Videos and Webinars

Strategic Plan Design: Smart Solutions for Overcoming Failed ADP/ACP Testing

Jul 25, 2018

How can clients facing retirement plan testing failures help expand your practice?
Discover potential solutions for turning retirement plan testing failures into success for both sponsors and your practice in this informative strategic plan design webinar.
Regional Director David Baum and Director Compliance Tami Delaney will cover topics including,
  • Failed adp test
  • Failed acp test
  • Coverage test
  • Non discrimination test
  • Avoiding testing failures

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Webinar Transcriptions

Jeff Wirth:  Good afternoon everyone, or good morning if you're on the west coast. Thank you for joining us today for the next edition of our Plan Sponsor webinar series. I'm Jeff Wirth, Executive Vice President at Newport Group. Before we get started, let's learn a little bit more about the audience with a simple question. Please launch the poll, please. Is your organization concerned with annual compliance testing? Obviously, the answers are yes, no or not sure. While you're answering the question, I want to thank all of you for taking the time out of your busy schedules to join us today. We have a great presentation for you [inaudible 00:00:39] fabulous presenters who are going to provide you with information that is important to plan sponsors like yourselves.

Jeff Wirth:  We also hope you will come away from this presentation with some actionable items for yourself and your company. If you could go ahead and close the poll please. So not surprising, the majority of you are concerned about annual compliance is the best thing, so this should be a very valuable session for you. Let's get right into the presentation. And remember, that throughout it, you can submit questions and we'll take as many as we can at the end of the session. Let me first introduced Tami Delaney, Director of Compliance. Tami has more than 25 years of industry experience, specializing in qualified compliance testing, plan administration, plan consulting and plan design, and leads those areas in Newport Group. Take it away, Tami.

Tami Delaney: Thank you Jeff, and welcome everybody to the webinar today. Our goal today is to give you some options to consider to help avoid or limit testing failures that you may run into in your plan. So the things we're going to touch on today first are testing, failures and corrections. We'll go through and describe some of the tests, specifically the ADPACP test, and we'll describe the failures and what corrections are necessary for plans to stay in compliance. Next, we'll touch on plan design, what plan design changes can be made to help, again, avoid some of those failures or at least limit the effect of those?

Tami Delaney:  We'll talk about the features and the pros and cons of each one of those features. Then we'll also explore the benefits of adding a non-qualified plan to effectively work with your current 401(k) plan to benefit the highly compensated or key employees in your company. Then if we have any time at the end, we'll touch on any questions that have come in. Okay. So first, we'll touch on testing requirements. So as many of you know as far as a testing that's required for your plans, you work at the end of the year submitting a laundry list of information to us for us to go through and effectively do the testing on your plan. These tests are required on an annual basis, and it's critical for your plan to stay in compliance.

Tami Delaney:  So the first test that we take a look at is called the coverage test. And in general, plans need to cover at least 70% of their non-highly compensated employees in the plan to be in compliance in this test. So to go through and do that test, we have to identify first who are your highly compensated employees, and who are your non-highly compensated employees. And it's very important that we get this identified correctly because this would significantly affect your testing results if we had incorrect information or incomplete information.

Tami Delaney:  We also need to look at the plan document and the effects of any provisions in your plan document. Are you excluding any employees that we need to know as we're performing this test? We also need to make sure we are always getting all employees, all part-times, seasonal, even information about leased employees. If they're leased for over a year, they can affect this test when we're looking at the coverage test to make sure we're covering enough people. And lastly, the controlled group and affiliated service group considerations. If there's any related companies that we need to take a look at, we always need to know that information because even if they're not participating in this plan, it will affect the testing.

Tami Delaney: So then once that we've got that information and determined who is actually benefiting in this plan, then we can go on and do the nondiscrimination tests, the actual deferral percentage test, or the ADP test, and the average contribution percentage test or the ACP test. And that's the test we're going to focus on today. So in general, just to quick touch-base on the mechanics of the ADP test, basically how it works is we compare the average deferral rate of the highly compensated employees with that of the non-highly compensated employees.

Tami Delaney: So we take those and add those together. The highly compensated employees are basically limited to what that non-highly group can do. So to do that, we add up all the deferral rates of the highest compensated employees and divide it by the number of highly, that gives us our deferral rate for the highly and then we do the same for the non-highly group. And remember, we always have to keep... we have to include in this average all those participants who are not deferring that are eligible for the plan. And those zeros can significantly affect the average deferral percentage rate.

Tami Delaney:  Again, we need to make sure that we're looking at the document, that we're using the right compensation to calculate this average deferral percentage, and then we have to identify whether we use current year or prior year testing, which can make a difference on what percentage do we look like look at? We always look at the current year percentages for the highly compensated employees, but do we compare that to last year's results for the non-highly or the current year results? And your document will dictate that.

