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Author: ilmostro Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 75700  
Subject: 401k's $ money purchase plans Date: 2/9/1998 6:22 PM
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It is my understanding that the money purchase plans have a contribution rate that can go as high as 25% of one's salary, but everyone has to contribute at the same rate. i.e. $3.00 per hour. And 401k's are elective and you can contribute nothing or up to 15% of your salary. I already now about the pitfalls of being considered a "highly compensated individual". Are the above statements true or am I way off on a tangent? And is it possible to have both plans at the same time? And if it is possible to have both plans at the same time what is the limits of both plans combined? Is it 15% + 25% = 35% or are the some other rules or regulations that would prevent you from shielding such a big portion of your wages? Thanks, Bryan
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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1701 of 75700
Subject: Re: 401k's $ money purchase plans Date: 2/9/1998 7:07 PM
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Ilmostro,

<<It is my understanding that the money purchase plans have a contribution rate that can go as high as 25% of one's salary, but everyone has to contribute at the same rate. i.e. $3.00 per hour. And 401k's are elective and you can contribute nothing or up to 15% of your salary. I already now about the pitfalls of being considered a "highly compensated individual". Are the above statements true or am I way off on a tangent? And is it possible to have both plans at the same time? And if it is possible to have both plans at the same time what is the limits of both plans combined? Is it 15% + 25% = 35% or are the some other rules or regulations that would prevent you from shielding such a big portion of your wages?>>

Well, you've got it a little mixed up. First, in a money purchase plan the employer -- not the employee -- is required to make a contribution based on a percentage of each employee's pay. That percentage is the same for all, and may not exceed 25% or $30K, whichever is less. A profit sharing plan (many of which include a 401k plan option) is one in which an employer contribution is discretionary. In the profit sharing plan, contributions may not exceed 15% of pay or $30K, whichever is less. A money purchase plan and a profit sharing plan may be combined, but the total contribution is capped for both combined at 25% or $30K, whichever is less. When combined, the money purchase (mandatory on the employer) is usually capped at 10% and the profit sharing (discretionary on the employer's part) is floating up to 15%.

Here's a brief description of all three (i.e., money purchase, profit sharing and 401k).

Profit Sharing Plan. The most popular type of a qualified defined contribution plan, a profit sharing plan permits employers to make a discretionary annual contribution of up to a maximum of 15% of pay or $30,000 to each employee's account. Originally designed to encourage productivity and to reward employees with part of a firm's annual profits, today employers may make contributions even when the business earns no profits in the year; however, no contribution by the employer is required during a profitable year. These plans are often coupled with a 401k arrangement to allow voluntary pre-tax contributions by employees out of their wages. Contributions and earnings accumulate tax free until withdrawn by the participant.

Money Purchase Plan. Also a qualified defined contribution plan, a money purchase plan is one in which the employer is required to make an annual contribution to each employee's account regardless of the firm's profitability for the year. Contributions are usually specified as a percentage of annual compensation, and are capped at the lesser of $30,000 or 25% of an individual's annual salary. Contributions and earnings accumulate tax free until withdrawn by the participant

401(k) Plan. Also known as a cash or deferred arrangement (CODA) plan, a 401(k) is a qualified defined contribution plan that takes its name from the section of the Internal Revenue Code which prescribes the rules under which it operates. It is a retirement plan in which the employer permits an employee to elect to receive part of his or her compensation in cash or to defer immediate receipt by contributing that part to his or her account in the 401(k) plan. Deferred contributions are made on a pre-tax basis, and those contributions and all earnings remain untaxed until withdrawn from the plan. The 401(k) may permit voluntary, after-tax contributions by employees. Earnings on after-tax contributions accumulate tax free until withdrawn. Many plans include a matching contribution from the employer according to a set formula (e.g., 50% of the employee's contribution up to a maximum of 6% of compensation). Employers may also make contributions to an employee's account independent of the employee's contribution, and these contributions may be tied to a firm's profits as part of a profit sharing plan. Participant pre-tax contributions are limited to the lesser of a maximum percentage of pay or $10,000 per year. The percentage limitation varies from employer to employer depending on a number of factors, but generally ranges from 12% to 20% of annual compensation.

