/23/92
03/01/94
05/01/92
08/01/01
12/01/04
08/20/07
07/24/00
09/16/96
01/16/06
09/10/98
05/24/04
04/18/07
09/30/91
11/16/05
12/30/02
04/26/05
08/02/04
07/17/00
09/17/07
09/28/93
10/29/07
06/30/05
11/02/94
06/23/03
06/19/07
03/01/04
05/03/04
DOH
DOT
2080
2080
2080
2080
2080
2080
2080
1300
2080
2080
2080
2080
2080
2080
2080
2080
2080
2080
2080
2080
2080
2080
2080
1938
2080
2080
2080
2080
2080
2080
2080
2080
1456
Hours
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
Eligible HCE
Key
Key
Key
Key
Key
Key
Key
Key
Key
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
Key

Retirement Plan Analysis
Data Provided by Prospect
SP
SP
JP
JP
JP
JP
JP
JP
JP
Hstaff
HStaff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Group
270,956.98
149,041.51
130,175.62
155,839.24
179,620.09
121,995.74
216,331.40
184,226.54
160,507.63
102,182.91
100,693.67
77,897.31
43,190.97
45,204.18
11,600.15
44,892.39
81,166.82
18,685.66
42,918.53
51,840.36
14,999.31
14,371.49
32,133.93
41,849.77
32,826.81
44,409.93
12,631.03
10,081.93
21,414.84
28,265.41
75,987.48
25,190.01
35,435.42
Gross
Compensation
501
TOTALS:
Senior
Senior
Junior
Junior
Junior
Junior
Junior
Junior
Junior
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
First Name
Partner 1
Partner 2
Partner 1
Partner 2
Partner 3
Partner 4
Partner 5
Partner 6
Partner 7
Staff HCE 1
Staff HCE 2
Staff NHCE 1
Staff NHCE 2
Staff NHCE 3
Staff NHCE 4
Staff NHCE 5
Staff NHCE 6
Staff NHCE 7
Staff NHCE 8
Staff NHCE 9
Staff NHCE 10
Staff NHCE 11
Staff NHCE 12
Staff NHCE 13
Staff NHCE 14
Staff NHCE 15
Staff NHCE 16
Staff NHCE 17
Staff NHCE 18
Staff NHCE 19
Staff NHCE 20
Staff NHCE 21
Staff NHCE 22
Last Name
07/27/49
02/20/45
04/13/66
09/10/69
06/03/62
03/25/66
07/04/59
05/30/66
11/11/66
11/09/70
09/15/73
08/19/81
04/26/72
12/16/67
08/10/83
06/15/68
02/22/80
07/23/67
09/29/44
05/18/66
08/22/79
12/20/76
11/13/77
12/13/67
12/10/70
10/07/62
03/10/86
09/14/82
06/26/70
04/29/67
03/23/64
08/12/54
07/26/63
DOB
01/01/84
01/01/84
01/01/92
06/01/98
10/01/96
01/01/06
03/23/92
03/01/94
05/01/92
08/01/01
12/01/04
08/20/07
07/24/00
09/16/96
01/16/06
09/10/98
05/24/04
04/18/07
09/30/91
11/16/05
12/30/02
04/26/05
08/02/04
07/17/00
09/17/07
09/28/93
10/29/07
06/30/05
11/02/94
06/23/03
06/19/07
03/01/04
05/03/04
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
Eligible HCE
91.00
6575.00
Key
Key
Key
Key
Key
Key
Key
Key
Key
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
Key
SP
SP
JP
JP
JP
JP
JP
JP
JP
Hstaff
HStaff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Group
270,956.98
149,041.51
130,175.62
155,839.24
179,620.09
121,995.74
216,331.40
184,226.54
160,507.63
102,182.91
100,693.67
77,897.31
43,190.97
45,204.18
11,600.15
44,892.39
81,166.82
18,685.66
42,918.53
51,840.36
14,999.31
14,371.49
32,133.93
41,849.77
32,826.81
44,409.93
12,631.03
10,081.93
21,414.84
28,265.41
75,987.48
25,190.01
35,435.42
Gross
Compensation
108,117.41
15,500.00
15,500.00
15,500.00
12,000.00
6,130.97
6,041.61
2,591.36
1,808.21
696.01
2,693.55
6,493.40
2,370.21
1,499.93
1,437.15
250.00
4,184.95
3,996.88
604.92
1,284.89
848.00
4,559.25
2,126.13
10,000.00
5,000.00
5,000.00
-
Pre-Tax
/Roth
Catch-up
15,500.00
5,000.00
Projected
12/31/1958
PASS
6.74%
10.40%
11.91%
7.70%
0.00%
0.00%
0.00%
0.00%
0.00%
6.00%
6.00%
0.00%
6.00%
4.00%
6.00%
6.00%
8.00%
0.00%
5.52%
0.00%
10.00%
10.00%
0.78%
10.00%
0.00%
9.00%
0.00%
6.00%
6.00%
3.00%
6.00%
0.00%
6.00%
ADP

41,858.16
6,900.00
4,471.25
3,905.27
4,675.18
3,065.49
3,020.81
1,295.68
904.11
348.00
1,346.77
2,435.00
1,185.11
449.98
431.14
125.00
1,255.49
1,332.30
302.46
642.45
424.00
2,279.62
1,063.06
Match
PASS
3.00%
3.00%
3.00%
3.00%
0.00%
0.00%
0.00%
0.00%
0.00%
3.00%
3.00%
0.00%
3.00%
2.00%
3.00%
3.00%
3.00%
0.00%
2.76%
0.00%
3.00%
3.00%
0.39%
3.00%
0.00%
3.00%
0.00%
3.00%
3.00%
1.50%
3.00%
0.00%
3.00%
ACP
159,582.74
23,600.00
15,292.95
9,763.17
11,687.94
13,471.51
9,149.68
16,224.86
13,816.99
12,038.07
3,494.66
3,443.72
2,664.09
1,477.13
1,545.98
396.73
1,535.32
2,775.91
639.05
1,467.81
1,772.94
512.98
491.50
1,098.98
1,431.26
1,122.68
1,518.82
431.98
344.80
732.39
966.68
2,598.77
861.50
1,211.89
New Comp
Nonelective
Contribution
13.26%
13.26%
10.50%
10.50%
7.50%
7.50%
7.50%
7.50%
7.50%
6.42%
6.42%
3.42%
6.42%
5.42%
6.42%
6.42%
6.42%
3.42%
6.18%
3.42%
6.42%
6.42%
3.81%
6.42%
3.42%
6.42%
3.42%
6.42%
6.42%
4.92%
6.42%
3.42%
6.42%
Employer
Contribution
Percent
319,558.31
51,000.00
40,264.20
29,168.44
28,363.12
13,471.51
9,149.68
16,224.86
13,816.99
12,038.07
12,691.12
12,506.14
2,664.09
5,364.17
4,258.30
1,440.74
5,575.64
11,704.31
639.05
5,023.13
1,772.94
2,462.89
2,359.79
1,473.98
6,871.70
1,122.68
6,848.00
431.98
1,252.17
2,659.73
2,238.68
9,437.64
861.50
4,401.08
All
Contributions
Total
502
TOTALS:
Senior
Senior
Junior
Junior
Junior
Junior
Junior
Junior
Junior
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
First Name
Partner 1
Partner 2
Partner 1
Partner 2
Partner 3
Partner 4
Partner 5
Partner 6
Partner 7
Staff HCE 1
Staff HCE 2
Staff NHCE 1
Staff NHCE 2
Staff NHCE 3
Staff NHCE 4
Staff NHCE 5
Staff NHCE 6
Staff NHCE 7
Staff NHCE 8
Staff NHCE 9
Staff NHCE 10
Staff NHCE 11
Staff NHCE 12
Staff NHCE 13
Staff NHCE 14
Staff NHCE 15
Staff NHCE 16
Staff NHCE 17
Staff NHCE 18
Staff NHCE 19
Staff NHCE 20
Staff NHCE 21
Staff NHCE 22
Last Name
07/27/49
02/20/45
04/13/66
09/10/69
06/03/62
03/25/66
07/04/59
05/30/66
11/11/66
11/09/70
09/15/73
08/19/81
04/26/72
12/16/67
08/10/83
06/15/68
02/22/80
07/23/67
09/29/44
05/18/66
08/22/79
12/20/76
11/13/77
12/13/67
12/10/70
10/07/62
03/10/86
09/14/82
06/26/70
04/29/67
03/23/64
08/12/54
07/26/63
DOB
01/01/84
01/01/84
01/01/92
06/01/98
10/01/96
01/01/06
03/23/92
03/01/94
05/01/92
08/01/01
12/01/04
08/20/07
07/24/00
09/16/96
01/16/06
09/10/98
05/24/04
04/18/07
09/30/91
11/16/05
12/30/02
04/26/05
08/02/04
07/17/00
09/17/07
09/28/93
10/29/07
06/30/05
11/02/94
06/23/03
06/19/07
03/01/04
05/03/04
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
Eligible HCE
91.00
6575.00
Key
Key
Key
Key
Key
Key
Key
Key
Key
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
nonkey
Key
SP
SP
JP
JP
JP
JP
JP
JP
JP
Hstaff
HStaff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Group
270,956.98
149,041.51
130,175.62
155,839.24
179,620.09
121,995.74
216,331.40
184,226.54
160,507.63
102,182.91
100,693.67
77,897.31
43,190.97
45,204.18
11,600.15
44,892.39
81,166.82
18,685.66
42,918.53
51,840.36
14,999.31
14,371.49
32,133.93
41,849.77
32,826.81
44,409.93
12,631.03
10,081.93
21,414.84
28,265.41
75,987.48
25,190.01
35,435.42
Gross
Compensation
108,117.41
15,500.00
15,500.00
15,500.00
12,000.00
6,130.97
6,041.61
2,591.36
1,808.21
696.01
2,693.55
6,493.40
2,370.21
1,499.93
1,437.15
250.00
4,184.95
3,996.88
604.92
1,284.89
848.00
4,559.25
2,126.13
10,000.00
5,000.00
5,000.00
-
Pre-Tax
/Roth
Catch-up
15,500.00
5,000.00
Projected
12/31/1958

