Important Pension Topics

Being an Employee does not necessarily qualify one for participation in the retirement plan. Eligibility requirements refer to prerequisites an Employee must satisfy before he or she is allowed to become eligible for participation in the plan. In designing a plan's eligibility requirements, Employers are allowed a fair amount of flexibility. We work closely with Employers to figure out their needs and to properly design and draft plans.

The Internal Revenue Code allows the following statutory exclusions:

(1) The plan may require a waiting period, generally six months or one year, but in some cases, up to two years.

(2) The plan may impose a minimum age requirement. The minimum age requirement may not exceed age 21.

(3) The plan may exclude union employees who are eligible to participate in a separate plan for union employees or a union sponsored plan which was negotiated in good faith.

The plan may impose other "non-statutory" eligibility requirements. The most common such provisions require that an Employee work at least 1,000 Hours of Service during the Plan Year and/or that the Employee still be employed on the last day of the Plan Year. Furthermore, the plan may exclude otherwise eligible Employees, typically by job description, department or sometimes even by name. When contemplating imposing non-statutory exclusions, the Employer must take care to be sure that all non-discrimination tests are passed each year. Non-discrimination testing is discussed in a separate section.

Once an Employee fulfills all of the plan's eligibility requirements, he or she becomes an Eligible Employee. Upon becoming an Eligible Employee, the individual must wait for the following Entry Date to actually become a Participant in the plan. Most of our Plans have one or two Entry Dates per year (the first day of the Plan Year and the first day of the seventh month of the plan year). Some 401(K) plans call for quarterly or even monthly Entry Dates.

(Traditional 401k vs. Roth 401k)

Traditional: The Traditional 401(k) Plan is one of the most popular types of retirement plans in the country. It allows an employee to defer a portion of his or her salary into a tax exempt trust. The employee is then taxed on only the net salary. For example, if an employee earns $40,000 and defers $3,000 into a Traditional 401(k), he or she is taxed only on the net salary of $37,000. The earnings in the trust are not subject to taxation. However, withdrawals from a Traditional 401(k) are taxable. Thus, you do not pay taxes at the time of the contribution, but rather the withdrawal.

Roth: A Roth 401(k) differs from a Traditional primarily in that you pay taxes at the time of the contributions, but you never pay taxes on those amounts ever again! For example, if an employee earns $40,000 and defers $3,000 into a Roth 401(k), he or she would be taxed on the entire $40,000. However, neither the earnings in the trust nor the subsequent withdrawals from the Roth 401(k) are subject to tax.  This tax preferred treatment is only available if certain requirements are satisfied, as explained below.

Following are a few of the exciting benefits of a Roth 401(k):

- Higher "effective" contribution rate than a Traditional 401(k).

- Tax-free income in retirement.

- Helps avoid tax on Social Security.

- Helps maximize estate assets.

- Has a much higher allowable contribution limit than a Roth IRA.

- Is available to all income levels, unlike the Roth IRA.

- Contributions are eligible to receive an Employer Match.

You are able to effectively increase the amount of your contribution with a Roth 401(k) because you are contributing after tax dollars. A $15,000 contribution to a Roth 401(k) is really equal to about a $23,077 contribution to a Traditional 401(k). (This assumes a 35% tax-rate) Therefore, you are able to put away a larger amount of money for your retirement. So for all of those people who want to maximize their 401(k), this is a way to effectively increase their retirement contributions. Furthermore, this $15,000 contribution is worth more than a $15,000 contribution to a Traditional 401(k).

This same principle applies to a $10,000 contribution or a $500 contribution. The Roth 401(k) is probably the most powerful way for most Americans to save taxes and to save for their retirement.

A Roth 401(k) is appealing to many Americans because they will receive tax-free income in retirement. Also, this tax-free income may help you avoid tax on Social Security benefits. Your Social Security Benefits are taxable if other taxable income plus Social Security Benefits exceed $25,000 (single) or $32,000 (joint). However, Roth 401(k) withdrawals are not taxable and, therefore, not included in the calculation of "other taxable income." Traditional 401(k) withdrawals would be included because they are taxed.

A Roth 401(k) may help maximize estate assets. This is possible because Roth 401(k) assets may be rolled into a Roth IRA, which do not require minimum distributions at age 70. (For more details on Required Minimum Distributions see the section of this website titled Distributions) Therefore, your assets can remain in a tax-free trust much longer.

Until now these substantial tax benefits described above could only be accessed through a Roth IRA. But a Roth IRA has two very significant restrictions: 1) There is a $5,000 contribution limit in 2009 ($6,000 if over 50 years old); and 2) there is an income limit so that if an individual made over $105,000 or a joint couple made over $166,000 they would not be allowed to participate or would be limited in their participation to a Roth IRA. The Roth 401(k) is much more powerful than the Roth IRA. It allows for contributions up to $16,500 in 2009 ($22,000 if over 50 years old) and it completely eliminates the income limit, allowing all individuals to partake regardless of how much or how little they make. (This is still subject to an ADP test which is unique from plan to plan and year to year. For more details on ADP testing see the section of this Website titled Non-Discrimination Testing).

There is one more benefit to a Roth 401(k) that distinguishes it from a Roth IRA. Contributions to a Roth 401(k) may be matched by a participant's employer on a pre-tax basis! If an employer matches employee contributions then employees are effectively receiving a salary increase just by contributing to their 401(k).

Roth 401(k) Contribution Summary:

- May be made in conjunction with Traditional 401(k) contributions. However, the combined total may not be greater than the dollar limit on Elective Deferrals for that year, which in 2009 is $16,500 ($22,000 if 50 or older), (see the section of this Website titled Contribution Limitations)

- Are eligible to receive an Employer Match. The matching contribution on Roth 401(k) contributions may only be treated as a pre-tax contribution subject to taxation upon distribution,

- Must be designated at the time of the contribution election as a Roth contribution. This designation may not be changed,

- Must be treated by an employer as income to the employee at the time of the contribution, meaning the contribution is taxed,

- Must have separate recordkeeping accounts,

- Are combined with Traditional 401(k) contributions for the ADP Test, (see the section of this Website titled Non-Discrimination Testing)

- May not be made by the Employer

- May not be made from Forfeitures

Roth 401(k) Distribution Summary:

- May only be made upon a participant's termination of employment, death, disability or attainment of retirement age,

- May be rolled over only to another Roth 401(k) or a Roth IRA,

- The contribution portion of the account always comes out tax-free. The earnings portion of the account comes out tax-free only if you are age 59 and it is five years after the year in which you made your first Roth 401(k) contribution. If a withdrawal is made prior to this time then the contribution portion still comes out tax-free and just the earnings portion is taxed.

- Are subject to Required Minimum Distributions. (For more details on Required Minimum Distributions see the section of this website titled Distributions) However, in order to avoid having to make the Required Minimum Distribution at age 70, Roth 401(k) assets may be easily rolled over to a Roth IRA, which is not subject Required Minimum Distributions,

- If made due to a failed ADP test then the Highly Compensated Employee (HCE) may choose if they want their Traditional or their Roth contributions to be returned, assuming the employee has made both types of contributions. If Roth contributions are returned prior to April 15 of the following year, then they are returned tax-free (only the earnings are taxed). However, if Roth contributions are returned after April 15 of the following year then they are subject to double taxation (when they were first contributed and when they are distributed) and the earnings are taxed.

Prior to March 28, 2005, if the benefit for a terminated employee was less than $5,000, the plan could pay this benefit without the participant's approval or spousal signature.

Recent legislation has, however, changed the rules for all involuntary payouts. Payouts of $1,000 or less may still be paid without participant approval. Involuntary payouts between $1,000 and $5,000 must now be transferred directly into an Individual Retirement Account (IRA) in the name of the participant.

Our first thoughts were that these new provisions would place quite a burden on the employer and plan administrator. Upon further investigation, however, our conclusions are exactly the opposite. We have checked with a number of banks and brokerage firms and have found many institutions quite eager to obtain this large influx of potential business. As a result, many institutions have set up a very easy procedure for transferring the funds into the IRA. In many cases, all the employer must do is write a very short letter to the bank or broker listing all the affected former participants with their name, last known address, date of birth, social security number and the amount to be transferred. The transfer is automatic and you do not even have to write a check.

In return, the employer no longer has to administer these small accounts, no longer has to be burdened with the fiduciary responsibility of investing their funds, and best of all does not have to bother with the income tax withholding and related deposits on the distributions.

We have always encouraged the payout of accounts of former employees under $5,000. We suggest you contact the bank or broker where the plan's funds are invested to set up the distribution process for involuntary payouts between $1,000 and $5,000. If your bank or broker does not handle these types of IRA transfers, let us know and we can put you in contact with a few that do.

Important Details:

As long as the Department of Labor's Safe Harbor is satisfied, the fiduciary obligation of the plan fiduciary and plan administrator end immediately upon the transfer of the benefit of the IRA. The Safe Harbor has five conditions:

1) The amount of the rollover may not exceed $5,000,

2) The IRA must be a traditional IRA, not a Roth IRA, nor a trust or custodial individual retirement account, nor or an individual retirement annuity. If the IRA is a custodial account, the custodian must be a bank, an insured credit union, or other corporation subject to supervision by the Commissioner of Banking.

3) There must be a written agreement between the fiduciary and the IRA provider.

4) The selection of the IRA may not result in a Prohibited Transaction (for more details on this see section entitled 'Prohibited Transactions.')

5) The participants must have been furnished information about the plan's automatic rollover procedures in the Summary Plan Description.

The written agreement between the IRA custodian/trustee and the fiduciary must include specific information on the investment and administration of the automatic rollover IRAs such as:

1) Selected investment products must preserve principal, provide adequate liquidity, and provide a reasonable rate of return (whether or not the rate is guaranteed)

2) IRA custodian/trustee fees for the administration of the IRA cannot exceed those charged for comparable IRAs.