Tami Delaney:  So then in order... Once we get those percentages calculated, we look at... To pass the test, the highly compensated rate can be no more than the lesser of two times the non-highly compensated employee ADP rate or the non-highly compensated employee rate plus two, or the highly compensated employee ADP is no more than 1.25 times the non-highly compensated employee rate. And we're going to look at a chart in just a second that'll help clarify that a little bit.

Tami Delaney:  The ACP test, basically,, the calculation is the same. And the ACP test covers the employer contribution or the matching contribution in the plan. The calculation is the same. There is some flexibility to be able to use a different type of [inaudible 00:06:50] compensation definition. Also, if you have built into your plan where the matching contribution only goes to those employees that are employed on the last day or require a thousand hours, we can exclude those from the ACP test as long as we pass coverage. Otherwise, the mechanics basically are the same. And I just want to point out for the ADP test, [inaudible 00:07:15] contributions are included and treated the same as pre tax contributions. The ACP test, if you have a plan that has the old fashioned voluntary after tax contributions, those are included in your ACP test.

Tami Delaney:   So here's a chart that just clarifies it a little bit. So if we have a non-highly compensated employee ADP rate of less than 2%, so that would be a plan where your participation for your non-highly group is pretty low. So on an average, that average comes out to be 2% or less, then your highly compensated employees are going to be limited to two times that non-highly compensated employee rate. And typically, if that's the case, those [highlies 00:07:58] are going to have some trouble passing the test and we're going to have to do some correction.

Tami Delaney:  The next level there, if non-highly compensated employee rate is between 2% and 8%, then your highly compensated employees are going to be limited to two percentage points above whatever that non-highly rate is. That's typically where we see most plans land. And then if you're fortunate enough to have a plan where you have great participation and your non-highly rate is above 8%, then your highly compensated employees are going to be limited to 1.2 times that rate, and more likely they're going to pass at that rate if you've got that good a participation. And then there's some examples there that just do those calculations for you so you can see how that works.

Tami Delaney:   Okay. So if you plan, you have an ADP test that's failing, there's a few alternatives that we can try. They must be allowed into the document. But the Newport document allow for these different types of alternative methods that we would take a look at before we get to a point of actually a full scale failure and correction. So the first one is statutory exclusion of otherwise excludable employees. And this is a great one to use. This works if your plan... If you allow participation in your plan earlier than one year, age 21, for your participants, then we can pull that group out separately. Anybody with less... the eligibility client requirements are less than that, we can pull them out and test them as a separate group. It's called the carveout rule.

Tami Delaney:  So basically, that will work well because you end up with a non-highly group of employees because there's very seldom a highly in that group. That can [inaudible 00:09:39] because a lot of times that group, they're the new hires, maybe the ones that there's a little bit more turnover that aren't participating. So you're going to have an opportunity to pull out the zeros out of the [inaudible 00:09:53] tests that you do for the rest of the company. And if using net compensation for testing... So you need to follow the document as far as what your compensation says.

Tami Delaney:  But if for some reason that doesn't work or growth compensation isn't working, it's causing you to fail, we can go look at net comp. And net comp is your gross compensation minus your deferrals, and minus your cafeteria plans. Once we have that net compensation, that you usually pulls that non-highly compensated employee rate up, because now you're using a lesser compensation to determine what that average is for that group. The highly compensated employees won't be affected as significantly because they usually are already capped out at the compensation limit that there is. So theirs won't change, but the non-highly group will be brought up by using that method.

Tami Delaney:  Re-characterization of excess contributions is another option. This is a creative way to shift contributions from one test to the other. You really have to have some specific fact patterns in your plan to make that work, but it is an opportunity to look at. And then finally on this list, we have plan imposed deferral limit. This is an item in your plan document, it has to be written in there, of what you're going to limit your highly compensated employees to defer. What this does is it just helps control your entire highly compensated employee deferral rate. If you're telling them, "Hey, you can't go more than 10% because it's going to cause the whole group to fail," it just helps control that a little bit. It doesn't necessarily get them to have more money into the plan, but it can help limits with refunds. That's where we end up. Also, anything that's above that deferral rate can be considered a catch-up then, for those employees that are eligible for that.

Tami Delaney: Okay. So if we've looked at all those alternative methods and the plan is still failing, at this point, corrections will be required. And there's a couple of corrections options that are out there. The first is the qualified nonelective employer contribution or the QNEC, as it's referred to, and this is an additional employer contribution that's given to the plan for just that non-highly compensated employee group. Basically, what it does is it's included in your ADP test to help bring their percentages up to a point that you're passing the test. These contributions need to be 100% vested and can end up being a significant number in some cases. So this can be an expensive alternative to making the correction.

Tami Delaney:  The second option that we have for correction is refunding the contributions to the highly compensated employees. So this is the one probably most are familiar with that do take place, but this one can be a very frustrating correction for those highly compensated state employees because it takes funds out of retirement and out of that tax deferred arrangement. It becomes taxable to them in the year that they receive it, and they may even have to forfeit some match that relate to that. So again, that becomes quite a frustration, especially if those highly compensated employees have this happen year, after year, after year.