76,128.24
6,900.00
4,471.25
3,905.27
4,675.18
5,388.60
3,659.87
6,489.94
5,526.80
4,815.23
3,065.49
3,020.81
2,336.92
1,295.73
1,356.13
348.00
1,346.77
2,435.00
560.57
1,287.56
1,555.21
449.98
431.14
964.02
1,255.49
984.80
1,332.30
378.93
302.46
642.45
847.96
2,279.62
755.70
1,063.06
Safe Harbor
Nonelective
104,924.42
23,600.00
15,292.95
5,857.90
7,012.77
8,082.90
5,489.81
9,734.91
8,290.19
7,222.84
1,451.00
1,429.85
1,106.14
613.31
641.90
164.72
637.47
1,152.57
265.34
609.44
736.13
212.99
204.08
456.30
594.27
466.14
630.62
179.36
143.16
304.09
401.37
1,079.02
357.70
503.18
New Comp
Nonelective
Contribution
13.26%
13.26%
7.50%
7.50%
7.50%
7.50%
7.50%
7.50%
7.50%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
4.42%
Employer
Contribution
Percent
299,170.07
51,000.00
40,264.20
25,263.17
23,687.95
13,471.50
9,149.68
16,224.85
13,816.99
12,038.07
10,647.46
10,492.27
3,443.06
4,500.40
3,806.24
1,208.73
4,677.79
10,080.97
825.91
4,267.21
2,291.34
2,162.90
2,072.37
1,670.32
6,034.71
1,450.94
5,959.80
558.29
1,050.54
2,231.43
2,097.33
7,917.89
1,113.40
3,692.37
All
Contributions
Total
503
TOTALS:
Senior
Senior
Junior
Junior
Junior
Junior
Junior
Junior
Junior
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
First Name
Partner 1
Partner 2
Partner 1
Partner 2
Partner 3
Partner 4
Partner 5
Partner 6
Partner 7
Staff HCE 1
Staff HCE 2
Staff NHCE 1
Staff NHCE 2
Staff NHCE 3
Staff NHCE 4
Staff NHCE 5
Staff NHCE 6
Staff NHCE 7
Staff NHCE 8
Staff NHCE 9
Staff NHCE 10
Staff NHCE 11
Staff NHCE 12
Staff NHCE 13
Staff NHCE 14
Staff NHCE 15
Staff NHCE 16
Staff NHCE 17
Staff NHCE 18
Staff NHCE 19
Staff NHCE 20
Staff NHCE 21
Staff NHCE 22
Last Name
07/27/49
02/20/45
04/13/66
09/10/69
06/03/62
03/25/66
07/04/59
05/30/66
11/11/66
11/09/70
09/15/73
08/19/81
04/26/72
12/16/67
08/10/83
06/15/68
02/22/80
07/23/67
09/29/44
05/18/66
08/22/79
12/20/76
11/13/77
12/13/67
12/10/70
10/07/62
03/10/86
09/14/82
06/26/70
04/29/67
03/23/64
08/12/54
07/26/63
DOB
01/01/84
01/01/84
01/01/92
06/01/98
10/01/96
01/01/06
03/23/92
03/01/94
05/01/92
08/01/01
12/01/04
08/20/07
07/24/00
09/16/96
01/16/06
09/10/98
05/24/04
04/18/07
09/30/91
11/16/05
12/30/02
04/26/05
08/02/04
07/17/00
09/17/07
09/28/93
10/29/07
06/30/05
11/02/94
06/23/03
06/19/07
03/01/04
05/03/04
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
HCE
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
nhce
Eligible HCE
91.00
6575.00
Key
Key
Key
Key
Key
Key
Key
Key
Key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Non-key
Key
59
64
43
39
47
43
50
43
42
38
35
27
37
41
25
41
29
41
64
43
29
32
31
41
38
46
23
26
39
42
45
54
45
Age
End of Year
270,956.98
149,041.51
130,175.62
155,839.24
179,620.09
121,995.74
216,331.40
184,226.54
160,507.63
102,182.91
100,693.67
77,897.31
43,190.97
45,204.18
11,600.15
44,892.39
81,166.82
18,685.66
42,918.53
51,840.36
14,999.31
14,371.49
32,133.93
41,849.77
32,826.81
44,409.93
12,631.03
10,081.93
21,414.84
28,265.41
75,987.48
25,190.01
35,435.42
Gross
Compensation
108,117.41
15,500.00
15,500.00
15,500.00
12,000.00
6,130.97
6,041.61
2,591.36
1,808.21
696.01
2,693.55
6,493.40
2,370.21
1,499.93
1,437.15
250.00
4,184.95
3,996.88
604.92
1,284.89
848.00
4,559.25
2,126.13
Pre-tax/Roth
15,500.00
Projected
10,000.00
5,000.00
5,000.00
-
Catch-up
5,000.00
12/31/1958
PASS
6.74%
10.40%
11.91%
7.70%
0.00%
0.00%
0.00%
0.00%
0.00%
6.00%
6.00%
0.00%
6.00%
4.00%
6.00%
6.00%
8.00%
0.00%
5.52%
0.00%
10.00%
10.00%
0.78%
10.00%
0.00%
9.00%
0.00%
6.00%
6.00%
3.00%
6.00%
0.00%
6.00%
ADP

105,633.37
30,500.00
30,500.00
7,750.00
6,000.00
3,065.49
3,020.81
1,295.68
904.11
174.00
1,346.78
1,623.35
4,663.96
374.98
359.29
62.50
2,092.48
3,996.88
151.23
642.45
424.00
4,559.25
2,126.13
Age-weighted
Matching
Contribution
13.26%
20.46%
5.95%
3.85%
0.00%
0.00%
0.00%
0.00%
0.00%
3.00%
3.00%
0.00%
3.00%
2.00%
1.50%
3.00%
2.00%
0.00%
10.87%
0.00%
2.50%
2.50%
0.19%
5.00%
0.00%
9.00%
0.00%
1.50%
3.00%
1.50%
6.00%
0.00%
6.00%
Employer
Contribution
Percent
9,634.88
2,336.92
452.04
174.00
811.67
560.57
1,555.21
75.00
71.86
902.96
984.80
378.93
151.23
423.98
755.70
-
Top Heavy
Minimums
223,750.79
51,000.00
51,000.00
23,250.00
18,000.00
9,196.46
9,062.42
3,887.04
2,712.32
870.01
4,040.33
8,116.75
7,034.17
1,874.91
1,796.44
312.50
6,277.43
7,993.76
756.15
1,927.34
1,272.00
9,118.50
4,252.26
All
Contributions
Total
4.50%
PASS
13.26%
20.46%
5.95%
3.85%
0.00%
0.00%
0.00%
0.00%
0.00%
3.00%
3.00%
HCE
ACP
2.71%
4.71%
0.00%
3.00%
2.00%
1.50%
3.00%
2.00%
0.00%
10.87%
0.00%
2.50%
2.50%
0.19%
5.00%
0.00%
9.00%
0.00%
1.50%
3.00%
1.50%
6.00%
0.00%
6.00%
nhce
ACP
504
$72,180.79
$114,184.20
$108,719.61
108,719.61
New
Comparability
Profit-Sharing
180,900.40
$295,084.60
295,084.60
Total
Weaknesses: Match is only fixed piece
Strengths: Meets need for fixed contribution

New comparability can target certain employees
Provides incentive to save while also giving a nonelective contribution
Forfeitures can allocate in addition to profit sharing
$30,296.10
$114,184.20
$108,000.00
108,000.00
Age & Service

Weighted Points
Allocation
255,609.86
$369,794.06
369,794.06
Total
Weaknesses: Costs significantly more than Plan Design A

Provides incentive to save while also giving a nonelective contribution
Provides meaningful benefit for employees
Service: 1 point for each year of age over 20, not to exceed 45 points
Notes and Plan Assumptions
Company Contribution Cost: $
$117,313.76
117,313.76
Fixed
5% Allocation
Age: 3 points for each year of service
30,296.10
114,184.20
Deferrals
Fixed
100% to 3%
Match
Plan Design B
Traditional Match, Fixed Nonelective, Points Allocation
Traditional Match, Fixed Nonelective, Points Allocation
Company Contribution Cost: $
72,180.79
114,184.20
Deferrals
Fixed
100% to 4%
Match
Plan Design A
Case Study #2 Utility Company

Summary of Totals
505
Last Name
Staff 1
Staff 2
Staff 3
Staff 4
Staff 5
Staff 6
Staff 7
Staff 8
Staff 9
Staff 10
Staff 11
Staff 12
Staff 13
Staff 14
Staff 15
Staff 16
Director
Staff 17
Staff 18
Staff 19
Staff 20
Staff 21
Staff 22
Staff 23
Staff 24
Staff 25
Staff 26
Staff 27
Staff 28
Staff 29
Staff 30
Staff 31
Staff 32
Staff 33
Staff 34
Staff 35
Staff 36
First Name
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Executive
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
3/18/1962
6/24/1949
4/4/1962
9/6/1952
1/20/1978
5/27/1968
10/9/1971
10/14/1974
3/24/1982
7/19/1979
2/5/1960
6/5/1943
12/9/1969
1/24/1957
10/24/1960
9/19/1964
9/22/1946
12/1/1955
10/16/1960
2/8/1947
11/3/1958
1/27/1959
9/15/1976
7/1/1958
8/24/1975
11/15/1951
6/15/1967
7/8/1977
7/13/1961
9/25/1942
4/26/1945
5/28/1969
4/30/1964
10/10/1950
8/14/1961
4/5/1980
12/30/1980
DOB
2/28/2005
4/16/2001
3/4/1996
8/9/1999
4/17/2006
6/25/2007
5/14/2001
5/24/2000
9/5/2006
5/11/2005
5/14/2007
12/3/1984
4/19/1999
1/30/2006
4/11/1996
6/17/1996
8/2/1999
3/7/1988
9/22/2003
11/29/2004
9/11/2006
5/30/1996
4/12/2004
8/3/1983
11/13/1997
7/17/1981
5/30/1998
7/25/2005
10/28/2003
3/8/1985
11/20/1997
10/29/2001
10/24/2005
4/24/2006
9/11/2006
8/6/2007
7/30/2007
DOH
46
59
46
56
30
40
37
34
26
29
48
65
39
51
48
44
62
53
48
61
50
49
32
50
33
57
41
31
47
66
63
39
44
58
47
28
28
3
7
12
9
2
1
7
8
2
3
1
24
9
2
12
12
9
20
5
4
2
12
4
25
11
27
10
3
5
23
11
7
3
2
2
1
1
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Age
Service Eligible
######
365
30.00
6570.00
30,743.44
30,690.13
46,120.00
38,013.38
26,883.90
14,707.00
44,493.77
40,321.70
23,427.15
29,465.67
22,395.53
54,719.23
26,600.00
47,670.31
44,435.00
35,370.00
97,219.20
35,208.00
27,568.82
36,513.00
24,082.50
40,347.05
44,589.52
37,187.50
48,015.75
59,919.26
32,351.25
26,330.06
36,733.54
56,515.37
29,543.48
80,303.21
64,628.40
40,796.00
24,174.63
6,750.10
15,048.00
Compensation
225,000.00
45,000.00

401(k) with Match and New Comparability
912.00
1,248.00
2,008.40
30.00
19.20
1,292.00
1,060.80
655.20
760.59
446.40
7,952.88
1,300.00
6,708.00
1,248.00
1,029.60
4,033.60
3,246.80
1,029.62
1,836.00
683.76
1,045.20
3,272.01
2,447.20
1,185.60
1,746.68
764.40
1,289.60
10,773.56
6,334.32
5,502.13
1,886.31
1,185.60
686.40
28.30
320.00
Pre-tax or
Roth
15,500.00
912.00
1,248.00
1,520.54
30.00
19.20
1,292.00
1,060.80
655.20
760.59
446.40
2,188.77
1,064.00
1,906.81
1,248.00
1,029.60
3,888.77
1,408.32
1,029.62
1,460.52
683.76
1,045.20
1,783.58
1,487.50
1,185.60
1,746.68
764.40
1,289.60
2,260.61
1,181.74
3,212.13
1,886.31
1,185.60
686.40
28.30
320.00
4%
Match
Calculation
922.30
1,534.51
2,306.00
1,900.67
806.52
441.21
1,334.81
1,209.65
702.81
883.97
671.87
5,471.92
798.00
2,383.52
2,221.75
1,768.50
4,860.96
1,760.40
1,378.44
1,825.65
1,204.13
2,017.35
1,337.69
3,718.75
1,440.47
5,991.93
1,617.56
789.90
1,836.68
5,651.54
1,477.17
2,409.10
1,938.85
2,039.80
725.24
202.50
451.44
New Comp
Profit
Sharing
506
TOTALS:
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
Last Name
First Name
1/16/1962
10/10/1974
1/16/1966
10/4/1949
9/24/1958
3/13/1956
10/13/1944
4/6/1954
5/19/1982
11/10/1982
10/11/1959
11/26/1973
8/17/1974
9/10/1970
5/29/1952
8/22/1947
4/16/1983
5/22/1957
5/7/1954
3/25/1960
10/30/1957
2/5/1971
2/3/1975
7/28/1981
7/18/1965
DOB
9/6/1994
7/12/2004
6/7/1993
11/17/1994
5/17/1993
3/29/1993
7/16/2001
9/22/2003
3/5/2007
3/14/2005
6/27/1989
9/18/1997
6/15/2000
10/6/2003
11/28/2005
12/1/2004
10/24/2005
10/25/1990
11/3/1994
10/15/2007
3/2/1995
5/7/2001
4/30/2007
5/16/2005
4/22/2002
DOH
46
34
42
59
50
52
64
54
26
26
49
35
34
38
56
61
25
51
54
48
51
37
33
27
43
14
4
15
14
15
15
7
5
1
3
19
11
8
5
3
4
3
18
14
1
13
7
1
3
6
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Age
Service Eligible
######
365
30.00
6570.00
2,346,274.42
40,118.81
54,083.01
42,210.90
42,295.33
39,464.56
12,617.63
51,948.00
29,120.60
18,220.00
31,323.56
48,866.03
38,064.00
35,957.26
41,512.74
56,404.51
40,644.69
27,164.60
57,016.01
33,190.00
6,318.75
50,814.10
44,408.84
20,449.76
33,119.88
31,060.00
Compensation
225,000.00
45,000.00

