IRS Announces 2017 Plan Limitations

The IRS has now announced the qualified plan limitations for 2017. These limitations are determined based on annual increases in the cost of living index. Because there was a modest increase in the index, some of the plan limits have been changed for 2017.

Increasing in 2017:

• The maximum annual benefit payable from a defined benefit plan will increase from $210,000 to $215,000.
• The maximum amount that can be contributed by and for a participant to a defined contribution plan (i.e. profit sharing or 401(k) plan) will increase from $53,000 to $54,000 (this amount does not include catch-up contributions).
• The maximum amount of compensation taken into account for plan purposes will increase from $265,000 to $270,000.
• The definition of “key employee” will include an officer making more than $175,000, up from $170,000.

Staying the same in 2017:

• The 401(k) deferral limit will remain at $18,000.
• The catch-up contribution for participants who have attained age 50 will remain at $6,000.
• The compensation-based definition of highly compensated employee (HCE) will remain at $120,000. Thus, an employee who earns more than $120,000 in 2016 will be deemed an HCE in 2017.

In addition, the Social Security taxable wage base will increase from $118,500 to $127,200. Though not a qualified plan limitation per se, this will have an effect on the calculations in a plan that uses permitted disparity as the allocation methodology.

Please contact us if you have any questions about how this may affect your own qualified plan.

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MID-YEAR AMENDMENTS TO SAFE HARBOR 401(k) PLANS – THE IRS BACKS OFF

For the past few years, there has been great concern in the benefits community about the IRS position on making mid-year amendments to 401(k) plans. Relying on ambiguously-worded language in the Regulations under Sections 401(k) and 401(m), the Service had ominously (but informally) indicated that any amendment to a plan that had elected safe harbor status for a plan year was suspect if it became effective during such plan year. The consequences of such a prohibited amendment were, at a minimum, the loss of the safe harbor election for the year (thus subjecting the plan to ADP and ACP testing), and the potential of plan disqualification (for violating the provisions of the safe harbor).

Over time, it became apparent that this position was not sustainable in the extreme, and the IRS began to carve out exceptions. Changes such as a mid-year replacement of a plan trustee and other inconsequential revisions to plan provisions (including Roth elections) were recognized as not violating the prohibition on mid-year amendments. Indeed, certain changes were mandated by law (relating to same sex spouses) and IRS procedures (the entire PPA restatement process itself could be claimed to violate the mandate against mid-year amendments). Still, there remained a high level of uncertainty about what could, and could not, be amended.

Finally, after years of silence despite repeated requests from ASPPA, among others, the IRS has now issued Notice 2016-16, in which it has significantly backed off its hard-line stance. There remain a few prohibited amendments, but these are neither surprising nor oppressive. For the most part, mid-year amendments are permitted, as long as they do not adversely affect the expectations of plan participants, and appropriate notice of such changes is provided (reasonable advance notice and an opportunity to make a new deferral election is required, but even most retroactive amendments are permitted with notice as soon as reasonably possible).

The following are among those provided as examples of permissible changes made mid-year:

  • The increase of future safe harbor non-elective contributions from 3% to 4%.
  • A retroactive increase in a safe harbor matching contribution for the plan year.
  • The addition of an in-service withdrawal provision.
  • A change in the plan’s default investment fund.
  • A change to the plan entry date for future participants.

One can extrapolate that other common amendments, such as the addition of a loan program or revisions to distribution options, are no longer problematic.

Explicitly prohibited are the following mid-year changes:

  • Increasing the years of service required for an employee to be vested in QACA contributions.
  • Reducing or narrowing the group eligible to receive safe harbor contributions.
  • Changing the type of safe harbor (i.e., switching from non-elective to matching or vice-versa).
  • Changing or adding a formula used to determine matching contributions (or the definition of compensation used to determine such contributions), or to permit discretionary matching contributions. However, even such amendments are permitted if they occur at least three months prior to the end of the plan year, such changes are made retroactive for the year, and an updated safe harbor notice and election are provided to participants.

Clarity is always welcome, and a reasonable approach is doubly appreciated. It would appear that the IRS took the comments of practitioners seriously, perhaps recognizing that there was little legal support, and no practical objectives to be achieved, for its hard-line position.

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Too Late for a New 2015 Safe Harbor But You Can Still Establish a 401(k) Plan

While October 1st may be the deadline to start a new Safe Harbor 401(k) plan for 2015, there is still plenty of time for a business owner to both establish a 401(k) plan and receive a meaningful contribution for 2015. In a Safe Harbor plan, owners and other Highly Compensated Employees (HCEs) may make 401(k) contributions of up to $18,000 plus an additional $6,000 for those over age 50 this year. In exchange for the ability to defer without the need for non-discrimination testing, the employer must commit to make one of two contributions:

  • A non-elective contribution of 3% of compensation to all eligible participants.
  • A matching contribution of 100% of the amount deferred up to 3% of compensation and 50% of the amount deferred on the next 2% of compensation.