Tami Delaney:  Either one of those corrections need to be done within 12 months after the end of the plan year that's failing. If the correction isn't done for some reason, something happens or there's a reason that they don't get completed, the there is a self-correction program that can be used to go ahead and do a correction after the fact, but it becomes even more expensive, because now you need to go ahead and do the refunds plus earnings to those highly compensated employees. But then the sponsor also needs to put in an employer contribution equal to the amount of those refunds. So, you don't want to let it go past that 12 month period if at all possible because it's just that much more costly.

Tami Delaney: But with those refunds, the goal is always to have those corrective refunds done within two and a half months after the end of the plan year, because if you don't, [inaudible 00:13:53] is imposed, now you have to pay a 10% the penalty for getting those refunds out later than the two and a half months. So the employer's responsible for that versus the plan, and there's an additional tax filing that needs to be done. So that's why again, to get these done, it's critical that we get good, accurate information to make sure these are calculated accurately and keep the plan in compliance.

Tami Delaney: Okay. So today we're... Then we want to talk about two types of plan design within the 401(k) plan that will work well to help avoid or limit the failures. Which ones are going to work best for your type of plan? That's hard to say. We have to look at a lot of different variables. What are the demographics of the plan? What are the participant levels? What are the costs? And what are the costs as a sponsor you're willing to incur? And just individuals back patterns of each plan. But we're going to touch on a couple of the options so that we can do a comparison of how they work.

Tami Delaney:  So the first option are automatic contribution arrangements or the ACA as it's referred to. This is basically defaulting or forcing participation of your eligible participants into the plan. For those that have not made an affirmative election, you're forcing them into the plan. And there's three different types of ACAs that can be put in place. One is a traditional ACA, the second is the eligible automatic contribution arrangement, or the EACA, and the third is the qualified automatic contribution arrangement, or the QACA as it's referred to.

Tami Delaney:  So we'll touch on each one of these. The traditional, it's the least regulated. Basically, you can add this at any time during your plan year. You can set a default rate. Normally, what we see is anywhere from two to 6% for forcing participants into the plan. It does require a reasonable notice to those participants before it is enacted to make sure they know what's going on. And once the money's in, it's in, there's no options to be able to pull any of the money out for those participants that decide they do not want to participate in the plan. The ADP test still applies, but it does increase participation, which should help that.

Tami Delaney:  The second one is the eligible automatic contribution arrangement, or the EACA. This one is much more regulated. Rules are a lot tighter on it. You can't amend during the middle of the year, you have to add it at the beginning of the year. An initial notice and a 30 day notice is required before each year. This one though, a couple of the benefits are, it does permit withdrawal of the defaulted amounts that have gone into the plan for those participants that they had that first contribution going out of the paycheck before they realized the situation and now they've decided they don't want to participate. So they can fill out a form saying zero, and there is an opportunity to get that money back out of the plan.

Tami Delaney:  And the benefit of that is now you don't have a plan that has these really small dollar amounts in the plan for participants that really aren't participating in any other way. It also allows up to six months for corrective distributions to cure an ADP or ACP failure, which is longer than the two and a half months under a normal traditional 401(k). And again, the ADP test still does apply. But by adding this feature, you're hopefully increasing participation in the plan. And the third option is the qualified automatic contribution arrangement, or the QACA. This one is a combination of a safe harbor arrangement, which we're going to talk about in a little bit here, or/and an ACA. It pulls the two together.

Tami Delaney: So now you've got a plan that is deemed to pass the ADP test. You're basically getting out of that, and you're forcing that participation in the plan. The notices are the same as they are noted up above in the EACA. This one does require an acceleration feature in the plan up to 6%. So you can start out... You have to start out at a minimum of three and then increase your participants each year by 1% until they get to that 6%. There's also that required safe harbor employer contribution under this particular arrangement.

Tami Delaney:  So some of the pros and cons of the automatic contribution arrangements are, as we've already touched on, it increases the number of employees in participating in the plan, which, in essence, will help that deferral percentage for that non-highly group increase. If you have an increased percentage, that's going to help your highly compensated employees pass the testing or be able to put some additional contributions then without passing. So those are really the benefits of adding these features in. There's no employer contribution required for the first two that we talked about, the traditional or the EACA, there is a required contribution for the QACA, the qualified contribution arrangement. So that's just something to keep in mind.

Tami Delaney: When you put an arrangement like this into the plan, you really can design it to pass the ADP test by using some of your historical information about, how did the plan look before, what percentage did it take for those [highlies 00:19:10] to actually pass testing? And then you can back into that and make that be your required contribution that you're forcing everybody in to the plan with. So let's say your [highlies 00:19:19], if they needed a 4% non-highly compensated employee rate to pass, historically, that might be the point that you start at for your defaulted rate for your non-highly group.

Tami Delaney:  Some of the cons in putting an automatic contribution arrangement in place is the increased cost. It could be you've got your increased cost in possibly an employer matching contribution. Because now you've got more people participating, if you as a sponsor are putting a match in the plan, that could be more expensive. You may have some employees that get frustrated because they're forced into the plan that you might have to deal with. And then there's the administrative side of it as far as just there's more work involved in making sure that you're administering it properly. There's some payroll functionality they have to make sure your software can handle.