401(k) with Match and New Comparability
114,184.20
1,170.00
2,929.60
4,056.00
2,620.80
2,279.64
730.40
1,619.44
741.10
431.93
832.80
1,911.00
1,747.47
1,101.08
1,788.80
1,150.20
736.32
1,650.48
2,318.80
96.00
5,428.80
1,070.38
297.00
1,508.00
Pre-tax or
Roth
15,500.00
72,180.79
1,170.00
2,163.32
1,688.44
1,691.81
1,578.58
504.71
1,619.44
741.10
431.93
832.80
1,911.00
1,438.29
1,101.08
1,788.80
1,150.20
736.32
1,650.48
1,327.60
96.00
2,032.56
1,070.38
297.00
1,242.40
4%
Match
Calculation
108,719.61
2,005.94
1,622.49
2,110.55
2,114.77
1,973.23
630.88
2,597.40
1,456.03
546.60
939.71
2,443.30
1,141.92
1,078.72
1,245.38
2,820.23
2,032.23
814.94
2,850.80
1,659.50
189.56
2,540.71
1,332.27
613.49
993.60
931.80
New Comp
Profit
Sharing
507
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Executive
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
First Name
Staff 1
Staff 2
Staff 3
Staff 4
Staff 5
Staff 6
Staff 7
Staff 8
Staff 9
Staff 10
Staff 11
Staff 12
Staff 13
Staff 14
Staff 15
Staff 16
Director
Staff 17
Staff 18
Staff 19
Staff 20
Staff 21
Staff 22
Staff 23
Staff 24
Staff 25
Staff 26
Staff 27
Staff 28
Staff 29
Staff 30
Staff 31
Staff 32
Staff 33
Staff 34
Staff 35
Staff 36
Last Name
3/18/1962
6/24/1949
4/4/1962
9/6/1952
1/20/1978
5/27/1968
10/9/1971
10/14/1974
3/24/1982
7/19/1979
2/5/1960
6/5/1943
12/9/1969
1/24/1957
10/24/1960
9/19/1964
9/22/1946
12/1/1955
10/16/1960
2/8/1947
11/3/1958
1/27/1959
9/15/1976
7/1/1958
8/24/1975
11/15/1951
6/15/1967
7/8/1977
7/13/1961
9/25/1942
4/26/1945
5/28/1969
4/30/1964
10/10/1950
8/14/1961
4/5/1980
12/30/1980
DOB
2/28/2005
4/16/2001
3/4/1996
8/9/1999
4/17/2006
6/25/2007
5/14/2001
5/24/2000
9/5/2006
5/11/2005
5/14/2007
12/3/1984
4/19/1999
1/30/2006
4/11/1996
6/17/1996
8/2/1999
3/7/1988
9/22/2003
11/29/2004
9/11/2006
5/30/1996
4/12/2004
8/3/1983
11/13/1997
7/17/1981
5/30/1998
7/25/2005
10/28/2003
3/8/1985
11/20/1997
10/29/2001
10/24/2005
4/24/2006
9/11/2006
8/6/2007
7/30/2007
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Eligible
30.00
6570.00
30,743.44
30,690.13
46,120.00
38,013.38
26,883.90
14,707.00
44,493.77
40,321.70
23,427.15
29,465.67
22,395.53
54,719.23
26,600.00
47,670.31
44,435.00
35,370.00
97,219.20
35,208.00
27,568.82
36,513.00
24,082.50
40,347.05
44,589.52
37,187.50
48,015.75
59,919.26
32,351.25
26,330.06
36,733.54
56,515.37
29,543.48
80,303.21
64,628.40
40,796.00
24,174.63
6,750.10
15,048.00
Compensation
225,000.00
45,000.00
912.00
1,248.00
2,008.40
30.00
19.20
1,292.00
1,060.80
655.20
760.59
446.40
7,952.88
1,300.00
6,708.00
1,248.00
1,029.60
4,033.60
3,246.80
1,029.62
1,836.00
683.76
1,045.20
3,272.01
2,447.20
1,185.60
1,746.68
764.40
1,289.60
10,773.56
6,334.32
5,502.13
1,886.31
1,185.60
686.40
28.30
320.00
Pre-tax or
Roth
15,500.00
YTD
889.20
1,248.00
997.80
30.00
19.20
1,185.60
1,060.80
655.20
760.59
446.40
1,590.68
780.00
1,341.60
1,248.00
1,029.60
2,916.68
998.40
722.74
1,060.80
683.76
1,045.20
1,277.36
1,048.80
1,185.60
1,746.68
764.40
967.20
1,665.56
854.91
2,358.19
1,886.31
1,185.60
686.40
21.23
192.00
3%
Match
YTD
1,537.17
1,534.51
2,306.00
1,900.67
1,344.20
735.35
2,224.69
2,016.09
1,171.36
1,473.28
1,119.78
2,735.96
1,330.00
2,383.52
2,221.75
1,768.50
4,860.96
1,760.40
1,378.44
1,825.65
1,204.13
2,017.35
2,229.48
1,859.38
2,400.79
2,995.96
1,617.56
1,316.50
1,836.68
2,825.77
1,477.17
4,015.16
3,231.42
2,039.80
1,208.73
337.51
752.40
5%
Fixed
YTD
9.000
21.000
39.000
24.000
6.000
3.000
21.000
24.000
3.000
9.000
3.000
69.000
27.000
6.000
36.000
36.000
24.000
60.000
12.000
9.000
3.000
36.000
12.000
72.000
30.000
78.000
30.000
6.000
12.000
69.000
30.000
18.000
6.000
6.000
3.000
-
Service
Points
1
3.000

401(k) with Match, Fixed 5% and Points for Age & Service Allocation
25.000
38.000
25.000
35.000
9.000
19.000
16.000
13.000
5.000
8.000
27.000
44.000
18.000
30.000
27.000
23.000
41.000
32.000
27.000
40.000
29.000
28.000
11.000
29.000
12.000
36.000
20.000
10.000
26.000
45.000
42.000
18.000
23.000
37.000
26.000
7.000
7.000
Age Points
Max
45.000
34.000
59.000
64.000
59.000
15.000
22.000
37.000
37.000
8.000
17.000
30.000
113.000
45.000
36.000
63.000
59.000
65.000
92.000
39.000
49.000
32.000
64.000
23.000
101.000
42.000
114.000
50.000
16.000
38.000
114.000
72.000
36.000
29.000
43.000
29.000
7.000
7.000
Total
Points
1,270.15
2,204.08
2,390.87
2,204.08
560.36
821.86
1,382.22
1,382.22
298.86
635.07
1,120.72
4,221.40
1,681.08
1,344.86
2,353.51
2,204.08
2,428.23
3,436.87
1,456.94
1,830.51
1,195.43
2,390.87
859.22
3,773.09
1,569.01
4,258.73
1,867.87
597.72
1,419.58
4,258.73
2,689.73
1,344.86
1,083.36
1,606.36
1,083.36
261.50
261.50
Points
Allocation
108,000.00
508
TOTALS:
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
Employee
First Name
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
Last Name
1/16/1962
10/10/1974
1/16/1966
10/4/1949
9/24/1958
3/13/1956
10/13/1944
4/6/1954
5/19/1982
11/10/1982
10/11/1959
11/26/1973
8/17/1974
9/10/1970
5/29/1952
8/22/1947
4/16/1983
5/22/1957
5/7/1954
3/25/1960
10/30/1957
2/5/1971
2/3/1975
7/28/1981
7/18/1965
DOB
9/6/1994
7/12/2004
6/7/1993
11/17/1994
5/17/1993
3/29/1993
7/16/2001
9/22/2003
3/5/2007
3/14/2005
6/27/1989
9/18/1997
6/15/2000
10/6/2003
11/28/2005
12/1/2004
10/24/2005
10/25/1990
11/3/1994
10/15/2007
3/2/1995
5/7/2001
4/30/2007
5/16/2005
4/22/2002
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Eligible
30.00
6570.00
2,346,274.42
40,118.81
54,083.01
42,210.90
42,295.33
39,464.56
12,617.63
51,948.00
29,120.60
18,220.00
31,323.56
48,866.03
38,064.00
35,957.26
41,512.74
56,404.51
40,644.69
27,164.60
57,016.01
33,190.00
6,318.75
50,814.10
44,408.84
20,449.76
33,119.88
31,060.00
Compensation
225,000.00
45,000.00
114,184.20
1,170.00
2,929.60
4,056.00
2,620.80
2,279.64
730.40
1,619.44
741.10
431.93
832.80
1,911.00
1,747.47
1,101.08
1,788.80
1,150.20
736.32
1,650.48
2,318.80
96.00
5,428.80
1,070.38
297.00
1,508.00
Pre-tax or
Roth
15,500.00
YTD
59,377.12
1,170.00
1,341.60
1,216.80
1,123.20
1,132.56
290.40
1,519.44
741.10
431.93
832.80
1,419.60
1,032.06
1,086.96
1,341.60
1,107.60
736.32
1,650.48
967.20
72.00
1,357.20
1,053.98
297.00
904.80
3%
Match
YTD
117,313.76
2,005.94
2,704.15
2,110.55
2,114.77
1,973.23
630.88
2,597.40
1,456.03
911.00
1,566.18
2,443.30
1,903.20
1,797.86
2,075.64
2,820.23
2,032.23
1,358.23
2,850.80
1,659.50
315.94
2,540.71
2,220.44
1,022.49
1,655.99
1,553.00
5%
Fixed
YTD
1,413.00
39.000
12.000
39.000
39.000
45.000
21.000
18.000
12.000
3.000
9.000
57.000
30.000
24.000
12.000
6.000
9.000
6.000
51.000
39.000
39.000
21.000
3.000
9.000
18.000
Service
Points
1
3.000

401(k) with Match, Fixed 5% and Points for Age & Service Allocation
1,478.00
25.000
13.000
21.000
38.000
29.000
31.000
43.000
33.000
5.000
5.000
28.000
14.000
13.000
17.000
35.000
40.000
4.000
30.000
33.000
27.000
30.000
16.000
12.000
6.000
22.000
Age Points
Max
45.000
2,891.000
64.000
25.000
60.000
77.000
74.000
52.000
61.000
45.000
8.000
14.000
85.000
44.000
37.000
29.000
41.000
49.000
10.000
81.000
72.000
27.000
69.000
37.000
15.000
15.000
40.000
Total
Points
108,000.00
2,390.87
933.93
2,241.44
2,876.51
2,764.44
1,942.58
2,278.80
1,681.08
298.86
523.00
3,175.37
1,643.72
1,382.22
1,083.36
1,531.65
1,830.51
373.57
3,025.94
2,689.73
1,008.65
2,577.65
1,382.22
560.36
560.36
1,494.29
Points
Allocation
108,000.00
cost:
$19,988.00
$171,343.86
79.65%
33,517.58
Owners' Share:
Staff Cost: $
Total
131,216.28
40,127.58
$79,345.86
Integrated
Profit-Sharing
50,536.28
28,809.58
Safe Harbor Match with Integrated Allocation

Provides incentive to safe while also giving a nonelective contribution
Weaknesses: May be more than they want to spend if $150,000 is researved for
retirement plan plus dividend distribution
Notice Requirements
Plan Design A
Case Study #3 Dental Practice

Summary of Totals
$63,110.00
ED & Spouse
ND & Spouse
Staff
cost:
$33,638.29
Cross-Tested
Profit-Sharing
28,424.29
0.00
5,214.00
ED & Spouse Share:

ND & Spouse Share:
Staff Cost: $
$19,281.00
Safe Harbor
NonElec
5,910.00
5,550.00
7,821.00
Deferrals
38,665.71
24,400.00
6,610.00
$69,675.71
ED & Spouse
ND & Spouse
Staff
cost:
$19,988.00
Enhanced
Safe Harbor
Match
7,880.00
7,400.00
4,708.00
56.93%
44.57%
$ 18,879.15
ED & Spouse Share:

ND & Spouse Share:
Staff Cost:
Total
73,000.00
56,642.86
25,489.15
$155,132.01
Discretionary
100% to 4%
7,880.00
7,400.00
4,708.00
Weaknesses: Expensive and unpredictable

Notice Requirements
No dividends leftover after plan contributions
Strengths: ED and spouse can pump up savings

ND has choice to save or forgo dividends and pay towards ownership through plan
Benefit of vesting on Fixed and Discretionary match without ACP test
Less expensive than plan design A
Safe Harbor with Triple Stacked Match
Weaknesses: Does not reward savers

ND must wait to fund his own retirement
Notice Requirements
Plan Design C
80.21%
30.77%
13,035.00
$116,029.29
Total
75,334.29
21,050.00
19,645.00
$19,988.00
$45,480.30
Fixed Match
157% to 6%
18,574.29
17,442.86
9,463.15
Safe Harbor with Triple Stacked Match
Deferrals
41,000.00
15,500.00
6,610.00
Strengths: ED and spouse can pump up savings

ND can forgo dividends and pay towards ownership through plan
Safe Harbor Nonelective triple use (pass ADP, satisfy TH min, GW count)
Staff cost is lower than Plan Design A - costs predictable
After funding the plan
Still have some of the $150,000 remaining after plan is fully funded
Plan Design B
$72,010.00
Dentists & Spouses

