1

DEFERRED COMPENSATION OUTLINE: National Retirement Policy: Three Legged stool: 1. Social Securitya. Safety net to put food on the table2. Company Pension3. Your own savings -401k or other savings 4. 4th Leg: Working after Retirement

Non-Qualified Plans: Wealthy will have Non-qualifed plans in addition to the qualified plan. a. They will have $5M. Will negotiate payment of $4M and then $1M after retirement ends.

Contracts: PROS & CONS EE & ER

EmployeeA. Pros: a. $ in retirementb. Lower Tax Bracket? (maybe)i. 50-60 highest income with a peak at 70.c. Higher Yield Company will pay higher yieldd. Tax deferral B. Cons: (Lack of Security a. Might never be paid. i. Bankruptcy: Company may go bankrupt-b/c EE becomes an unsecured creditorii. Hostile Mgt: Move on Apple. Will future management honor arrangement? iii. Cash Shortage in future: 1. Kodak-so many retires: b. No access for emergenciesCompanyA. Pros: a. Golden Handcuffs: incentive for EE to stay b. Forfeitures: bad boy provisionsi. Covenants not to compete-to make it expensive for them to compete: 1. If you compete-they forfeit their future non-qualifed plans payments. 2. Famous Cases: Ford Mustang- Lee Iacoka (sp?) moved to Chrysler forfeited all funds. c. Future Managements Problem.d. Less ERISA(Employee Retirement Income Security Act of 1974) i. Little bit of Laborii. Less IRSiii. TOP HAT plans (only for executives)B. Cons: a. High Yield (promise high interest rate)b. Timing of Tax Deductioni. Deductible when EE has the income ii. Cant deduct the $100k or the interest until the EE actually gets the money

NON Qualified Plans into 3 types of Plans: A. Deferred Compensation Agreement (tailored)a. Bill Self will have his own plan with KU different than everyone else. B. Top Hat: Group-Tired to Qualified Plan. Excess Benefit Plana. 30 years Pension= 50% incomeb. Comp: 100 Pension: 50i. 200100ii. 400200iii. 800400 **most can pay is 210K**iv. Pension plan law ERISA does not allow to go over $210Kv. So companies will make up the difference with a non-qualified plan. C. Yr of Employer DeductionReg. 1-404(b): taxable yr cash-method EE reports the income. HYPO: You are lawyer for the EE. A. Want to have income tax when I get payment.B. Assurance that want to get paid. C. Creative ways to accomplish this: a. Problem: The closer you get to security then the closer you get triggering taxable income. b. EARLY TAXATION: i. Constructive Receipt: Is the $ made available to you? (even if you only got 400K we will tax you on all $500K)ii. 402(b)1. Sec. 1.83.3(e)-Property: Funded Trust iii. 409A (Biggest Tax Problem) So how get rid of these 3 tax problems? A. Constructive Receipt: a. Danger words made available b. Look at the law page 7 of handouts. 1.451-2 Constructive Receipt of Incomec. made available so that he may draw upon it at any time. d. DEFENSE: income is not constructively received if the taxpayers control of its receipt is subject to substantial limitations or restrictions. e. All have to say $100K plus 6% will be paid to you until x date (15 years) OR will be paid to you and will not be made available to you before x date B. 402(b)a. HYPO: Grandfather gifts $10K no income tax Sec 102-Gifts)i. Instead puts 10K in trust: Income, interest and Dividends. 1. Deposit into trust is not ii. Company: $20,000 Bonus to you. Yes taxable1. Instead puts in Trust: Now EE only gets dividends and interest. a. If you have a funded Trust- you EE will be taxed the DAY the money is put in the trust. b. Even though you dont have access to the funds. c. Creates a big cash flow problem when you have to pay taxes on $20K that you havent earned yet. iii. Deposit: iv. Invested Income: Secular Trust: (funded Trust) Creditors cannot access EE pays taxes on: ERs contributions Trust earnings (by way of tax on trust) Distributions tax free Trust may make distributions to EE to help w/ increased tax liability 83 Analysis: 402(b)(1): Contributions to EEs non exempt trust shall be included in the GI of the EE in accordance with 83 transfers of property for services; Reg. 1.83-3(e), (8): property includes a beneficial interest in assets set aside from creditor claims of transferor.

Rabbi Trusts: Creditors MAY access Irrevocable trust ER considered owner of trust EE Pays taxes on: Actual receipt of compensation, not contributions Substantial Restricted benefits no constructive receipt not currently taxed Taxed when made available 83 Analysis: Reg. 1.83-3(e): property does not include an unfunded and unsecured promise to pay money or property in the future. Potential access to trust assets by ER creditors makes the trust unfunded

Rabbi v. Secular(Funded)Taxation Funded-SecularRabbi

Deposit

EmployeeIncome No Income

Employer Deduction No Deduction

Investment IncomeTrustTaxed to company (all assets are listed as co assets).

DistributionNo Effect Income and Deduction

Co gets Ded @ DepositWhenever EEMakes $$

When the trust actually distributes $ to the EE.

v. HYPO: Circuit City: and Rabbi Trust1. Bank account: a. Executive A: $500Kb. Executive B: $220k2. Instead of a savings account: Set up Rabbi Trust: a. Terms of the trust say this will be paid to executive A unless company declares bankruptcy b. **This makes it hard for the EE to lose out on Hostile management and Cash shortage. i. Does not protect against Bankruptcy.

Rev. Ruling: 60-31: A. Individual PlanB. Group PlanC. Football player signing agreement:

Rabbi Trusts: Triggers: A. If certain events happen, the Rabbi Trust would become a funded trust. B. 10% HairCut: (if 1M in plan) Executive can get the full plan balance minus 10%. So you could get 900K. Then become Funded Trust. a. Enron: Executives had this. Executives 70% of plan was Enron stock. So all employees lost $100. b. Executives, took the rabbi trust. c. 3 years later congress enacted: 409A. Elminates the Haircut Triggers. i. Whats dangerous is 409A talks about any contract not just trusts

409A Starting point: Dangerous & applies to plans. a. Applies to simple contracts. b. Three Thing Regulation: a. When Election can be Made: usually only in preceding year b. Assets Set Aside: e.g., rabbi trust: i. Cannot protect from creditors; and ii. Cannot be offshore c. Distributions i. Only permissible for six possible events; ii. No acceleration or triggers possible iii. Public traded company? Execs wait 6 Mo. c. Tax Results of 409A: a. Comply: i. Employee has income upon future receipt ii. Company deducts compensation in same year b. Fail Tests: i. EE has income in YR earned, even if cant actually gets it ii. Treated as ordinary income to EEso ER withholds income tax iii. Company pays 20% penalty on all EE income iv. Fail Test after Years of deferral? ALL accumulated income is taxes, plus interest and 20% penalty. d. HYPO: $500K pay me $400 now and $100 later. a. If you mess up the test: Drafted wrong. (step outside the contract)i. Executives taxed when the $ is earned. Taxed on all $500 not just the $400. ii. Plus a 20% penalty on amount that is deferred-co. pays the penalty on the deferment. 1. Accelerate all penalties and interest. 2. All just contract law. 3. Comp can deduct the taxes but not the penalties or interest. 4. 3 years down the road..deffered 300K 5. Exception: defer the year you are hired. Distributions allowed: 6 possible ways. Contract add all 6..but DO NOT specify anything other than that. ADD all 6 dont add, when college goes to college, divorce etc. . This will trigger 300k income if take 20K for e. What is an unforeseeable emergency? a. See page 17 of notes. Enron: Exon look at paragraph I: 6 months after for separated from service

Problem: Nonqualified Deferred comp arrangements. P.20

Problem C: a. Constructive Receipt: was it made available Dont have constructive receipt b/c $ not available for 5 years. b. Sec 402c. Funded:a. EE: Deposits Taxed $120b. Company: Ded $40c. Interest: Trustd. Unfundede. 409A-distributions permits? Prob D: a. UnFunded:a. EE: No incomeb. Company: No Ded-EE(5 years)c. Interest: Company

Section 83: Compensation in PropertyA. GR: Taxed on labor regardless if paid in cash or property (car dealership, orthodontist) a. Compensation usually Cashb. Property-c. Stocki. Restricted ii. Stock Optionsiii. Why would any company do this? Make employees think like an owner. Increase productivity. CompanyEE

CashDeductIncome

Payroll Tax7.65%7.65%15.30%

d. Why stock: i. Incentive: EE thinks like an owner: Works to increase stock value since feels sense of investment in business ii. Reward EE who stay long termiii. Tax deduction by just printing stock certificatese. Why not? i. Small business owner loses control.

