Retirement Plans

A Traditional 401(k) Plan is a defined contribution plan which allows eligible employees to make pre-tax elective deferrals through payroll deductions. Along with employee pre-tax deferrals, Employers may make two types of discretionary contributions: (1) Profit Sharing Contribution – a contribution given to all eligible employees; or (2) Matching Contribution – a contribution given only to those individuals who actively defer into the Plan. Employers may choose to have neither option, one option or both.

401(k) Plans require that contributions made under the Plan meet specific nondiscrimination requirements. In order to ensure that the Plan satisfies these requirements, the Employer must perform an annual test, also known as the Actual Deferral Percentage (ADP) test. If the Employer provides a matching contribution, an additional test, the Actual Contribution Percentage (ACP) test must also be performed. These tests verify the deferred wages and employer matching contributions do not discriminate in favor of highly compensated employees.

Traditional 401(k) Plans offer some of the widest range of benefits and options to the Employer and Employee. Employer and Employee contributions are deductible on the Employer’s federal income tax return, in addition, employee contributions and earnings are tax deferred until they are withdrawn from the account.

A Safe Harbor 401(k) Plan is a Traditional 401(k) Plan that includes certain “safe harbor” provisions. Similar to a Traditional 401(k) Plan, eligible employees are allowed to make pre-tax elective deferrals through payroll deductions, but with a Safe Harbor 401(k) Plan, there are certain contributions which the Employer is required to make on behalf of the employees.

Most notably, in a Safe Harbor 401(k) Plan, Employers are required to make a contribution each year. Employers may make one of two contributions: a non-elective contribution equal to 3% of each eligible employee’s compensation or a matching contribution equal to 100% on the first 3% deferred, plus 50% on the next 2% deferred. The required contribution is also 100% vested.

Most Employers choose Safe Harbor because they are not required to conduct the annual nondiscrimination tests (ADP and ACP) that are required in a Traditional 401(k) Plan. This allows the Highly Compensated Employees to defer the maximum without regard to what the Non Highly Compensated Employees defer. In a Traditional 401(k) Plan, Highly Compensated Employees can be restricted on how much they may defer. Like a Traditional 401(k) Plan, Employer and Employee contributions are deductible on the Employer’s federal income tax return, in addition, employee contributions and earnings are taxed deferred until they are withdrawn from the account.

Roth 401(k) plans allow eligible employees to make post-tax elective deferrals through payroll deductions. That means employees pay all applicable state and federal taxes on the deferrals upfront, later allowing for tax-free distributions of the Roth deferrals and their earnings.

Actually, they differ very little. Employers are required to report and track Roth deferrals separately from traditional deferrals, but many of the administrative functions remain the same as listed below:

• Maximum deferral limits for both Roth and Traditional are the same
• Participants can make Roth catch-up contributions
• Roth deferrals can be matched, but match contributions are considered pre-tax and will be taxed appropriately at the time of distribution
• Nondiscrimination tests must be performed for plans with a Roth feature (unless they are Safe Harbor Plan)

Plans may offer both, but for administrative purposes, Employers may make participants choose one type of deferral for a plan year. A Roth feature can be added to an already existing traditional 401(k) through a plan amendment.

A Cross-Tested Plan or New Comparability Plan is a defined contribution plan that uses a certain testing method to show that the Plan does not discriminate in favor of Highly Compensated Employees and proves the projected benefit of all employees are equal. In a Traditional Profit Sharing Plan, an Employer must have a uniform formula for all eligible participants; in a Cross-Tested Plan, an Employer must have a uniform formula for each defined group. This means that the Employer may divide its eligible employees into two or more groups and provide a different allocation within each group. Most Employers divide the employees between owners and non-owners or Highly Compensated Employees (HCEs) and Non Highly Compensated Employees (NHCEs).

Yes, a cross-testing feature may be added to an existing 401(k) Plan.

The best way to know is to provide a complete census to BPI and they will run a test for you. This plan design does not work for all Employers; the Plan must pass a test each year to ensure the projected benefit is nondiscriminatory. In addition, it is possible to pass such test one year and fail the next or vice versa.

An Employee Stock Ownership Plan (ESOP) is a defined contribution plan which gives eligible employees a beneficial ownership in the company. Employers make contributions either in company stock or cash. The amount of the contribution is dependent on many things, not just the company’s profit.

ESOPs give participants an extra incentive to make the company prosper. Contributions are deductible on the Employer’s federal income tax return, in addition, employee contributions (if a 401(k) feature is added) and earnings are tax deferred until they are withdrawn from the account.

A 401(k) feature may be included in an ESOP as an added benefit (ADP and ACP testing applies). Employee deferrals may be used to buy traditional 401(k) investments and/or company stock.