3) An IRA owner, the former plan participant, has the right to enforce the terms of this agreement

4) The agreement should provide a description of acceptable methods for directly rolling over employer plan assets to an IRA (check, wire transfer, etc.)

5) If there is a minimum amount allowed to be rolled over, this should be addressed in the agreement.

The Trustee may rollover all "involuntary cash-out" distributions less than $5,000. Furthermore, the Trustee of a terminated plan may establish Automatic Rollover IRA's for missing participants.

What is a 401(k) Plan?

One of the most popular types of plans in this country during the past 20 years is the 401K plan. A 401K plan is actually a profit sharing plan with an additional section entitled a Cash or Deferred Arrangement (CODA). The plan has all the provisions of a profit sharing plan, allowing the Employer to make discretionary contributions. But, in addition, the CODA allows the Employees to also make tax deferred contributions, entitled Elective Deferrals, into the plan. In addition to or in lieu of a profit sharing contribution, the Employer may also make a Matching Contribution to the plan. The Matching Contribution is typically a percentage of the Employee's Elective Deferral and, therefore, is allocated only to those Employees making contributions. Many Employers will match the Employee's Elective Deferral as a way of encouraging Employee participation in the plan.

How is the Employee Taxed?

Only the net salary is subject to income taxation. For example, if an employee earns $40,000 and defers $3,000 into the trust, he or she is taxed only on the net salary of $37,000. The entire $40,000 is, however, subject to FICA and SDI.  However, this differs for a ROTH deferral.  Given the same example, and assuming now that the deferral is a ROTH, the same employee would be taxed on the full earnings of $40,000.  The distribution in most all cases would be non-taxable.  Please see the ROTH 401(k) section for more details.

Why would an employee want to do this?

There are four incentives for an employee to defer a portion of his salary:

(a) He or She effectively receives an income tax deduction for the amount deferred.

(b) The earnings in the trust are not subject to current income taxation. For the younger employee especially, this can result in very significant savings over their working life.

(c) The employer has the right to match a portion of the deferral. This is the equivalent to a salary increase that will be realized if and only if the employee defers a portion of their salary into the plan.

(d) Since the funds are deducted from the employee's paycheck, it serves as a forced savings for the employee who otherwise has a hard time saving.

What are the disadvantages to salary deferrals?

Amounts contributed to the plan are not available to the employee currently. He or She cannot use the funds for living expenses or any other type of expenditure.

What are the limits?

View Current Year Limits

How do I sign up for Participation?

There are Salary Deferral Election Forms available under the forms section (create link). You can specify either a fixed dollar amount or a percentage to be deducted from each paycheck AND/OR a fixed dollar amount or a percentage to be deducted from any bonus.

What is the Entry Date?

Upon becoming an Eligible Employee, the individual must wait for the following Entry Date to actually become a Participant in the plan. Most of our Plans have one or two Entry Dates per year (the first day of the Plan Year and the first day of the seventh month of the plan year). Some 401(K) plans call for quarterly or even monthly Entry Dates.

What is the sign up period?

In order to enter on a particular entry date, you can sign up any time during the previous month. The Employer may, at its discretion, extend the sign up period.

Once an Election is made, can it be changed or revoked during the year?

Your election may be revoked at any time. In addition, you may reduce the amount or percentage of your deferral at any time and as many times as you wish during the year. You may NOT, however, increase your deferral amount or percentage until the next entry date.

How much is the Employer Matching Contribution?

The employer has no obligation to match a portion of your deferral. At their discretion, however, they may make a matching contribution.

When will I receive my money from the Trust?

The law allows distributions from the plan after any of the following events:

(a) Attainment of the normal retirement age of 65

(b) Death

(c) Disability

(d) Termination of service with the employer

When will I be taxed on Distributions?

You will be taxed on distributions from the plan when you withdraw funds from the trust. If the distribution is as a result of the termination of service and is withdrawn prior to age 59 1/2, a premature distribution penalty of 10% federal and 2 1/2% to the state of California must be paid in addition to the income tax. (For a more complete discussion on this topic see section entitled 'Distributions').  However, a distribution from a ROTH 401(k) will in most all cases not be taxed.  The penalties for early withdrawal are still applicable.  Please see the ROTH 401(k) section for more details.

Once eligible for a distribution, what will my payout options be?

An employee who terminates is entitled to a distribution from the plan. When you terminate you should request a Distribution Election form upon which you can make your election as to how you receive your benefits. Generally, you will be given the following options:

(1) Receive the benefits in cash, in which case you will be liable for the tax and possibly the premature distribution penalty;

(2) Have an annuity purchased for you which will pay you monthly benefits beginning at age 65,

(3) Leave the funds in the trust where they will continue to earn interest on a tax deferred basis; or

(4) Transfer the funds to your IRA or another qualified plan.

Can I borrow money from the Plan?

If the trustee, in a non-discriminatory manner, chooses to grant you a loan; you may borrow up to 1/2 of your vested interest and no more than $50,000.00. The loan must be repaid within five years and bear a reasonable rate of interest. Payments will be deducted from each of your paychecks. (For a more complete discussion on this topic see section entitled 'Participant Loans').

HISTORY AND BACKGROUND

Any Employer contribution to a Defined Contribution (DC) plan must pass non discrimination tests. For testing purposes, all eligible employees are categorized as either a Highly Compensated Employee (HCE) or a Non Highly Compensated Employee (NHCE). For 2009, an HCE is generally an employee who had Compensation of over $105,000 in the PRIOR Plan Year, is a 5% Owner, or is a lineal relative of a 5% owner. The $105,000 limit is adjusted for cost of living; please refer to the 'Overview' section to see the current and up to date compensation limits. A NHCE is any eligible employee who is not an HCE.

Historically, DC plans could only pass non discrimination tests by comparing contributions for HCE to the contributions for NHCE. To pass the test, all NHCE’s had to have an allocation rate equal to or greater than the highest allocation rate granted to any HCE.

Since the early 1990's, we are allowed to use a second approach for passing non discrimination tests, commonly referred to as "cross testing". Instead of comparing current year contributions to pass the tests, a cross tested allocation formula compares eventual benefits. Use of the cross testing approach provides many advantages to the employer including, but not limited to, the following:

(1) Allows the employer to contribute different amounts or percentages to different groups of employees.

(2) Allows the employer to contribute a higher percentage for employees who are either older or have more years of service with the employer.

(3) Allows the employer to contribute more for certain profitable divisions or subsidiaries and much less for the less or non profitable divisions.

Plans which have a uniform allocation schedule, i.e. contribute the same percentage for all eligible Participants, are deemed to have a Safe Harbor allocation formula. These plans must pass only the coverage test under Internal Revenue Code section (IRC) 410(b). Plans using a cross tested allocation formula must also pass the General Test, which includes an Average Benefits Test under IRC 410(b) and a Rate Group Percentage Test under IRC 401(a)(4). Those tests are described later in this section.

COVERAGE TEST UNDER IRC 410(b) AND IRC 401(a)

After having established the eligibility requirements for participation, each plan is always allowed to exclude some Employees, either by job category, by name, or any other means that do not violate other age, race, religious or gender related statutes. The plan must, however, pass the coverage requirements of IRC 410(b), which requires that:

The percentage of eligible NHCE actually benefiting from the plan must be equal to or greater than 70% of the percentage of eligible HCE actually benefiting from the plan.

In a profit sharing plan, or for the testing of any Employer contribution, a Participant is considered to be benefiting if he or she shares in the allocation of the Employer contribution. In a 401(K) plan, a Participant is considered to be benefiting if he or she is allowed to make Elective Deferrals, regardless of whether the Employee chooses to defer or not. The coverage of the profit sharing and the 401(K) portion of the plan must be tested separately.

Example # 1: Assume there are 10 eligible HCE and 100 eligible NHCE. If all 10, or 100%, of the HCE are benefiting from the plan, then at least 70, or 70%, of all NHCE MUST be benefiting from the plan.

Example # 2: Assume the same plan with 10 eligible HCE and 100 eligible NHCE. If 6, or 60%, of the HCE are benefiting, then only 42, or 42%, of the NHCE must be benefiting from the plan. Calculation: HCE coverage X 70% = Required NHCE coverage --> 60% X 70% = 42%.

When performing this test, we must include all Employees who have met the age and service requirements. Generally, the statute allows us to impose a requirement that an Employee work for one year before entering the plan and be at least 21 years old by the end of the Plan Year. These are the ONLY statutory eligibility requirements. Many, if not most, plans will also impose a requirement that an Employee must work at least 1,000 hours during the Plan Year and/or be employed on the last day of the Plan Year to be allowed to share in any Employer contribution. The 1,000 hour and last day of the Plan Year requirements are not, however, statutory requirements. Therefore, an Employee who has met the age and service requirements but does not share in the allocation because he was not employed on the last day of the Plan Year is considered to be an eligible Employee who is NOT benefiting for the purpose of the coverage test. An Employer who has a large layoff or a small Employer with just a few terminations during the Plan Year may be forced to make contributions for Employees who would not have otherwise shared in the allocation of the Employer contribution.

Example # 3: Assume a plan requires that an Employee be employed on the last day of the Plan Year to share in Employer contributions. The Plan has only 1 HCE and 10 NHCE who have met the age and service requirements. The HCE is still employed on the last day of the Plan Year, but 4 of the NHCE terminated before the end of the year, leaving only 6 NHCE to share in the Employer contribution. Since 6 of 10, or 60%, is less than 70%, this plan FAILS IRC 410(b).

Example # 4: Assume a plan requires that an Employee be employed on the last day of the Plan Year to share in Employer contributions. The Plan has only 1 HCE and 3 NHCE who have met the age and service requirements. The HCE is still employed on the last day of the Plan Year, but 1 of the NHCE terminates prior to year end. Since only 2 of 3, or 66%, of NHCE are benefiting, plan FAILS.

