tribute an additional amount, up to $6,000, as a “catch up” salary reduction contribution, making their maximum salary reduction limit $24,000 for the year. The Code also limits the overall amount that can be contributed to a plan each year. The maximum permitted total 401(k) plan contribution for an individual (including salary reduction and all employer contributions, whether matching or profit sharing) is $53,000 in 2015, or 100% of compensation if less. This maximum is $59,000 for those over 50 because the $6,000 catch up salary reduction contribution is not counted in the annual limit. To be deductible to the firm, the total employer contribution to a plan for all participants (excluding salary reduction contributions) cannot exceed 25% of total compensation. Under the Code, the maximum amount of compensation that can be considered for an individual for retirement plan purposes is $265,000 in 2015. The examples demonstrate that these limits permit generous contributions. A 401(k) plan cannot discriminate in favor of highly-compensated employees (“HCEs”). For 2015, an HCE is an individual who is a 5% owner of the employer sponsoring the plan or who has earned more than $120,000 in 2014. In order to prove that it is not discriminatory, a 401(k) plan must pass special tests to check the level of salary reduction contributions and matching contributions for HCEs compared to nonhighly-compensated employees. If a regular 401(k) plan fails these tests, the employer must make an extra contribution to the plan or return some of the deferrals of HCEs. In some cases, the plan must also pass discrimination tests for the employer profit sharing contributions. This may sound complicated, but in practice there are a variety of techniques to use to automatically satisfy the discrimination requirements. One option is to adopt a “safe harbor” method of satisfying the 401(k) discrimination rules, such as illustrated above for Law Firms A and B. The benefit of a safe harbor 401(k) plan is that the employer does not need to perform the discrimination tests on an annual basis. Consequently, any HCEs, subject to certain limitations, may contribute the full 401(k) plan annual dollar amount without regard to the amount any nonhighly-compensated employee defers. There are two commonly used 401(k) safe harbor methods. The first requires an employer contribution of 3% of pay for all 32
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eligible employees. The second requires an employer matching contribution of 100% of a participant’s salary reduction contributions to the first 3% of pay and 50% of salary deferral contributions up to the next 2% of pay. The effect of this formula is that a participant must defer at least 4% of pay in order to receive the full contribution. Thus, for simplicity, many employers choose to offer a safe harbor matching contribution of 100% of a participant’s salary reduction contributions up to 4% of pay. The “cost” for using a safe harbor method is that safe harbor contributions of either type must be 100% vested immediately and they must be made even if the employee works less than 1,000 hours during the year or terminates employment during the year. Both types of safe harbor plans can also provide for additional matching contributions that are exempt from testing if they meet certain requirements. These additional matching contributions can require employees to work for a certain number of years in order to become vested in the contributions. A commonly-used vesting schedule permits employees to vest over a six-year period, so that the employee is 20% vested in his or her plan accounts after two years of employment and earns an additional 20% vesting after each successive year, becoming 100% vested after six years. If the employee terminates employment before becoming fully vested, he or she is only entitled to the vested percentage of the accounts. The nonvested portion will be forfeited, and the law firm can use the forfeited funds to pay plan administrative expenses, reduce the firm’s contribution to the plan, or contribute to other participants. A plan can provide for employer contributions in addition to safe harbor contributions. These additional contributions are frequently referred to as “profit sharing” contributions, but they are not contingent upon the firm’s profits. They can be subject to a vesting schedule (as described for matching contributions), and can be contingent upon the employee’s working more than 1,000 hours in the year and being employed on the last day of the year. There is great flexibility in structuring employer profit sharing contributions. If a firm wishes to provide maximum benefits for partners or other attorneys, one method is to use a type of contribution formula known as “cross-tested,” as illustrated above in Examples 1 and 2. Such a formula permits a firm to determine how the contri-
butions will be shared and can minimize staff costs. This type of plan will need to be tested each year to verify that the contribution satisfies discrimination tests; the testing depends upon the ages and compensation of the attorneys and staff in the firm. Other types of profit sharing contributions do not require annual discrimination testing. A retirement plan is considered “top heavy” if more than 60% of the accounts are held by certain key employees. If a plan is top heavy, the employer must make a special top heavy minimum contribution of at least 3% of each non-key-employee’s pay for those employees who are employed at the end of the year. Many law firm plans become top heavy. As another benefit of using a 401(k) safe harbor method, the 3% contribution safe harbor satisfies the top heavy requirement. Also, a plan that provides only safe harbor matching contributions is deemed to have satisfied the top heavy contribution requirement. To use a 401(k) safe harbor, the firm must give a written notice to employees before the first day of the plan year. This notice must describe the safe harbor method that will be used. For the 3% contribution safe harbor, the firm can give a “wait and see” safe harbor notice that states that the firm may make the safe harbor contribution for the year. If the firm decides to make the contribution, it must provide a supplemental notice at least 30 days before the end of the year stating that the safe harbor contribution will be made. This supplemental notice can be included in the safe harbor notice for the subsequent plan year. Thus, a 401(k) plan offers a firm flexibility in contributions. Contributions are not required if not advantageous in a particular year. Isn’t Retirement Plan Administration Complex and Expensive? Maintaining a tax-qualified retirement plan is not a complex process. With proper guidance, administrative expenses should be reasonable and are not a reason to avoid establishing a plan. The first requirements are to have a plan document, and then to follow the terms of that document. Plan documents are available in formats pre-approved by the IRS. These forms of documents must be revised for law changes once every five to six years. Regarding investment of contributions, the plan can either hold all contributions in a pooled trust account in which the trustees