Staff
Safe Harbor
Match
15,280.00
4,708.00
Safe Harbor Match with Integrated Allocation
Deferrals
65,400.00
6,610.00
509
510
Last Name
Dentist
Spouse
Dentist
Spouse
EE1
EE2
EE3
EE4
EE5
EE6
EE7
EE8
EE9
First Name
Experienced
ED
New
ND
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
11/20/52
07/09/53
01/04/75
09/22/73
05/10/61
05/23/57
10/05/84
02/27/78
07/21/75
09/28/81
10/03/83
11/05/81
05/29/84
DOB
10/17/77
01/01/90
06/01/01
01/01/06
07/31/00
05/17/04
08/14/06
09/08/98
02/07/06
12/12/05
06/21/05
10/11/04
06/01/07
DOH
DOT
2080
1040
2080
1040
1456
1820
1820
1820
1820
1820
1820
1820
1820
Hours
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Eligible
15,500.00
15,500.00
15,500.00
8,900.00
1,170.00
1,560.00
1,800.00
780.00
1,300.00
62,010.00
642,700.00
Pre-tax or Roth
175,000.00
22,000.00
175,000.00
10,000.00
17,500.00
19,200.00
19,500.00
29,000.00
22,000.00
20,000.00
44,500.00
44,500.00
44,500.00
Gross
Compensation

Census Data Provided by Prospect
511
Dentist
Spouse
Dentist
Spouse
EE1
EE2
EE3
EE4
EE5
EE6
EE7
EE8
EE9
Experienced
ED
New
ND
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
TOTALS:
Last Name
First Name
11/20/52
07/09/53
01/04/75
09/22/73
05/10/61
05/23/57
10/05/84
02/27/78
07/21/75
09/28/81
10/03/83
11/05/81
05/29/84
DOB
10/17/77
01/01/90
06/01/01
01/01/06
07/31/00
05/17/04
08/14/06
09/08/98
02/07/06
12/12/05
06/21/05
10/11/04
06/01/07
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Eligible
91.00
6570.00
642,700.00
175,000.00
22,000.00
175,000.00
10,000.00
17,500.00
19,200.00
19,500.00
29,000.00
22,000.00
20,000.00
44,500.00
44,500.00
44,500.00
Gross
Compensation
62,010.00
15,500.00
15,500.00
15,500.00
8,900.00
1,170.00
1,560.00
1,800.00
780.00
1,300.00
-
Pre-tax or
Roth
15,500.00
Projected
10,000.00
5,000.00
5,000.00
-
Catch-up
5,000.00
1/1/1958
19,988.00
7,000.00
880.00
7,000.00
400.00
700.00
768.00
1,160.00
780.00
1,300.00
-
Safe Harbor
Match
79,345.86
23,500.00
2,431.19
23,500.00
1,105.09
1,933.90
2,121.76
2,154.92
3,204.75
2,431.19
2,210.17
4,917.63
4,917.63
4,917.63
Integrated
Profit Sharing
Contribution
13.43%
11.05%
13.43%
11.05%
11.05%
11.05%
11.05%
11.05%
11.05%
11.05%
11.05%
11.05%
11.05%
Profit Sharing
Contribution
Percent

Social Security Integration and Safe Harbor 401(k) with Match
99,333.86
30,500.00
3,311.19
30,500.00
1,505.09
2,633.90
2,889.76
2,154.92
4,364.75
2,431.19
2,210.17
5,697.63
6,217.63
4,917.63
Employer
Contribution
Including
Safe Harbor
17.43%
15.05%
17.43%
15.05%
15.05%
15.05%
11.05%
15.05%
11.05%
11.05%
12.80%
13.97%
11.05%
Employer
Contribution
Percent
171,343.86
51,000.00
23,811.19
46,000.00
10,405.09
3,803.90
4,449.76
2,154.92
6,164.75
2,431.19
2,210.17
6,477.63
7,517.63
4,917.63
All
Contributions
Total
512
Dentist
Spouse
Dentist
Spouse
EE1
EE2
EE3
EE4
EE5
EE6
EE7
EE8
EE9
Experienced
ED
New
ND
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
TOTALS:
Last Name
First Name
11/20/52
07/09/53
01/04/75
09/22/73
05/10/61
05/23/57
10/05/84
02/27/78
07/21/75
09/28/81
10/03/83
11/05/81
05/29/84
DOB
10/17/77
01/01/90
06/01/01
01/01/06
07/31/00
05/17/04
08/14/06
09/08/98
02/07/06
12/12/05
06/21/05
10/11/04
06/01/07
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Eligible
91.00
6570.00
ED
ED
ND
ND
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Classification
642,700.00
175,000.00
22,000.00
175,000.00
10,000.00
17,500.00
19,200.00
19,500.00
29,000.00
22,000.00
20,000.00
44,500.00
44,500.00
44,500.00
Gross
Compensation
53,110.00
15,500.00
15,500.00
15,500.00
1,170.00
1,560.00
1,800.00
780.00
1,300.00
-
Pre-tax or
Roth
15,500.00
Projected
10,000.00
5,000.00
5,000.00
-
Catch-up
5,000.00
1/1/1958
19,281.00
5,250.00
660.00
5,250.00
300.00
525.00
576.00
585.00
870.00
660.00
600.00
1,335.00
1,335.00
1,335.00
Safe Harbor
NonElective
33,638.29
25,250.00
3,174.29
350.00
384.00
390.00
580.00
440.00
400.00
890.00
890.00
890.00
New
Comparability
Profit Sharing
Contribution

New Comparability and Safe Harbor 401(k) with 3% Nonelective
52,919.29
30,500.00
3,834.29
5,250.00
300.00
875.00
960.00
975.00
1,450.00
1,100.00
1,000.00
2,225.00
2,225.00
2,225.00
Employer
Contribution
Including
Safe Harbor
17.43%
17.43%
3.00%
3.00%
5.00%
5.00%
5.00%
5.00%
5.00%
5.00%
5.00%
5.00%
5.00%
Employer
Contribution
Percent
116,029.29
51,000.00
24,334.29
20,750.00
300.00
2,045.00
2,520.00
975.00
3,250.00
1,100.00
1,000.00
3,005.00
3,525.00
2,225.00
All
Contributions
Total
513
TOTALS:
11/20/52
07/09/53
01/04/75
09/22/73
05/10/61
05/23/57
10/05/84
02/27/78
07/21/75
09/28/81
10/03/83
11/05/81
05/29/84
Experienced
ED
New
ND
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Staff
Dentist
Spouse
Dentist
Spouse
EE1
EE2
EE3
EE4
EE5
EE6
EE7
EE8
EE9
DOB
First Name Last Name
10/17/77
01/01/90
06/01/01
01/01/06
07/31/00
05/17/04
08/14/06
09/08/98
02/07/06
12/12/05
06/21/05
10/11/04
06/01/07
DOH
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Y
Eligible
91.00
6570.00
642,700.00
175,000.00
22,000.00
175,000.00
10,000.00
17,500.00
19,200.00
19,500.00
29,000.00
22,000.00
20,000.00
44,500.00
44,500.00
44,500.00
Gross
Compensation
62,010.00
15,500.00
15,500.00
15,500.00
8,900.00
1,170.00
1,560.00
1,800.00
780.00
1,300.00
-
Pre-tax or
Roth
15,500.00
Projected
7,665.71
5,000.00
2,665.71
-
Catch-up
5,000.00
1/1/1958
19,988.00
7,000.00
880.00
7,000.00
400.00
700.00
768.00
1,160.00
780.00
1,300.00
-
Safe Harbor
Match
Enhanced
45,480.30
16,500.00
2,074.29
16,500.00
942.86
1,650.00
1,810.29
2,734.29
1,225.71
2,042.86
-
Fixed
Match
157%

Safe Harbor 401(k) with Triple Stacked Match
19,988.00
7,000.00
880.00
7,000.00
400.00
700.00
768.00
1,160.00
780.00
1,300.00
-
Discretionary
Match
4.00%
85,456.30
30,500.00
3,834.29
30,500.00
1,742.86
3,050.00
3,346.29
5,054.29
2,785.71
4,642.86
-
Employer
Contribution
Including
Safe Harbor
17.43%
17.43%
17.43%
17.43%
17.43%
17.43%
0.00%
17.43%
0.00%
0.00%
6.26%
10.43%
0.00%
Employer
Contribution
Percent
155,132.01
51,000.00
22,000.00
46,000.00
10,642.86
4,220.00
4,906.29
6,854.29
3,565.71
5,942.86
-
All
Contributions
Total
514
CHOOSING
A RETIREMENT SOLUTION
for Your
Small Business
This pamphlet is a joint project of the U.S. Department of Labor's Employee Benefits Security Administration
(EBSA) and the Internal Revenue Service. Its publication does not constitute legal, accounting, or other
professional advice. It does, however, constitute a small entity compliance guide for purposes of the Small
Business Regulatory Enforcement Fairness Act of 1996.
This pamphlet and other EBSA publications are available by calling toll-free:
1-866-444-EBSA (3272)
Or by viewing them on the Internet at:
www.dol.gov/ebsa
It is also available from the IRS by calling
1-800-TAX FORM (1-800-829-3676)
(Please indicate publication number 3998 or catalog number 34066S when ordering.)
This material is also available to sensory-impaired individuals upon request.

Voice Phone:
1-202-219-8921
TDD* phone
1-800-326-2577
Starting a small business retirement savings

plan can be easier than most business people
think. Whats more, there are a number of
retirement programs that provide tax advan
tages to both employers and employees.
maximum contribution eligible for the credit is

$2,000. The credit rate can be as low as 10
percent or as high as 50 percent, depending on
the participants adjusted gross income.
A Roth 401(k) program that can be added to a
401(k) plan to allow participants to make after-tax
contributions into separate accounts, providing an
additional way to save for retirement.
Distributions upon death or disability or after age
59 1/2 of amounts held for 5 years in Roth accounts,
including earnings, are generally tax free.
Why Save?
Experts estimate that Americans will need 70 to 90
percent of their preretirement income to maintain their
current standard of living when they stop working. So
now is the time to look into retirement plan programs.
As an employer, you have an important role to play in
helping Americas workers save.
A Few Retirement Facts

Most private-sector retirement vehicles are either
Individual Retirement Arrangements (IRAs), defined
contribution (DC) plans or defined benefit (DB) plans.
By starting a retirement savings plan, you will help

your employees save for the future. Retirement plans
may also help you attract and retain qualified employ
ees, and they offer tax savings to your business. You
will help secure your own retirement as well. You can
establish a plan even if you are self-employed.
People tend to think of an IRA as something that indi

viduals establish on their own, but an employer can
help its employees set up and fund their IRAs. With
an IRA, the amount that an individual receives at
retirement depends on the funding of the IRA and the
earnings (or income) on those funds.
Any Tax Advantages?

