Remarkably Bright Solutions

5 Big Mistakes that Have Small Business Retirement Plans in Hot Water

October 5, 2017

Kelsey N.H. MayoPoyner Spruill LLP ©Poyner Spruill LLP

Introduction

• Background

• 5 Stakeholders

– Owners

– Employees

– Internal Revenue Service (IRS)

– Department of Labor (DOL)

– Pension Benefit Guarantee Corporation (PBGC)

Agenda: 5 Common Mistakes

• Choosing the Wrong Plan

• Not Reading the Plan

• Missing Related Companies

• Failed Non-Discrimination

• Ignoring Fees

CHOOSING THE WRONG PLAN

Why the Plan Matters

• Contributions

– Limits

– Type

– Amounts

• Non-Discrimination Testing

• Size of the Business

• Limits on Other Plans

Common Types of Plans

• SIMPLE IRA

• SIMPLE 401(k)

• Simplified Employee Pension (SEP) Plan

• 401(k)

• Pension Plan

SIMPLE IRA

• Pros

– Employer and Employee Contributions permitted

– Easy to Adopt

– Low Company Fees

– IRA-based = Less Involvement

– No Nondiscrimination Testing

– No 5500 Reporting

• Cons

– Required ER Contribution

– Cannot Limit Eligibility; Eligible if earned $5k+ in 2 prior years and expected to earn $5k+ this year

– No Vesting Permitted

– Higher Participant Costs

– Lower Contribution Limits

– Roth Not Permitted

– Fewer than 100 Employees

SEP IRA

• Pros– Simple—No EE Deferrals

– Employer Contributions Discretionary

– Low Company Fees

– IRA-based = Less Involvement

– No Nondiscrimination Testing

– Full Contribution Limit

– No 5500 Reporting

• Cons– Employer Contribution

Same Percentage for All

– Cannot Limit Eligibility, Except Age 21 and Received Comp in 3 of Last 5 Years

– Vesting Not Permitted

– Higher Participant Costs

– Roth Not Permitted

SIMPLE 401(k)

• Pros

– ER and EE Contributions

– May Limit Eligibility

– Loans and Roth Permitted

– Limited Nondiscrimination Testing

– More Control Over Distributions

– Can convert to regular 401(k) Plan

• Cons

– Fewer than 100 Employees

– Lower Contribution Limit

– Required Employer Contribution

– No Vesting Permitted

– Annual Reporting

Profit Sharing/401(k) Plan

• Pros– Flexible

• ER Contribution Discretionary

• Non-Uniform Contributions

• May Exclude Employees

– Higher Contribution Limits

– Roth & Loans Permitted

– Vesting Permitted

– Control of Distributions

• Cons– Nondiscrimination

Testing (unless safe harbor rules are met)

– Annual Reporting

– Higher Service Provider Fees

– More Complex

Pension Plans

• Pros

– Highest Contribution Limits

– Ultimate Benefit Higher (particularly if older)

– Longer Vesting Permitted

• Cons

– Additional Reporting

– Additional Fees• Actuary

• PBGC (if covered)

– Most Complex

– Limited In-Service Distributions

Plan Type Errors

• Sponsoring Other Plans– Cannot have any other plan with SIMPLE IRA or

SIMPLE 401(k)

– Cannot use federal form for SEP if there is another plan (and all employees must be eligible)

– Be mindful after acquisitions

– Includes related entities

• Number of Employees– SIMPLE IRA or SIMPLE 401(k) only for those with less than

100 employees

– Misclassification, leasing is a problem

Plan Type Errors

• Excluding Employees

– Misclassification is a problem

– Often cannot exclude owners and partners

– Improper exclusion can be very costly

• Design

– Is owner achieving objective?

– Is this the most efficient setup?

NOT READING THE PLAN

Why it Matters

• Must Follow Plan Document

– ERISA Fiduciary Duty

– IRS Code Requirement

• Not Reading is Expensive

– Retroactive Corrections

– Additional Contributions

– Non-Deductible Penalties

Most Common Errors

• Excluding Employees

– Plan document will establish • Who is in the plan and who is excluded

• What eligibility criteria apply

– Law sets outer limits on the plan’s options• Some plans do not allow you to exclude groups

Most Common Errors

• Excluding Employees

– Different eligibility for different contributions

• Employer doesn’t always apply different eligibility correctly

• Keep it simple, if possible!

