HOW IT WORKS

A Third-Party Administrator (TPA) is an organization that handles the administration of a retirement plan. The administrative responsibilities inherent in a qualified plan are quite expansive and failure to comply can result in significant financial penalties for the sponsoring business. Having a TPA involved in overseeing a qualified plan can provide business owner(s) with peace of mind and allows them to focus more on regular business operations.

The tasks performed by TPAs include:

• Putting together the Plan Document
• Coordinating the issuance of the individual policies
• Preparing benefit statements for both the employer and plan participants
• Handling Transactional Requests from Plan Participants
• Ensuring that the plan remains compliant with IRS requirements
• Preparing reports required by the IRS, DOL and other government agencies
• And so much more

Yes. National Life Group requires the use of a TPA for all Qualified Plans.* Though National Life Group cannot serve in the role of TPA, our Advanced Markets team can provide a list of providers that can serve in this role.

*Exceptions include SEP and SIMPLE IRA plans as well as Solo 401k plans that have less than $250,000 in assets.

Want to learn a few tips for success when working with the TPA? Click the video below to hear how one experienced agent interacts with the TPAs he works with.

General Eligibility

All full-time employees who are age 21 and older and have completed one year of service must be eligible to participate in a qualified plan. A two-year service requirement may be used if the plan provides for 100% immediate vesting after two years. Part-time or seasonal employees, if employed less than 1,000 hours annually, may be excluded depending on the terms of the plan.

However, as of January 1, 2021, § 401(k) plans must allow long-term part-time employees to participate in the plan as it relates to the opportunity to make elective deferral contributions. This rule applies to part-time employees who have worked at least 500 hours in the preceding three consecutive 12-month periods starting January 1, 2021. Therefore, such employees will not be eligible to participate until their first three 12-month periods end (some time in 2024).

Nonresident aliens with no source of U.S. income and employees covered by a collective bargaining agreement may also be excluded. It might be possible to exclude some additional employees as long as the plan follows very specific coverage testing guidelines established by the IRS.

Vesting Requirements

Participants in defined contribution and defined benefit plans must eventually have a non-forfeitable right to their benefits based on a predetermined vesting schedule selected by the plan trustee.

Defined Contribution Plans

Employee contributions, such as salary deferrals into a 401(k) plan and Safe Harbor matching or non-elective contributions must be fully and immediately 100% vested.

Employer contributions can be fully and immediately 100% vested or they can be subject to a vesting schedule that is no less generous than either of the following:

• Three Year Cliff Vesting – Participants are 100% vested after three years of service
• Two-to-Six Year Graded Vesting – Participants must be at least 20% vested after two years of service, resulting in 100% vesting after six years of service.

If a plan is top-heavy, either 100% immediate vesting, three-year cliff vesting, or six-year graded vesting is required.

Defined Benefit Plans

Vesting schedules must be no less generous than:

• Five-Year Cliff – Participants are 100% vested after five years of service.
• Three-to-Seven Year Graded – Participants must be at least 20% vested after three years of service and acquire another 20% for each additional year of service, resulting in 100% vesting after seven years of service.

If the plan is top-heavy, employer contributions can be fully vested immediately or one of the following vesting schedules is required:

• Three Year Cliff – Participants are vested after three years of service, or
• Two-to-Six Year Graded Vesting – Participants must be at least 20% vested after two years of service and acquire another 20% for each additional year of service, resulting in 100% vesting after six years of service.

Forfeitures

• Forfeitures result when employees who are not fully vested in the plan terminate employment.
• In a defined contribution plan, any non-vested forfeiture amounts must be reallocated to the accounts of remaining participants or used to reduce employer contributions to the plan.
• In a defined benefit plan, if an employee is not 100% vested, any non-vested forfeiture amounts must be used in the plan to reduce the employer’s plan contribution in the next year.

Distributions from defined contribution and defined benefit plans may be made in the event of retirement, permanent disability, termination of employment, or death. Distributions may be paid to participants or their beneficiaries in the form of monthly installments or in a lump-sum, if permitted by the plan.

Required Minimum Distributions (RMDs) are the minimum amount that a retirement plan account owner must withdraw annually starting with the year that he or she reaches 72 or if later, the year in which he or she retires. However, if the retirement plan account is an IRA or the account owner is a 5% owner of the business sponsoring the retirement plan, the RMDs must begin once the account holder is age 72, regardless of whether he or she is retired.