There are two possible solutions to this problem. The simplest would be to eliminate the last day of the year service requirement and make an Employer contribution for all Employees who have met the age and service requirements, regardless of whether they are still employed. This annoys many Employers who have no interest in contributing money for ex-employees. The Employer may, however, create a separate Rate Group for the terminated Employees, and possibly contribute a smaller percentage for the terminated Employees. If, however, the Plan is Top Heavy (see section entitled "Top Heavy Plans"), they will be required to contribute a minimum of 3% of Compensation for the terminated Employees OR if the plan is cross tested, they will be required to contribute a minimum of 5% of Compensation if the 5% Gateway is used.

Another possible solution would be to make the eligibility requirements more lenient. For example, lower the age requirement to 18 or even waive the age requirement altogether. Since, as you will see later, the General Test works much better with young NHCE, we generally waive the age requirement for most of our cross tested plans anyway. Of greater impact on IRC 410(b), however, is to reduce the service requirement. Lower the waiting period from 12 months to 6 months, or even less. This makes more NHCE eligible, lessening the impact of terminated participants on the coverage and other non discrimination tests. The Employer is still being required to make a contribution for an Employee who would not otherwise receive an allocation, but the fact that the Employee is still employed and probably has little or no vesting may make the contribution more palatable to the Employer.

Example # 5: Assume same facts as in Example # 4 above, 1 HCE and 3 eligible NHCE, one of which has terminated prior to year end. There is, however, another active NHCE who is not eligible because he has only 3 months of service. If we amend the plan to require only 3 months of service, this Employee is now eligible. We now pass the Ratio Test because we now have 4 eligible NHCE, 1 of which is terminated and 3 of which are still employed and are benefiting in the plan. 3 of the 4 eligible NHCE, or 75%, are benefiting and since this is greater than 70%, the plan passes the coverage test.

CROSS TESTING

As discussed earlier, a cross tested DC allocation formula tests current year contributions by comparing eventual benefits. We must, therefore, convert the current year contribution to an eventual benefit to create a basis for comparison. The IRS has issued Regulations giving us guidance in doing so.

The first step is to convert the current year contribution to a cash value at the Normal Retirement Date, typically age 65 in a DC plan. In doing so, the IRS Regulations require that we use an interest rate of between 7.5% and 8.5%. We virtually always use 8.5% because it makes the test work better. Therefore, if we use a formula, or go to an annuity table, we can calculate how much the current year contribution will grow to at age 65, assuming an 8.5% interest rate.

Example # 1: Assuming an interest rate of 8.5%, if you contribute $1,000 for a 25 year old employee, this $1,000 will grow to $26,133 by the time the employee turns age 65. If you contribute $1,000 for a 60 year old employee, this $1,000 will grow to $1,504 by the time the employee reaches age 65. Even though the contributions for each of these two employees is the same dollar amount, the contribution for the 25 year old converts to a much greater benefit than the same contribution for the 65 year old because the contribution for the 25 year old has 40 years to grow and the contribution for the 60 year old has only 5 years to grow. Interest compounded over a long period of time can generate dramatic results.

The second step is to assume that the cash value calculated above will be used to purchase a single premium annuity which will pay the participant a guaranteed monthly income for the remainder of his life beginning at age 65. The IRS allows the use of a number of different mortality tables, which produce reasonable and acceptable annuity assumptions. We generally use the 1993 Unisex Group Annuity Table, which results in an annuity rate of 7.9483 for the annual benefit. Pretty much any mortality table will produce the same relative results. The cash value calculated in step #1 above, when divided by the annuity rate will equal the annual guaranteed benefit. If further divided by 12, you will get the monthly benefit provided by the cash lump sum accumulated by age 65.

Example # 2: Assume the same facts in Example # 1 above for the 25 year old. At age 65, his or her $1,000 contribution had grown to $26,133. We then assume that the $26,133 is taken to an insurance company and an annuity is purchased in full for this amount. The insurance company would then pay an annual benefit to the participant for the rest of his or her life of the following amount:

$26,133 divided by 7.9483 = Annual Benefit of $3,288

It is important to remember, that this process and all the assumptions referred to, are for non discrimination testing purposes only. We are in no way obligated to purchase annuities for 65 year old participants. All distribution options and requirements are discussed in the Distributions section of this Learning Center.

Example # 3: Let's now make the same calculations for the 60 year old participant from Example # 1 above. This participant also received a contribution of $1,000, but their contribution only grew to $1,503 since they had only 5 years for their contribution to grow. If we took the cash value at age 65 of $1,503 to the same insurance company, the benefit would be calculated as follows:

$1,504 divided by 7.9483 = Annual Benefit of $189

The last step in converting the current contribution to eventual benefit is to make the annual benefits calculated for each participant comparable. We do this by calculating the Equivalent Benefit Accrual Rate, or EBAR. This is calculated by dividing the annual benefit for each participant by his current annual Compensation.

Example # 4: Let's carry the first three examples to their final step. We will assume that the 25 year old and the 60 year old in the previous examples each had Compensation of $20,000. The EBAR for 25 year-old is calculated as follows:

EBAR = Annual Benefit / Current Annual Compensation = $3,288 / $20,000 = 16.44%
EBAR for the 60 year old is calculated as follows:
EBAR = Annual Benefit / Current Annual Compensation = $189 / $20,000 = 0.95%

AVERAGE BENEFITS TEST

After converting the current year contribution for each participant to a cash equivalent at age 65, then to an annual retirement benefit, and lastly to an Equivalent Benefit Accrual Rate (EBAR), we are now prepared to go the Average Benefits Test. The Average Benefits Test under IRC 410(b) compares the average EBAR of all HCE to the average EBAR of all NHCE.

For the purpose of the following examples, assume the following set of facts:

The next step is to calculate the average benefit percentage for the HCEs and the NHCEs. The average HCE average benefit percentage is calculated by adding the EBAR for each HCE and dividing by the number of HCEs. The process is the same for the NHCEs.

Example: Using the census data from the above, the calculations are as follows:

Step # 1: Add the EBAR of all three HCE and divide by three. Average HCE benefit percentage = 5.24 + 11.86 + 4.73) / 3 = 7.28%
Step # 2: Same calculation for NHCE = (19.34+32.80+3.22+15.58+1.42+16.44+16.44) / 7 = 15.03%.
Step # 3: Divide average NHCE % by HCE % Ratio of NHCE % / HCE % = 15.03% / 7.28% = 206.61%

Since this ratio is equal to or greater than 70%, the plan passes the Average Benefits Percentage test. The test is passed easily on a benefits basis even though it would have failed miserably on a contributions basis. Even though the plan contributes between 14% and 20% for each of the HCE and only 5% for each of the NHCE, the plan passes the average benefits test because the HCE are generally older than the NHCE.

RATIO PERCENTAGE TEST

While the average benefits test compares the EBAR for both profit sharing and 401(K) elective deferrals, the ratio percentage test under IRC 401(a)(4) looks only at the employer's non-elective, or profit sharing, contributions.

Using the same census in the above example, considering only the profit sharing contributions and ignoring the 401(K) elective deferrals, the EBARs for each employee are as follows:

A separate rate group is set up for each HCE and then each rate group is tested as follows.

Step # 1: Calculate the "concentration percentage", which is the total number of NHCE covered by the plan divided by the total number of employees covered by the plan. In the above example, 7 of the 10 employees covered by the plan are NHCE. The concentration is, therefore, 70%.

Step # 2: A "safe harbor" percentage is calculated. The safe harbor percentage is 50%, reduced by 3/4 of the concentration percentage in excess of 60%. The unsafe harbor is 10% less than the safe harbor percentage, but not less than 20%. The midpoint is the percentage half way between the safe harbor and unsafe harbor percentages. In the above census, the percentages are calculated as follows:

Safe Harbor % = 50% - ((70% - 60%) X 3/4) = 50% - 7.5% = 42.50%
Unsafe Harbor % = Safe Harbor minus 10% = 42.50% - 10.00% = 32.50%
Midpoint % = (42.50% + 32.50%) / 2 = 37.50%

The uses of these percentages will be seen shortly.

Step # 3: Calculate the ratio percentage of the NHCE and HCE for each rate group and then calculate the ratio of the NHCE % to the HCE %. This is easiest explained by example. In the above census, Participant #1's EBAR (considering profit sharing contribution only) is 3.67%. 5 of the 7 (71.43) of the NHCE have an EBAR equal to or greater than Participant #1's 3.67%. 3 of 3 (100%) of the HCE have an EBAR equal to or greater than Participant #1's EBAR. The ratio of the NHCE % to the HCE % is then calculated: 71.43% / 100% = 71.43%.

Step # 4: Compare the ratio % (71.43%) in our example, to the midpoint between the safe harbor and unsafe harbor % calculated in step # 2 above. Since 71.43% is greater than or equal to our Midpoint Percentage of 37.50%, our plan passes the non discrimination test for Fred's rate group.

Step # 5: Repeat the same procedure for each of the other rate groups. For Participant #2's group, 3 of 7 (42.86%) of the NHCE have an EBAR equal to or greater than Participant #2's EBAR of 10.08%. 1 of 3 (33.33%) of the HCE have an EBAR equal to or greater than Participant #2's. 42.86% / 33/33% = 128.59%. For Participant #3's group 5 of 7 (71.43%) have an EBAR equal to or greater than Participant #3's EBAR of 3.78%. 2 of 3 (66.67%) of the HCE have an EBAR equal to or greater than Participant #3's. 71.43% / 66.67% = 107.14%. Since 128.59% and 107.14% are both greater than the Midpoint Percentage of 37.50%, the plan passes for both Participant #2's and Participant #3's rate groups.

In addition to the ratio percentage test the plan must also pass a coverage test, as explained earlier, when considering only profit sharing contributions.