Tami Delaney: And things to look at then as far as the cost, how much more can my highly compensated employees really participate in the plan, and how much more can they defer by adding this in? And is it worth the cost and the effort to put it in? Those are things just to consider as you're looking at the various options that are available under the automatic contribution arrangement.

Tami Delaney: So that brings us to the second plain design option, which is the safe harbor plan design. This one, I think more are probably familiar with, or many of you actually already have. So this is basically buying out of that ADP test. If you put the safe harbor plan in place, you're getting an automatic pass on the ADP test, as long as your plan is set up accordingly. What you are doing though is you're committing, as a sponsor, to that employer contribution that you have to give into the plan. But by putting this in, again, it gets you out of this ADP test. So no more refunds of the employer, highly compensated employees, deferrals come out of the plan, which is always a real positive.

Tami Delaney: So if we just touch on the different types of design for a safe harbor, there's a matching contribution, and then there's the non-elective contribution. You can pick from either one of those what works best for your plan. So if we start with the matching contribution, there's actually two types, the basic match and the enhanced match. The basic match is 100% of the first 3% of compensation deferred, plus 50% of the next two, or the enhanced match is 100% of the first 4% of compensation deferred. So then enhanced match, you're going to match a little bit faster into the plan, and it could be a little bit more costly to you as a sponsor. Sometimes it's just easier to do the enhanced match and get that money in.

Tami Delaney:  As far as the restrictions for these matching contributions, they're the same. The contributions of the match must go to all employees who defer. No matter what, you cannot have any allocation methods or conditions. You can't require that they're employed on the last day or have a thousand hours. It goes to everybody who deferred. The safe harbor match is also 100% invested, so there's no forfeitures available to reduce any future contributions, which can be a negative.

Tami Delaney:  But the benefit of the matching contribution is, for those plans that have low participation, this might be a good option because this might cost you less than that 3% nonelective contribution we're going to talk about in a second. But do keep in mind oftentimes when a safe harbor feature is added to a plan, it does automatically increase that participation rate anyway, because now your employees want to get in and make sure they're getting that matching contribution.

Tami Delaney:  So the second option under the safe harbor is that non-elective contribution. So this is a contribution that must be at least 3% of compensation for any eligible to defer, whether they're deferring or not. So you're covering everybody, even if they're not participating in the plan. And again, there's no allocation conditions that can be applied to that. It's 100% vested against, so no forfeitures available for future reduction of any contributions. And this could be beneficial for those plans that have very high level rate of participation. So if you have a lot of your employees already participating by deferring into the plan, the 3% may cost you less than what the matching contribution would be because of the high participation rate.

Tami Delaney:  The third option, which I didn't list here again, but we very talked about is that QACA, that's the combination of the safe harbor contribution and that automatic arrangement. So pros, of course, for the safe harbor is that pass on the ADP test. You're buying yourself out of having to do that test. And if the plan is designed right, you're also getting... you may get out of doing any additional top-heavy contribution as long as there's no other contributions in the plan. It makes it a simple plan for employees to understand, and then it does allow your highly compensated employees to max out their deferrals, which is the goal of the safe harbor.

Tami Delaney: What a safe harbor plan design does not do is it doesn't automatically help you pass that coverage test that we talked about earlier, or the top-heavy test. If you are doing an additional contribution in addition to the safe harbor, some of those rules kick back in, so it doesn't give you a pass on that top-heavy. And it's a required contribution, so you as the sponsor have to be committed to putting that into the plan.

Tami Delaney:  The next couple of slides we're not going to look at in detail. This is really more just a tool for you to use. It's a nice comparison with all the things that we've talked about; the automatic contribution arrangement, on this sheet here, we have the traditional in the first column, and then the EACA is the second column, and then the third column is the qualified automatic contribution arrangement, which is that combination in that safe harbor. And it just gives you what the requirements are, the features and the effect on the testing.

Tami Delaney:  The next two slides do the same thing in comparison for the safe harbor. If you're looking at that non-elective 3%, basic match, enhanced match, it just gives you some guidelines there in the future of how it affects the plan. But the biggest thing of any of these types of arrangements to put into a plan, it's all about timing. Timing is very important. You have to do amendments to get these features added to your plan on a timely basis, and then the notices that are required to make sure those are getting distributed timely to be able to actually put these into the plan.

Tami Delaney: So, as we talked about utilizing the automatic contribution arrangement or safe harbor can really help maximize those highly compensated employee deferral contributions, which is typically the goal. And as we talked about, a traditional 401(k) plan really can limit the highlights to what they can do. Because of that ADP test, refunds can be very frustrating to the [highlies 00:26:30], because now they're not meeting their contribution objectives. But we always have to look at the cost versus the benefit of adding these features into the plan because they do take some additional administration and work on the part of you as a sponsor.