Although this deadline has passed, employers may still establish a 401(k) plan for 2015 as long as there are sufficient payrolls remaining to allow all eligible employees to participate, if they wish. While some may argue that with only a few payrolls remaining this year, it is too late to establish a plan and receive a meaningful contribution for the year, with careful planning that is not the case. Applicable regulations allow a new plan to utilize a “first year rule” to perform the ADP and ACP non-discrimination testing. This allows a new plan that has no prior year testing data to assume that the Non-Highly Compensated Employees (NHCEs) are deferring at the rate of 3% of pay, which would enable the HCEs to defer (and receive an additional matching contribution of) up to 5% of compensation.   For the 2015 plan year, the compensation limit is $265,000, which would allow for deferrals and matching contributions of up to $13,250 each for anyone earning that much. Note that there must still be sufficient compensation payable before year end to defer the maximum amount.

An additional profit sharing contribution of $26,500 may also be made for a total contribution of $53,000 for 2015. Thus, a 401(k) program can maximize an owner’s contribution on a much more cost-effective basis than a profit sharing contribution alone, by the use of 401(k) deferrals and matching contributions to reduce the percentage of compensation the owner is required to contribute for the staff. However, if it does become too late in the year to implement a 401(k) program, please remember that an owner can still maximize his or her contribution at $53,000 for 2015 by implementing a profit sharing plan as late as December 31, and adding the 401(k) feature with or without the Safe Harbor for 2016.

If you are interested in implementing a new plan for 2015, please do not hesitate to contact any of the partners, sales director or case managers at The MandMarblestone Group for a free consultation.

– Stephanie Broncatello, CPC, QPA, QKA

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The MandMarblestone Group is Turning 40!

The MandMarblestone Group, LLC traces its history back to October 30th, 1975 when it was founded as Robert Mand, P.C. – a one-man firm based in Lafayette Hill, PA focusing on the newly implemented ERISA law. Almost 40 years later, The MandMarblestone Group, LLC is widely recognized as the region’s leading tax law and consulting firm with offices in Philadelphia and Boston, with more than 40 employees.

The MandMarblestone Group is known for providing qualified retirement plans to its clients, large and small, that enhance contributions for business owners, their family members and favored employees. The source of our success and growth has been our commitment to our clients and the collaboration we maintain with their financial professionals and accountants to collectively provide the best possible services and results for our mutual clientele.

As we approach our 40th anniversary and celebrate MMG’s success, it is essential that we express our sincere, heartfelt appreciation to our loyal clients and to our accounting and financial partners. You’ve enabled us to thrive and expand, and your participation and services have been crucial in our day-to-day growth over the past 4 decades.

We are eagerly looking forward to 40 more years of collaboration and beyond!

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IRS Announces 2016 Plan Limitations

The IRS has now announced the qualified plan limitations for 2016. These limitations are determined based on annual increases in the cost of living index. Because there was no increase in the index, plan limits will remain the same as in 2015.

Staying the same in 2016:

  • The maximum annual benefit payable from a defined benefit plan remains at $210,000.
  • The definition of “key employee” will include an officer making more than $170,000.
  • The 401(k) deferral limit will remain at $18,000.
  • The catch-up contribution for participants who have attained age 50 will remain at $6,000.
  • The compensation-based definition of highly compensated employee (HCE) will remain at $120,000.  Thus, an employee who earns more than $120,000 in 2015 will be deemed an HCE in 2016.
  • The maximum amount of compensation taken into account for plan purposes will remain at $265,000.
  • The maximum amount that can be contributed by and for a participant to a defined contribution plan (i.e. profit sharing or 401(k) plan) remains at $53,000 (this amount does not include catch-up contributions).

In addition, the Social Security taxable wage base will remain at $118,500.  Though not a qualified plan limitation per se, this will have an effect on the calculations in a plan that uses permitted disparity as the allocation methodology.

Please contact us if you have any questions about how this may affect your own qualified plan.

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MARKET RATES OF RETURN IN CASH BALANCE PLANS – TOO GOOD TO BE TRUE?

Conventionally, returns in cash balance plans are credited based on a fixed rate defined in the plan document.  However, more attention has been raised recently to the idea of utilizing actual rates of returns in cash balance plans.  This is a concept that gains in popularity as the market grows, but may have unexpected consequences on the complicated “behind the scenes” compliance testing to ensure a plan remains qualified.

