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ABC Plans: IRS Gives Birth to New Profit Sharing Plan
Posted on: 2007-01-03 14:43:46 Cristina Callegari In 1993, the Internal Revenue Service released final regulations under Code section 401(a)(4). These regulations, which deal with the general non-discrimination standards applicable to qualified pension and profit sharing plans, allow for a new type of defined contribution plan in which allocations may be based upon the age of plan participants. The Age Based Contribution (ABC) Plan represents a "breakthrough" in retirement planning. Now, small business owners can enjoy the best of both worlds: the power of a pension plan, with the simplicity and flexibility of a profit sharing plan. Prior to 1990 when the regulation was initially proposed, it was generally accepted that the only plans that could take age into account as a factor in determining benefits or contributions were pension plans, either defined benefit plans or target benefit plans. Other types of defined contribution plans, although not expressly prohibited from using age as a factor in determining contributions or allocations, were viewed as presumably discriminatory, in favor of the older, highly compensated employees, if age influenced employer allocations. The regulations under Internal Revenue Code section 401(a)(4) outline for the first time the standards by which the IRS will judge all qualified plans for non-discrimination purposes. One of the tests prescribed under the regulations allows any defined contribution plan, including profit sharing plans, to test for non-discrimination on the basis of benefits rather than contributions: output rather than input. (See Treasury Reg. sec. 1.401(a)(4)-8). ABC Plans in Operation To satisfy the new non-discrimination rules using the benefits test, allocations are adjusted to take into account both age and compensation. This is done by multiplying each employee's compensation by a factor equal to the present value of $1 payable at the testing age, for example age 65. The present value calculation is based on an interest rate of 7 1/2% to 8 1/2%. Employer contributions are then allocated based on the ratio of each person's age-adjusted compensation to the age-adjusted compensation of all employees. Since the present value of a dollar is greater for those closer to the testing age, they will receive a proportionately larger share of the allocations. Each year the plan must demonstrate that non-highly compensated employees are provided equal equivalent benefit accrual rates" compared to the highly compensated. The equivalent benefit accrual rate" is determined by projecting each employees benefit allocation to the same testing age based on the same rate of interest, and converting it to a hypothetical life annuity and dividing by current compensation. The chart below provides a hypothetical comparison of a traditional profit sharing plan versus an ABC Plan, both allocating $35,000. As the chart shows, the difference is dramatic. Despite the fact that the results are similar to a pension plan, this is in every way a profit sharing plan. That's very important to any business that has to have flexibility. Because the ABC Plan is a profit sharing plan, contributions are completely discretionary. Each year the employer determines the amount that will be contributed. Contribution can vary from year to year, or a contribution may be skipped entirely, to allow the owner to meet other personal or business needs. The Age Based Contribution Plan approach presents an enormous opportunity for employers in meeting their retirement planning needs. Clients who have or are considering a profit sharing plan should take a look at the ABC Plan. This approach could be the ticket to improving the overall efficiency of the employer's retirement plan. And the best part of it is, It's as simple as ABC!" Traditional Profit Sharing vs. Age Based Plans Age Compensation Traditional Plan Contribution AGE Based Contribution Owner 55 $150,000 $ 18,147 $ 25,875 Employee 1 45 $ 49,000 $ 4,129 $ 3,738 Employee 2 40 $ 35,000 $ 2,949 $ 1,776 Employee 3 35 $ 35,000 $ 2,949 $ 1,181 Employee 4 30 $ 28,000 $ 2,360 $ 840 Employee 5 25 $ 35,000 $ 2,949 $ 1,050 Employee 6 20 $ 18,000 $ 1,517 $ 540 Totals $350,000 $ 35,000 $ 35,000 The information contained in this document is not intended to (and cannot) be used by anyone to avoid IRS penalties. This document supports the promotion and marketing of pension plans. You should seek advice based on your particular circumstances from an independent tax advisor. The articles and opinions in this publication are for general information only and are not intended to provide specific advice or recommendations for any individual. We suggest that you consult your representative, attorney, or accountant with regard to your individual situation. Neither MetLife nor any of its affiliates or related companies offer tax or legal advice. L050163CB(exp1207)ENT-LD This article appears courtesy of Cristina Callegari. Cristina is a Registered Representative offering securities through MetLife affiliated broker/dealers including Metropolitan Life Insurance Company (member NASD) or MetLife Securities, Inc. (member NASD/SIPC). Insurance and annuities offered through Metropolitan Life Insurance Company. She focuses on meeting the individual insurance and financial services needs of people in the New York Metropolitan area. You can reach Cristina at the office at 1979 Marcus Avenue, Suite 234, Lake Success, NY 11040 Tel: 516-326-7041. |