Tami Delaney: One other design that we were going to touch on here is excluding the highly compensated employees from the 401(k) plan completely. So if you'd like your design your plan to actually exclude those [highlies 00:26:56] out of the plan, they just cannot participate at all, you pretty much are avoiding that ADP test completely, because now there's no test to do. There's no [highlies 00:27:04] to compare that average to anymore. Of course what that does is it kicks the [highlies 00:27:09] out and now they can't participate. But another great plan design would be to add a non-qualified plan to help meet those highly compensated employees' objectives and getting contributions into a plan for them.

Tami Delaney:  So with that said, I'd like to introduce David Baum. David is Newport Group's regional director for non-qualified plans in the western United States. He has more than 25 years experience in the executive benefits arena and has been with Newport Group since 2005. David is responsible for identifying marketing opportunities in order to promote the Newport Group's deferred compensation and executive benefits services. He is a chartered life underwriter, and has spoken at a variety of audiences on the subject of deferred compensation and executive benefits. David, I'll turn it over to you.

David Baum: Thank you Tami. And good afternoon, or good morning. I guess it's almost afternoon for those of you on the west coast. I don't know about all of you, but I have heard a lot of information from Tami. And with the way that it talks about or the way that she spoke about corrective procedures and contributions, to me, it sounds very, very, very expensive. So we're going to talk about different a kind of solution today, and that is adding a non-qualified plan. Some of you may have a non-qualified plan well ready, but adding a non-qualified plan to take care of the issue of refunds or the highly compensated employees, because after all, those are the people that really make your company sing.

David Baum: So we know that a qualified plan meets the requirements of code section 401(a). We know that there is a variety of the risks and requirements that go into keeping the qualified plan compliant. What about a non-qualified plan? The non-qualified plan does not meet the requirements of 401(a). You cover a select group of management or highly compensated employees. And with a non-qualified plan, I want you to think in terms of reversing the 401(k), if you will. What I mean by that is that the employee essentially becomes an... He or she can contribute an unlimited amount to a non-qualified plan. So essentially, an unlimited 401(k).

David Baum: All of that money goes in pretax. And we'll talk about how the plan works in the second, but the key to remember is these plans are generally exempt from all of the rules of title one of Arisa. And the reason for that is because the assets of the plan, in other words, the contributions that either the employee or the employer make are held on the balance sheet of the employer until they are distributed to the employee. And you can set up a rabbi trust, and we'll talk about what that is in a minute, to all the assets. But they're all balance sheet items and therefore they are subject to the company's creditors in the event of insolvency.

David Baum: So let's turn our attention to the differences between a qualified 401(k) and a non-qualified plan. As we've heard from Tami, we've got some serious rules to worry about with regards to the qualified plan. A couple of those rules are the limits that the IRS imposes on all of the employees who work for you. 118,500 or 24 five if you're using the catch-up is the limit on the deferral. And obviously, we know that a lot of employees don't even get that amount in because it's refunded. But secondly, and what is really critical and a lot of people worry about is the fact that if I have employees who earn over $275,000, that is the compensation limit that the IRS allows you to take into account when you do a calculation for any qualified plan, 401(k), defined benefit, doesn't really matter what it is.

David Baum: And so if I earn above that amount, none of that money counts for the purpose of the qualified plan. So as a percentage, as a highly compensated employee, I'm not able to defer the same percentage of my income as the lower compensated employees can do. Obviously, the non-qualified plan then allows the 100% of the federal, and the employer can come around and add a 401(k) makeup match. We have a lot of plans where the match looks just like what it would in the 401(k), or there can be some discretionary or independent match depending on the plan design. Again, the IRS does not dictate the rules here.

David Baum: There are certain rules that the non-qualified plan must meet... excuse me, under 409 cap A of the internal revenue code. But as long as we comply with those rules, we're basically looking at a plan that aligns with the employers desires, not so much what the IRS dictates to us. As I said, the assets are sitting on the balance sheet of the employer. In a 401(k), you take the tax deduction now, you send the money to a qualified trust, and we don't have to worry about the assets being on the balance sheet. In a non-qualified plan, all of the money that is contributed, employer or employee is considered a corporate asset for the employer until it is distributed. In a 401(k), I can roll over my balance to an IRA. In an unqualified plan, I cannot. That sounds like a downside.

David Baum: But one of the upsides is that I can actually get to distribute a distribution from the plan while I'm still working. So, I can set up my accounts where I can contribute money to the plan, salary, bonus, commissions, or whatever it happens to be, I can pick when I want the money to come up to me, I can pick how I want the money to come up to me, let's let's say lump sum or payments over five, 10 or 15 years, and I don't have to have a financial emergency in order to do that. That is just the plan design feature. When [inaudible 00:34:06] money comes out, it's taxed as ordinary income. There's no capital gain treatment, and the employer is going to get a deduction for those payments that are made to the employee.