Compensation paid in Restricted stock: 83Restrictions: a. ON transfer: i. Closely held business to avoid dilution: 1. Buy/Sell & Right of first Refusalc. On Date that stock vestsi. substantial risk of forfeiture1. Most common: lose stock if quit job early. (put a time frame like if 10 years) 2. HYPO: go work for competitor, quit job in 10 years etc. d. Amount and Year of Incomei. Amount of Income: 1. Value of Stock @ time below less amount paidii. Year: Earliest of: 1. No substantial risk of forfeiture 2. Stock is transferable a. Is there a chance you might lose your stock? i. Yes if you quit job too early.ii. Also if the company cant meet an earnings requirement. iii. Covenant not to compete.iv. Comitte a crime. Etc. 3. Stock is actually sold by employee

Compensation Paid in Restricted Stock: Sec 83Amount and Year of Income: Stock FMV$Paid

2011$10K$1K

2016$50K*forfeiture expires

2018$70KStock Sold

2011: No taxable income2016: 49K W2 Form income--$49K Witholding taxes: social security taxes ER deductions $49K2018: $20K LT Capital Gain

Tax Trap When Your Option Price is Same as Market Price MAKE 83(b) ELECTION!!!!!Stock FMV$Paid

2011$10K$10K

2016$50K

2018$70K

**TAX TRAP: 2016: $40K W2 Form income*withholding taxes; social security taxes2018: $20K LT Capital gainIs there away around this to make it as if she bought the stock on the exchange? a. Make a section 83 b election! b. 2011: Income=0 (10-10)c. 2016: Dont use the GR: use 83B No W2 Incomed. 2018: $60K LT Capital Gain*How make election? There is a form, within 30 days of making the transfer of property. *need knowledgeable people knowing this exists. *Unfair aspect of this: What happens if she quits before 2016? And she made the 83b election? a. the company that deducted 9K, the individual EE cannot take a deduction for the loss in the 10K 1K example, when the EE quits early*Want to be reasonably confident that you will be there for 5 years, to make sure you vest.

EE STOCK OPTIONS: a. NQSO: Non-qualified employee stock option. b. ISO: Incentive Stock OptionsWhat is a stock option? a. Grant date:a. Stock $11b. Price $10 optionc. Exercise Date: b. NQSO:a. Excise of option usually triggers W2 Form compensation income (withholding taxes, SS taxes)b. Employer tax deduction for compensation the same year employee has incomec. When Executive excersises, they generally sell it the same day. Generally will diversify, sell it pay taxes and diversify. c. ISO: a. Exercise of option not trigger W2 Comp to EEi. AMT issues, thoughb. Sell Stock > 1 year after exercise date and >2 years after grant date = LT Cap Gainc. ER does NOT get tax deduction. d. *Tends to only happen to cos that dont care about owners*e. Big issue with ISO is the volatility of the stock market. i. Executives.

HYPO: EE Stock option to purchase ER stock for $10 anytime over next 4 yrstrading @ $11. Taxed on the $1 of income on the GRANT DATE? *Special rule for stock options: Only taxed on the Grant Date, if they have readily ascertainable FMV a. Only if the option (as opposed to the company stock) is traded on an established market (oversimplified)b. Reg. 1.83-7(b)StockOption

2011Grant$11 $1

201250%$16 $6 < 600%

2013100%$22 $12 < 1200%

HYPO: When taxed? Taxed on Exercise date. Exercised in 2013 @ $10 Exercise Price 2013: W2 Form Compensation=$12/shareWithholding taxes, social security, etcER: tax deduction=$12/share2015 Sell Stock for $26LT Capital Gain $4/share (Income/Sale proceeds FMV @ Exercise Date) (26-22)Same Facts: ISOExercise in 2013 @ $10 Exercise Price2013: no income, but AMT preference =$12/share)2015: LT Capital Gain=$16/share($26 sale price - $10 cost)ER : No income tax deductionsStockOption

2011Grant$11 $1

201250%$22 $12 < 600%

2013100%$26 $ < 1200%

2014$9Worthless

**Point: Restricted Stock can still have value even when stock options are underwater**

Timeline: 1930a. Social security 1935/1938 (kicks in at 65)1940a. WWIIb. Labor unionsa. Pensions from companiesb. Life expect: 63-681960a. Major bankruptciesa. Studebakerb. White Motor corporations1974-100,00 a. Labor Day 1974a. ERISA law signed into acti. Provided security-required a trust to exist.ii. Corp paid $ into a trust then paid to employees.iii. 100K Defined Benefit Plans: 1981-1986a. Regan elected/starts terma. Introduced IRA to everyoneb. If you work $2,000 (now $5500 with inflation)b. 1986-401K Plansa. These plans IRAs ad 401Ks were designed to supplement defined benefit plans. Now they are actually replacing the defined benefit plans. 2005: only 30,000 defined benefit plansa. Life Expectancy: 78

Fortune 1000 Companies: 2004 :59% DB Frozen 9%2008: 45% DB Frozen 25%Risk shifting.

Spending time in this class to planning without the defined benefit plans.

Employer-Sponsored Tax-Favored Retirement Plans1. Overview: a. 401(a) Qualified Retirement Plan is Most Favored: Two Types i. Defined Contribution Plan: including 1. 401(k): Cash or deferred Arrangement 2. 403(a): Qualified annuity Plan 3. 408(p): SIMPLE IRA 4. 408(k): Simplified Employee Pension (SEP) 5. Profit sharing plans 6. Stock Bonus plans 7. Money Purchase Pension Plansii. Defined Benefit Plan1. 2. Qualified Retirement Plans and Annuities a. In General i. Taxable Distribution: employer contributions, earnings on contribs, or benefits not in GI until amount are distributed even if funded and vested. ii. Employer Deduction-404: current deduction w/I limits even though not in EEs GI. iii. FICA Tax: contribs to a QRP (other than elective deferrals and after-tax contributions) are exempt from FICA along w/ distributions. iv. Minimum Participation Rules: 1. 410(a) Rule: Cannot delay EEs participation in plan beyond the later of: a. Service: one yr of service (i.e., 21 mo period w/ 1K of service); or i. Exception: a plan providing 100% vesting to ER contribs after two years of service may impose 2 yr requirement. 1. But: cannot apply if plans contains a 401Kb. Age: attaintment of age 21. 2. Cant Exclude Participation: on the basis of attainment of a specified age 3. May Exclude Participation: a. Job classification b. Other basis so long as not an age proxy4. Defined Benefit Plan--401(a)(26): must cover the lesser of: a. 50 employees; or b. The greater of of: i. 40% of the workforce; or ii. 2 people. v. Vesting Rules--411:1. General Rule: Accrued benefits must become nonnforfeitable after a specified period of service or, if earlier, at attainment of normal retirement age under the plan.a. Age Limit: Plan may not specific an age later than age 65 or, if later, the 5th anniversary of participation. 2. Amendments: May not reduce previously accrued benefits or eliminate optional forms of benefits. 3. Involuntary Distributions: w/o consent of EE are not allowed before the later of the time the participant has attained normal retirement age under the plan or attained age 62. a. Exception: if present value of accrued benefits @ time of distrib is no more than $5kmandatory cashout. vi. Income Limit401(a)(16), 17, 404, 415: 260K b. Minimum Coverage and Nondiscrimination Requirements i. In General: 1. Policy: ensure QRP provides meaningful benefits to an ERs rank-and-file EEs and highly compensated EEs so the goal of retirement security for both is achieved. 2. Two Requirements: a. Minimum Coverage Requirements; and i. 401(a)(3)ii. 410(b)b. Nondiscrimination Requirements. i. 401(a)(4)ii. 401(a)(5) 3. Highly Compensated Employee--414(q)a. Compensated more than $120,000 AND is top 20% of the payroll (all EEs)b. OR 5% owner of the business own more than 5% so if exactly 5% then not 5% owner4. Election for HCE: at election of ER, EEs who are HCE based on compensation may be limited to the top 20% of highest paid employees. 5. Operation of the Requirements: a. Applied annualy b. Disregarded Employees: i. not satisfied min age and service conditions, ii. non resident aliens; and iii. employees covered by a collective bargaining agreement c. Aggregation with others plans allowed (b/c collectively bargained plans are deemed to satisfy the discrimination requirements)ii. Minimum Coverage Requirement: plans coverage of employees must be nondiscrim1. Plans Ratio Percentage: percentage of non-HCE covered over percentage of HCEs covered. 2. Satisfaction of Minimum Coverage Requirement: 70% or higher ratio %3. Fail Minimum Coverage Requirement: Less than 70% ration % than multi part test:a. Plan must cover a group (or Classification) of EEs that is reasonably and established under objective biz criteria, such as hourly or salaried EEs; and b. Plans ration percentage must be at or above a specific level specified in the regs. 4. Average Benefit Percentage Test: must also be satisfied: a. Requirement: the average rate of contributions or benefit accruals for all nonhighly compensated employees in the workforce (taking into account all plans of the employer) must be at least 70 percent of the average contribution or accrual rate of all highly compensated employees.iii. Overview of Coverage RulesIRC 410(b)1. Three Basic Tests: Try to satisfy the first, then keep moving downa. 70% Test: 410(b)(1)(A)b. Ratio Percentage Test: 410(b)(1)(B)i. Ratio Percentage: NHCE Benefiting %/HCE Benefiting %ii. Benefiting Percentage: # of HCE Benefitting/Total nonexcludable HCEsiii. Excludable HCE: 1. Not met minimum age/service2. Nonresident alien 3. Collectively bargained employees 4. Employees of QSLOBs; and 5. Certain terminated Employees c. Average Benefit Test: 410(b)(1)(C): Two Parts i. Nondiscriminatory Classification Test: Two Tests 1. Reasonable Classification: Reg. 1.410(B)-4(b): classification must be reasonable and established under objective business criteria a. job categoriesb. Salary v. hourly 2. Nondiscriminatory Classification: a. Determine NHCE Concentration Percentage: i. Total nonexcludable NHCE/Total nonexcludable EEsb. Refer to chart in Reg. 1.401(b)-4(c)(4)(iv) to determine safe harbor and unsafe harbor percentages c. Compare the plans ration percentage with the above. i. Ratio % = or above safe harbor, plan satisfies nondiscrim classification test. ii. Ration % below SH but above unsafe harbor, the prong must be satisfied w/ facts and circumstances and factors in Reg. 1.410(b)-4(c)(3). iii. Ratio % = or below unsafe harbor, plan fails coverage ii. Average Benefits Percentage Test: Average benefit % must be equal to or greater than 70%1. Average Ben %: iv. General Nondiscrimination Requirements1. Three General Approaches: a. General Rule: i. Three Steps: 1. Determine the: a. Allocation Rate: DC Plans: amount of employer contribution allocated to an EEs account for the plan year as a % of the Ees compensations for the plan yr. b. Accrual Rate: DB Plans: amount of annual payments under the Es accrued benefit payable at normal retirement age in the form of a straight life annuity divided by # yrs of service. 2. Form Rate Groups of EEs w/ same or higher rate 3. Each group must satisfy the 410(b) minimum coverage tests. a. If ratio % of rate groups is less than 70%: then i. Minimum ration % of 45% if NHCE % is 60% or less ii. Minimum ratio % 20.375% if the NHCE % is 99 %. b. Design Based Safe-Harbors: i. Generally: 1. DC Safe Harbor1.401(a)(4)-2(b)(2): allocates contribs pursuant to thae formula in the reg2. DB Safe Harbor1.401(a)(4)-3(b)(2): same as above ii. DC Safe Harbor Design: requires a uniform allocation formula that allocates to each EE: 1. Same % of plan yr compensation; 2. Same dollar amount; or 3. Same dollar amount for each uniform unit of service (not to exceed one week). iii. DB Safe Harbor: Must satisfy each:1. Uniformity Requirements of Reg. 1.401(a)(4)-3(b)(2); and a. Uniform Normal retirement formula b. Uniform post normal retirement benefit c. Uniform subsidiesd. No contributory DB plans allowed; and e. The period of accrual must be uniform and uniformly applied. 2. One of the Accrual Requirements of Reg. 1.401(a)(4)-3(b)(3),(4) or (5). c. Cross-Testing: 3. Types of QRPs a. Defined Benefit Plan: benefits determined under plan formula i. Formula Example: 2% x (Averaged compensation) x years of service = Annual retirement benefit ii. Individual Accounts: not maintained for each participant iii. Minimum Funding Requirements--4121. Risk: of investment loss/gain born by Er through increases/decreases in required contributions to fund promised benfits 2. Excise Taxes--4971: for a failure to make required contributions, unless there is a funding waiver. iv. Guaranteed: benefits under the PBGC. b. Defined Contribution Plan: Separate account maintained for each participant, to which contribs are allocated and investment earnings (and losses!) are credited. i. Benefits Based on: account balance only ii. Risk: bore by the EE4. Rollovers:a. General Rule: distribs from QRP that is an eligible rollover distrib may be rolled over to another such plan or IRA. b. Two Types of Rollovers: i. Direct Rollover: direct payment from the distributing plan to the recipient plan; and ii. 60-Day Rollover: contribution of the distribution to the eligible retirement plan w/I 60 days of receipt. c. Taxed: not included in GId. NonSpouse Beneficiaries: are not able to use 60 day rollover under 402(c)(11). e. See Page 27 of Committee Report