ACTUAL DEFERRAL PERCENTAGE (ADP) TEST

There is a separate non discrimination test for only the elective deferrals into the 401(K) portion of the plan.

All eligible NHCE’s may contribute 401K elective deferrals up to the contribution limitations, which for 2009 is 100% of Compensation to a maximum of $16,500, plus a Catch Up contribution of $5,500 if the Participant is age 50 or older. The contribution limitations also apply to HCE’s, but HCE’s may be further limited if there is not widespread participation amongst NHCE’s. To determine the amount of elective deferrals an HCE may contribute, we are required to perform an Actual Deferral Percentage (ADP) Test.

A deferral percentage is calculated for each Participant. This is simply done by dividing a Participant's elective deferral by his or her Compensation. For example, a Participant with Compensation of $40,000 who contributes $2,000 to the 401K plan has a deferral percentage of 5% ($2,000 / $40,000). The same calculation is made for all Participants, NHCE and HCE. We then calculate the average deferral percentage for all NHCE’s.

Example: Assume we have three NHCE with Compensation, Elective Deferrals and Deferral Percentages as follows:

NHCE #1: Comp of $40,000, Elective Deferral of $4,000, and a Deferral % of 10%.

NHCE #2: Comp of $30,000, Elective Deferral of $1,500, and a Deferral % of 5%.

NHCE #3: Comp of $20,000, Elective Deferral of $0, and a Deferral % of 0%.

The average deferral percentage of the NHCE is 5% ((10% + 5% + 0%) / 3)

The HCE’s are then limited to the greater of the following:

(1) The average HCE deferral % may not exceed the average NHCE % x 1.25; or

(2) The average HCE deferral % may not exceed the lesser of:

(a) The average NHCE deferral % + 2 %, or

(b) The average NHCE deferral % X 2

If the plan fails the ADP test, it must be corrected in one of two ways: (1) return enough elective deferrals to HCE until the test is passed, or (2) the Employer must contribute a Qualified Non Elective Contribution (QNEC) to the NHCE in amounts sufficient to pass the test. The QNEC method will only work if the "current year method" of testing is used. This is more fully explained below.

In testing the HCE deferral percentages, the deferral percentage of NHCE of the PRIOR year is used. For example, the average 2002 NHCE deferral percentage is used to test 2003 HCE elective deferrals. Instead of this "prior year method", the Employer may elect to use the current year NHCE deferral percentages, but if they do, the current year method must be used for at least the next five years.

ACTUAL CONTRIBUTION PERCENTAGE (ACP) TEST

The ADP test is used to test elective deferrals. The Actual Contribution Percentage (ACP) is used to test Employer Matching Contributions. The calculations are exactly the same as explained for the ADP test above, using the Employer Contributions instead of the Eligible Employee’s deferred amount.

Vesting represents the non-forfeitable interest of a Participant in their Account Balance. A Participant who is 40% vested in his or her account upon termination of employment is entitled to receive only 40% of their Account Balance. The remaining 60% goes back into the plan in the form of a Forfeiture. Thus, if a Participant terminates employment prior to becoming 100% vested, their entire Account Balance may not be distributed to them.

A Participant is always 100% vested in contributions they make to the Plan, such as Rollover Contributions or Elective Deferrals. However, Employers may choose to make their Employer Contributions subject to a vesting schedule. There is no requirement to do so, but many of our clients find this reduces employee turnover by rewarding long term employment with the company. We agree, and most of our plans use a vesting schedule. The Code offers two minimum vesting alternatives:

The plan's vesting schedule may provide for more rapid vesting, but not slower. These schedules may have to be accelerated if the plan is Top Heavy. (For a more complete discussion on this topic see section entitled 'Top Heavy')

As mentioned earlier, Employee contributions are always 100% vested or "non-forfeitable." There are also certain Employer Contributions which must be 100% vested immediately. Qualified Non-Elective Contributions (QNECs) or Qualified Matching Contributions (QMACs) are immediately non-forfeitable, or 100% vested. Also, if a Plan has a two-year service requirement before an Employee is eligible to participate, the Employer Contributions must be immediately 100% vested.

Background

The law permits qualified retirement plans to allow participants to borrow funds from the plan. The plan is not required to permit participant loans, but many plans including most plans we write and administer do allow for participant loans. Such provisions give the plan sponsor the ability to help a participant who may be in need of cash or may be facing a financial emergency; with no risk and in most cases little cost to the sponsoring Employer. Allowing for Participant Loans is, in our opinion, a much more attractive alternative than allowing for Hardship Distributions. (For a more complete discussion on this topic see section entitled 'Distributions')

Restrictions on a Plan's Loan Program

If a plan does allow participant loans it is required to have a written Loan Program. The Loan Program is not required to be part of the plan document, although we generally make the program part of our plans. The following restrictions are imposed on a Plan's general Loan Program:

1. Loans must be available to all Participants on a reasonably equivalent basis. A plan sponsor may limit loans to a minimum threshold amount of up to $1,000. However, it may not limit loans based on factors upon which a commercial lender would not rely; such as age, race, sex, religion, national origin, or job performance issues unrelated to the creditworthiness of the Employee.

2. Loans must not be made available to Highly Compensated Employees in an amount greater than the amount available to other Employees.

3. Loans must bear a reasonable rate of interest. The interest rate must be consistent with rates charged by commercial lenders for a loan made under similar circumstances. The rate must be reviewed each time a loan is originated, renewed, renegotiated, or modified.

4. Loans must be fully secured. We almost always use the Participant's Account Balance or Accrued Benefits to secure the loan. This eliminates any possible collection problems for the sponsoring Employer.

5. The parties to any loan agreement must intend to repay the loan. We generally advise using payroll deductions for loan repayments to avoid collection problems.

Restrictions on Participant Loans

In addition to the above restrictions on a Plan's general loan program, each individual loan is subject to certain constraints. Unless loans meet these certain requirements, they will be taxable to the Participant. In order for a loan to qualify as a non-taxable and non reportable event to the Participant it must:

1. Be repaid over no more than a five year term. This five year period may be extended if the loan proceeds are used to purchase a personal residence.

2. Require substantially level, fully amortized payments, which must be paid no less frequently than quarterly. For example, a loan that pays interest-only over five years with a balloon payment at the end would not qualify.

3. Be evidenced by a legally enforceable agreement. The agreement must specify the amount and date of the loan, the repayment schedule and, if a Participant is married and the Participant's Account Balance is pledged as security for the loan, then spousal consent is required. Spousal consent must be given within 90 days before the date the loan is made and it must be in writing. Furthermore, if the Plan is a Defined Benefit Plan or a Money Purchase Plan, the spousal signature must be witnessed by a notary public.

4. Not be for more than the lesser of:

(a) One half of the Participant's vested Account Balance; or

(b) $50,000

Each of the above must be reduced by the highest loan balance of any previous or existing loans to the Participant during the 12-month period ending on the day before the date a new loan is to be made.

Generally, if no other plan loans are outstanding a Participant may borrow up to the following amounts:

Additional collateral may be required if a loan exceeds 50% of the Participant's Vested Account Balance. These amounts are limitations according to law. However, most of our Plans limit the amount of a loan to an absolute maximum of 50% of a Participant's vested account balance.

If a Participant wants a new loan and has a loan outstanding or has had a loan in the past 12 months, this limit must be reduced by the Participant's highest loan balance of any existing or previous participant loans during the past 12 months.

Penalties for Loan Violations

A loan that fails to meet these requirements is subject to regular income tax. If the Participant has not attained 59 1/2, an additional 10% premature distribution penalty (plus 2 1/2% CA penalty) is imposed. The amount of the loan subject to taxation depends on which rule is violated and when the violation occurs. If a loan by its terms does not require repayment within 5 years or does not call for at least quarterly payments of principal and interest then the entire amount of the loan is subject to taxation. If the loan exceeds the dollar limitation, only the amount in excess of the limit is subject to the taxation. If the loan terms are in compliance but the loan goes into default, then the amount of principal and interest remaining upon default or, if later, at the end of any cure period allowed by the plan administrator is deemed distributed and, therefore, subject to taxation. A cure period can continue up to the last day of the calendar quarter following the calendar quarter in which a default occurs.

Miscellaneous

There are no restrictions to how a loan is used by a Participant. The Plan Administrator is not required to examine the creditworthiness of each borrower. Interest paid on a participant loan is generally not deductible. However, if the Participant is not a Key Employee and the loan is secured by that participant's principal residence, the interest may deductible.

Cautions to the Plan Sponsor:

It is nice for the Employer to be able to provide this benefit to Participants in need. We would, however, caution Employers because loans are often fraught with complications. Furthermore, if there are a lot of participant loans, administration of these loans can become costly. The following are a few guidelines we recommend to Employers in order to make their life with loans a little easier and help keep the loan administration costs down:

1. Limit Participants to only one outstanding loan at a time.

2. Require the repayment of loans to be made through payroll deductions.

3. Consider imposing a reasonable one time loan set up fee and/or an annual loan administration fee.

4. Do not charge too low an interest rate. This only encourages costly and unnecessary borrowings. The trust is not a bank, so do not adopt policies that cause the trust to perform too many banking functions.

When is a Plan Top Heavy?

A defined contribution (DC) Plan is Top Heavy for a Plan Year when the aggregate of the Account Balances of all Key Employees under the Plan exceeds 60% of the aggregate of the Account Balances of all Participants as of the preceding Plan Year's Determination Date.

With respect to a defined benefit (DB) pension plan, if, on the preceding Plan Year's Determination Date, the present value of cumulative Accrued Benefits under the Plan for Key Employees exceeds 60% of the present value of cumulative Accrued Benefits under the plan for all Participants.

If the Employer maintains more than one plan, there are certain aggregation rules that may apply.