On the surface, utilizing actual market rates of return seems to be the best option to allow each participant in the plan to share equitably in investment gains and losses of the plan assets.  However, in the small company context, these plans are subject to very complex testing methodologies to ensure the plan is nondiscriminatory, provides meaningful benefits to the appropriate number of eligible employees, and is not providing benefits in excess of the maximum allowable benefit.  Failure to satisfy any of these requirements (not an all-inclusive list) may result in plan disqualification and loss of past and/or future favorable tax treatment.

In the smaller company/small plan arena, larger benefits are typically provided to the Highly Compensated Employees (HCEs) than to the Non-Highly Compensated Employees (NHCEs) in the cash balance plan.  Additionally, the cash balance plan provides the larger portion of the overall benefit of the HCEs.  The majority of the NHCEs’ benefits are provided in the defined contribution plan (e.g., employer funded profit sharing contributions).  The determination of whether benefits are nondiscriminatory is based on the combined benefits of the two plans.

Although often glazed over or forgotten, a cash balance plan is a defined benefit plan.  As such, the accrued benefit is the key element in testing compliance with the above requirements.  The accrued benefit is a monthly annuity payment beginning at normal retirement age, e.g. $500 per month starting at age 65 for the life of the participant.

The method for determining the accrued benefit used for testing purposes has not been formally defined in written guidance from the IRS.  However, the IRS’ position has been verbally offered during conferences and presentations.  So we, as third party administrators, consultants, and actuaries, are left with two options.  We can either use the position stated by the IRS or come up with our own method and hope that it will be acceptable if/when final rules are published or if the plan is audited.

Let’s assume we believe the position of the IRS will be the ultimate method provided in written guidance.  Without getting into the mathematical calculations used in the determination of the accrued benefit, the use of actual rates of return will have the following impacts:  A high rate of return will produce a larger accrued benefit; A low rate of return will produce a smaller accrued benefit.

If the HCEs are receiving larger benefits in the cash balance plan, a high rate of return makes them even higher. However, the NHCEs’ benefits are minimally impacted by the high rate of return in the cash balance plan. Therefore, the overall benefits being provided will less likely be nondiscriminatory.  This would require additional contributions to be provided for the NHCEs.  In an extremely favorable market environment, this could be prohibitively expensive.

The maximum allowable benefit that can be paid from a cash balance plan is measured as an accrued benefit, which is translated to an equivalent maximum lump sum.  This maximum lump sum may or may not be the same as the hypothetical account balance.  Because of the methodology that must be used to adjust the maximum allowable benefit payable before age 62, if the rate of return is high in the year a participant is due to be paid out, the maximum allowable accrued benefit will be low and the maximum allowable lump sum will be small.  For example, the maximum lump sum could be $1,000,000 if the rate of return is 5%, but would be $110,000 if the rate of return is 20%.

Generally, every defined benefit plan must provide meaningful benefits to a minimum number of participants.  If the actual rate of return is low in any given year, the benefit accrued for that year would be small.  If too few participants accrue a meaningful benefit, additional benefits would have to be provided in the cash balance plan.   This would typically impact the NHCEs and not the HCEs.

All defined benefit plans are subject to benefit restriction rules based on the funded status of the plan.  Benefit restrictions could mean lump sum payments are limited or completely restricted, and benefit accruals could be frozen.  In general terms, the funded status is measured as the ratio of assets to benefit liabilities.  Benefit liabilities are directly impacted by the interest credit rate used in a cash balance plan.  A plan using the actual rate of return would have high liabilities in a year where the actual return is high and lower liabilities where the actual return is low.  Because benefit liabilities are projected into the future, high investment returns alone may subject the plan to benefit restrictions.

One final point to consider is that a distribution to a participant must be at least equal to  the accumulated contributions credited in the cash balance account.  In a worst case scenario, the plan sponsor would be required to provide additional funding to make up for a negative investment return.

For the reasons noted above, we would typically recommend against using the actual rate of return as the plan’s interest credit rate.  However, there are some limited cases where these issues do not pose significant problems.  If you are interested in discussing your specific situation, please contact our office.

— Virginia C. Wentz, EA, FSPA, CPC

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SAY YES TO GOING GREEN

As environmental consciousness continues to grow, our consciousness as a firm grows. We began embarking on a paperless initiative early last year and continue to do so. To date, we have 358 clients with their trust information online and we are hoping that with your help, we can get virtually all trust information for each of you online.

So, what can you as the client do to help?

  • Contact your Investment Advisor to determine if third-party online access is available. If yes, please contact your Case Manager at our firm.
  • Contact us to determine if your Investment Institution is already online.
  • Provide us electronic copies of your remittance files and census files versus paper copies.

So, what’s in it for you?

  • Contributing to the green initiative.
  • No more requests for missing Investment Statements.
  • No more delays in trust reconciliation due to missing Investment Statements.
  • Improved efficiency.

We thank you in advance for your assistance with this and we look forward to hearing from you.

– Kimberly Veitch, QKA

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