A retirement plan has significant tax advantages:
Defined contribution plans are employer-established

plans that do not promise a specific amount of benefit
at retirement. Instead, employees or their employer
(or both) contribute to employees individual accounts
under the plan, sometimes at a set rate (such as 5 per
cent of salary annually). At retirement, an employee
receives the accumulated contributions plus earnings
(or minus losses) on such invested contributions.
Employer contributions are deductible from the

employers income,
Employee contributions are not taxed until distributed
to the employee, and
Money in the program grows tax-free.
Any Other Incentives?
Defined benefit plans, on the other hand, promise a

specified benefit at retirement, for example, $1000 a
month at retirement. The amount of the benefit is
often based on a set percentage of pay multiplied by
the number of years the employee worked for the
employer offering the plan. Employer contributions
must be sufficient to fund promised benefits.
In addition to helping your business, your employees

and yourself, recent tax law changes have made it eas
ier than ever to establish a retirement plan. They
include:
Higher contribution limits so your employees (and you)
can set aside even larger amounts for retirement;
Catch-up rules that allow employees aged 50 and
over to set aside additional contributions. The
amount varies, depending on the type of plan;
Tax credit for small employers that would enable
them to claim a tax credit for part of the ordinary
and necessary costs of starting a SEP, SIMPLE, or
certain other types of plans (more on these later).
The credit equals 50 percent of the cost to set up
and administer the plan, up to a maximum of $500
per year for each of the first 3 years of the plan; and
Tax credit for certain low- and moderate-income
individuals (including self-employed) who make
contributions to their plans (Savers tax credit).
The amount of the credit is based on the contribu
tions participants make and their credit rate. The
Small businesses may choose to offer IRAs, DC plans, or

DB plans. Many financial institutions and pension prac
titioners make available one or more of these retirement
plans that have been pre-approved by the IRS.
On the following two pages you will find a chart outlin
ing the advantages of each of the most popular types of
IRA-based and defined contribution plans and an
overview of a defined benefit plan.
-3
IRABASED PLANS
Payroll
Deduction IRA
Key
Advantage
Employer
Eligibility
Employers
Role
Contributors to
the Plan
Maximum
Annual
Contribution
(per participant)
See www.irs.gov/ep for
annual updates
Contributors
Options
Minimum
Employee
Coverage
Requirements
Withdrawals,
Loans and
Payments
Vesting
SEP
SIMPLE IRA Plan

Salary reduction plan with little
administrative paperwork.
Permits high level of salary deferrals

by employees without annual
discrimination testing.
Any employer with 100 or fewer

employees that does not currently
maintain another retirement plan.
Any employer with one or more

employees.
May use IRS Forms

5304SIMPLE or 5305SIMPLE
to set up the plan. No annual
filing requirement for employer.
Bank or financial institution
handles most of the paperwork.
No model form to establish this

plan. Advice from a financial
institution or employee benefit
advisor may be necessary.
A minimum amount of employer
contributions is required. Annual
filing of Form 5500 is required.
Employee salary reduction con

tributions and employer contri
butions.
Employee salary reduction contribu

tions and employer contributions.
$4,000 for 2007;

$5,000 for 2008.
Additional contribu
tions can be made by
participants age 50 or
over up to $1,000 in
2007.
Up to 25% of compensa Employee: $10,500 in 2007.

tion1 but no more than
Additional contributions can be
$45,000 for 2007.
made by participants age 50 or
over up to $2,500 in 2007.
Employee: $15,500 in 2007.

made by participants age 50 or over
up to $5,000 in 2007.
Employee can decide

how much to
contribute at any time.
Employer can decide

Employee can decide how much
whether to make contri to contribute. Employer must
butions yeartoyear.
make matching contributions
or contribute 2% of each
employees compensation.
Employee can decide how much to

contribute pursuant to a salary
reduction agreement. The employer
must make either specified matching
contributions or a 3% contribution
to all participants.
There is no require
ment. Can be made
available to any
employee.
Must be offered to all

employees who are at
least 21 years of age,
employed by the employ
er for 3 of the last 5 years
and had compensation of
$500 (for 2007).
Must be offered to all employees

who have earned income of at
least $5,000 in any prior 2
years, and are reasonably
expected to earn at least
$5,000 in the current year.
Generally, must be offered to all

employees at least 21 years of age
who worked at least 1,000 hours in
a previous year.
Withdrawals permitted
anytime subject to
federal income taxes;
early withdrawals sub
ject to an additional tax
(special rules apply to
Roth IRAs).
anytime subject to fed
eral income taxes, early
withdrawals subject to
an additional tax.
Withdrawals permitted anytime

subject to federal income taxes,
early withdrawals subject to an
additional tax.
Withdrawals permitted after a spec

ified event occurs (e.g., retirement,
plan termination, etc.) subject to
federal income taxes. Plan may
permit loans and hardship
withdrawals; early withdrawals
subject to an additional tax.
Contributions are
immediately 100%
vested.
Contributions are imme Employee salary reduction con

diately 100% vested.
tributions and employer contribu
tions are immediately 100% vested.

tions and most employer contribu
Some employer contributions may
vest over time according to plan
terms.
Easy to set up and

maintain.
Easy to set up and

maintain.
Any employer with one Any employer with one

or more employees.
or more employees.
Arrange for employees

to make payroll deduc
tion contributions.
Transmit contributions
for employees to IRA.
No annual filing
requirement for
employer.
May use IRS Form

5305SEP to set up
the plan. No annual
filing requirement for
employer.
Employee contributions Employer contributions

only.
remitted through
payroll deduction.
Employer: Either match

employee contributions 100% of
first 3% of compensation (can
be reduced to as low as 1% in
any 2 out of 5 yrs.); or con
tribute 2% of each eligible
employees compensation.2
Maximum compensation on which 2007 contribution can be based is $225,000.
Maximum compensation on which 2007 employer 2% nonelective contributions can be based is $225,000.
After 2007
Safe Harbor 401(k)
Employer/Employee Combined:
Up to the lesser of 100% of com
pensation1 or $45,000 for 2007.
Employer can deduct amounts that
do not exceed 25% of aggregate
compensation for all participants.
DEFINED CONTRIBUTION PLANS
IRABASED PLANS
Payroll
Deduction IRA
Key
Advantage
Employer
Eligibility
Employers
Role
Contributors to
the Plan
Maximum
Annual
Contribution
(per participant)
See www.irs.gov/ep for
annual updates
Contributors
Options
Minimum
Employee
Coverage
Requirements
Withdrawals,
Loans and
Payments
Vesting
SEP
SIMPLE IRA Plan
Automatic Enrollment
Safe Harbor 401(k)3
401(k)
Profit Sharing
Salary reduction plan with little

administrative paperwork.

by employees without annual
discrimination testing.
Permits high level of salary deferrals by

employees without annual discrimination
testing (after 2007).

by employees.
Permits employer to make large

contributions for employees.
Provides a fixed, preestab

lished benefit for employees.
Any employer with 100 or fewer

employees that does not currently
maintain another retirement plan.

employees.

employees.

employees.

employees.
Any employer with one or

more employees.
May use IRS Forms

5304SIMPLE or 5305SIMPLE
to set up the plan. No annual
filing requirement for employer.
Bank or financial institution
handles most of the paperwork.

plan. Advice from a financial
institution or employee benefit
advisor may be necessary.
A minimum amount of employer
contributions is required. Annual
filing of Form 5500 is required.
No model form to establish this plan.

Advice from a financial institution or
employee benefit advisor may be
necessary. A minimum amount of
employer contributions is required.
Annual filing of Form 5500 is required.

plan. Advice from a financial institu
tion or employee benefit advisor
may be necessary. Annual filing of
Form 5500 is required. Requires
annual nondiscrimination testing to
ensure plan does not discriminate
in favor of highly compensated
employees.

plan. Advice from a financial insti
tution or employee benefit advisor
may be necessary. Annual filing of
Form 5500 is required.
No model form to establish

this plan. Advice from a
financial institution or
employee benefit advisor
would be necessary. Annual
filing of Form 5500 is
required. An actuary must
determine annual contributions.
Employee salary reduction con

tributions and employer contri
butions.

tions and employer contributions.
Employee salary reduction contributions

and employer contributions.
Employee salary reduction

contributions and maybe employer
contributions.
Annual employer contribution is

discretionary.
Primarily funded by employer.
$4,000 for 2007;

$5,000 for 2008.
Additional contribu
tions can be made by
participants age 50 or
over up to $1,000 in
2007.
Up to 25% of compensa Employee: $10,500 in 2007.

tion1 but no more than
$45,000 for 2007.
made by participants age 50 or
over up to $2,500 in 2007.
Employee: $15,500 in 2007.

up to $5,000 in 2007.
Employee: See annual update for 2008

dollar limit. Additional contributions can
be made by participants age 50 or over.
Employee: $15,500 in 2007.

up to $5,000 in 2007.
Up to the lesser of 100% of

compensation1 or $45,000 for
2007. Employer can deduct
amounts that do not exceed 25%
of aggregate compensation for all
participants.
Annually determined contri

bution.
Employee can decide

how much to
contribute at any time.
Employer can decide

Employee can decide how much
whether to make contri to contribute. Employer must
butions yeartoyear.
make matching contributions
or contribute 2% of each
employees compensation.

must make either specified matching
contributions or a 3% contribution
to all participants.
Employees, unless they opt otherwise,

3% salary reduction contributions, with
automatic annual increases for 3 years.
The employer must make either specified
matching contributions or a 3% contribu
tion to all participants.

can make additional contributions,
including matching contributions as
set by plan terms.
Employer makes contribution as

set by plan terms. Employee
contributions, if allowed, as set by
plan terms.
Employer generally required

to make contribution as set
by plan terms.
There is no require
ment. Can be made
available to any
employee.
Must be offered to all

employees who are at
least 21 years of age,
employed by the employ
er for 3 of the last 5 years
and had compensation of
$500 (for 2007).
Must be offered to all employees

who have earned income of at
least $5,000 in any prior 2
years, and are reasonably
expected to earn at least
$5,000 in the current year.

a previous year.
Generally, must include all employees who

have not already opted out and who are
at least 21 years of age who worked at
least 1,000 hours in a previous year.

a previous year.

who worked at least 1,000 hours
in a previous year.
Generally, must be offered to

all employees at least 21 years
of age who worked at least
1,000 hours in a previous
year.
anytime subject to
federal income taxes;
early withdrawals sub
ject to an additional tax
(special rules apply to
Roth IRAs).
anytime subject to fed
eral income taxes, early
withdrawals subject to
an additional tax.
Withdrawals permitted anytime

subject to federal income taxes,
early withdrawals subject to an
additional tax.
Withdrawals permitted after a spec

ified event occurs (e.g., retirement,
plan termination, etc.) subject to
federal income taxes. Plan may
permit loans and hardship
Withdrawals permitted after a specified

event occurs (e.g., retirement, plan
termination, etc.) subject to federal
income taxes. Plan may permit loans
and hardship withdrawals; early
withdrawals subject to an additional tax.
Withdrawals permitted after a

specified event occurs (e.g., retire
ment, plan termination, etc.) subject
to federal income taxes. Plan may
permit loans and hardship with
drawals; early withdrawals subject
to an additional tax.
Withdrawals permitted after a

specified event occurs (e.g.,retire
ment, plan termination, etc.) sub
ject to federal income taxes. Plan
may permit loans and hardship
Payment of benefits after a

specified event occurs (e.g.
retirement, plan termination,
etc.). Plan may permit loans;
early withdrawals subject to
an additional tax.
Contributions are
immediately 100%
vested.
Contributions are imme Employee salary reduction con

diately 100% vested.
tributions and employer contribu

tions and most employer contribu
Some employer contributions may
terms.
Employee salary reduction contributions

vest immediately and most employer
contributions must be 100% vested after
2 years of service. Some employer
contributions may vest over longer
period according to plan terms.
Employee salary reduction

contributions are immediately 100%
vested. Employer contributions may
terms.
May vest over time according to

plan terms.
May vest over time according

to plan terms.
Easy to set up and

maintain.
Easy to set up and

maintain.
Any employer with one Any employer with one

or more employees.
or more employees.
Arrange for employees

to make payroll deduc
tion contributions.
Transmit contributions
for employees to IRA.
No annual filing
requirement for
employer.
May use IRS Form

5305SEP to set up
the plan. No annual
filing requirement for
employer.
Employee contributions Employer contributions

only.
remitted through
payroll deduction.
Employer: Either match

employee contributions 100% of
first 3% of compensation (can
be reduced to as low as 1% in
any 2 out of 5 yrs.); or con
tribute 2% of each eligible
employees compensation.2
Maximum compensation on which 2007 contribution can be based is $225,000.
Maximum compensation on which 2007 employer 2% nonelective contributions can be based is $225,000.
After 2007
Safe Harbor 401(k)
Defined Benefit
Up to the lesser of 100% of com
pensation1 or $45,000 for 2007.
Employer/Employee Combined: Up to
the lesser of 100% of compensation or
the dollar limit for 2008 (see annual
update). Employer can deduct amounts
that do not exceed 25% of aggregate
Up to the lesser of 100% of
compensation1 or $45,000 for 2007.
institution can do much of the paperwork.

Additionally, administrative costs are low.
Payroll-Deduction IRAs
Even if an employer does not want to adopt a retire
ment plan, it can allow its employees to contribute to
an IRA through payroll deductions, providing a simple
and direct way for eligible employees to save. The
decision about whether to contribute, and when and
how much to contribute to the IRA (up to $4,000 for
2007, $5,000 in 2008, increasing thereafter) is always
made by the employee in this type of arrangement.
Employers may either have employees set up their

own SIMPLE IRAs at a financial institution of their
choice or have all SIMPLE IRAs maintained at one
financial institution chosen by the employer.
Employees can decide how and where the money will
be invested, and keep their SIMPLE IRAs even when
they change jobs.
Many individuals eligible to contribute to an IRA do

not. One reason is that some individuals wait until the
end of the year to set aside the money and then find
that they do not have sufficient funds to do so.
Payroll deductions allow individuals to plan ahead and
save smaller amounts each pay period. Payroll deduc
tion contributions are tax-deductible by an individual,
to the same extent as other IRA contributions.
401(k) Plans
401(k) plans have become a widely accepted retire
ment savings vehicle for small businesses. Today, an
estimated 44 million American workers participate in
401(k) plans that have total assets of about $2.5 trillion.
With a traditional 401(k) plan, employees can choose
to defer a portion of their salary. So instead of receiv
ing that amount in their paycheck today, the employee
can contribute such amount into a 401(k) plan spon
sored by their employer. These deferrals are accounted
separately for each employee. Generally, the deferrals
(plus earnings) are not taxed by the federal govern
ment or by most state governments until distributed.
Simplified Employee Pensions (SEPs)

A SEP allows employers to set up a type of IRA for
themselves and each of their employees. Employers
must contribute a uniform percentage of pay for each
employee, although they do not have to make contri
butions every year. For the year 2007, employer con
tributions are limited to the lesser of 25 percent of pay
or $45,000. (Note: the dollar amount is indexed for
inflation and will increase.) Most employers, including
those who are self-employed, can establish a SEP.
401(k) plans can vary significantly in their complexity.