David Baum: On the other hand, in a 401(k), I can have a loan, I can take a loan against my account. In a non-qualified plan, since the assets don't belong to me yet, no loans are permitted. So I can't borrow the money, I can't go pledge my account balance at the bank. But the in service distribution becomes something that is very, very nice from a financial planning perspective because I'm deferring all of compensation on a pretax basis. And all of the earnings, again, from the employee's perspective, all of the earnings are pretax until such time as the employee takes it into income.

David Baum:  So why deferred compensation? For the employer, it's simply a matter of recruit, retain, and reward my key people. I can provide additional benefits that I can not do with the 401(k). If I fund the plan properly, the plan will actually be an enhancement to my PNL, not a downside. I stay competitive. 92% in our last survey of the fortune 1,000 actually have deferred compensation plans, and it's a golden handcuff for the employer. It's a way to your key employees to you by having some sort of contribution, for instance, the vests over time. From the employee's perspective, I put in an unlimited amount of money, I own a an interest rate or whatever it is on those earnings, depending on the plan design. Again, most plans are tied to some sort of menu of investments, just like your 401(k), and I own money on the plan, and then I take the money out when I plan it, not when the plan says I am.

David Baum:   So what I want you to think of is in the 401(k) world, we got 59 and a half, 70 and a half and required mandatory distributions of the 70 and a half. In a non-qualified plan, all of that goes away. So much greater flexibility and much greater planning for the employee. There are really two types of plans on the next page that plan designs actually follow. The first is what we're call an elective deferral plan. The elective deferral is simply the money the employee would have taken into compensation is now being deferred to the plan. And if there was a match, so be it. If there's a discretionary contribution by the employers, so be it.

David Baum:  The second type of plan is what we call the supplemental benefit plan or a supplemental executive retirement plan. It's where the employer decides to put the money away. It usually takes one of two forms, either the employer decides on an annual basis how much to put into the plan of what the earnings will be... Well, the second type is where I make a promise to the employee that says the employee will get x dollars at some time in the future, and that plan looks very much like the old defined benefit plan. Either way, they are supplemental executive retirement plans and usually the employee is required to meet service and/or age based vesting in order to receive the money.

David Baum: So what are the tax consequences? For the employee, all the deferrals, the income tax deferred, all of the earnings of the tax [inaudible 00:37:58]. FICA is treated exactly the same as you do under your 401(k) now. I pay FICA on the money when it is earned. If there's an employer contribution, I pay FICA on that money when the employer contribution is vested, or as it vests. As I said before, all distributions of tax is ordinary income, no capital gain treatment. And if there's benefits paid to a spouse or deceased to state, that is treated as ordinary income. From the employer's perspective, if I decide to use a trust, that trust is a grantor trust, and think of it like a bank account, but also belonging to the employer.

David Baum: What the trust does do is it protects the employee if there's a change of management. If there is a merger or acquisition or a change of heart by the employer, it protects the employee from the employer themselves. As an employer, I get no deduction for money going into the plan, into the trust. All the deduction comes out later, plus all of the earnings, so kind of the reverse of the way it works with the 401(k). All the benefit payments to the employer are tax deductible to the corporation. And if the trust invest in taxable assets, or the employer invests in taxable assets, then those assets are taxable to the employer while they are sitting on the employer's balance sheet.

David Baum: So, let's look at a pictorial of how the plan would actually work. Essentially, I'm going to set up a deferred compensation plan with a plan document. The employee is going to put money into the plan, or I the employer, am going to contribute some sort of match to the plan or some sort of discretionary contribution, and that's going to create an account balance so that employee. And on Newport's website, the employee is able to see that account balance, and it looks just like an account balance in a 401(k). You're going to also be able to see the investment options and whatever the investment options are that the employer has decided they're going to use as a menu for that employee to pick from. It's going to look just the same as the 401(k) looks to them now. Could be a menu of investments, could be a fixed rate. Makes no difference.

David Baum: The next part that happens is the deferred compensation is paid out from the account balance as a benefit payment to the employee, tax deductible to the corporation whenever either the plan document says it's payable or based on the plan documents rules when the employee has chosen to take a payment, whether it's an inservice distribution or whether it's a payment termination or whatever it happens to be. And a corresponding deduction for the co-operation. As I said before, not only the money the employee contributed, but all of the earnings as well become tax deductible.

David Baum:  If the company sets up a rabbi trust, then what's going to happen is the money is going to go from the employer to the trustee. And if the trustee is directed then to invest the money in either mutual funds, corporate owned life Insurance, company's stock, whatever it happens to be... Some plans are tied to company stock, some plans are tied to mutual funds, sometimes plans are tied to a fixed rate, other plans use corporate owned life insurance with mutual funds inside of them. So there's a variety of things that can be done from a funding perspective. All of those assets are held then by the rabbi trustee.