Most Common Errors

• Excluding Employees

– Excluding part-time employees• Cannot have a blanket part-time employee exclusion

– May have a service requirement, but no plan allows a blanket exclusion

• Once the service requirement is met, employee is eligible and cannot lose eligibility based on hours worked

Most Common Errors

• Excluding Employees

– Service requirements• Some plans permit a service requirement to participate

• Plan will dictate how you must count service

– Elapsed time: based on anniversary dates

– Hours of service: based on completing sufficient hours

Most Common Errors

• Excluding Employees

– Service requirements• Ensure the employer is counting correctly

• Be VERY careful if someone is rehired

– Don’t assume they can be treated like a new hire

– Special rules will apply

– Might need to be allowed to participate early

Most Common Errors

• Compensation Definition

– Plan will dictate what “compensation” means

Most Common Errors

• Compensation Definition

– Plan will dictate what “compensation” means

Most Common Errors

• Compensation Definition

– Critical to understand what is included in “compensation” and what is not included

– BONUSES—Common Errors!• Not deferring from bonuses

• Excluding bonuses from match calculation

• Not treating “holiday” bonuses as compensation

– Severance• Not eligible source for deferrals

• Ensure excluded from plan year match calculation

Most Common Errors

• Compensation Definition

– Special Compensation• Home office stipends

• Car allowances

• Moving expenses

• Commissions

• Jury duty

– Review all payroll codes regularly to ensure accurate coding

Most Common Errors

• Distributions

– In-Service Distributions• Sometimes participants need to access money while employed

• Certain plans may provide a number of options

Most Common Errors

Most Common Errors

• Distributions

– Hardships• Understand eligibility

– Availability of loans

– Available balance

• Obtain and maintain correct documentation

Most Common Errors

• Distributions

– Distributions after termination• Small balances may need to be automatically paid out

• Ensure participants get a distribution kit

– Might be permitted to leave their money in the plan

– Don’t lose track of them

Most Common Errors

• Distributions

– Required minimum distributions• 5% owners must begin receiving, even if employed

• Everyone else, only after termination

• Required beginning date

– April 1 after

– Year person attains 70.5

UNDERSTANDING RELATED COMPANIES

Why it Matters

• IRS Requirements

– Certain rules apply on an aggregated basis to “controlled groups”• Counting service

• Eligibility for distributions

• Nondiscrimination

– Certain plans may be offered only if “controlled group” doesn’t offer another plan

Why it Matters

• Design

– Some plans automatically make everyone in the controlled group eligible

– Might be able to aggregate plans• Save money

• Lower cost

• Create efficiencies

What is a Related Company

• It Gets Complicated…

What is a Related Company

• To Oversimplify a Bit:

– Parent-subsidiary: One company owns at least 80% of another company

– Brother-sister: Two companies are at least 80% owned by the same 5 or fewer people• (There is more to this test, in particular)

What is a Related Company

• Attribution

– This is what trips people up

– Could have a related company with no overlapping ownership

Family Attribution

• Spouse:

– Interest is generally attributed to other spouse

– Unless• Spouses are legally separated

• Or all the following requirements are met

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Family Attribution

• Spouse:

– Attributable UNLESS • The other spouse has no direct ownership in the entity

• The other spouse has no participation in the entity

– Not an employee

– Not involved in management

• No more than 50 percent of gross income is passive (rents, royalties, dividends, interest, etc.)

• Interest is not subject to restrictions in favor of spouse or minor (under 21) children

37

Family Attribution

• Children to Parents

– Parent deemed to own child’s interest

– BUT ONLY IF • Child is under age 21

• Or parent controls more than 50 percent of entity

38

Family Attribution

• Parents to Children

– Child deemed to own parent’s interest

– BUT ONLY IF • Child is under age 21

• OR child controls more than 50 percent of interests

39

Family Attribution

• Grandparents to Grandchildren

– Only if grandchild owns more than 50 percent of the business

• Grandchildren to Grandparents

– Only if grandparent owns more than 50 percent of the business

• Siblings

– No attribution

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Organizational Attribution

• Corporation to Shareholder

– Shareholder owns at least five percent of corporation

– Attributed proportionate share

• Partnership to Partners

– Same rule

• Trust to Beneficiaries

– Same rule (but applies more broadly)

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Family Attribution

• Ownership of Corp A

– Kelsey owns one-third of Corp A

– Nicole, Kelsey’s 19 year-old child, owns one-third

– Will, Kelsey’s 25 year-old child, owns one-third

How much of Corp A is Kelsey deemed to own?