However, many financial institutions and other organi
zations offer prototype 401(k) plans, which can greatly
lessen the administrative burden on individual employers
of establishing and maintaining such plans.
SEPs have low start-up and operating costs and can be

established using a two-page form. And you can
decide how much to put into a SEP each year offer
ing you some flexibility when business conditions vary.
Safe Harbor 401(k) Plans

A safe harbor 401(k) plan is intended to encourage
plan participation among rank and file employees and
to ease administrative burden by eliminating the tests
ordinarily applied under a traditional 401(k) plan. This
plan is ideal for businesses with highly compensated
employees whose contributions would be limited in a
traditional 401(k) plan.
SIMPLE IRA Plan

This savings option is for employers with 100 or fewer
employees and involves a type of IRA.
A SIMPLE IRA plan allows employees to contribute a
percentage of their salary each paycheck and requires
employer contributions. Under SIMPLE IRA plans,
employees can set aside up to $10,500 in 2007 by pay
roll deduction. For years after 2007, annual cost-of-liv
ing updates can be found at www.irs.gov/ep.
Employers must either match employee contributions
dollar for dollar up to 3 percent of an employees
compensation or make a fixed contribution of 2 per
cent of compensation for all eligible employees.
A safe harbor 401(k) plan allows employees to con

tribute a percentage of their salary each paycheck and
requires employer contributions. In a safe harbor
401(k) plan, the mandatory employer contribution is
always 100 percent vested.
Automatic Enrollment Safe Harbor

401(k) Plans
SIMPLE IRA plans are easy to set up. You fill out a
short form to establish a plan and ensure that SIMPLE
IRAs (to hold contributions made under the SIMPLE
IRA plan) are set up for each employee. A financial
Beginning in 2008, automatic enrollment safe harbor

401(k) plans can increase plan participation among
rank-and-file employees and ease administrative bur
-6
den by eliminating the tests ordinarily required under

a traditional 401(k) plan. This plan is for employers
who want a high level of participation, and also have
highly compensated employees whose contributions
might be limited under a traditional plan.
If you do make contributions, you will need to have a

set formula for determining how the contributions are
allocated among plan participants. The funds are
accounted separately for each employee.
As with 401(k) plans, profit-sharing plans can vary
greatly in their complexity. Similarly, many financial
institutions offer prototype profit-sharing plans that can
reduce the administrative burden on individual
employers.
All employees are automatically enrolled in the plan

and contributions are deducted from their paychecks,
unless they opt out after receiving notice from the
plan. There are set employee contribution rates,
which rise incrementally over the first few plan years,
although different amounts can be chosen. Employer
contributions are also required. In addition, there is a
safe harbor for the default investment options provided
under the plan that relieves the employer from liability
for the investment results. Where contributions are
invested following the safe harbor, state payroll with
holding law is preempted, so plans may automatically
deduct contributions from employees wages unless
they opt out.

Some employers find that defined benefit (DB) plans

offer business advantages. For instance, employees

often value the fixed benefit provided by this type of

plan. In addition, employees in DB plans can often

receive a greater benefit at retirement than under any

other type of retirement plan. On the employer side,

businesses can generally contribute (and therefore

deduct) more each year than in defined contribution

plans. However, defined benefit plans are more com
plex and, thus, more costly to establish and maintain

than other types of plans.

Profit-Sharing Plans
Employer contributions to a profit-sharing plan are
discretionary. Depending on the plan terms, there is
often no set amount that an employer needs to
contribute each year.
To Find Out More

IRS Web site: www.irs.gov/ep

Tax form and publication ordering number:
1-800-TAX-FORM (1-800-829-3676)
(You can place your order 24 hours a day, 7 days a
week.)
The following jointly developed publications are avail

able for small businesses on the DOL and IRS Web
sites and through the toll-free numbers listed below:
401(k) Plans for Small Businesses (Publication 4222)
Payroll Deduction IRAs for Small Businesses
(Publication 4587)
SIMPLE IRA Plans for Small Businesses (Publication
4334)
SEP Retirement Plans for Small Businesses
(Publication 4333)
Retirement Plan Correction Programs (Publication
4224)
Retirement Plan Correction Programs CD-ROM
(Publication 4050)
Also available from the U.S. Department of Labor:

Meeting Your Fiduciary Responsibilities
Understanding Retirement Plan Fees and Expenses
Small Business Retirement Savings Advisor:
www.dol.gov/elaws/pwbaplan.htm
DOL Web site: www.dol.gov/ebsa

Publications request number: 1-866-444-EBSA (3272)

Also available from the Internal Revenue Service:

Publication 560, Retirement Plans for Small
Business (SEP, SIMPLE, and Qualified Plans)
Publication 590, Individual Retirement
Arrangements (IRAs)
Publication 4530, Designated Roth Accounts under
a 401(k) or 403(b) Plan
-7
Revised June 2007
Publication 3998 (Rev. 6-2007)
U.S. Department of Labor
for Small
SEP Retirement Plans Businesses
SEP Retirement Plans for Small Businesses is a joint project of the

U.S. Department of Labor's Employee Benefits Security Administration (EBSA)
and the Internal Revenue Service.
It is available on the Internet at: www.dol.gov/ebsa. For a complete list of
publications or to speak with a benefits advisor, call toll free:
1-866-444-EBSA (3272).
Or contact the agency electronically at www.askebsa.dol.gov.
SEP Retirement Plans for Small Businesses (IRS Publication 4333) is also
available from the Internal Revenue Service at:
1-800-TAX-FORM (1-800-829-3676)
(Please indicate publication number when ordering.)
This material is available to sensory impaired individuals upon request:
Voice phone: (202) 693-8513
TDD:
(202) 501-3911
This publication constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.
Looking for an easy and low-cost

retirement plan? Why not consider
a SEP?
Employee An employee is not only someone

who works for you, but also may be a selfemployed person as well as an owner-employee
who has earned income. In other words, you can
contribute to a SEP-IRA on your own behalf. The
term also includes employees of certain other
businesses you and/or your family own and certain
leased employees.
Simplified Employee Pension plans (SEPs) can

provide a significant source of income at retirement
by allowing employers to set aside money in
retirement accounts for themselves and their
employees. Under a SEP, an employer contributes
directly to traditional individual retirement
accounts (SEP-IRAs) for all employees (including
the employer). A SEP does not have the start-up
and operating costs of a conventional retirement
plan and allows for a contribution of up to 25
percent of each employees pay.
Eligible Employee An eligible employee is an

employee who:
1. Is at least 21 years of age, and
2. Has performed service for you in at least 3
of the last 5 years.
All eligible employees must participate in the plan,
including part-time employees, seasonal employees,
and employees who die or terminate employment
during the year.
Advantages of a SEP
Contributions to a SEP are tax deductible, and
your business pays no taxes on the earnings on
the investments.
Your SEP may also cover the following employees,

but there is no requirement to cover them:
You are not locked into making contributions

every year. In fact, you decide each year whether,
and how much, to contribute to your employees
SEP-IRAs.
Employees covered by a union contract;

Nonresident alien employees who did not earn
income from you;
Employees who received less than $450 in
compensation during the year (subject to cost-ofliving adjustments).
Generally, you do not have to file any

documents with the government.
Sole proprietors, partnerships, and corporations,
including S corporations, can set up SEPs.
Compensation The term generally includes

the pay an employee received from you for a years
work. As the owner/employee, your compensation
is the pay you received from the company.
Employers must follow the definition of
compensation included in the plan document.
You may be eligible for a tax credit of up to

$500 per year for each of the first 3 years for the
cost of starting the plan.
Administrative costs are low.
ESTABLISHING THE PLAN
As you read through this booklet, here are some

definitions you will find helpful:
There are just a few simple steps to establish a SEP.

Step 1: Contact a retirement plan professional or
a representative of a financial institution that offers
retirement plans and choose either the IRS model
SEP, Form 5305-SEP, Simplified Employee Pension
-1-
the IRS model form) and its instructions, along

with certain information about SEP-IRAs
(described in Employee Communications below).
The model SEP is not considered adopted until
each employee is provided with a written statement
explaining that:
Individual Retirement Accounts Contribution

Agreement, or another plan document offered by
the financial institution. Regardless of the SEP
document you choose, when filled in, it will
include the name of the employer, the requirements
for employee participation, the signature of a
responsible official, and a written allocation
formula for the employers contribution.
1. A SEP-IRA may provide different rates of return

and contain different terms than other IRAs the
employee may have;
2. The administrator of the SEP will provide a copy
of any amendment within 30 days of the
effective date, along with a written explanation of
its effects; and
3. Participating employees will receive a written
report of employer contributions made to SEPIRAs by January 31 of the following year.
A SEP may be established as late as the due date

(including extensions) of the companys income tax
return for the year you want to establish the plan.
For example, if your businesss fiscal year (a
corporate entity) ends on December 31 and you
filed for the automatic 6-month extension, the
companys tax return for the year ending December
31, 2004, would be due on September 15, 2005,
allowing you to make the initial SEP contribution
no later than September 15, 2005.
OPERATING THE PLAN
Choosing a financial institution for your SEP is

one of the most important decisions you will make,
since that entity becomes a trustee to the plan.
Trustees work closely with employers and agree to:
Once in place, a SEP is simple to operate. Your

trustee will take care of depositing the
contributions, investments, annual statements, and
any required filings with the IRS.
Receive and invest contributions, and
Contributions to SEP-IRA Accounts
Provide each participant with a notice of

employer contributions made each year and the
value of his/her SEP-IRA at the end of the year.
Your obligation is to forward contributions to your

financial institution/trustee for those employees
who participate as described in your plan
document. You will want to keep your financial
institution aware of any changes in the status of
those employees in the plan. As you hire new
employees, for instance, you will include them in
the SEP if they satisfy the eligibility criteria
described in the plan.
Trustees of SEP-IRAs are generally banks, mutual

funds, insurance companies that issue annuity
contracts, and certain other financial institutions
that have been approved by the IRS.
Step 2: Complete and sign Form 5305-SEP (or
other plan document, if not using the IRS model
form). When it is completed and signed, this form
becomes the plans basic legal document, describing
your employees rights and benefits. Do not send it
to the IRS; instead, use it as a reference since it sets
out the plans terms (e.g., eligible employees,
compensation, and employer contributions).
Your contributions to each employees SEP-IRA

account cannot exceed the lesser of $42,000 for
2005 (subject to future cost-of-living adjustments)
or 25 percent of the employees compensation.
These limits apply to your total contributions to
this plan and any other defined contribution plans
(other SEPs, 401(k), 403(b), profit-sharing, or
money purchase pension) you have.
Step 3: Give your employees a copy of the Form

5305-SEP (or other plan document, if not using
You do not have to make contributions every year.

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When you contribute, you must contribute to the

SEP-IRAs of all participants who actually
performed work for your business during the year
for which the contributions are made, even
employees who die or terminate employment
before the contributions are made. Contributions
for all employees generally must be uniformfor
example, the same percentage of contributions.
You must also provide a written statement

containing information about the terms of the
SEP, how changes are made to the plan, and
when employees are to receive information about
contributions to their accounts. (See Step 3
above.)
Your financial institution must provide each
employee participating in the plan with a plain,
nontechnical overview of how a SEP operates.
Employee salary reduction contributions cannot be

made under a SEP.
In addition to the information above, the

financial institution provides an annual
statement for each participants SEP-IRA,
reporting the fair market value of that account.
There are special rules if you are a self-employed

individual. For more information on the
deduction limitations for self-employed individuals,
see IRS Publication 560, Retirement Plans for Small
Business (SEP, SIMPLE, and Qualified Plans).
The financial institution also gives participating

employees a copy of the annual statement filed
with the IRS containing contribution and fair
market value information. (See Reporting to the
Government below.)
How Does a SEP work?

