Highly Compensated: Any employee who either (1) owned 5% or more of the company in the current or previous year or (2) earned $100,000+ in the previous year. NOTE: If you own 100% of the company and your spouse is on your payroll, your spouse will be considered highly compensated even if their income is below $100,000.

Key Employee: A participant who, at any time during the plan year is (1) an officer who earned $145,000 or more, (2) a more than 5% owner, or (3) a more than 1% owner earning $150,000 or more.

Non-Discrimination Testing: These are tests performed on the plan each year to make sure the plan is not discriminating against groups or classes of employees.

The most commonly known test is the Top Heavy test. This test checks to make sure that the Key employees don't hold more than 60% of the total plan assets. If they do hold more than 60%, a 3% of pay contribution to all non-key employees may be required to correct the plan.

Another important test for 401(k) plans is the Average Deferral Percentage Test (ADP). The ADP test looks at what percentage of pay the highly compensated group is contributing compared to the non-highly compensated group. If the highly compensated group average is greater than 2% of the Non-Highly Compensated group's average, then the highly compensated group will have over contributed and will be required to take a refund.

401(k): Section 401(k) is the IRS code that allows eligible participants in a Defined Contribution plan to make voluntary tax deferred contributions. These contributions remain in a Trust and are invested by the participant. The participants are not taxed on the income they defer nor are they taxed on the growth of their investments. Taxes are paid when the money is withdrawn after age 59 1/2.

Safe Harbor Plan: A Safe Harbor plan is one that requires the employer to make a 100% vested contribution to his or her employees in the form of a 4% match or a 3% non-elective contribution. A Safe Harbor plan can avoid non-discrimination testing. Safe Harbor plans allow business owners to participate in their company retirement plan regardless of employee participation.

Profit Sharing: This is an employer contribution made to his or her employees. Profit Sharing contributions are given to all eligible employees. Profit Sharing can be allocated in different ways depending on the demographics of the group and is typically vested up to 6 years. Here are some allocation formulas used in most profit sharing plans:

Pro Rata: every eligible employee receives an equal % of their pay

Integrated: an eligible employee earning more than the social security wage base ($97,500) will receive a larger % of pay contribution

Age Weighted: after a minimum contribution requirement is met, the older employees will receive a larger % of pay contribution

New Comparability: classes of employees can be segregated into groups (owners, officers, managers, rank and file), age disparity between the groups allow for tiered levels of benefit. This formula will not work if the top tier is younger than the bottom tier

Defined Benefit Plans: A Defined Benefit Pension Plan (DB) is a Qualified Plan where contributions to the plan are based on a participant's age and compensation. This plan works best for business owners age 44 and older with few or no employees. The contribution limit in a Defined Benefit plan can be upwards of 100% of pay. These plans cost more to administer and contributions to employees may be higher then most Defined Contribution plans, however the level of contribution to the business owner can be so great, leading to large tax deductions, in most cases it's worth it.

Eligibility Requirements: Age 21, 1 year of service and semi-annual entry dates are the most restrictive eligibility requirements in qualified retirement plans.

Defined Benefit/Defined Contribution Off-Set Plans: This is a perfect hybrid plan. A Defined Contribution plan for all employees including the owners and a Defined Benefit Plan for only the Owners. The Profit Sharing contribution to the employees is used to off-set the contribution under the Defined Benefit Plan which allows us to exclude all the employees from the Defined Benefit Plan.  Employees in the DC plan must receive a Profit Sharing contribution ranging from 5% to 7.5% of compensation depending on the demographics of the group.

EXAMPLE:

Participant	Age	Income	DB	Profit Sharing	401(k)
Owner 1	65	$200,000	$203,000	$12,000	$20,500
Owner 2	55	$150,000	$100,000	$9,000	$20,500
subtotal		$350,000	$303,000	$21,000	$41.000
Participant 1	45	$50,000	$0	$3,000	$0
Participant 2	30	$50,000	$0	$3,000	$0
Participant 3	34	$50,000	$0	$3,000	$0
Participant 4	29	$50,000	$0	$3,000	$0
Participant 5	25	$50,000	$0	$3,000	$0
subtotal		$250,000	$0	$15,000	$0
Total		$850,000	$0	$36,000	$41,000

Total Contribution to Owners:  $365,000 (96%)

Total Contribution to Employees: $15,000 (4%)

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