David Baum: Why would companies use corporate owned life insurance? A very simple reason for that is, as I said before, any of the assets that are sitting on the books of the employer are taxable to the employer as the earnings from those assets. As the assets create earnings, those earnings are currently taxable. And by putting the mutual fund and letting the custodian of the mutual fund, if you will, be the insurance company, there are no taxes to pay on the employer's side. So, the reason these plans make so much sense is I'm using money that I would have paid my employee anyway, they're putting the money in the plan, I'm getting to invest it on a tax deferred basis, sitting inside the corporate owned life insurance and then I'm getting a tax deduction for the whole thing when I pay it out. So, that's the reason these plans make so much sense.

David Baum: But at Newport, we don't really care what you choose for a funding vehicle, whether it be tax-managed assets on the corporate owned life insurance side or whether it be non-tax managed assets, mutual funds, stock, whatever it happens to be. Newport can basically administer any plan because the values or what the employees sees on their account balance are valued daily just like they are in a 401(k). And essentially, the plan then becomes something that the employees value because it is now a financial planning tool. It is something that I can use to put, for instance, my kids through college, and I'm doing it all on a pretax basis without any of the limitations that occur, for instance, if the employer offers say a 529 plan.

David Baum: So how long does it take to implement plan? Essentially, the non-qualified plan, if it's new to you and you're going to add as a benefit to the company, typically, it takes about 90 days. A document is drafted, that document has to comply with code section 409 cap A. And within that document, we then set up whatever the goals are for the employer in order to retain his or her employees. Those goals, inservice accounts, termination, change of control, things like that, are all part of the plan design. The plan is communicated to the highly compensated employees.

David Baum: And then the great part about fixing the testing failure is this. When I make an election, as we all know, I can say, Look, I don't want to receive that refund. So I'm going to check the box if the plan document calls for it, and the plan design has been designed this way. I'm going to check the box that says, if I receive a refund from my 401(k) plan, please be sure to take the same amount of money out of my income in the year I received the refund and contributed automatically to the non-qualified plan. All right. By doing that, the employee doesn't get frustrated that additional income is coming to them that they have to pay tax on.

David Baum: As Tami said earlier, the other way to do it is to call the highly compensated group out completely and then no matter what they put into the non qualified plan, it's not going to have any effect on the qualified plan. So again, setting up the plan about 90 days, set up the rabbi trust, do the communications, transfer the payroll files, just like you would in a 401(k), send the money to the trustee on a payroll by payroll basis or however you'd like to contribute it, again, those rules don't apply as they do in a 401(k), and the plan goes live and we're all set. Hopefully, that gives you a little bit of a high overview of the way non-qualified plans work. And I'm now going to turn it back over to Jeff.

Jeff Wirth: Thank you Tami and David. Some great information. One of the things I realized as we were going through this is how many acronyms we had, and maybe we should've had a poll done to see what your favorite was. So there was FICA, [inaudible 00:47:19] and ACA, but I think my favorite was QACA. Anyway. Certainly some great information there. We do have some time for some questions. We've had some good questions come in throughout it, but if you have some that you didn't have a chance to do earlier, go ahead and put them in there. We'll address as many as we can with the time left. So first off, Tami, I've got a question here for you.

Tami Delaney:  Okay.

Jeff Wirth: [inaudible 00:47:47] to go to all non-highly compensated or can you select the non-highly compensated that you want to receive the tunic?

Tami Delaney: So the basic answer is that yes, it does have to go to all of your non-highly compensated employees, because it has to be a defined allocation, a uniform allocation. So first of all, tunics have to be allowed by your plan document for even to be able to do this as a correction method. So that's the first thing to look at. Then if it is allowed, you do have to follow an allocation method that's in the document, whether it's a pro-rata allocation, or you can go and do a dollar allocation, uniform dollar amount to each of the non-highly compensated employees.

Tami Delaney: But basically, you cannot go through and pick and choose who you want to give that tunic allocation to. Because there used to be... Years ago, I think it was pre 2006, you could do that bottom up tunic, it was called, where you take your employees with the least amount of come, give them the highest contributions, of course, that would really increase their deferral allocation rate and help that deferral rate in total for the non-highly group. Well, the IRS caught onto that and said, "Nope, you can't do that anymore. We're going to take that away as an allocation method." So now you have to be much more uniform in who you do the allocation to as far as your non-highly group.

Jeff Wirth: Great. Thank you Tami. David, the next question is for you. I would like to learn more about options to consider when the company is not interested in safe harbor.

David Baum: And Jeff, this is one obviously I can't blame companies that are not interested in safe harbor. I was just doing a quick calculation on a $10 million payroll, that would be about three or $400,000, and that's a lot of money. Putting in a non-qualified plan would be the answer, and the non-qualified plan would simply be the administrative fees of all of the money came from the employee. And if the money was to come, if some of the money was to come from the employer, then the employer could pick and choose who to contribute to, because you can't discriminate within a non-qualified plan.

David Baum: You can pick and choose who gets what contribution, and you can pick and choose how much that contribution is going to be. So not everybody within your non-qualified plan number one, needs to get a contribution from the employer and number two, not everybody gets the same amount. You can have different vesting schedules, a whole bunch different things can be done to alleviate, if you will, the problem and get away from having to put it in the safe harbor.