Pension Plans: Legal Definitions of QRP Section 401A. Pension Plan (Section 412 must pay every year regardless of profits)a. General Rules:i. Cannot provide in-service distributions 1. Exceptions: a. Age of 62 still working 401(a)(36)b. Reach normal retirement age ii. May provide death and disability benefits b. Defined Benefit (D/B) Actuaries involved (not with the Money purchase and Target plans) i. Provide retirement income (concept) to replace your paycheck. c. Money Purchase Pension Plani. Defined Contribution Plans (D/C) will fund annually ii. Some formula: 6% or 5%-we will add this amount to your account for every year you work, this amount.d. Target Benefit (Type of money purchase pension plan)i. Defined Contribution Plans (D/C)-not income replacement-just deferred compensationii. Issues of Discriminations: D/B plans $ favor older workers. iii. Set up as a Defined benefit plan, instead we have a target benefit plan. iv. Rule: Plan cannot discriminate with contributions or Benefits. v. HYPO: DB plan pay 50% $40,000/yr need: $300,000 to buy this annuity 1. Worker age 55 80K have 12 years to save - $27,0002. Worker age 40 80K have 27 years to save - $10,000 3. Even though the contributions discriminate- the benefits dont discriminate because they are the same for both employees. 4. Then you set up the plan as a DC plan. This is how you 5. Practical TIP: you dont want a target benefit plan with 10 or more EEs a. HYPO: EEs that do the same work for the same pay then the EEs fight and there becomes issues with younger and older employees. vi. Age Weighted P/S plan- set up as a target benefit plan-same rule though, B. Profit Sharing Plans (discretion) (becoming more popular than the pension plans) a. No requirement for profits Reg. 1.401-1(b)(1)(ii)b. Has to be a Fixed # of yearsc. Stated Age (60)d. Separate from Servicee. This type is a LONG TERM retirement Plan. f. Discretionary contribution by ER, but plan formula must be set in plan document. C. Stock Bonus (ESOP) (Employee Stock Ownership Plan)a. Defined: similar to a profit sharing plan except benefits are distributable in stock of the ER, and that the contributions by the ER are not necessarily dependent upon profits. All the allocation and discriminating plans. b. KC has 5 of the top ESOP companies-Article in readingc. Leveraged ESOP-most likely to see

Stock Bonus PlansESOP

1.Pass Through of voting rights (merger/Sale) 409(e)(1)xx

2.Right to Demand Stockxx

a. Co is EE Owned (in bylaws of the co)

b.

3.EE Put Option Xx

4.When quit how soon can you get stockxx

a.One year rule

5.Age 55 Retire at 50% of stockxx

6.Prohibited transactions (where diff is)a. Buying stock & loans-Can borrow $$b. Waiver of Duty to diversify c. **These are what make the ESOP more attractive**

N/AOkMake them a little better because of these are OK.

Put option: at any time can put the stock to someone at a certain price.

HYPO: Leveraged ESOP (debit)

408-IRAs (EP/Simple) (next weeks class)

a. D/B Plan: Need definitely determinable benefits b. Flat Dollar plan: everyone gets a benefit of $10,000 no one does thisc. Flat Percentage plan-everyone gets 20% no one does thisd. UNIT Benefit Plan:**most common** Number of years of service x % (picked by company) x average compensation of high 5 years20x1% x 100,000=$20,000*have to be definitely determinable cant have contingent payments cant jigger with the numbers. If have lots of forfeitures you can change the percent given.

Conceptual Problem: When does the D/B liability kick in for the employer? A: when the EE quits

incidental benefit rule retirement trust account. What does the IRS allow us to put into this trust? A limited amount. Disability, death benefits-funeral expense s to the family,

Defined Contribution DC Plans: BalanceGrows from 4 sources: a. Employer Contributionsa. How allocate? % of Total compensation of total payrollb. -basic compensation: if hired at $50K yearc. -Total Compensation: hired plus bonus amount etc. b. Investment Income a. Allocated: % of Total Assetsc. Forfeitures: a. Rewarding long term employeesb. Vesting Schedules: c. What formula do we use for allocations? A. Cant discriminate: cant say basic comp plus bonuses, not overtime. But could say basic comp plus OT but not bonuses, because wouldnt discriminate against the average employees)B. Safe Harbor-just allocate as % of Compensationd. EEs own contributions (100% to your own account)

REV Ruling: 84-155: *have to give credit for past service-past service cost*

**Moving towards the general plans (like Paychex has) where a business can pick and choose their certain options of the plan. Prototype plans-not having lawyers draft these individually anymore.

Recurring and substantial-for profit sharing plans. Dont have to put in every year.

Jurisdiction: (3 players)a. Labor: Employee Securitya. Sep Trustb. Pay according to planc. Diversify investmenti. Adequate Cashd. Prohibit self-deal-owners prohibited from looking at employees accounts as personal piggy bank.b. IRS-Limit Benefits to Rich **this class is aimed at learning at this IRS**a. Cap on Contrib/Benifb. No Discriminate HCE (highly compensated employees)c. PBGC: (pension benefit guarantee corporation) a. Insure D/B Plans (one that plans the monthly benefit to employees)b. *no insurance of defined contribution plans**c. Max of $40k per year.

ERISA is the compromise 1974 of multiple legislation: 26 USC 40129 USC 1302ERISA Section 1251-this was the section of the bill that became the same statute. Will find in the Tax Volume and the Labor Volume. **All of these are the same code.

