Tag Archive for: DB/DC

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What is a 414(k) Plan?

“My client emailed me asking about a ‘414(k) plan.” Is that a new type of plan—or  was that a typo?’ 

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Nevada focused on plan design.

Highlights of the Discussion

While it may have been a typo, there is such a thing as a 414(k) plan—or more precisely—a 414(k) account.  A 414(k) account [created pursuant to IRC Sec. 414(k)] is a separate account within a defined benefit (DB) plan that is derived from employer contributions and, for the most part, is treated as a defined contribution (DC) plan [IRC Sec. 414(k)].

The 414(k) separate account balance is treated as a DC plan for purposes of satisfying the minimum participation and vesting standards, maximum contribution limitations, nondiscrimination tests for matching and after-tax contributions, and treatment of after-tax contributions as a separate contract [IRC Sec. 414(k)(1) and (2)]. To create a 414(k) account, the plan document provisions describing this separate account must contain language similar to the language of other DC plans.

Generally, contributions to a 414(k) account are in addition to the contributions that fund the DB plan’s basic retirement benefits and are used to enhance retirement benefits. The 414(k) separate account is credited with actual trust earnings. Under the individual account rules of IRC Sec. 414(i), 414(k) separate account benefits are based solely on the amounts contributed to the account and any income, expenses, gains, losses, or forfeitures that may be allocated to the participant’s account. 414(k) accounts may be appealing because they could allow participant direction of assets.

Certain transfers from the DB portion of the plan to the 414(k) separate account are prohibited: Sponsors cannot transfer

  • Excess earnings from the DB portion of the plan to the 414(k) separate account;
  • Assets from the DB plan to the 414(k) account; or
  • Excess DB assets to fund matching contributions in the 414(k) account.

Transferring a distribution from the DB portion of the plan to the 414(k) account is also questionable.

Conclusion

Not a new type of plan, a 414(k) account is a separate account within a DB plan derived from employer contributions and, for the most part, treated as a DC plan. The plan document must contain language to support this arrangement.

 

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Contribution limits with combined DB/DC plans

“I am meeting with a new client who has a defined benefit (DB) plan and would like to add an “individual k” plan. Can he do this and, if so, what are the contribution limitations?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Rhode Island is representative of a common inquiry related to an employee covered by two plans.

Highlights of the Discussion

There are several layers to consider in your client’s situation. First, keep in mind that an individual k plan is a type of 401(k) plan that is designed to cover only small business owners and their spouses, (i.e., businesses without eligible common-law employees).

To answer your question, yes, a business owner can have both a 401(k)/profit sharing plan and a DB plan. The question on contribution limitations depends on whether the DB plan is covered by the Pension Benefit Guaranty Corporation (PBCG—the governmental entity that insures private sector DB plans). If a sponsor has a question about coverage, it can ask the DOL to make the call: Requesting a coverage determination

The PBGC insures most private-sector (i.e., non-governmental) DB plans [ERISA 4021(a)]. There are some notable exceptions to coverage, however ([ERISA 4021(b)].

Among others, the PBGC does not insure the following types of plans:

  • Governmental plans;
  • Small professional service plans;
  • Substantial owner plans;
  • Certain Puerto Rico plans;
  • Certain church plans.

Please see the PBGC’s definitions for the above listed exemptions on the PBGC’s website at PBGC Insurance Coverage.    

Where a DC and DB plan are combined, and the DB plan is covered by the PBGC, then there is no combined contribution limit. The deduction limits for contributions to DC and DB plans apply separately. A business owner, in this case, can fully contribute to both a DC and a PBGC-covered DB plan within the prescribed limits for each.

In the case at hand, one must be mindful of the substantial owner exemption from PBGC coverage. A private-sector DB plan is exempt from PBGC coverage if it is established and maintained exclusively for substantial owners of the plan sponsor (i.e., if all participants are substantial owners).

A participant is a substantial owner if, at any time during the last 60 months, the participant:

  • Owned the entire interest in an unincorporated trade or business, or
  • In the case of a partnership, is a partner who owned, directly or indirectly, more than 10 percent of either the capital or profits interest in such partnership, or
  • In the case of a corporation, owned directly or indirectly more than 10 percent in value of either the voting stock or all the stock of that corporation.

Where a DC and DB plan are combined, and the DB plan is not covered by the PBGC, as would be the case in an owner-only situation, then there is a combined contribution limit as follows:

If there is an employer contribution to the DC plan, then the maximum deductible contribution to both types of plans combined is the greater of

  • 25 percent of the aggregate compensation of all participants; or
  • the amount necessary to meet the minimum funding standard for the defined benefit plan.

Consequently, the plan sponsor would fund the DB plan up to the required amount, then fund the DC plan if there is still room.

For this purpose, the IRS says the first six percent of deductible contributions made to the DC plan is ignored for the above limits; and salary deferrals to the 401(k) plan are not counted toward the deduction limit.

Conclusion

Determining the maximum deductible contribution that a plan sponsor can make to a DB and DC plan that are combined can be tricky. Business owners should always seek advice from their tax advisors when calculating plan contribution limits.

© Copyright 2024 Retirement Learning Center, all rights reserved