Jeff Wirth: Thanks David. I think one of the great things about Newport is we have expertise across all different solutions and can work with the client to identify what makes the most sense in their particular situation. So certainly, you've laid that out really nicely. Tami, next question's for you. What about plan design changes that would help with testing for groups with large variable hourly employees?

Tami Delaney: Those sponsors that have a lot of hourly employees and a lot of turnover really struggle with passing ADP testing because that group a lot of times will not want to participate in the plan. So a couple of things to consider is, if you have a lot of that hourly employees or a lot of turnover, I would always recommend that you have an eligibility requirement of one year, age 21, before you even are eligible for the plan. If you make them plays wait that year, that will keep a lot of those types of employees out of the plan because of that turnover rate.

Tami Delaney: Also, if you do include that, you do want to make immediate [inaudible 00:52:03] into your [inaudible 00:52:07] but only apply the safe harbor to those that have met the one year, age 21 eligibility requirement. So that limits that safe harbor contribution to those that really are going to be a little bit more longterm employees. But if you do that, keep in mind that group that is under the one year, age 21 eligibility requirement will be substitute to an ADP test. But again, more than likely, that group, you're not going to have a highly compensated employee in.

Tami Delaney: So again, you're kind of pulling them out of that safe harbor required contribution, still have to test them, but because there may not be any [highlies 00:52:42] in that group, you're not going to have any testing failures in that group. But once if you still have that hourly in the plan where you've got a lot of people aren't participating, then I think the suggestion would be, again, an automatic contribution arrangement can help really push those employees into the plan to participate, or a safe harbor contribution. And I would select the matching contribution because if those employees, they are eligible to participate, but they may not be, if again that group is a lot of turnover, so then your employer contribution will be less expensive if you stick with the match and they're not participating. Otherwise, as David has made clear, a great solution would be a non-qualified plan and just take care of the [highlies 00:53:30] outside of your 401(k) plan.

Jeff Wirth: Great. Thank you Tami. David, next question's for you. So this is something that we often see with our plans where a company has a long term set of compensation plan and a restricted stock unit plan. One of our participants wants to know, how would that work with a non-qualified plan?

David Baum: Great question, Jeff. And we see this quite often. We do a lot of plans for public companies. As we all know, RSUs are pretty common amongst the executive groups at public companies, and RSUs are a great tool to help the executive invest, if you will, in the company. And if the company stock does really well, the executive is going to have a major tax issue when that RSU vests. Typically, those are on a three or four year rolling vesting cycle, and it becomes really problematic.

David Baum: Secondly, with a longterm incentive plan, they typically work the same way. The employer sets out goals for the employee, if the employee meets those goals and the longterm incentive plan is met, and typically there's the three or four year vesting schedule for that, there's going to be a taxable event at the end of that. So what can be done to avoid the taxes is simply to allow for the re-deferral if you will, because the first deferral occurred, essentially, in the IRS's eyes when the RSU was granted. One of the things that we can do is set up a re-deferral.

David Baum: If the RSU has been already been granted and we are outside of 12 months, so we've got more than 12 months before vesting, with that or the longterm incentive plan, we can allow for those are issues or longterm incentive payments to be re-deferred to the deferral plan, and that re-deferral must be for a period of five years. Again, that is an IRS rule. However, for new grants of either longterm incentive or RSUs, those can be deferred for any amount of time, usually two years, and that deferral needs to occur within 30 days of the grant date. However, both of those features are available, and it makes a world of difference to the employee if we add that as a feature to the non qualified plan because then that tax that was going to occur is deferred further into the future. So they work really well with non-qualified plans, bottom line, Jeff.

Jeff Wirth: Thanks David. There's one more quick question [inaudible 00:56:30]. For any of you who asked questions that we weren't able to get back to, we'll work directly back with you. But one of the questions here that I'll take is, we're always on the cusp of pass/fail. Is there a way we could promote participation? I guess I'll use that as a little bit of an opportunity to promote... just reach out to your relationship manager. Obviously, we have a variety of resources internally to help with this, whether it's an education campaign, whether it's looking at some of the options we've talked through today. What we'd want to do is sit down with you and your team and figure out what's the best solution for your company and see how we can help. Because being on the edge of that certainly is nerve wracking for the executives and others.

Jeff Wirth: But we're up against the hour. So if you'll hang in with me for a couple more minutes, I have just a couple of closing administrative items to cover. On the interface, you can download today's presentation. If there's things you'd like when the recording or whatever, you certainly can do that. All attendees of today's webinar will also receive an email after the webinar, which will include links to the replay and the tools I just mentioned. So you'll have another opportunity to access those tools. On your screen is our contact information, should you have any questions. And when you exit the webinar, you'll see three quick questions. We'd really appreciate if you'd take the time to answer those, so we can continue to bring you topics of interest. We've gotten great feedback on all of these, but we'd certainly like your... how you feel about it. And then lastly, we'll see you next quarter, and thank you for taking the time to attend today's webinar.

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