IRA: governed by section 408 (individual retirement account)a. No part can be invested in life insuranceb. Interest is nonforfeitablec. Assets cant be commingled with other property.

U has an IRA in 2013/2014? a. Earned Income b. Max : is Lesser of $5,500 or 100a. Married: spousalc. Can I deduct? Under 96,000 married, or less than $60K single

Trust vs. Custodial account? Custodial account: mutual funds, operates like a trust: Look at 5305:

Best plan with least administrative costs? *SEP & SIMPLE Look at: No trust, no DOL reports, No 5500 forms etc.

How set up an SEP? a. 5305-SEP Simplified EE Pension-Individual Retirement Accounts Contribution Agreement b. Requirements: a. ER agrees to contributions made on behalf of each eligible ee will bei. Based only on the first $260,000 of compensationii. Same percentage of comp for every EEiii. Limited annually to the smaller of $41,000 or 25% of compensationiv. Paid to the employees IRA Trustee, custodia, or insurance company. c. What wrong with SEP? its only like a profit sharing plana. Only employer contributions-not EE contributions. b. This is where the 401K plan comes into play.

W-210%

me$300K (only up to $260k)$26K

EE 1$260K$26K

EE 2$26K$2,600

SIMPLE: Savings Incentive Match Plan for Employees of Small Employers: (where EEs can contribute unlike the SEP) a. *General rule ER has to match 3% -under extraordinary circumstances can go lower but should plan on contributing 3%b. Non-elective contribution: c. Notice to EEs for the SIMPLE IRA Plan: d. Salary Reduction Agreement: for payroll deductions

Things to think about when deciding plan type: a. Age of employeesb. 50 or less EEs to have a SIMPLE planc. Turnover of employees-vesting of SIMPLE vs. SEP

Max Contribution 260K

ElectCatch up(over 50)

IRA$5,500 1,000=$6500

SIMPLE12,0002500: $14,500

401K17,5005500= $23,000

403(b)17,5005500= $23,000

S.E.P (solo)(no ee's)*ideal candidate for SEP-no EEs**52,000 (25% x 260,000)

D/BNO LIMIT (only what actuaries say)NO LIMIT

DB plans-national shifts are away from DB to now DC plans. WHY? A: DC Plans: The investment risk is all on the employee. B: DB: The risk for DB plan is all on the company.

DCDB

Deferred CompensationRetirement Income

Investment RiskEECompany

Administor

ActuatriesNO yes

PBGCNO Yes

FASBNO Yes

Monster Tax Deduction Possible?

Monster Tax Deduction Possible: HYPO: NO discrimination in contribution or benefit for HCE. -DB plan **big issue for AGE**Doctors AGE: W-2PensionAnnual ContributionD/CTrick (older and owner of business Can set up the DB plan-D/B

55$500K$200K$200,00050,00055 Dr. 500k

25$500K$200K$20,00050,00025 Nurse50K

Contrib$220,000 DB plan to contribute100,000

*For each Doc have to have a pot of money of $2,500,000 to pay for the annuity

When do you want it? Only when you want more than $52,000-the solo defined benefit plan is the way to go.

Plan our own company retirement Plan: How much $ do you want? SOLO (no ee's)1-50 EE'sMore than 50 EE's

Pail SEP (up to 25% of pay)SIMPLE (cheap 401K plan)3% of payroll(2% of payroll-nonelective contribution401K Safe Harbor-less admin costs (cant have IRA plans with more than 50EEs)

BucketSolo Safe Harbor 401K plan (25% of pay plus $12,000 401K contribution)Safe Harbor 401K4% payroll *have to match*401K Safe Harbor

BarrelSolo DB Plan (if over 50)Combo D/C & D/B (have 401K and defined benefit plan)D/C & D/B Combo

Edward Jones #s Plans Set up each year: Solo CompaniesWith EEs

300 Solo D/B15,000 SIMPLE

3,000-Solo 401K4,000 401(k)

20,000 SEP

SECTION 415: Limitations on Benefits and Contributions under Qualified Plans401(a)(16): Trust is is not a qualified trust if the plan provides for benefits or contribution that exceed the limits of 415 Limits of Contributions D/B Max: Lesser of415(b)(1): maximum benefit that can accrue under a defined benefit plan is, when the benefit is converted to an annual life annuity, the lesser of:a. Max Annual: $210,000 (2012 $200,000) ORb. 100% of the average three years which the employee had the greatest aggregate compensation. (415(b)(2)(3) states its not just preceding 3 yrs)a. 99, 100, 101- average is 100 so thats most can put in. b. Exception: Does not apply to collectively bargained for plans 415(b)(7)c. EXCEPTIONS (limits-special but no one ever does these)a. 10,000 for anyone ruleb. Early retirementc. Highly Comp Executives: Worked less than 10 years. i. Cant get 210 limit if less than 10 years. Shrink to ratio to number of years actually worked at the company. 1. HYPO Executive makes 10M. for 3 yearsa. 21, 21, 21 = 63K is this exc. 415 limit because less than 10 years workedd. Age Adjustments: a. Benefits Begin Before 62415(b)(2)(C); Reg. 1.415(b)-1(d)(1): dollar limit reduced to annual benefit that is the actuarial equivalent of an annual benefit equal to the regular dollar limit beginning at age 62. b. Benefits Begin After 65415(b)(2)(D); Reg. 1.415(b)-1(e)(1): the dollar limit is increased to an annual benefit (beginning when benefit payments begin) that is the actuarial equivalent to the regular dollar limit beginning at age 65.e. Plan Participation Adjustment415(b)(5): If ee has less than 10 yrs of participation dollar limit reduced by multiplying by (Yrs of participation)/10. a. Reduction of 100% Compensation Limit: the fraction by which the regular limit is multiplied is based upon the employee's of years of service with the employer, rather than the number of years that the employee has participated in the planD/C Plans--415(c)(1) Generally, the maximum annual additions that can be made to a participant's account under a defined contribution plan cannot exceed the lesser of: $53,000; or 100% of EE compensation Annual Addition--415(c)(2): Sum for that year of: Employer Contributions Forfeitures Employee Contributions Self Employed Individuals--???

404-Employer Tax Deductionsa. Max 25% Payroll (plus 401(K)) b. 4872: 10% penaltya. Solution Plan Document Correction

HYPO: 2012-when Max was $50,000 or 100% of pay. a. Rich Guy : W2=$500,000b. Cratchit: W2= $50,000c. Rich Guy would pick 10% contributions so that Cratchet would get $5,000 and Rich guy gets $50,000 in the account.

401(a)(17): Annual CompSame HYPO as above: add Mid guy with annual salary of $280,000. a. Because of this rule Rich guy also looks like he only makes 280,000. b. Now Mid Guy and Rich Guy look like they make the same amount of $. c. Now Crachet gets 10K and Rich guy would get 50K and the company policy would be 20% limit. **This is tension between ERISA and IRS is this trick.

404 EMPLOYER TAX DEDUCTIONS Generally limited to 25% of the participants compensation Compensation in Excess of $265 not taken into account. Not Include: Elective deferalls Employee contributions ESOP of C Corp: 404(a)(9) Payments of Principal: deductible to extent of 25% limit Payments of Interest: deductible without regard to limit Dividends: Deductible if: Used to repay loan, if distributed to plan participants; or Plan gives participants opportunity to elect either to receive them or have them reinvested in employer stock and are elected to be reinvested by participants

Self Employed Earnings:IRS looks at Current wages plus Deferred compensation: total *if you want to get full 25% of compensation

404(a)(8)(d)Terms: not tested on.

SECTION 401(k): EE Contributions to Plansa. Max Mandatory EE contributions: 10%b. 401(m)-as in Matching contributionsc. What is a mandatory contribution? Section 411c2c amounts contributed to the plan by the employee which are required1. As a condition of employment 2. As a condition of participation in such plan or3. As a condition of obtaining benefits under the plan attributable to employer contributions.