Quincy Chintz Company decides to establish a
SEP for its employees. Quincy has chosen a SEP
because the chintz industry is cyclical in nature,
with good times and down times. In good years,
Quincy can make larger contributions for its
employees, and in down times it can reduce the
amount. Quincy knows that under a SEP, the
contribution rate (whether large or small) must be
uniform for all employees. The financial
institution that Quincy has picked to be the trustee
for its SEP has several investment funds for the
Quincy employees to choose from. Individual
employees have the opportunity to divide their
employers contributions to their SEP-IRAs among
the funds made available to Quincys employees.
When an employee participating in the plan

receives distributions from his/her account, the
financial institution sends him/her a copy of the
form that is filed with the IRS for the
individuals distribution. (See Reporting to the
Government below.)
The financial institution will notify the
participant by January 31 of each year when a
minimum distribution is required.
Reporting to the Government
Employee Communications
When employees participate in a SEP, they must
receive certain key disclosure documents from you
and/or the financial institution/trustee:
SEPs are not required to file annual financial

reports with the Federal government. SEP-IRA
contributions are not included on the Form W-2,
Wage and Tax Statement.
You must give employees a copy of IRS Form

5305-SEP and its instructions (or other
document that was used to establish the plan).
When new employees become eligible to
participate in the plan, they also must receive a
copy of the plan.
The financial institution/trustee handling

employees SEP-IRAs provides the IRS and
participating employees with an annual statement
containing contribution and fair market value
information on Form 5498, IRA Contribution
Information.
-3-
not reasonable, you should consider replacing the

trustee.
Your financial institution also will report on Form

1099-R, Distributions From Pensions, Annuities,
Retirement or Profit-Sharing Plans, IRAs, Insurance
Contracts, etc., any distributions it makes from
participating employees accounts. The 1099-R is
sent to those receiving distributions and to the IRS.
TERMINATING THE PLAN

Although SEPs are established with the intention of
continuing indefinitely, the time may come when a
SEP no longer suits the purposes of your business.
When that happens, consult with your financial
institution to determine if another type of
retirement plan might be a better alternative.
Distributions
Participants cannot take loans from their SEP-IRA.
However, participants can make withdrawals at any
time. These monies can be rolled over tax free to
another SEP-IRA, to another traditional IRA, or to
another employers qualified retirement plan
(provided the other plan allows rollovers).
To terminate a SEP, notify the financial institution

that you will not make a contribution for the next
year and that you want to terminate the contract or
agreement. Although not mandatory, it is a good
idea to notify your employees that the plan will be
discontinued. You do not need to give any notice
to the IRS that the SEP has been terminated.
Money withdrawn from a SEP-IRA (and not rolled

over to another plan) is subject to income tax for
the year in which an employee receives a
distribution. If an employee withdraws money
from a SEP-IRA before age 59 1/2, a 10 percent
additional tax generally applies.
MISTAKES AND HOW TO CORRECT

THEM
Even with the best of intentions, mistakes in plan
operation can happen. The U.S. Department of
Labor and the IRS have correction programs to
help employers with SEPs to correct plan errors,
protect participants interests, and keep the plans
tax benefits. These programs are structured to
encourage early error correction. Ongoing review
makes it easier to spot and fix mistakes in the plans
operations. A booklet on the DOL/IRS correction
programs is listed in the Resources section below.
As with other traditional IRAs, participants in a

SEP-IRA must begin withdrawing a specific
minimum amount from their accounts by April 1
of the year following the year the participant
reaches age 70 1/2. For the year following the year
a participant reaches age 70 1/2, he/she must
withdraw an additional required minimum
distribution amount by December 31 of that year,
and annually thereafter. The financial
institution/trustee will notify the participant by
January 31 of each year when a minimum
distribution is required. (See IRS Publication 590,
Individual Retirement Arrangements (IRAs) regarding
required distributions.)
YOUR SEP A QUICK REVIEW

Choose a financial institution to set up your
SEP.
Monitoring the Trustee
Sign the agreement; set up the SEP-IRAs.
As the plan sponsor, you should monitor the

financial institution/trustee to assure that it is
doing everything it is required to do. You should
also ensure that the trustees fees are no more than
reasonable for the services it is providing. If the
trustee is not doing its job properly, or if its fees are
Inform your employees about the plan.

Deposit contributions by the due date of your
tax return.
Monitor your financial institution/trustee.
-4-
401(k) Plans for Small Businesses, Publication

4222, provides detailed information regarding
the establishment and operation of a
401(k) plan.
RESOURCES
The U.S. Department of Labors (DOLs) Employee
Benefits Security Administration and the IRS
feature this booklet and other information on
retirement plans on their Web sites:
Order from:
www.dol.gov/ebsa - Click on Compliance

Assistance for Small Employers and on
Publications/Reports for information you and
your employees can use.
IRS: 1-800-TAX-FORM (1-800-829-3676)

DOL: 1-866-444-EBSA (1-866-444-3272)
Related materials available from

DOL:
www.irs.gov/ep - Click on Information for Plan

Sponsor/Employer. This Web site is filled with
plain-language information that will help you
maintain your SEP properly. All the IRS forms
and publications mentioned in this booklet are
available here.
DOL sponsors two interactive Web sites the

Small Business Advisor, available at
www.dol.gov/elaws/pwbaplan.htm, and, along with
the U.S. Chamber of Commerce and the Small
Business Administration,
www.selectaretirementplan.org.
In addition, the following jointly developed

publications are available on the IRS and DOL
Web sites and can be ordered through the toll-free
numbers listed below:
Related materials available from the

IRS:
Business (SEP, SIMPLE, and Qualified Plans).
Choosing a Retirement Solution for Your Small

Business, Publication 3998, provides an overview
of retirement plans available to small businesses.

Arrangements (IRAs).
Retirement Plan Correction Programs, Publication

4224, provides a brief description of the IRS and
DOL correction programs. The publication also
includes a description of programs sponsored by
the Pension Benefit Guaranty Corporation
(PBGC) that apply to defined benefit plans.
Retirement Plan Correction Programs CD-ROM,
Publication 4050, provides information on the
IRS and PBGC (applicable to defined benefit
plans) correction programs, plus a link to DOL
information.
SIMPLE IRA Plans for Small Businesses,
Publication 4334, describes another type of
retirement plan designed for small businesses.
August 2005
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-Notes-
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11/5/04
1:24 AM
Page 1
for Small
SIMPLE IRA PLANS Businesses
11/5/04
1:24 AM
Page 2
Simple IRA Plans for Small Businesses is a joint project of the U.S. Department of Labor's
Employee Benefits Security Administration (EBSA) and the Internal Revenue Service.
This publication and other EBSA materials are available by calling toll-free:
1-866-444-EBSA (3272)
Or visit the agency's Web site at: www.dol.gov/ebsa
Simple IRA Plans for Small Businesses is also available from the Internal
Revenue Service at:
1-800-TAX-FORM (1-800-829-3676)
(Please indicate catalog number when ordering)
This material is available to sensory impaired individuals upon request:

Voice phone: (202) 693-8664
TDD:
(202) 501-3911
This publication constitutes a small entity compliance guide for purposes of the Small Business Regulatory Enforcement Fairness Act of 1996.
Thinking about a retirement plan?

If it seems like the right thing for
your business now, heres a SIMPLE
one.
ESTABLISHING THE PLAN

Starting a SIMPLE IRA plan is easy to do!
Step 1: Contact a retirement plan professional or
a representative of a financial institution that offers
retirement plans. Many financial institutions will
probably have a pre-approved SIMPLE IRA plan
form that you can review.
A SIMPLE (Savings Incentive Match Plan for

Employees of Small Employers) IRA plan offers
great advantages for businesses that meet two basic
criteria. First, your business must have 100 or
fewer employees (who earned $5,000 or more
during the preceding calendar year). In addition,
you cannot currently have another retirement plan.
If you are among the thousands of business owners
eligible for a SIMPLE IRA plan, read on to learn
more.
Step 2: Choosing a financial institution to

maintain employees' SIMPLE IRAs is one of the
most important decisions you will make, since that
entity becomes a trustee to the plan. (Alternatively,
you can decide to let employees choose the
financial institution that will receive their
contributions.)
A SIMPLE IRA provides employers and their

employees with a simplified way to contribute
toward retirement. It reduces taxes and, at the
same time, attracts and retains quality employees.
And compared to other types of retirement plans,
SIMPLE IRA plans offer lower start-up and annual
costs they are just simpler to operate.
Regardless of who makes the choice, only the

following institutions can be designated as trustees
of SIMPLE IRA plans: banks, mutual funds,
insurance companies that issue annuity contracts,
and certain other financial institutions that have
been approved by the IRS. Trustees agree to:
Receive and invest contributions, and
Provide the employer with a summary
description of the plan features each year.
Other Advantages of a SIMPLE IRA Plan:

SIMPLE IRA plans are easy to set up and run
your financial institution handles most of the
details.
Employees can contribute, on a tax-deferred
basis, through convenient payroll deductions.
You can choose either to match the employee
contributions of those who decide to
participate or to contribute a fixed percentage
of all eligible employees pay.
You may be eligible for a tax credit of up to
$500 per year for each of the first 3 years for
the cost of starting a SIMPLE IRA plan. (IRS
Form 8881, Credit for Small Employer
Pension Plan Startup Costs).
Administrative costs are low.
You are not required to file annual financial
reports.
Step 3: Choose a model form or other plan

document offered by your financial institution. If
your financial institution offers a model SIMPLE
IRA plan document, you will have a choice of two
forms to use:
IRS Form 5304-SIMPLE, Savings Incentive
Match Plan for Employees of Small Employers
(SIMPLE) - Not for Use With a Designated
Financial Institution, or
IRS Form 5305-SIMPLE, Savings Incentive
Match Plan for Employees of Small Employers
(SIMPLE) for Use With a Designated Financial
Institution.
-1-
The model form you use will depend on whether

you decide to select the financial institution that
will receive contributions or to let your employees
select financial institutions.
If employees are allowed to select the financial
institutions that will receive their SIMPLE IRA
plan contributions, you will fill out Form

5304-SIMPLE.
If you require that all contributions under the
SIMPLE IRA plan be initially deposited with a
designated financial institution, you will fill out
Form 5305-SIMPLE.
Enrolling Employees in a SIMPLE

IRA Plan
Your choice of the employees covered will be set

out in your selected plan document. You can
choose to cover all employees without restriction.
Alternatively, you can limit the employees covered
to those who received at least $5,000 in
compensation during any 2 years prior to the
current calendar year and who are reasonably
expected to receive at least $5,000 during the
current calendar year.
A SIMPLE IRA must be set up for each employee

eligible to participate. Employees must receive
notice of their right to participate, to make salary
reduction contributions, and to receive employer
contributions. In addition, employees must receive
information about the plan, including a copy of the
summary description. The required notice also
informs employees of the plans election periods
during which eligible employees can decide to
contribute to the plan. For employers that use one
of the model forms, page 3 of Form 5304-SIMPLE
and page 3 of Form 5305-SIMPLE contain a
model notice.
SIMPLE IRA plans operate on a calendar-year

basis. An employer may initially set up a SIMPLE
IRA plan as late as October 1.
Step 4: Complete and sign the selected IRS form

(or other plan document, if not using a model
form). When it is completed and signed, this
document becomes the plans basic legal document,
describing your employees rights and benefits. Do
not send it to the IRS; instead keep it handy.
Employee Contributions
Employees can make salary reduction contributions
in any amount to a SIMPLE IRA plan up to the
legal limits. The maximum amount that an
employee can contribute is $9,000 in 2004,
increasing to $10,000 in 2005. (This amount may
be subject to adjustments for years after 2005.)
Additional employee contributions (known as
catch-up contributions) are allowed for employees
age 50 or over. The additional contribution limit is
$1,500 in 2004, $2,000 in 2005, and $2,500 in
2006. (This amount may be subject to adjustments
for years after 2006.)
OPERATING THE PLAN

A SIMPLE IRA plan is true to its name when it
comes to plan operation. Contributions under the
plan (employees and yours) are simply deposited
into individual retirement accounts or annuities.
Participants in a SIMPLE IRA Plan

Employees who elect to make contributions or to
whose accounts you deposit contributions are
participants. Your obligation is to provide
information to your financial institution on those
employees who can participate as described in your
plan document. You will want to keep your
financial institution aware of any changes in the
status of those employees who can participate (for
example, new employees).
Each year employees can change their contribution

levels during the plans election period. This
election period must be at least 60 days long, and
employees must receive prior notice about an
upcoming election opportunity. SIMPLE IRA
plans that have already been established must have
an annual election period that extends from
November 2 to December 31. A plan can have
more election periods each year in addition to this
60-day election period.
-2-
communicate to employees before the beginning of

the 60-day election period.
Employer Contributions
You have two choices in determining your
contributions to the SIMPLE IRA plan:
A 2 percent nonelective employer contribution,
where employees eligible to participate receive
an employer contribution equal to 2 percent of
their compensation, regardless of whether they
make their own contributions.
A dollar-for-dollar match up to 3 percent of
pay, where only the participating employees
who have elected to make contributions will
receive an employer contribution, i.e., the
matching contribution.
Depositing and Investing Plan

Contributions
Employee contributions must be deposited in the
financial institution serving as trustee for the plan
within 30 days after the end of the month in which
the amounts would otherwise have been payable to
the employee in cash. Your employer contributions
must be made by the due date (including
extensions) for filing your businesss Federal income
tax return for the year.
Each year, you can choose which one you will use
for the next years contributions. This choice is
part of the information you are required to
After forwarding the SIMPLE IRA plan

contributions to the trustee, the trustee will invest
the funds, in many cases at the direction of the
How Does a SIMPLE IRA Plan Work?