Consequences of being Top Heavy

Generally, the primary consequence of a Defined Contribution Plan being Top Heavy is that the Employer must make a minimum contribution to each eligible non Key Employee equal to the lesser of (a) a percentage equal to the highest percentage contributed on behalf of any Key Employee, or (b) 3% of eligible Compensation.

With respect to 401(k) Plans, there is another consequence of being Top Heavy. In determining the amount of the Top Heavy Minimum Contribution, Elective Deferrals made by Key Employees are treated as Employer Contributions. However, Elective Deferrals made by Non-Key Employees are not treated as Employer Contributions. Therefore, if a 401(k) Plan is Top Heavy and Key Employees make Elective Deferrals, then all of the Non-Key Employees must receive an Employer contribution.

Under a top heavy DB plan, the Accrued Benefit, when expressed as an annual retirement benefit, of a non Key Employee must not be less than the Employee's average Compensation multiplied by the lesser of (a) 2% times the number of Years of Service, or (b) 20%.

There are also faster vesting schedule requirements for Top Heavy Plans. A Top Heavy Plan must contain either a three year cliff vesting provision or a six year graded vested provision. Under the three year cliff vesting schedule, an Employee who has completed at least three Years of Service must be 100% vested. Under the six year graded schedule, an Employee with two Years of Service must be at least 20% vested, then earn an additional 20% of vesting for each subsequent Year of Service, so that a Participant is 100% vested after earning six Years of Service.

Relevant Top Heavy Definitions

Key Employee: Is any Employee who during the prior Plan Year was; 1) an officer of the Employer with annual Compensation above $130,000, 2) a more than 1% owner of the Employer with annual Compensation above $150,000, or 3) a more than 5% owner of the Employer. This definition is used for determining if a Plan is Top Heavy.

Determination Date: Is generally the last day of the Plan Year.

Overview

A Distribution is a payment from a Retirement Plan's Trust to either a Participant or Beneficiary. Generally one of five events must take place before a Trustee is allowed to distribute assets from the Trust:

1. Participant attains Normal Retirement Date (NRD)

2. Termination of Participant's Employment

3. Death of Participant

4. Participant's Permanent Disability

5. Termination of the Plan

After one of these five things happens, a Participant or their Beneficiary must choose exactly how they would like to receive their money. They indicate their wishes on the "Distribution Election Form." (Visit Forms page ). It may vary from plan to plan, but the different options generally are:

1. Receive a cash lump sum distribution, which will generally be taxed as ordinary income.

2. Have the Trustee use the account balance to purchase a Straight Life Annuity or a Joint and Survivor Annuity.

3. Leave the money in the company's retirement Trust. This allows for continuing deferral of federal and state income taxes.

4. Have a Direct Rollover to an Individual Retirement Account (IRA) or another Qualified Retirement Plan that accepts rollovers.

Premature Distributions

Upon termination a Participant may want to access their retirement funds and rather than rolling over the funds or keeping them in the trust, they choose to take out a cash distribution. Generally, if a Participant chooses to take this distribution prior to reaching age 59 1/2 it is deemed a Premature Distribution. In addition to paying normal income taxes on such distributions they are punished by a 10% federal premature distribution penalty. If they reside in California there is an additional 2 ½ % premature distribution penalty.

Exceptions to the 10% Federal Penalty Tax (and 2 1/2% for CA)

There are, however, exceptions to the rule. The Premature Distribution Penalty tax does not apply if the distribution is:

1. Made because of a disability

2. Made to a Beneficiary due to the death of the Participant.

3. Part of a Lifetime Distribution. This means that each distribution must be part of a series of substantially equal periodic payments made over the life (or joint life) expectancy of the Participant or the Participant's Beneficiary. Furthermore, the payments must begin after a separation from service. And they may not be modified before the end of the five-year period after benefits commence and the attainment of age 59 1/2.

If a Distribution made prior to age 59 1/2 does not meet one of these exceptions, the 10% Federal premature distribution penalty and the and 2 1/2 % CA penalty shall apply.

Required Minimum Distributions (RMD) - Prior to Participant's Death

If a Participant is no longer employed and has reached age 70 1/2, he or she must begin taking distributions. Furthermore, if a Participant is a 5% Owner and has reached age 70 1/2, he or she must begin taking distributions even if they are still employed. The amount of this Required Minimum Distribution (RMD) is determined by three factors: the Account Balance, the Participant's age, and a factor based on the Participant's life expectancy, which is determined from a mortality table published by the IRS. The RMD rules are intended to prohibit a Participant from keeping money in a tax free vehicle indefinitely.

For Participants who are NOT 5% Owners, payments must commence by the later of the April 1st following the calendar year during which the Participant turns 70 1/2 or the year the Participant actually retires. For Participants who are 5% Owners, payments must commence by April 1 following the calendar year during which the Participant attains age 70 1/2.

Calculation of RMD

The RMD is calculated by dividing the Participant's Account Balance as of December 31 of the previous year by a factor provided by the IRS issued Uniform Lifetime Table. In determining the appropriate life expectancy, or distribution period, the Uniform Lifetime Table assumes the Participant has a Beneficiary who is 10 years younger than the Participant. The factors of the Uniform Lifetime Table are as follows:

In calculating the RMD for a particular year, use the distribution period factor next to the age of the Participant as of the December 31 of the year. For example, if you are calculating the RMD for 2009, use the Participant's age as of 12/31/2009.

Example: Assume Jack was born on May 15 1939, thus turning 70 1/2 on November 15 2009. His Account Balance on 12/31/2008 was $650,000 and on 12/31/2009 was $710,000. His 2009 and 2010 RMD is calculated as follows:

2009 RMD = 12/31/2008 Account Balance / Uniform Lifetime Table factor

= $ 650,000 / 27.4 (Jack is age 70 as of 12/31/2009)

= $ 23,723

This amount is the 2009 RMD, but may be paid any time in 2009 or

in the first quarter of 2010, on or before 4/01/2010.

2010 RMD = 12/31/2009 Account Balance / Uniform Lifetime Table factor

= $ 710,000 / 26.5

= $ 26,792

This amount must be paid no later than 12/31/2010.

Every Participant's RMD from a qualified plan or a regular IRA is calculated by using the above table except a Participant with a spouse who is more than 10 years younger than the Participant. In that case, the IRS issued Joint and Last Survivor Table is used to calculate the RMD, which will provide a more favorable result for the Participant.

If an individual is required to take a RMD and fails to do so, that individual is subject to a fifty percent (50%) excise tax on the amount of the shortfall. For example, if a Participant is required to take $4,000 distribution, but takes only $3,000, the Participant must pay an excise tax of $500, which is 50% of the $1,000 shortfall.

If an account holder has more than one IRA, the RMD should be calculated for each account and the RMD withdrawn from each account. Alternatively, he or she may add up the total RMD from all accounts and withdraw that total RMD from just one IRA, or any combination of IRAs he or she so chooses.  The RMD for each account in a qualified plan must, however, be withdrawn from that plan.  An RMD from an account in a qualified plan may not be withdrawn from the account of another qualified plan or from an IRA.

The foregoing rules apply to Participant's in a qualified retirement plan and account holders of a regular Individual Retirement Account (IRA). There are, however, no RMD requirements for the account holder of a Roth IRA during his or her lifetime.   That said, there are RMD requirements for the beneficiary of a ROTH IRA.

Required Minimum Distributions (RMD) - After the Participant's Death

The death of a Participant creates a new set of RMD rules. Upon the death of the Participant, the Beneficiary generally has two choices as to how they would like to receive distributions from the deceased Participant's account:

(1) The entire amount in the deceased Participant's account must be distributed by the December 31 of the year containing the five year anniversary of the Participant's death.

OR

(2) The distributions must be made over the life expectancy of the Beneficiary beginning no later than the December 31 of the year following the year of the Participant's death.

Distributions under the first option are pretty straightforward. Distributions can be made at any time as long the entire account has been distributed by the December 31 of the year containing the fifth anniversary of the Participant's death. For example, Elmer died on March 15 2007. If Elmer's Beneficiary chooses not to take distributions over his or her lifetime, the entire account must be distributed no later than December 31 2012. Exceptions for spousal Beneficiaries will be discussed below.

If the Beneficiary opts to take distributions over his or her life expectancy, distributions are calculated using the life expectancy of the Beneficiary as of the year after the death of the Participant and subtracting 1 for each subsequent year. Life expectancies are determined using the IRS issued Single Life Expectancy table, the values of which are as follows:

Example: Larry, a 76 year old Participant in a qualified profit sharing plan, left his entire account balance to his daughter, Mary, who was born in November 1954. Larry dies in March, 2008. Mary, who will be 55 years old, must take her first distribution by 12/31/2009 based on her life expectancy of 29.6 (see above table). Assume the account balance has a value of $500,000 on 12/31/2008, $530,000 on 12/31/2009 and $545,000 on 12/31/2010. Her RMD for 2009, 2010 and 2011 are calculated as follows:

2009 RMD = 12/31/2008 Account Balance / Beneficiary's Life Expectancy

= $ 500,000 / 29.6

= $ 16,892

2010 RMD = 12/31/2009 Account Balance / Beneficiary's Life Expectancy minus 1

= $ 530,000 / 28.6 (Initial Life Expectancy of 29.6)

= $ 18,531

2011 RMD = 12/31/2010 Account Balance / Beneficiary's Life Expectancy minus 2

= $ 545,000 / 27.6 (Initial Life Expectancy of 29.6)

= $ 19,746

There are a few exceptions and/or variations to the foregoing rules:

If the Participant or account holder dies on or after the required beginning date (generally the April 1 following the attainment of age 70 1/2) AND the Beneficiary is older than the accountholder, the Participant's remaining life expectancy is used to calculate the minimum distributions. Usage of this longer life expectancy will result in smaller annual distributions.