Compensation and Contribution Limits (401K plans) salary deferrals- $18,000 $6,000 if the employee is age 50 or older (IRC Sections 402(g) and 414(v)) annual compensation- $265,000 in 2015 (IRC Section 401(a)(17)) total employee and employer contributions(including forfeitures) - the lesser of 100% of an employees compensation or $53,000 for 2015 (not including "catch-up" elective deferrals of $5,500 in 2014 and $6,000 in 2015 for employees age 50 or older) (IRC section 415(c))Example:Mary, age 49, whose annual compensation is $360,000 ($30,000 per month), elects to defer $1,458 per calendar month, up to $17,500 for the 2014 year. Mary may contribute to the plan until she reaches her annual deferral limit of $17,500 even though her compensation will exceed the annual limit of $260,000 in September.Employer matching contributionsIf your plan provides for matching contributions, you must follow the plans match formula.Example:Your plan requires a match of 50% on salary deferrals that do not exceed 5% of compensation. Although Mary earned $360,000, your plan can only use up to $260,000 of her compensation when applying the matching formula for 2014. Marys matching contribution would be $6,500 (50% x (5% x $260,000)). Although Mary makes salary deferrals of $17,500, only $13,000 (5% of $260,000) will be matched. She must receive a matching contribution of $6,500 (50% x $13,000) under the terms of the plan

401(k) only get pre-tax benefit from income tax NOT the social security amount and Medical

IRS put in incentives so that it is fair for all employees. What is a 401K plan?a. 401K contributions are legally considered ER contributions put in at the employees discretion. b. 404 applies to 401Ks because they are viewed as ER contributions. c. **Big difference with IRA and 401K is the employer cant stop the EE from taking money out of the plan**Ways to get $ out of 401K while still working: a. Hardships1. 2 requirements to have a hardshipiii. Immediate and heavy financial need: Safe Harbors:1. Illness of self, dependent or spouse. 2. Destruction of property3. Avoiding eviction 4. Tuition-post secondary education5. Purchase principle residenceiv. You have no other resources to satisfy that need (financial necessity) # No Other Sources1. Company office can rely on the statements on the employee unless there are obvious showing by the employee that they have other sources. v. Tax Trap: 1. Under 59.5 have a 10% penalty2. Exemptions from 10% penalty:a. Medicalb. Higher education (IRA)c. 1st Home (IRA)d. **better off taking a loan than taking a hardship unless meet the specific requreiemtns because get taxed on the distribution**2. Details to think about Hardshipsa. Once taken-must have NO contributions to 401(k) for one year afterb. When resume contributions must be less than contributions prior to taking the hardship. b. Loans

1. 401(k) Plans: profit share or stock bonus plan that contains a qualified cash or deferred arrangement.a. Elective Deferral Max402(g): $18K or, if less, the EEs compensation. i. Pre-Tax basis ii. Qualified Roth Contribution Program: permits participant to elect to have all/portion of EDs treated as designated roth contributions. 1. Not excludable from participants gross income 2. Dollar Limit: same as limit on EDs, reduced by actual EDs not treated as designated Roth Contributions. 3. Treated the same for all other purposes as EDs4. Qualified Distributions: a. Defined: distrib mad after the end of a specified period (usually 5 yrs after first designated roth contrib) that is i. Made on or after the date on which the participant againt 59.5ii. Made to a beneficiary (or estate of the P) on or after the death; iii. Attributable to disability b. Tax Treatment: excluded from income, even if including earnings not taxed.5. Roth Conversion: from nonroth to Roth is okay, but some taxes when contributions were pretax contributions. b. Catch-Up Contributions414(v): an employee who will be 50 by end of yr make make an additional $6k. c. Distributions: elective deferrals, attributable earnings cannot be distrib b4 the earliest of: i. Severance from employment ii. Deathiii. Disabilityiv. Attainment of age 59.5; or v. Termination of plan d. Hardship Distributions: only elective deferrals, not associated earnings can be distributed. e. Qualified Roth Contribution Program: permits participant to elect to have f. Automatic Enrollment: when EE becomes eligible, EDs are made at a specified rate unless she elects out. i. Notice: ee must have effective opportunity to elect to receive cash in lieu or have EDs at different rate. ii. Opt Out Distribution: if elect out w/I 90 days of first contribution, there is no 10% penalty to have that money given back to you. g. Special Nondiscrimination Test: the actual deferral percentage test applies to elective deferrals under a 401k plan. i. Design Based Safe Harbor: a 401k plan with certain design features w/ respect to contribs (elective, matching, and nonelective) and enrollment, satisfaction of the minimum coverage requirement is a sufficient test of the amount of whether EDs and matching contribs are nondiscrim. 1. 401(k)(12) Safe Harbor: plan is good on the nondiscrim test if satisfies one of two contribution requirements and a notice requirement. a. Contribution Requirements: a plan generally satisfies the contribution requirement under the safe harbor if the Er either: i. Satisfies a matching contribution requirement; or ii. Makes a nonelective contribution to a defined contribution plan of at least three percent of an EEs compensation on behalf of each NCE who is eligible to participate in the plan. 2. Page 38 of committee report

ADP Test: actual deferral percentage testApplication of participation and discrimination standardsExcess Deferral: a. Applies to any employeeb. Max $18,000/per yearc. Applies tax payer per tax payer-cant add together 3 jobs. Its an annual limit for an individualExcess Contribution ADP TEST:a. Highly Comp Employee a. Compensated more than $120,000 AND is top 20% of the payroll (all EEs)b. OR 5% owner of the business own more than 5% so if exactly 5% then not 5% ownerb. Average Deferral of non-highly compensateda. Limit the HCE on the amount can contribute b. See numbers in HOYTS sample. How does the owner get employees to contribute more ?-Statute prohibits ER from asking EE to make arrangements. i.e. if you want health insurance, then contribute 10% of the plan. -What is excluded is the match option.

HYPO: Looking at the 20% for HCE: All companies will make the election to add the 20% to classify as HCE. So in Dr. office below: dr A$ COMPDEFERRAL PERCENTAGE

B320

C300

D280

E2808

F2809

E24010

StaffU602%

W503%

X40

Y30

Z30

HYPO Again: Who is a HCE? TomDianeHarry

Comp100k100k100k

% owner0.330.330.33

Who is HCEHCE b/c 5% HCEHCE

Safe Harbor 401K: Avoid ADP TEST: there will be no ADP testthe price of the safe harbor may be the match. a. 401(k)(11): Simple 401Ka. Match up to 3% ORb. 2% to every EE (non-elective contribution)b. 401(k)(12)(B)Match to Contributing Employeesa. Max 4% of payroll costsi. 100% to 3%ii. 50% to 5%iii. Max of 4% totalc. 401(k)(12)(C): a. 3% contribution to every EEi. nonelective contributiond. 401(k)(13): Auto Enroll with Safe Harbor Match (only about 6 years old 2008)a. Auto enroll: i. 100% match on first 1% of EEs contributionii. 50% on the next 2%1. Total of EE contribution 3% and ER contribution of 2%iii. Each year EE contributions enroll at another 1% up to 6%: yearEE %Match %

13%2%

24%2.50%

35%3.00%

46%3.50%

56%3.50%

66%3.50%

beyond

Total: 9.50%

Mandatory participation: Bottom of page 6: Non-discrimination test for EE and matching contribution tests.

SIMPLE IRA COST SIMPLE 401(K)ADVANTAGESDISADVANTAGES

1.NO 55003% match exposure?

2.NO ADP TESTLower $ limit than 401(k)12,000 vs. 17,500

3.No Investment responsibility (IRA)No forfeiture possibility

NO D.O.L Reports on Investment

NO Top Heavy Rates

Automatic Enrollment

Shift Gears: Taking Money out of the AccountsA. Distributions: Why? To Provide retirement Income. B. Congress Restricted Access to the $$ b/c want it saved for retirement: a. LAWS: a. Laws that prevent early distributionsb. Force distributions in Retirementc. COMPANY POLICIES IN ADDITION TO THE LAWS:C. Prevent Early distributionsa. 401k no distribution untili. Separation of serviceii. Dieiii. 59.5iv. Hardshipb. Profit sharing plans:i. Fixed number of yearsc. Defined benefit plansi. Before the normal retirement aged. IRAs: NO RESTRICTIONSi. Can take out at any age: Code 408!ii. What would stop you from taking $ out of your IRA? D. There is a 10% penalty if you take the $ out before 59.5. 72 (f or t)? E. Force Distributions: a. Kicks in at age 70.5 or after deathb. 401(a)(9) Plansc. IRAs 408(a)(6)d. 50% penalty-not taking the required distribution!i. LOOK for this with widows dont know when to take it out and get hit with a 50% penalty for not taking the funds out when the administrator fails.

HYPO: Quit your job at age 30. What is your legal right to take your money not the permission to take the funds? drafted in 1974 looking at defined benefit plans: 401A14a. It states that the employer does not have to write a check until you are 65 years old. b. Company policy will usually make it available to you. c. Can you make the company keep the money for you. (hold remaining funds in past ER account)a. Here this a lot in law firms: why?-law firm pays the admin fees. b. Involuntary cash out: If you account balance is $5,000 or less.

Lifetime Distributions after age 70.5. a. Exception is if you marry someone that is more than 10 years younger than you. Hugh Hefner example. Marry 26 year old, can look at the chart for your spouse too not your own amount.

On the death of someone and the beneficiary: What happens

HYPO: 80 year old Aunty Em: 5.35%a. Leaves IRA to Neice age 33: b. Tax law will take IRA- and add 2 words to add to IRA: a. Annty Em IRA beneficiary Niece. c. Why? Tells the world that we are now liquidating the IRA. The niece can take out over her life expectancy. d. Objective is tax deferral: so look at a. Power of a STRETCH IRA-IRA paid out over the life expectancy of the beneficiary. All we know is that the IRA will be liquidated over the life expectancy. b. Niece is paid out at 2% payout. 1/50 = 2%e. What happens name son who is 51 years old: life expectancy 33 years 1/33 = 3% pay out. f. Power of IRA: Tax code only requires 2-3% g. When you pick the beneficiary of the IRA-it is better because of tax deferral. h. If you want to give to kid name a trust account:i. If you do the STRETCH IRA wrong you have to liquidate in 5 years.j. If you do it correct, you can go forward for 50 years.