Example 1:
Elizabeth works for the Rockland Quarry Company, a small business with 50 employees. Rockland has decided
to establish a SIMPLE IRA plan for all its employees and will match its employees contributions dollar-fordollar up to 3 percent of each employees salary. Under this option, if a Rockland employee does not contribute
to his or her SIMPLE IRA, then that employee does not receive any matching employer contributions from
Rockland.
Elizabeth has a yearly salary of $50,000 and decides to contribute 5 percent of her salary to her SIMPLE IRA.
Elizabeths yearly contribution is $2,500 (5 percent of $50,000). The Rockland matching contribution is $1,500
(3 percent of $50,000). Therefore, the total contribution to Elizabeths SIMPLE IRA that year is $4,000 (her
$2,500 contribution plus the $1,500 contribution from Rockland). The financial institution partnering with
Rockland on the SIMPLE IRA has several investment choices and Elizabeth is free to pick and choose which
ones suit her best.
Example 2:
Austin works for the Skidmore Tire Company, a small business with 75 employees. Skidmore has decided to
establish a SIMPLE IRA plan for all its employees and will make a 2 percent nonelective contribution for each
of its employees. Under this option, even if an eligible Skidmore employee does not contribute to his or her
SIMPLE IRA, that employee would still receive an employer nonelective contribution to his or her SIMPLE
IRA equal to 2 percent of salary.
Austin has a yearly salary of $40,000 and has decided that this year he simply cannot make a contribution to his
SIMPLE IRA. Even though Austin does not make a contribution this year, Skidmore must make a nonelective
contribution of $800 (2 percent of $40,000). The financial institution partnering with Skidmore on the
SIMPLE IRA has several investment choices, and Austin has the same investment options as the other plan
participants.
-3-
participants. SIMPLE IRAs can be invested in

stocks, bonds, mutual funds, and similar types of
investments. Employee and employer
contributions are always 100 percent vestedthat
is, the money an employee has put aside plus
employer contributions and earnings from
investments cannot be forfeited. Employees can
move their SIMPLE IRA assets from one SIMPLE
IRA plan to another in accordance with the
procedures of the financial institution.
SIMPLE IRA plan), along with the financial

institution's procedures for withdrawals and
transfers.
Each year, in addition to the information above,
employees must receive an annual election notice
describing their right to make salary reduction
contributions and the employers decision to make
either matching or nonelective contributions for
the following year. For employers that use one of
the model forms, page 3 of Form 5304-SIMPLE
and page 3 of Form 5305-SIMPLE contain a
Model Notification to Eligible Employees that can be
used to provide this information to employees.
Communicating With Employees

There are two key disclosure documents that keep
participants informed about the basics of how the
plan operates, inform them of changes in the plans
structure and operation, and provide them a chance
to make decisions and take timely action with
respect to their accounts.
Every year, during the 60-day election period at the

end of the year, employees must be given the
opportunity to enter into a salary reduction
agreement or to modify an existing agreement.
Reporting to the Government
The summary description is a plain-language

explanation of the plan and is comprehensive
enough to inform participants of their rights and
responsibilities under the plan. It also informs
participants about the features of the plan. This
document is usually provided by the financial
institution and is given to participants at the plans
inception, when employees first join the plan, and
annually thereafter.
SIMPLE IRA plans are NOT required to file

annual financial reports with the government.
Distributions from the plan are reported by the
financial institution making the distribution to
both the IRS and the recipients of the distributions
on Form 1099-R, Distributions from Pensions,
Annuities, Retirement or Profit-Sharing Plans, IRA,
Insurance Contracts.
A summary description must include:

1. The names and addresses of the employer and
trustee,
2. A description of the requirements for eligibility
to participate,
3. The benefits provided,
4. The time and method of making salary
elections, and
5. The procedure for, and effects of, withdrawals
and rollovers (including the penalties for early
withdrawals).
The financial institution/trustee handling the

SIMPLE IRAs provides the IRS and participants
with an annual statement containing contribution
and fair market value information on Form 5498,
Individual Retirement Arrangement Contribution
Information.
SIMPLE IRA contributions are not included in the
Wages, tips, other compensation box of Form
W-2, Wage and Tax Statement. However, salary
reduction contributions must be included in the
boxes for Social Security and Medicare wages.
Employers can satisfy the summary description

requirement by providing employees with the most
recent copy of IRS Form 5304-SIMPLE or 5305SIMPLE provided by the Financial Institution (if
one of these model forms is used to establish the
-4-
When Employees Want to Stop

Contributions
31 of that year. (For further details regarding the

required minimum distribution amount, see IRS
Publication 590.)
Employees may elect to terminate their salary

reduction contributions to a SIMPLE IRA plan at
any time. If they do so, the SIMPLE IRA plan may
preclude them from resuming salary reduction
contributions until the beginning of the next
calendar year. Employers that are making
nonelective employer contributions must continue
to make them on behalf of these employees.
Monitoring the Trustee
Distributions
As the plan sponsor, you should monitor the

trustee to assure that it is doing everything that it is
required to do. You should also ensure that the
trustees fees are no more than reasonable for the
services it is providing. If the trustee is not doing
its job properly, or if its fees are not reasonable, you
should consider replacing the trustee.
Participants cannot take loans from their SIMPLE

IRAs.
TERMINATING THE PLAN
SIMPLE IRA contributions and earnings can be

withdrawn at any time. When participants take a
distribution, they typically can elect to:
Take a lump sum distribution of their account,
or
Roll over their account to an IRA or another
employers retirement plan.
Although SIMPLE IRA plans are established with

the intention of being on-going, the time may
come when a SIMPLE IRA plan no longer suits the
purposes of your business. When that happens,
consult with your financial institution to determine
if another type of retirement plan might be a better
alternative.
Distributions from a SIMPLE IRA are generally

subject to income tax for the year in which they are
received. If a participant takes a withdrawal from a
SIMPLE IRA before age 59 1/2, generally a 10
percent additional tax applies. If such withdrawal
occurs within 2 years of beginning participation,
the 10 percent tax is increased to 25 percent.
To terminate a SIMPLE IRA plan, notify the

financial institution that you will not make a
contribution for the next calendar year and that
you want to terminate the contract or agreement.
You must also notify your employees that the
SIMPLE IRA plan will be discontinued.
You do not need to give any notice to the IRS that
the SIMPLE IRA plan has been terminated.
SIMPLE IRA contributions and earnings may be

rolled over tax-free from one SIMPLE IRA to
another. A tax-free rollover may also be made from
a SIMPLE IRA to another type of IRA, or to
another employers qualified plan, after 2 years of
beginning participation in the original plan.
MISTAKES AND HOW TO

CORRECT THEM
Even with the best intentions, mistakes in plan
operation can still happen. The U.S. Department
of Labor and the IRS have correction programs to
help SIMPLE IRA plan sponsors correct plan
errors, protect participants, and keep the plans tax
benefits. These programs are structured to
encourage you to correct the errors early.
A specific minimum amount of SIMPLE IRA

contributions and earnings is required to be
distributed by April 1 of the year following the year
the participant reaches age 70 1/2. After this initial
year, the participant must receive a required
minimum distribution for each year by December
-5-
Periodically reviewing the plan makes it easier to

spot and correct mistakes in plan operation.
See the Resources section for further information.
Retirement Plan Correction Programs CDROM, Publication 4050, provides in-depth

information on the IRS, DOL, and PBGC
correction programs.
YOUR SIMPLE IRA PLAN A

QUICK REVIEW
Order from:
IRS: 1-800-TAX-FORM (1-800-829-3676)
DOL: 1-866-444-EBSA (3272)
Choose a financial institution to set up your

SIMPLE IRA plan.
Enroll your employees and start salary
reduction contributions.
Deposit contributions timely.
Tell your employees about their rights under
the plan.
Monitor your trustee.
Related materials available from DOL:

DOL sponsors two interactive Web sites - the Small
Business Advisor, available on the DOL Web site,
and, along with the U.S. Chamber of Commerce
and the Small Business Administration,
www.selectaretirementplan.org.
Related materials available from the IRS:
RESOURCES

Business (SEP, SIMPLE, and Qualified Plans)
Arrangements (IRAs)
The U S. Department of Labors (DOLs)

Employee Benefits Security Administration and the
IRS feature this booklet and additional information
on retirement plans on their Web sites:
www.dol.gov/ebsa - Click on Compliance
Assistance for Small Employers and on
Publications/Reports for information you and
your employees can use.
www.irs.gov/ep - Click on Retirement Source for
Plan Sponsors/Employers. All the forms and
publications mentioned in this booklet are available
on this Web site.
The following jointly developed publications are
available on the IRS and DOL Web sites and
through the toll-free numbers listed below:
Choosing a Retirement Solution for Your Small
Business, Publication 3998, provides an
overview of retirement plans available to small
businesses.
Retirement Plan Correction Programs,
Publication 4224, provides a brief description
of the IRS, DOL, and Pension Benefit
Guaranty Corporation (PBGC) correction
programs.
-6-
NOTES
-7-
11/5/04
1:24 AM
Page 3

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American Society of Pension Professionals & Actuaries

American Society of Pension ProfessionalS & Actuaries

CPC Study guide

Advanced Retirement Plan Consulting

CPC Study Guide:

4245 North Fairfax Drive, Suite 750

Controlled Groups under IRC 414(b) and 414(c) .................................................................1

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Effect of QSLOB Status on Qualified Plans .................................................................21

Minimum Participation Test Under IRC 401(a)(26) .............................................................47

Correction Procedures ....................................................................................................75

Cash or Deferred Arrangements (CODA) Basics ...................................................................87

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

QNECs and QMACs .....................................................................................................111

Other Plan Types .......................................................................................................................147

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Loan Default and Offset ...............................................................................................209

ERISA Coverage ........................................................................................................................223

Blackout Notices ............................................................................................................236

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Employee Plan Compliance Resolution System (EPCRS) Overview ................................269

Correction for Failure to Make Timely Deposit of Deferrals ..................................288

Plan Types ..................................................................................................................................345

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Case Study # 9 ............................................................................................................................392

About this Study Guide

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Explanation of the ASPPA CPC Examination

What is the purpose of the CPC examination?

What topics may appear on the CPC examination?

Will the CPC examination be given on a computer?

Why is the CPC examination an essay type instead of multiple-choice?

ability to apply knowledge meaningfully to realistic consulting situations.

How are the examination questions structured?

How many hours of study are required to pass the examination?

How should a candidate study for the examination?

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Are there any calculations on the CPC examination?

Who grades the ASPPA CPC examination?

How is the passing mark determined?

How many times a year is the examination given?

Where can I obtain additional information on the CPC examination?

Test Taking Tips

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

The Grading Process

Controlled Groups under IRC 414(b) and 414(c)

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

85% owned by Co. A

50% owned by Co. A

95% owned by Co. B

100% owned by Co. C

85% owned by Co. B

Chapter 1: Related Groups & Business Transactions

EXAMPLE: The ownership of two related companies is as follows:

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

ATTRIBUTION UNDER IRC 1563 FOR CONTROLLED GROUPS

No direct ownership in spouses business (caution: community property

Not a director, not an employee and does not participate in management of

No distribution restrictions of spouses stock in favor of the spouse or minor

Chapter 1: Related Groups & Business Transactions

CPC Study Guide: Advanced Retirement Plan Consulting, 3rd Edition

Ownership held by a deferred compensation plan (qualified or nonqualified);

Certain interest held by a subsidiary;

Restricted stock; and