If the Participant's Beneficiary is a trust or an estate, neither of which has a life expectancy, the distribution is based on the Participant's life expectancy in the calendar year of death and by subtracting 1 for each subsequent year.

If more than one Beneficiary is designated, the life expectancy is determined by the age of the oldest Beneficiary. If the plan allows the trustee to set up separate accounts for each Beneficiary, the life expectancy could be determined for each Beneficiary. The same result could be achieved by transferring each Beneficiary's share of the account to his or her own IRA by the December 31 of the year following the year of death.

If the designated Beneficiary dies after the Participant, but before receiving his or her first distribution from the account, the deceased Beneficiary is included in determining the age of the oldest Beneficiary. The distribution period is calculated without regard to the successor Beneficiary.

If a spouse is the Participant's sole named Beneficiary, the spouse may treat the deceased Participant's account or IRA as their own and roll it over to their own IRA. When using this method of distribution, the actual age of the spouse is used each year in determining the distribution factor. This factor would be determined by using the single life expectancy table.

A spouse of a Participant in a qualified plan may leave the account in the plan and not have any required distributions until the later of the end of the year the Participant would have attained age 70 1/2 OR December 31 of the following year.

In-Service Distributions

Qualified retirement plans are subject to rules that restrict a Participant's access to his or her plan accounts. All retirement plans may provide that a Participant's account may be distributed upon retirement, death, disability, or separation from service. Some plans may allow Participants to withdraw funds prior to one of these events. Allowing for such in-service distributions is an optional plan feature. According to the law, whether certain accounts are accessible to the Participant depends on the type of contribution used to fund that account. In general, accounts funded with a participant's 401(k) Elective Deferrals are less accessible than accounts funded with other employer contributions. Funds which are attributable to 401(k) elective deferrals may be accessed by the Participant under the following circumstances:

1. Attainment of age 59 1/2

2. Hardships (see below for determining when Hardships are allowed)

3. Termination of the plan

4. Sale or other disposition of substantially all assets used by a corporation

5. Sale or other disposition by corporation of its interests in a subsidiary

The funds which are attributable to non-elective employer contributions are much easier to access. These funds may be distributable after one of the following:

1. The attainment of a stated age

2. The occurrence of some event such as layoff or sickness

3. The funds have been held in the plan for at least two years. This two-year period runs from the date contributions are actually made and not from the date on which they were deemed made.

Most of the plans we write do not allow for in-service distributions. We have taken over a number of plans which allowed for in-service distributions, and in many cases, the Participants were unhappy with the retirement plan. We feel the primary cause of this dissatisfaction is that in-service distributions often give employees the feeling that this is a savings account and not a retirement plan. The stated objective of a retirement plan is to save money for retirement. Allowing for in service distributions often results in disgruntled employees because there is no accumulation of funds for retirement.

Hardship Distributions

Hardship withdrawals are an optional plan feature. They allow a Participant to withdraw money from their account without otherwise becoming eligible for a distribution. A Participant may qualify for a hardship distribution if it is in response to an immediate and heavy financial need (the events test) and it is necessary to satisfy that need (the needs test). Both the events test and the needs test must be satisfied in order for a distribution to satisfy the IRS requirements and qualify as a hardship distribution.

For purposes of determining whether these tests are satisfied, the regulations provide two different standards: the general standard and the safe Harbor standard. The events test is considered satisfied if a distribution is made for any of the following reasons:

1. Payment of medical care expenses for the Participant, the Participant's spouse, or any dependents. Expenses for medical care are also covered.

2. The purchase of a Participant's principal residence (but not mortgage payments).

3. Payment of tuition, related educational fees and room and board expenses for the Participant, Participant's spouse, children or dependents.

4. Payments necessary to prevent eviction from or foreclosure on a mortgage on the Participant's principal residence.

5. The events test is considered satisfied using the general standard if the plan sponsor considers all relevant facts and circumstances and determines that the distribution is due to a hardship. The regulations point out that whether this hardship can be foreseen or the fact that it is voluntarily incurred is generally not relevant.

The needs test is considered satisfied if the distribution is made for any of the following reasons:

1. The amount of the distribution does not exceed the amount necessary to relieve the financial need.

2. The Participant has obtained all distributions and all nontaxable loans from all plans maintained by the Employer.

3. The Participant does not make elective contributions and employee contributions to the plan and all other plans maintained by the Employer for at least six months after the hardship distribution is received.

4. If, based on all the facts and circumstances, a distribution is needed to relieve the Participant's financial need. This is the general standard and it entails that the plan determine whether the need can be relieved through other resources reasonably available to the employee. This requires intruding into the personal financial circumstances of employees. If the plan sponsor does not wish to do this they may rely on the participant's written statement that his or her financial need cannot be satisfied by any of the following:

a) Reimbursement or compensation by insurance or otherwise;

b) Liquidation of the Participant's assets;

c) Ceasing contributions under the plan;

d) Other distributions or nontaxable loans from plans maintained by the employer or any other employer;

e) Borrowing from commercial sources on reasonable commercial terms.

If item number four is the standard used to pass the needs test, the Participant is not required to cease making elective contributions.

Caution to Employers

Many people allow for hardship distributions in their plans because they believe it will increase participation among Non-Highly Compensated Employees, which will help the plan pass the ADP test. We strongly advise our clients against allowing for hardship distributions for a few reasons:

1. Hardship distributions rarely offer the best solution to solving a Participant's problem. They are subject to regular taxation plus a 10% federal premature distribution penalty if under age 59 1/2 (plus 2 1/2% for California). After paying these taxes the resulting distribution is equal to barely half of the Participant's original account balance. Furthermore, taking such a distribution almost always wipes out a majority, if not all of the Participant's account balance.

2. Determining whether a Participant qualifies for a Harship Distribution often puts Employers into very difficult situations with their Employees. Sooner or later Employers will have to deny a request for a hardship withdrawal. This often creates dissatisfaction among employees toward the employer even though the employer is simply fulfilling his fiduciary responsibilities.

3. On the part of the fiduciary there is little room for error. A fiduciary can disqualify the plan by allowing for hardship that is not truly a hardship, or for even giving money in excess of the actual hardship required. The hardship rules require the Employer to be the judge and jury and even investigator. We would not generally suggest that the Employer undertake this responsibility.

If not a Hardship Withdrawal, then what?

With all of this in mind, taking out a participant loan is almost always preferable to a hardship distribution. When compared with a Hardship Distribution, a participant loan:

1. Gives the Participant nearly an equal amount of money and often times more,

2. Usually has no restriction on how the money is used,

3. Maintains the Participant's account balance in the plan,

4. Maintains his or her participation in the plan, and

5. Eliminates current tax liability.

6. Eliminates premature distribution penalty if the Participant is under age 59 1/2.

7. Relieves the Employer of the responsibility of having to investigate, verify, and determine whether the Employee qualifies for the Hardship Distribution under the strict IRS Regulations.

Background

Each Participant with an Account Balance or Accrued Benefit is required to complete a Beneficiary Designation Form upon which he or she will designate who is to receive his or her benefits in the event of the death of the Participant. This form constitutes instructions to the Trustee who is to receive the Accrued Benefit of the deceased Participant and takes precedence over any other document, including the Participant's will or family trust. It is, therefore, extremely important that the Participant complete a newly updated Beneficiary Designation Form whenever there is change in his or her desired Beneficiary or a change in marital or family status.

Information Required

The Participant is required to complete the form in full and must provide the following information: (1) Name of Participant (2) Social security number of Participant (3) Address and telephone number of Participant (4) Name of primary Beneficiary, relationship, and their address (5) Name of secondary Beneficiary, relationship, and their address The primary Beneficiary, if still living, will be entitled to the Accrued Benefit upon the death of the Participant. If the primary Beneficiary predeceases, or dies simultaneously to, the Participant, the secondary Beneficiary will be entitled to the benefits. The Participant may name as many primary Beneficiaries or secondary Beneficiaries as he or she chooses, just so long as their wishes are made clear to the Trustee. For example, a typical designation would be to name "my wife Mary Smith" as the primary Beneficiary and "my three children, Jack Smith, Emily Jones, and Raymond Smith, equally" as the secondary Beneficiary.

Spousal Rights

With the enactment of the Retirement Equity Act of 1984, the spouse of the Participant has certain rights with regards to the disposition of the deceased Participant's Accrued Benefit. Once a spouse has been married to the Participant for one year, the general rule is that the spouse is the primary Beneficiary, regardless of any other documentation to the contrary, including the latest Beneficiary Designation Form, the Participant's will or family trust, any prenuptial agreement, etc. The spouse of a year or more will not be the Beneficiary if, and only if, the spouse waives his or her rights to be the Beneficiary. The waiver language, along with space for the spouse's signature, is at the bottom of the Beneficiary Designation Form. Furthermore, we require the spousal signature be notarized. The spousal waiver is permanent and may not be rescinded. Once the spouse waives his or her rights, they may not ever reclaim their rights. (For a more detailed commentary see section entitled Spousal Rights).

Somebody dies and there is no Beneficiary Designation Form!!

Despite the importance of this form, Participant's may still neglect to fill out the form or the Beneficiaries listed may pre-decease the Participant. If no valid Beneficiary Designation Form exists, the Trustee must distribute benefits to potential beneficiaries in the order stipulated in the Plan Document.  In most of our plans, this order is (1) the surviving spouse, (2) the trustees of a revocable living trust established by the Participant during his or her lifetime, (3) the Participant's children, and (4) the Participant's estate.  Thus, in order to ensure that a Participant's wishes are fulfilled, he or she must fill out the form and complete a new updated form whenever there is change in his or her desired Beneficiary or a change in marital or family status.

We strongly encourage all Employers to review their files at least once per year to make sure you have a valid Beneficiary Designation Form on file for each Participant, both active and inactive.  The Employer will be burdened by additional unwanted duties and responsibilities if a Participant dies without a valid Beneficiary Designation Form on file. 