3 definitions need to know: a. RBD: Required Beginning Date: a. IRA: i. Congress gives you a 3 month grace period: April 1st of the year you turned 70.5. ii. April 1 following the calendar year the IRA account owner attains age 70.5. b. Qualified Retirement Plan (403b)i. Later of: 1. April 1st following the calendar year that the account owner attains age 70.5 OR2. April 1 following the calendar year that the employee separates from service (ex. Someone who works past age 71) Individuals who own 5% or more of a business are not eligible for this later RBD: their RBD is April 1 following the calendar year that they attain age 70.5. c. Technical tax terms: i. Beneficiaries: a. Non-Human beneficiaries cannot do a stretch IRAb. Designated Beneficiary (DB): Fancy tax term for human being. Determination Date: How do you get rid of problem beneficiary a. Disclaimer: someone says they dont want the inheritance b. Cash out a beneficiary pay out the charityc. Separate account for different beneficiaries: a. Divide into 3 different accounts for the beneficiaries.

Problem with STRETCH IRA: a. Death: Before or After RBD-required beginning date: b. PAGE 10 of handout: Chartc. **Worst beneficiary-your estate!**

HYPO: Child with an IRA from dead father: Cant roll over into the sons IRA. Instead: can only do an Alex beneficiary Charles IRA. Instead: Widow: Rollover option is available from dead spouse to widow to roll over surviving spouse.

Mutiple DBs: Must use the Oldest DB payout:

What if the IRA is payable to a trust? Then the trust 1/3 to each family member. **This is a big issue because you cant have 3 different trusts**

What you want to do is a STRETCH IRA. Slow you down are multiple beneficiaries or non-human beneficiaries.

Surviving spouse Dont want a roll over for a young widow: under age 59.5 Why b/c there is a 10% penalty. She can roll over what she wants into her own account 700,000 then leave 300K in husbands IRA.

Conduit Trust: Just a sign over to the beneficiary. Nothing ever accumulates. Accumulation Trust:

TAXED: a. GR: Ordinary Income (taxed like annuity)b. EXCEPTIONS: a. Tax-Free Return of Capitalb. NUA. Employer Approved Stocki. LTCGc. TAX-Free Roll Overd. Born before 1936): Lump Sum Distributionc. 20% Withholding: anything eligible for rolloverd. Penaltiesa. 10% penalty before 59.5b. 50% penalty- 401a9. If you dont take the minimum distribution e. Estate Tax:

**NO CONSTRUCTIVE RECEIPT ONLY ACTUAL DISTRIBUTIONS**402: Taxability of beneficiary of employees trust:

Annuity: Paid $30K55-Life Expectancy 30 yearsAnnuity $4,000/yeara. $1000 Exclusionb. $3000 Annuity c. $invested/expected = $30K/30 years

Simplified Method (page 3 handout): Special rules for Qualified employer retirement plans:

IRS Form: 8606-Non-Deductable IRANonDeductable IRA: 2000 Contribution10000 balance8000 growth.

Lumps all IRAs together-treats them all lumped together. **Stay away from non-deductible IRAs***Real danger-you have to track and attach the form for the rest of your life. Really shrinks non-deductable IRA??

60 Day Roll Over: a. $ payable to employee. Really doing trustee to trustree transfers. b. Be careful about co-mingiling the funds in your own account. c. **dont like the 60 day roll over you prefer the trustee to trustee transfer**

Law of a RollOver: Rules applicable to rollovers from exempt trusts: page 3 of handout: a. Exclusions from Income: b. Hardship waivers: a. May waive 60 day requirement: i. What wont work: ignorance of the law-no excuse. ii. Only a mess up by the bank or a natural disaster will stop from being taxable. What is hit with the 20% withholding tax-c. Penalties: a. 2 ways to draft a statute: b. French: anything is permitted c. German: Penalize everything unless you find an exception.

ONLY exception is a medical exemption. All other hardships are hit with a 10% penalty.

How to set up a qualified plan?401a. Must notify EEs:a. SPD-Summary Plan Descriptionb. Receive within 90 days of 1st day of employment: DOL ruleb. Notify the DOL:c. Notify the IRS? NO legal requirement to notify the IRSa. Worry about an IRS audit which says that your plan does not qualify under the IRS Codeb. 5300 Formc. 5302 Form: EE Censusi. Pay the IRS a couple thousand $$ for reviewing your planii. Determination Letter:1. Only issued for qualified plans 401a or 501(c) (3)

Regulation 1.401-1 Defined Benefit Defined Contributiona. Document must be in WRITINGb. Communicated to Employees (through determination letter from the IRS-or competent retirement lawyer)c. Established by Employera. Union Plans: Multi Employer Plansd. Exclusive Benefit of the Employeesa. IRS gets suspicious if ER wants to co-mingle the ER funds. e. Permanancea. 10 years (at least 3 years)-If you terminate in 1 year IRS says you didnt have a permanent plan f. Plan: Like a business plan. It is like the idea lists who puts in money, explains all the rules.g. Trust: Holds the money and cuts the checks for the employees based on the rules in the plan. a. Is Tax exempt.

401 Qualifed Pension, Profit-Sharing & Stock Bonus Plans: a. Trust: U.S. Based ONLYa. Custodial Accounti. Annuity Plan b. Can $ ever revert to the employer?a. Mistake-Yes can b. Defined Contribution Plan: Profit sharing, 401K, Stock option/ESOPi. $ NEVER can go back to the Employerc. Defined Benefit Plan: i. Possible for the $ to go back to the employer. HYPO EXAMPLE: D/B Plan Termination1/1/2013 Assets: $1,000,000Liabilities ($1,100,000)30% MarketAssets $1,300,000 assets exceed the liabilities above. $200,000

Congress stopped this: a. Taxable Income b. 50% penalty- when $ ever reverted to Employer. a. Could lower penalty down to 20% if started a new plan. Company Perspective:

Termination vs. a Freeze (Boing 68,000 ees frozen). HYPO Example: Formula: 2%x #years x Average Compensation 2% x 30 years x 60k= $36,000EE35$30,00055$50,000Freezing here65$60,000New formula like Sprint/Bowing: 2% x 20 (years in the plan not years of service) x $50,000 = $20,000*FREEZE is stopping all future credits funds stay in the account**TERMINATION all money leaves the plan *

HCE: a. 5% ownerb. $115,000 + Top 20%

New Comparability formula: use allocation formulas which target particular groups of employees for benefits, referred to as cross-testing plans. 3.11 Allocation to participants accounts-Cross-testing or new Comparability.

401(a)(5): Exceptions to legally discriminate (B) Contributions and benefits bear uniform relationship to compensation. Meaning that you can put in different $ amounts as long as the percentage of the $ is the same. (C) Certain disparity permitted. HYPO: EXAMPLE: First $117,000a. 6.2 % OASDI (old age survivor disability insurance) b. 1.45% HI-health insurance medicare/Medicaidc. 7.65% (Total EE Contributions)d. 7.65%(Total ER Contributions-matches the EE portion)e. 15.3% goes to $0 to $117,000$117,000 +$260,000 401(a)17 ERISA 400,000

A. $50,0005%0

B. $117,0005%10%10%

C. $200,0005%10%10%

D. $400,0005%10%10%0%

401(L)(2) Defined Contribution PlanBase amount (5.7 threshold) Excess 48%510%611.7%712.7%813.7%

HR 10 KEOGH Rules: A. Owner-EE 1. self employed2. partnership3. P.C. (doctors and lawyers to incorporating under) 356. More generous pension rules and out of the Keogh.

1982: TOP HEAVY RULES: a. were most of the account balance for the owners? 401(a)(10)(B) Top Heavy Plan:

D/B Annuity:a. Married Employees 417a. Issuing QJSA-Qualifed Joint Survivor Annuitiesi. Must issue unless there is a waiver by the spouse. 1. Waiver Must be: a. Witnessed ORb. Notarized b. QPSA-Qualified Payout(?) Survivor Annuity i. 50% DropP/S? 401k?NO Annuitites.Married? -Death 100% surviving spouse (ERISA)

Death of Male:QRP (401)IRA's (408)

Beneficiary: Kids from 1st marriedBy law-$ goes to 2nd WifeGoes to Kids

Pre-Nupp-give to each other says each retirement account goes kids from first marriage 2nd wife (federal law)Goes to Kids

*legal argument is signed before they were married. Kids can sue for breach of contract of the pre-nupp

Post-Nupp sign after the marriage to make the pre-nupp agreement valid Kids of Kids

Life Insurance Will401KIRA

Beneficary Named2nd Wife2nd Wife2nd Wife

Divorce 2012State Law-goes to kids (not ex spouse by default)

2013 DeathKidsFederal Law: 2nd Wife?? Unknown

401A (11)D/B: Corp 2% x # of years x Comp2% x 20 Years x $10K = $40K

New: 1% x # of years x comp= $20K *new company cant take away old benefit. 401A(12) Any merger or consolidation with or transfer of assets or liabilities to any other plan.would receive a benefit immediately after the merger, consolidation, or transfer which is equal to or greater than the benefit he would have been entitled to receive immediately before the merger, consolidation, or transfer.