A 401(k) plan generally offers participants an opportunity to direct their account contributions to a broad range of investment options from conservative risk to aggressive risk. These options may include institutional or mutual funds investing in the money market, bond market or stock market; annuities; guaranteed investment contracts (GICs); company stock; and self-directed brokerage accounts. A typical plan will offer a selection of a money market fund, a bond fund, and a stock fund.

In general, a 401(k) plan limits withdrawals of assets to five occasions: Termination from employment, disability, reaching the age of 59 1/2, retirement and death. Additionally, the plan may optionally include provisions for loans and/or hardship withdrawals.

State and local governments are prohibited from offering a 401(k) plan to their employees. This was also once true of private, tax-exempt employers as well; however, as of January 1, 1997, the latter may now establish a 401(k) plan for their qualified employees.

Regards.....Pixy


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Author: rbednarski Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1719 of 75700
Subject: Re: 401k's $ money purchase plans Date: 2/11/1998 2:35 AM
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>>Here's a brief description of all three (i.e., money purchase, profit sharing and 401k).

If I may add a bit to the descriptions of the PS plan and the MP plan for the benefit of any business owners out there, Pixy:

In both the PS and MP plans it is possible for the plan to provide a higher percentage to certain highly compensated employees. One way is to use what is called "permitted disparity". The whole idea with this is the plan is allowed to discriminate in favor of employees who make more than the Social Security wage base (68,400 for 1998) to make up for the fact that SS discriminates against these folks. Typically you can get about a 3% difference in the contribution rate for the highly paid person versus the lower paid person.

But the real exciting development over the past 7 years or so is a plan design that variously goes by the name of "cross-tested", "tiered", or "new comparability". These plans can provide a significant difference between the higher paid folks and the lower paid folks because they measure discrimination by converting the contribution to equivalent benefits at age 65 and then compare those benefits as a percent of pay. They are a way for owners of small (and not so small) companies to set up plans that provide up to a 25% of pay contribution to themselves without having to give 25% for the rank and file. When used in a Profit Sharing plan a 401(k) feature is often included to allow the rank and file to bump up their own retirement savings.

A simple example will give the flavor of how these plans work (although it is simplified a little). Say you have a two-person company, an owner aged 55 making $160,000 and 2 employees aged 30, each making $40,000. Say the goal is for the owner to get a contribution of $30,000. Under IRS rules we can convert this to an annual benefit at age 65 by accumulating it at a stated interest rate (the highest allowed is 8,5%) to age 65 and then converting it to a life annuity (I use 9 for the annuity factor and that meets IRS rules) In this case the accumulation at age 65 would be 67,830, the annual benefit would be 7,537, and that would represent a benefit of 4.710% of pay.

Now assume the plan gives the 2 employees 5% of pay each, or $1,500. Accumulating it to age 65 gives an accumulation of 26,069, the annual benefit would be 2,897, and that would represent a benefit of 9.65% of pay. Since the 9.65% benefit they are receiving exceeds the 4.710% of pay the owner is getting the plan satisfies the discrimination requirements.

This kind of plan will cost more to set up and administer than a plain vanilla plan, but frequently the results are well worth it. Any technically competent pension administration firm can set this type of plan up.

Sorry to be so long winded.

Rich

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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1723 of 75700
Subject: Re: 401k's $ money purchase plans Date: 2/11/1998 9:38 AM
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Rich,

<<If I may add a bit to the descriptions of the PS plan and the MP plan for the benefit of any business owners out there….>>

Thanks for the good addition from the standpoint of the small business owner.

Regards……Pixy


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Author: rbednarski Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 1741 of 75700
Subject: Re: 401k's $ money purchase plans Date: 2/12/1998 2:33 AM
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>>A simple example will give the flavor of how these plans work (although it is simplified a little). Say
you have a two-person company, an owner aged 55 making $160,000 and 2 employees aged 30,
each making $40,000>>

Ooops, that should have been $30,000 each for the employees. Changed my data in mistream and didn't go back and change this. Sorry.

Rich

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