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Family Attribution

• Ownership of Corp A

– Kelsey owns one-third directly

– Nicole, Kelsey’s 19 year-old child, owns one-third

– Will, Kelsey’s 25 year-old child, owns one-third

• Kelsey is deemed to own 100 percent

– Kelsey is automatically attributed Nicole’s one-third interest because she is under 21—giving Kelsey effective control of two-thirds

– Because Kelsey has effective control of two-thirds, Will’s one-third interest is attributed to Kelsey

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What is a Related Company

• And Then it Gets More Complicated…

• Even if Two Companies Aren’t Under Common Control, They Could Be an “Affiliated Service Group”

– One organization is regularly providing services to another

– Two organizations are regularly affiliated in providing services to others

Most Common Errors

• Attribution

– Easy to miss

– Can result in expensive errors

• “Standardized” plans

– Allow all related entities to participate

NON-DISCRIMINATION TESTING

Why it Matters

• Tax Code Has Non-Discrimination Requirements

– Sets the upper limit on how much highly compensated employees may receive

– Generally looks at difference in contributions

• Failing to Test Can Be Expensive

• Utilizing Permitted Difference in Contributions Can Maximize Value to Owners

What Testing Applies

• Coverage/Eligibility Test

– Looks at who is offered the plan

• Average Deferral Percentage Test

– Looks at who is utilizing the 401(k) feature

• Average Contribution Percentage Test

– Looks at who is getting a matching contribution

• Top Heavy Test

– Considers how much of the plan will be paid to key employees

What Testing Applies

• 401(a)(4) Testing

– Looks at who is getting profit sharing contributions

• 414(s) Compensation

– Looks at whether the compensation definition discriminates against non-highly compensated employees

• Benefits Rights and Features

– Looks at who can take advantage of each plan feature

Most Common Errors

• Rollovers as Business Startups

– Owner decides to leave corporate job and strike out on her own

– Needs funds to get started—401(k) is biggest pot of money

– Rollover balance into a new 401(k) and the new 401(k) invests in the new company (i.e., plan is owning new company)

– If there are employees other than the owner, be careful to comply with non-discrimination

Most Common Errors

• Ignoring Non-Discrimination

– Correcting the Error• Refund the highly compensated employees

• Add additional amounts to rank and file employees

– Correction Programs• Self correction if detected quickly

• IRS-approved correction if longer and significant

– If Detected by IRS• Penalties

Most Common Errors

• Advantage of Understanding Non-Discrimination

– Avoiding Penalties

– Maximizing Owner Objectives

IGNORING FEES

Why it Matters

• Fees Impact Ultimate Returns

• Fiduciary Duty

• Hot Area for Claims and Lawsuits

• Department of Labor Examination

Most Common Errors

• Ignoring Who Pays What

– Plan May Pay Reasonable Expenses of Administration• Recordkeeping

• Trustee

• Custodian

• TPA

• Attorney Fees

• Audit Fees

– May not Pay Design Expenses• Studying design options

• Discretionary amendments

Most Common Errors

• Ignoring Who Pays What

– Small Business Plans Often Have Large Percent of Plan in a Few Accounts• Fees paid by the plan disproportionately impact those accounts

• Fees are a deductible business expense

• May be more beneficiary to pay expenses outside of the plan

Most Common Errors

• Share Class

– Hot Topic in Litigation

– This Should be Reviewed Regularly by Investment Fiduciary

– If Not in Lowest Net Expense Share Class—Need to Justify Why

Most Common Errors

• Recordkeeping

– Benchmark Every 3 Years• RFP

• Or just market comparison

– If Business is Rapidly Growing, Consider Doing It More Often• Merger

• Boom in head count

– Asset Based Fees Can Quickly Get Out of Sync With Going Market Rate in Certain Conditions

Most Common Errors

• Disclosures

– Service Provider Disclosures• Ensure you have them

• Prohibited transaction if not

• Be sure to review them

– Participant Disclosures• Read these

• Distribute timely

Most Common Errors

• Investment Lineup

– Too few

– Too many

– Brokerage only

Most Common Errors

• Documentation

– ERISA is Focused on Process

– If it Isn’t Documented, it Didn’t Happen

– Document• Committee minutes

• Review of investments

• Review of service provider fees

Conclusion

• Choosing the Wrong Plan

• Not Reading the Plan

• Missing Related Companies

• Failed Non-discrimination

• Ignoring Fees

These materials have been prepared by Poyner Spruill LLP for informational purposes only and are not legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. © Poyner Spruill LLP

Questions

Kelsey N.H. MayoPartner, Employee BenefitsPoyner Spruill LLP704.342.5307919.783.2935kmayo@poyners.com