401(A)(13): Assignment and Alienation: CREDITOR PROTECTION WITH ERISA. a. Assignment: Where you say to someone I will transfer my account to you. b. Alienation: (ira part of bankruptcy estate)c. Retirement account is completely protected from creditors. d. 5 exceptions of where people can get to your retirement account: a. Administration fees up to 10%b. Loans-borrow from your plan (401a plans) a. 4 issues: i. Sec 401a 13ii. 4975 Prohibited Transactionsiii. 72 (q) Loan presumed to be a distributioniv. Does plan offer loans? you dont have to offer loans (it is permissible but not required)1. (IRA-LOANS ARE PROHIBITED!! 408 IF YOU BORROW IT DISQUALIFIES THE PLAN THAT DAY!! )c. QDRO (qualified domestic relations order)-if you get a divorce and making a paymentd. IRS Levy: Seize account if behind on taxese. Embezzle (Guidry-supreme court case)

ERISA Rules: 4975 Prohibited Transactions: Ellis Case. Applies to QRPs, IRA, health savings account, medical savings a. There is hereby imposed a tax on each prohibited transaction. b. 15% of the amount involved with respect to the prohibited transaction for each year. c. The tax imposed by this subsection shall be paid by any disqualified person who participates in the prohibited transaction. What are the PROHIBITED TRANSACTIONS? a. Sale or exchange or leasing, of any property between a plan and a disqualified person. b. Lending of money or other extension of credit between a plan and a disqualified person. c. Furnishing of goods, services, or facilities between a plan and a disqualified person; d. Transfer to or use by a for the benefits of a disqualified person of the income or assets of a plan. Who is a DQd Person? Fiduciary Person providing services to the plan An employer any of whose emplyees are covered by the plan An employee organization any of whose members are covered by the plan An owner, direct or indirect, of 50 percent or more of And so onSpecific Exemption: UMB says to Department of labor: we want to use some mortgage funds as a qualification of an exemptionthey are a great product, will you approve of this transaction? They will then publish the results in the federal register, you search the federal register and will see it there! Special Exemptions: a. You supply the DOL a waiver and the DOL approves-if DOL says the employees are protected then the IRS wont subject the employees to the penalty. b. Waivers are published with the federal register. c. Most common: People just dont realize this is a prohibited transaction. a. Then it is caught on the IRS audit. IRS doesnt care if you find that if they would have applied for the waiver and the DOL would have granted the waiver. b. IRS doesnt care-they just impose the 15% penalties.

Special rules for Prohibited Transactions INDIVIDUAL RETIREMENT ACCOUNTS IRA: Stops being an IRA on the date of the prohibited transactionsso just borrowing money from the IRA will destroy. Rental Property: Common transaction-Unspecified:

ELLIS CASE: 401K = $250,000a. Wants to convert to IRA= $250,000b. Creates LLC CST used cars 98% is owned by the IRA and Ellis owning 2% c. Check the box and have it taxed as a corporationd. Ellis: President- paid salary of $10,000e. IRS says this is a prohibited transaction and that he received $250K when the IRA was disqualified. f. Shows how harsh the prohibited transactions rules are by the IRS.

General Rules: A corp w/o shares or shareholders does not fit w/I the def of a DQ person under 4975(e)(2)(G). The corp becomes a DQ person only after the corp issues its stock to the IRA. The TP becomes a DQ p as president and director of the corp that isues the stock to the IRA only after the stock was issued.

General Exemption: 4975 D1: Its ok to have a loan, President can borrow from their individual retirement account as long as it is available from all qualified participants.

Section 72(p): GR: Not a taxable distribution if the following requirements are met: a. Max amount able to borrow is the lesser of: a. $50K or of your retirement account ie. BALANCEi. Ie. Balance $40K you can borrow $20K: ii. $90K/ Borrow $45K (50%) ; 120/only $50K allowed to borrow. b. Term of the Loan has to be 5 years or less and no balloon payment amounts. a. Exception is if for home loan- 15 years b. Cant deduct the interest to buy the home. (better to have the mortgage where you can deduct your interest)c. Level amortization: d. 2 things a plan administrator does: a. Payroll deductions to pay the loan back. b. Terms the of the loans become due the day your quit your job.

Qualified domestic relations order defined: 401 a 13 P A qualified domestic relations order: basically a divorce decree. a. Can use this to collect child support. Normally just splitting the account, but here you can use this to get to the retirement account in the future. b. If given wife the QDRO then any distributions will be taxed to the wife.c. If the distribution is given to support a child in college-then the amount would be taxed to the dad.

What does it take to be a qualified Domestic Relations Order? a. which creates or recognizes the existence of an alternate payees right o , or assigns to an alternate payee the right t, receive.. b. Must have: a. Paragraph 3 stays it CANNOT contain: does not require a plan to provide any type or form of benefit or any option, not otherwise provided under the plan HYPO: says pay wife x amount for the rest of her lifeplan administrator refuses to offer this this is an annuity. Similarly defined benefit plan: Go to the plan administrator and see if it will work prior to getting the judge to sign off on the plan. To get the QDRO to work. Never surprise the plan administrator may not be able to do it under the plan.

401(a)(16)401(a)(17): Compensation Limit: a. $150Kb. $265K (current limit)(indexed for inflation)i. For purposes of ERISA: only look at income up to $250K (or 260) of their W2 earnings. 401(a)(19): a. Vesting on Match (once you are 50% vested in employer contributions- then you are 100% vested in matching contributions to matching contributions from employer).

Defined Benefit plans (opinion of speaker): best plan-bedrock of the plan.

Participation/Vesting Plans: 410(a)Participation: Employee by employee a. AGE-exclude anyone under age 21 (NO MAX age) (if education institution can be 26) AND b. SERVICE-less than 1 year can exclude (more than 1,000 hours- time) (401K always)-When reach 1 year at the beginning of the next plan year OR within 6 months of obtaining the right. -Could have a bi-annual entry date (July and January)-Minimum requiredc. EXCEPTION: 2 years of service if (b)Coverage: Workforce 70% of all employees participation a. Test: 1.70% at least of the Non-HCE participation-kind of ridiculous test when 100% participation-so the real test is #22. Percent of Non-HCE at least 70% of the %HCE (more than 115K or 5% owners)3. Fair Cross Section: For companies that have various divisions (like separate businesses within oneGE/Omaha steak) Reasonable classifications for multiples cross section. Can have different types of plans for different cross sections.

VESTING Schedule: 411: EMPLOYER CONTRIBUTIONSVesting Schedules: ERISA Minimums: (see chart below) Only comes into play for a profit sharing plan: a. Cliff Vestingb. Graded VestingOther Vesting: Special (all from different statutes) a. EE Contributionsa. Always 100% Vested Non-deductible contributionsb. 401(K)a. ER contributions at the election of the employee (not called employee contributions)b. 100% vested for the EE c. Matchinga. 401(a)(19) more than 50% vested in regular vesting, the match must be 100% vested. CliffGraded (6 year)More generousMatching 401(a)(19)Bad Boy Clause

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HYPO: VERY common question. Employee who quits their job then returns to the same employer. a. $10K balance. 3 years working. Quit in 2000a. Check $4,000 forfeit $6,000b. 3 more years: $10K again: -does the EE have the right to get the $6,000 back. -is the employee 40% vested or 100%-$6,000 is gone forever-forfeited forever-BREAK in SERVICE: work less than 500 hours in the year. -TEST is 5 years break in service. Then EE gets no credit for the $10k. -BUT if quit in 2007: if less than 5 years they get credit for the years of service.

1962: Keogh self employed-partnership-owner ees-Harsh-Faster vesting had strict rules in regards to vesting and discrimination Missouri Statutes: General: Ch 351 P.C.: Ch 356 Issues was that people were upset that w/ Corp articles you could put $45k in the pension plans but only $7,500 in a partnership.

Definition of Top Heavy Plans 416 (ABA says we should repeal 416)1982: Tefra after the control of the control of few owners. a. Took the Keogh rules and applied them to Top Heavy Plan-more than 60% of the account balance goes to key employees - *every year the top heavy rules become less and less important. -*ABA has recommended that the congress repeal the Top Heavy. b. What happens if a plan becomes Top Heavy? -used to be faster vesting-but this in no longer effective-Minimum Benefits (DB plans) and Minimum Contributions (D/C plans). -NO exception that you are integrated for social security-Most top heavy you will have to pay is 20%

FiduciaryDisqualified person: Party in Interest

Affirmative Obligationsa. Proper investment: proper investorb. Diversify exempt from a duty to diversify ESOPc. Sufficient cash on hand (duty) a. Laddered securities. Bonds that d. Reasonable rate of return rather than look investment by investment-just look at overall portfolio. e. Duty to Comply with the plan documentsa. Ie. If someone is vested or if someone has the right to a loanf. Exclusive benefit of employeesa. Simply resigning-does not relieve you from this duty-must pursue correction to resign safely. Handles Money:g. Plan can insure itselfh. Fiduciary must be bondeda. Banks and Inurance does not have to do thati. Fiduciary personally liable for mistakesa. Compare to exculpatory clausesb. Plan cannot buy insurance for the fiduciary i. Cant do like you would corporate law-no legal defense clause.ii. NORMALLY: Corporation buys the insurance-but plan cant buy itj. Entire Board of Directors are Fiduciary to the company.