Background

The spouse of any Participant in a qualified retirement plan has certain rights to that Participant's vested Account Balance. Questions concerning spousal rights most commonly arise during one of three events: (1) distributions during the Participant's lifetime; (2) the death of the Participant; or (3) the dissolution of the marriage.

Spousal Rights in the event of distributions to the Participant

If a Participant has an Account Balance or Accrued Benefit in excess of $5,000, no distribution, other than a Required Minimum Distribution (RMD), may be paid to a Participant without the written and notarized consent of the spouse.

Spousal Rights in the event of a Participant's Death

If a Participant has been married for at least one year, upon the death of a Participant, benefits are provided automatically to the surviving spouse unless those benefits were waived by the Participant's spouse. The consent must be in writing and must be witnessed by a notary public. It must also specify who will receive benefits upon the Participant's death and the form in which those benefits are to be received. Once a spouse has given his or her consent, it may not be revoked. (For a more complete discussion on this topic see section entitled 'Beneficiary Designation Rules')

If a spouse does not waive those rights, the Account Balance must be made available to the surviving spouse within a reasonable amount of time. Anything within 90 days shall be deemed reasonable. As a general rule, the spouse must not be treated less favorably than other Participants entitled to distributions. Otherwise, such treatment shall be deemed unreasonable.

Spouses and Participant Loans

If a Participant's Account Balance is pledged as security for the loan, then spousal consent is required. Spousal consent must be given within 90 days before the date the loan is made and it must be in writing. Furthermore, if the Plan is a Defined Benefit or Money Purchase Pension Plan, the spousal signature must be witnessed by a notary public. If a secured loan is outstanding at the time of death, the Account Balance of the Participant is first reduced by the amount of the outstanding loan.

QDRO's and Spousal Rights in the Dissolution of the Marriage

As a general rule, plans are prohibited from distributing a Participant's Account Balance to anybody other than the Participant while the Participant is still alive. A Distribution arising from a Qualified Domestic Relations Order (QDRO) is an exception to this rule.

A Domestic Relations Order is a judgment, decree, or other order made pursuant to a state domestic relations law that relates to the provision of child support, alimony, or marital property rights. A Qualified Domestic Relations Order is a Domestic Relations Order that creates a right for an Alternate Payee to receive some or all of a Participant's benefits in a qualified plan. The Alternate Payee must be the spouse, former spouse, child, or other dependent of a Participant.

A QDRO must clearly state the following information:

1. The name and last known mailing address of the Participant and each Alternate Payee awarded benefits.

2. The amount or percentage of benefits to be paid to the Alternate Payee and the form in which those benefits are to be received.

3. The plan to which the order applies.

A QDRO has the following limitations:

1. It may not contain a provision requiring a plan to provide any type or form of benefit or any option not otherwise available under the plan terms.

2. It may not contain a provision that would require the plan to pay increased benefits. For example, a QDRO may not ask for payment to an Alternate Payee in an amount greater than the Participant's vested Account Balance.

3. Benefits payable can only be equal to the present value of the benefit actually accrued as of that date. Therefore, benefits accrued after the date benefits commence under the QDRO may not be reflected in the payments to the Alternate Payee.

4. Defined Contribution plans may compute Account Balances only as of specific valuation dates set forth in the plan. A plan administrator is not required to approve a QDRO which requires the computation of an amount on a date other than an established valuation date.

5. It may not require a plan to pay to one Alternate Payee benefits that have already been awarded to another Alternate Payee in a separate QDRO.

QDRO Procedure

Upon receipt of a Domestic Relations order, the plan administrator must promptly notify the Participant and the Alternate Payee that an order has been received and inform them of the plan's procedures for reviewing orders. A plan must have reasonable procedures for reviewing domestic relations orders, but this information need not be contained in the plan document. The administrative expenses associated with reviewing a QDRO may be paid from general plan assets, but may not be charged to the Participant or the Alternate Payee.

While an order is under review, the plan administrator cannot pay to a Participant any amounts that would be payable to an Alternate Payee if the order were qualified. These amounts must be separately accounted for and must be held back from distribution for at least an 18-month period.

Qualified plans are prohibited from complying with non-Qualified Domestic Relations Orders. Any payment pursuant to such an order will provide a basis for disqualifying the entire plan.

Timing of QDRO Payments

The timing of the distribution of benefits to an Alternate Payee may vary depending on the terms of the plan and the QDRO. In some situations, payment may be given to an Alternate Payee prior to the time a Participant is allowed to receive benefits. If the plan contains a provision permitting immediate distribution to Alternate Payees upon approval of an order (and most of our plans do), and the order calls for immediate distribution, then benefits may be paid right away.

If the plan does not contain this provision to pay Alternate Payees immediately, an order may still require payment when a participant attains age 50, even if the Participant has not terminated employment. This language need only be in the QDRO for this to take effect.

If an order does not take advantage of either of these early distribution options, payment will occur at whatever point called for in the order after the Participant becomes eligible for a distribution.

Taxation of QDRO payments

If the Alternate Payee is the spouse or former spouse of a Participant, the distribution is taxed to the Alternate Payee. If it is not a spouse or former spouse, the distribution is taxed to the Participant. The 10% premature distribution penalty that generally applies to distributions made before a Participant attains age 59 ½ does not apply to any distribution to a spousal Alternate Payee. Furthermore, a spousal Alternate Payee may rollover the distribution.

Who Is a Fiduciary?

Retirement plans are managed for the exclusive benefit of the plan's participants by representatives called fiduciaries. A Fiduciary is a person who exercises any discretionary authority or control over the management of the plan or its assets, or who is paid to give investment advice regarding plan assets. Plan Sponsors and Trustees identified in the plan document are always fiduciaries.

In determining whether or not an individual is a Fiduciary, one considers the functions the individual performs, not the person's title. Plan service providers such as actuaries, attorneys, accountants, brokers, and individuals performing only ministerial functions are not fiduciaries unless they exercise discretion or are responsible for the management of plan assets.

Fiduciary Duties and Obligations

A Fiduciary does assume a large amount of responsibilities. A Fiduciary is legally responsible for adhering to certain rules of conduct and must do all of the following:

1. Act in the exclusive retirement benefit interest of Participants and beneficiaries and control the expenses of administration,

2. Make decisions with the level of care that a prudent person familiar with retirement plans would use under the same circumstances,

3. Diversify investments to minimize the risk of large losses unless it is clearly imprudent to do so,

4. Use care to prevent co-fiduciaries from committing breaches and rectify the actions of others,

5. Hold plan assets within the jurisdiction of United States courts,

6. Be bonded in the amount of 10% of funds handled up to a $500,000 maximum bond,

7. Act according to the terms of the plan documents unless the documents are in conflict with the provisions of ERISA, and

8. Not engage in Prohibited Transactions. (for a more complete discussion on this topic see section entitled 'Prohibited Transactions')

Breach of Fiduciary Duties

Fiduciaries that breach their duties may be personally liable to make a plan whole for losses incurred by their breaches. Losses may possibly include lost opportunity costs, attorney's fees and court costs. Even if a Fiduciary is unaware that he or she is violating their fiduciary duties, they may still be held liable for the violation. A Fiduciary cannot be held liable for breaches committed before they became a Fiduciary. However, they should take steps to remedy the situation and not doing so may result in a subsequent independent breach of fiduciary duty.

Fiduciaries may also be held liable for failing to act. For example, a Fiduciary's failure to take reasonable steps to correct a co-fiduciary's breach is impermissible under the following circumstances if he:

1. Knowingly participates in or tries to conceal a co-fiduciary's breach,

2. Enables a co-fiduciary to commit a breach by failing to meet his or her specific fiduciary responsibilities,

3. Knowing of a co-fiduciary's breach fails to make a reasonable effort to remedy it.

Correcting Fiduciary Breaches

A Fiduciary must try to remedy a personal breach or a breach of a co-fiduciary. For example, if the breach was due to making an improper investment, the Fiduciary should dispose of the investment. In the case of a co-fiduciary's breach the Fiduciary might notify the Employer or the plan Participants of the breach, institute a lawsuit against the co-fiduciary, or bring the matter before the DOL. A Fiduciary's resignation as a protest against a co-fiduciary's breach, without making a reasonable effort to remedy it or prevent it, will not relieve the Fiduciary of liability.

Minimizing Fiduciary Responsibilities

Fiduciary responsibilities can be rather burdensome and knowingly or unknowingly committing breaches is quite easy. Therefore, we strongly recommend all of our clients to minimize their fiduciary responsibilities to the greatest extent possible. Fiduciaries should accept only the responsibilities for which:

1. They have the necessary skills and knowledge,

2. They can carry out faithfully, and

3. They can exercise procedural due diligence in executing their duty, and document all their actions and decisions.

They are not required by law to be clairvoyant when carrying out their duties or when making investment decisions. They are expected to follow a process that ensures their decisions are well-informed and consistent with the plan's stated objectives at the time the decision is made. In light of these high standards to which Fiduciaries are expected to abide, many of our clients choose, and we recommend, delegating responsibilities. For example, responsibility for investment decisions can be shifted to an investment manager or, in certain cases, to plan Participants (see "Delegating Investment Responsibility" below). In fact, if a Fiduciary lacks the required expertise in an area, he or she must seek expert advice. However, the Fiduciary will remain responsible for the quality of the decision. In addition to delegating duties to others, a Fiduciary may minimize his or her responsibility by obtaining fiduciary liability insurance or by obtaining an indemnity from the plan sponsor in lieu of, or in addition to, fiduciary liability insurance. There is a complete discussion on Fiduciary Liability Insurance below. Following this advice will help to minimize Fiduciary responsibility, however, it is impossible to completely eliminate a Fiduciary's liability. If, however, the Fiduciary acts with prudence, he or she should have no problem fulfilling his or her duties without liability.