HYPO: go to company and worry about something. Even if you resign, does not protect you from liability: a. How to get out of this realm: LABOR 404(c): if you let the employee invest their own account, you wont be liable if they make bad investments. b. DOL came out with regulations that were more restrictive:

Ways around prohibited transactions: 4975 Classic prohibited transaction is between the fiduciary and the plan: a. DOL looks at the standards. a. They say yes or nob. Blanket exemptions-loansDOL wants damages from Fiduciary if there is a prohibited transaction. IRS: 15% penalty. 100% penalty if you dont correct within a year (if the plan loses money)15% penalty is on the amount involved: Amount involved: a. Greater of: a. Amount paid ORb. FMV of propertyb. HYPO: Example: a. Corporationi. Owner gives building valued at 1.5M 2.0 Mb. Plan : gives $1M to corporationc. Is this prohibited transaction? Yes 15% penalty unless undo the deal within 1 year then 100% penalty. d. Fix: put the plan in the same position would have been before this transaction. e. $2M plus interest f. If the plan gave 4M instead of 1, the amount on the penalty would be on the 4M not the 1M because a greater amount. Disqualified Person: a. A fiduciaryb. A person providing services to the plan a. This could be a law firm giving legal fees for advice on the planc. An employer any of whose employees are covered by the plan the company would be prohibitedd. An employee organization

ERISA Litigation: 2 types of claimsa. Someone that filed for benefit and didnt get it 95% b. 5% fiduciary litigationERISA covers 2 types of plans: a. Retirement accountsb. Welfare benefit plansa. See ALL company policies-vacation, company xmas turkey etc. Benefit to plaintiffs attorneys: a. What makes it qualified as ERISA?a. Written Plansb. Notify Employees (SPD)-vacation policy, benefits etc. c. Appeals process within the company before denied the claims. Generally with ERISA litigation it helps the DEFENSE in 2 ways: a. Procedural hurdle: a. You cant sue me in court b/c the court will want you to go through the appeals process. b. EE would have to appeal the Christmas turkey with the company. i. Plaintiffs hate this b/c it delays the process. ii. Sometimes will say dont have to appeal because it will be FUTILE (ceo took home all the turkeys for himself). c. Remove the case to Federal Court: b/c ERISA is a federal lawi. Often what happens is there is a grievance from employees. Normal contract claimii. Plaintiffs dont like this because it is more formalb. Remedies Hurdle: a. ERISA in federal court: can only get $ you claimed and attorney fees. b. NO punitive NO Pain and suffering (none of the state court remedies). c. ***Most powerful preemption law: conflict between state and federal law federal trumps state law***i. ERISA is the most powerful preemption law. ii. MO Law: any state statute that relates to ERISA is just null and voidperiod. 1. Why? Uniform administration. Companys nationwide-want one law in all 50 states. What they pushed for in 1974 of preemption of 50 states laws. 2. One exception is Insurance: states can regulate health insurance.

Egelhoff v. Egelhoff: 2nd marriages caseFacts: Dad designated 2nd wife as beneficiary of his pension. They divorced and he died intestate. Children from 1st marriage sued 2nd wife for the $$ b/c the State statute revokes beneficiaries upon divorce. Wife argues ERISA preempted the state statute. Issue: does Erisa preempt? Holding: YES. Erisas Preemption Section: 29 usc 1144(a): ERISA shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benfit plan covered by ERISA. A state law relates to an ERISA plan if it has a connection with or reference to such a plan. B/c ERISA requires plan documents to specify the basis on which payments are made to and from the plan, the State statute implicates a core ERISA concern. State statute has prohibited connection w/ ERISA b/c it interferes w/ national uniformity of plan admin

ERISA will also preempt state slayer statutes D.N. v. US Facts: Child was paid his fathers 401(k) after his wife killed him and became ineligible to receive it. Child argues he is not subject to income tax because he was not the distributee, his mother, as the primary beneficiary, was the distributee. Issue: who is the distributee subject to income recognition when 401(k) funds transfer to the participants lineal descendants instead of the listed beneficiary as a result of a State Slayer statute? Holding: Child is distributee because the mother never received it and because she was no longer entitled to it when the plan refused to distribute upon notice of the murder investigation.

ERISA & Divorce Decrees: Kennedy v. Plan Admin Dupont: Facts: Decedent had a Saving and Investment Plan (SIP) with the power to name a beneficiary and revoke that designation as prescribed by the plan administrator. He named his wife with no secondary beneficiary. Upon their divorce, wife was divested from her interest by the decree but decedent did not execute a document removing her. Issue: Must a plan administrator follow a divorce decree that is not a QDRO that redirects beneficiaries without modifying the documents? Holding: No. There is no exception to the plan administrators duty to act in accordance with plan documents. Solution: Company could insert in plan document that after a divorce, if former spouse is still named as beneficiary, the form spouse shall not be entitles to benefits. No violation of ERISA OK to follow plan document

ERISA preemption of State Common Law Actions for Wrongful Discharge in Avoiding Pension Contributions Ingersoll-Rand v. McClendon Facts: filed wrongful discharge action under state tort and K theory alleging principal reason for termination was desire to avoid contributing to s pension fund. Issue: Does an action for recovery of future wages, mental anguish and punitive damages, rather than lost pension benefits relate to any covered employee benefit plan? Holding: yes 514 of ERISA broadly supercedes state law and decisions having the effect of law. relates to the plan b/c the Tx Supreme Courts remand requires a finding of an ERISA plan in existence in for liability, this sufficiently relates. ERISA Cause of Action: for terminations interfering w/ rights guaranteed by ERISA provides the exclusive remedy for those rightsthe right to not be terminated for pension contributions

ERISA Preemption of State Statute Prohibiting Subrogation FMC v. Holliday: FACTS: s self-funded health care plan paid a portion of medical bills from accident that was involved in a personal injury case. The sponsoring company notified they will seek reimbursement under the Plans subrogation provision from any recovery. sought declatory judgment that Penn. Statute precluding reimbursement from a claimants tort recovery prohibited subrogation rights under the plan. Issue: Is ERISA preempted by state statute for subrogation rights/ Holding: No. ERISA preempts the application of the state statute because ERISAs deemer clause states that a plan shal not be deemed to be an insurance company or in the business of insurance. The Subrogation statute applies to insurance companies.

Appeals court: want to give-only reverse of egregious look to trial court as fact finder. De Novo: brand new, will just take note, but no obligation of what the trial court did. arbitrary & capricious-shock the human caution. no longer Firestore case: now look at De Novo:Loop hole: under state law, when you have a trust, decision of the trustee is final is not subject to review. Retirement plans and these types of plans are basically trusts. (Firestone case). Termination of Plans: Formal termination: Board of Directorsa. Meet and put on the agenda and vote to terminate the plan. b. IRS: 5310 Form to terminate a plan(give comfort for termination of plan)i.Qualified on Paper-did the plan document meet everything for ERISAii. Qualified in Operation: -What find: Bad ADP plan for 401aTop Heavy Plan 3% What cures: take money from the owners account. c. Permanent-Regs say you can terminate in 10 years.-Safe with 3 years. Practitioners say. -laws change, employees dont like it, D/B Plan: Termination: actually pay out all of the $$Freeze: dont pay out the $$ just dont add new participants and not going to give any credit for future service. No going to liquidate the assets.

What happens when a plan is terminated? If there is a plan termination the EE is 100% vested. MC question for EXAM. So if 20% vested with 10K balancethe employee gets full 10K not 2K of what was vested. Therefore can cost the company more money.

Partial Termination: HYPO: Tyson plants in multiple states: AR 33%Mo 33%OK 33%-decide to shut down and no longer have any employees here. Does the employee get a check for 2k or 10K because the company is still in existence? A: If less that 20% of the workforce loses job then not a termination. If more than 33% then yes a termination plan and YES the employee substantial reduction in the workforce is fully vested in the benefits.

ESSAY Questions Back Page: Style: a. State what the law is: General Rule is and the exceptions. b. Apply the facts: Do these facts fit the general rule or fit the exceptions.c. Reach Conclusion: d. What does the client need to know about?

$500,000GR: Taxed as ordinary income. Exceptions: Dont really apply to this situation (but can get an extra point or two for mentioning)LSD bornd 1935Conclude: Taxed as Ordinary Income. *Talk about 10% penalty before 59.5-GR all penalty is taxed -Ex: Termination employees greater than 55 Can take an exemption from company plan. -Facts are he is 53-Conclude that there is a $50,000 penalty tax. What can you do to avoid this? Advise: 60 day roll over-you wont have to pay tax on distribution-avoid ordinary income and the 10% penalty. Facts: April 1st may 1stYes he can still do this roll over

$300,000 Profit Sharing Plan: -Never a distribution-want to go to 2 kids. 2 legal issues? -Never distribution: -401(a)(a) 70.5 must take the distributions-50% penalty Conclusion: you are wrong you always have to take distributions from the plan.

Kids/2nd wife: 401(a)(11)-surviving spouse gets 100% 401 (ERISA)-Doesnt matter that you named the 2 kidsby law the wife gets the funds. Mention the Kenndy case. Advise: IRA-408-issue is you have to get the spouses