Delegating Investment Responsibility

A Fiduciary's responsibility to invest the plans assets may be delegated in one of two ways:

1. Hiring an investment manager

2. Giving participants investment control.

For purposes of ERISA an investment manager is a bank, insurance company, or a registered investment adviser under the Investment Advisors Act of 1940 (Advisors Act) who acknowledges in writing that it is a Fiduciary with respect to the plan and accepts the power to manage plan assets. A plan sponsor or Fiduciary should ask about the advisors registration status and inquire about experience and the amount of assets under management.

According to ERISA section 404(c), if a Participant is given control over the investment of his or her account, plan Fiduciaries will not be held responsible for investment losses resulting from that exercise of control. However, there are very specific requirements that must be met and followed in order to claim this defense.

Even if the plan satisfies these requirements plan Fiduciaries cannot completely eliminate liability for investment decision-making. They remain responsible for the selection and monitoring of funds available for investment, for prompt and accurate execution of transactions, and for providing adequate disclosure.

Fiduciary Liability Insurance Coverage for Plan Sponsor and Trustees

Plan participants and others may bring lawsuits against fiduciaries if they feel that a Fiduciary has not followed the rules outlined above. This can have serious financial consequences for the Plan Sponsors and Trustees. If sued, they are personally responsible for all expenses related to the lawsuit, including defense costs, judgments and penalties. These costs must be paid for with their personal assets, including their home or business! Plan fiduciaries are open to many types of lawsuits. Plan participants may sue individually or as a class if they feel that benefits were misrepresented or if they believe that different decisions by the trustees could have yielded a higher return. They may even sue over enrollment issues.

Under ERISA 410, the plan cannot relieve them of this responsibility with indemnification language. However, the law specifically permits persons with personal financial exposure to purchase Fiduciary Liability Insurance. ERISA does not require Fiduciary Liability protection; the only mandatory insurance is an ERISA/Fidelity bond to protect the plan assets from losses due to misuse or misappropriation (See section below titled Fidelity Bond). ERISA Fidelity bonds protect the plan assets and Fiduciary Liability Insurance protects the Plan Sponsors and Trustees.

A lot of insurance companies do not offer Fiduciary Liability Insurance. You can check with your insurance agent. If they cannot help, we have done some research and found that Colonial Surety Company offers Fiduciary Liability Insurance. They have reasonable prices and are easy to deal with. However, there are other companies who may offer a better product and/or a better price, Colonial is merely a suggestion. They offer coverage up to $1 million, which is available as an endorsement to their ERISA Fidelity Bonds for qualifying plan assets.

- Coverage includes defense costs and penalties

- Choice of $0, $5,000 and $10,000 deductible

- Basic policy covers two trustees. Coverage available for all trustees/fiduciaries

- Available in all states

- Simple online quote and purchase process at www.colonialsurety.com .

If you prefer to purchase the insurance through a Colonial representative, or if you have any questions concerning the purchase of this bond, contact John Caserta at (800) 221-3662 Ext. 20. If you decide to purchase Fiduciary Liability Insurance and you decide to go with Colonial, be sure to reference our corporate account number: CA0298. If you give them that number, we may receive a 20% rebate on the cost of the insurance and, if we do, we will pass this savings on to you.

Every Fiduciary's situation is unique, but you may want to seriously consider purchasing Fiduciary Liability Insurance as protection from personal liability for costs related to lawsuits brought for fiduciary decisions.

Fidelity Bond

New DOL regulations state that all retirement plans, which cover at least one non-owner employee, must have a Fidelity Bond to protect the plan assets. Failure to obtain sufficient fidelity bonding now triggers the need for a costly independent annual CPA audit of the plan. If you do not already have one, we strongly advise you to purchase the bond as soon as possible.

In order to waive the annual CPA audit requirement, adequate fidelity bonding must be effective the first day of the plan year. The amount of fidelity bonding required is generally 10% of trust assets. If however, your trust has investments in limited partnerships, artwork, collectibles, mortgages and/or real estate, the amount of the bond must be equal to at least 100% of the value of those assets.

Overview

Unless covered by an exemption, economic transactions involving a plan's assets and parties related to the plan are strictly prohibited. For example:

1. Direct or indirect sale, exchange, or lease of property,

2. Transfer or use of plan assets,

3. The investment in employer securities or employer real estate in excess of the legal limits, or

4. Dealing with the plan assets where the fiduciary has a conflict of interest such as self-dealing, acting on behalf of a party whose interest is adverse to the interests of the plan, or receiving a kickback from any other person in connection with a transactions involving plan assets.

A Party in Interest generally includes plan Fiduciaries, service providers, sponsoring Employers, and those who control the Employer, as well as individuals who are related to any of the aforementioned by family or business ties. In other words, a Fiduciary should not hire his spouse as a paid investment advisor to the plan assets. It is also important to know that these transactions are prohibited even if they prove to be beneficial to the plan and its Participants.

Correction of Prohibited Transactions

A prohibited transaction may be corrected by undoing the transaction to the extent possible but in any event by placing the plan in a financial position no worse than the position it would have been in had the party in interest acted under the highest fiduciary standards.

A Fiduciary must try to remedy a breach of a co-Fiduciary. Also, the Fiduciary might notify the Employer or the plan Participants of the breach, institute a lawsuit against the co-Fiduciary, or bring the matter before the DOL. A Fiduciary's resignation as a protest against a co-Fiduciary's breach, without making a reasonable effort to remedy it or prevent it, will not relieve the Fiduciary of liability.

Penalties for Engaging in Prohibited Transactions

A prohibited transaction is a breach of Fiduciary duty. Any Fiduciary who engages in a prohibited transaction is, therefore, personally liable for any losses to the plan and must restore to the plan any profit made by the Fiduciary through the use of the plan's assets. A 20% penalty may be imposed by the DOL for certain breaches. Also, for prohibited transactions occurring after August 5, 1997, a penalty tax is imposed on a disqualified person for each year or part thereof that the transaction remains uncorrected. This tax is equal to 15% of the amount involved and an additional tax equal to 100% is imposed if the prohibited transaction is not timely corrected.

Failure to Timely Deposit 401(k) Elective Deferrals Is a Prohibited Transaction

Failing to timely deposit 401(k) Elective Deferrals into the trust is one of the most common forms of a prohibited transaction. Salary deferrals must be deposited to the trust as soon as they become plan assets. Salary deferrals will be considered plan assets as of "the earliest date on which the contributions can reasonably be segregated from the general assets of the Employer." In any event, that date may be no later than 15 days following the month in which the contributions are withheld by the Employer or would have been paid to the Employee in cash if not withheld from wages. Once these Elective Deferrals become plan assets their retention by the Employer is treated by the IRS as a prohibited transaction. The DOL usually treats such a transaction as a prohibited loan from the plan to the Employer.

On February 29, 2008 the DOL issued proposed regulations providing additional guidance on this issue. The existing standard of making deposits as soon as the money can be segregated from the employer's general assets remains in force. But a clear safe harbor time frame is established for small plans with fewer than 100 participants at the beginning of the plan year. The safe harbor deadline is the 7th business day after the day on which such amounts would have been payable to the participant in cash (in other words, withheld from paychecks).

When a former participant is paid a cash distribution from the plan, the plan administrator is usually required to withhold federal and state taxes (For a complete discussion on the different type of distributions and how much tax should be withheld, see the section of this website titled Distributions). In order to make the deposits you must have a federal and state ID Number for the Trust. (This is different than the numbers you may have for your business) Following are instructions for making the deposits of those taxes withheld:

Federal Taxes:

This deposit of federal income taxes should be made directly to your bank. A check for the amount of the federal income tax withheld should be made out and sent directly to your bank. The payment should be accompanied by a federal depository coupon. The coupon booklet, IRS form 8109, is 3 1/4 inches tall and 8 1/2 inches wide. There are only a few things to complete on the coupon:

a) On the top center of the form, enter the amount of the depository.

b) To the right of the amount, under "Type of Tax", check box "945".

c) On the far right of the coupon, check the calendar quarter that the withholding took place in. Jan - March = 1st quarter, etc.

If the IRS did not send you a coupon book, you can call them at (800) 829-1040 to request your supply of preprinted forms. If you need to make a depository prior to receiving your coupon book, you should go to your bank to make the depository and they can supply you with a blank coupon. In addition to the above information, in the middle of the form you will have to complete the name and address of your retirement trust and the trust federal ID number.  (Please be sure to us the Retirement Trust's Federal ID number and NOT the corporate ID number.)

State Taxes:

A check for the state income tax withheld should be made out from the trust to the Employment Development Dept (EDD) and mailed to the following address:

State of California

Employment Development Department

P. O. Box 826276

Sacramento, CA 94230-6276

The payment must be accompanied by a depository coupon you should have received from the EDD when they issued you your ID number. Most of the form is pre-printed, but you do need to complete the following info:

a) Enter the date of the distribution to the former participant in the upper center of the coupon.

b) Under "Payment Type", check "Quarterly" box.

c) On the far right of the coupon, enter the amount of the state income tax withheld on line "D", " California PIT". Enter the same amount on line "G", which is the total.

The EDD is usually pretty good about getting the coupon books to you. If you have an ID number, you probably have the coupon book. If by chance you do not have or cannot locate your coupon book, you can call the EDD at (888) 745-3886 and request a coupon book, form DE 88.

Filing Requirements

Once the Trust has a Federal Tax ID Number, you must file an annual form 945, whether there was income tax withholding during the year or not.

If the Trust has a State ID number, you must file a quarterly form DE6 and an annual DE7 with the EDD, whether there was income tax withholding during the period or not.

These forms are very simple and self explanatory.  If you have questions, need help, or would like us to prepare the forms for you, please advise us and we will be happy to help.