Retirement plan participants and IRA owners (including owners of SEP IRAs and SIMPLE IRAs), are responsible for taking the correct amount of RMDs on time every year from their accounts, and face a penalty for failure to take RMDs.

Special Rules for Defined Benefit Plans

• At retirement, benefit payments are paid to participants, as guaranteed under the plan.
• In addition to retirement benefits, the plan provides a survivor death benefit (as required by the IRS), and may provide larger insured death benefits, early retirement benefits, and/or disability benefits.
• If a participant dies prior to retirement, an insured pension plan pays a death benefit in the form of an income stream or lump sum payment to the participants named beneficiary.

Loans

Defined contribution and traditional defined benefit plans may allow loans to participants prior to retirement or termination of service (note that 412(e)(3) plans do not allow loans). Outstanding loans may not exceed the maximum of $50,000 or 50% of the participant’s vested accrued account balance. The $50,000 limit is reduced by the excess of the highest outstanding loan balance within one year of a new loan. The loan must be repaid in equal installments, at least on a quarterly basis, within five years, unless the loan is secured for the purchase of the participant’s principal residence. Loan interest is not deductible.

Alongside other more traditional plan assets (stocks, bonds, mutual funds, etc.), qualified plans may also purchase life insurance on the lives of the participants to provide participants a pre-retirement death benefit.  However, life insurance can be included in a qualified plan only if it is incidental to the primary purpose of the plan, which is providing retirement benefits.  This is referred to as the Incidental Benefit Rule, with which both defined contribution and defined benefit plans must comply.

Why add life insurance to a qualified plan? The below video discusses some of the key benefits:

Defined Contribution Plans

There are two ways to calculate the amount of the contribution that can be allocated to a life insurance premium.

1. If (indexed) universal life insurance is in the plan, each participant can allocate up to 25% of their annual contribution for the life insurance premium.
2. If whole life insurance is in the plan, each participant can allocate up to 49.9% of their annual contribution for the life insurance premium.

Profit-sharing plans also have “seasoned money” rules pertaining to life insurance. These rules potentially allow for even more of the contributions in the plan to be used to pay the life insurance premium for a participant’s account. The seasoned money rules include a two-year rule and a five-year rule. Under the two-year rule, 100% of the money in a participant’s account (including earnings) that has been in the account for least 2 years may be reallocated towards a life insurance premium under the profit-sharing plan. The five-year rule allows anyone with at least 60 months of participation in a profit-sharing plan to direct up to 100% of their account (both old and new money) towards life insurance.

Defined Benefit Plans

There are two ways to calculate the amount of the contribution allocated to life insurance premium.

1. The “100-Times Test” calculates a pre-retirement death benefit that does not exceed 100 times the participant’s monthly retirement benefit or the present value of the accrued benefit, whichever is greater. The insurance death benefit formula is expressed as a multiple of the monthly retirement benefit.
2. The “Two-Thirds Rule” (Rev. Ruling 74-307) uses an actuarial formula to calculate the amount of the contribution going to the life insurance premium. This method will generally produce larger face amounts of insurance than the 100-Times Test.

Distribution Planning Considerations

When a participant who is entitled to a distribution from a qualified plan wishes to continue the life insurance provided through the plan after termination of employment, there are typically limited options for accomplishing this. These options include:

1. Purchasing the Life Insurance Policy from the Plan

• The policy must be purchased for its Fair Market Value
• The plan administer will want to document that the sale of the policy to the insured/participant meets the requirements of the Department of Labor’s Prohibited Transaction Exemption 92-6.

Or

2. Distribute the Policy to the Participant/Insured

• The participant/Insured must include the policy’s fair market value in income
• The participant may offset the amount included in income by the cumulative amount of the cost of insurance included in income over the years.

But at National Life, we offer a unique third option…

Option 1: Safe Harbor 401(k)

Assume that it is John and Susan’s preference to maximize their savings potential through a flexible plan that provides for both employer contributions and employee salary deferrals. A safe harbor 401k plan with a non-elective contribution in combination with a cross-tested profit sharing plan could be an effective strategy. This model will allow for John and Susan to maximize contributions for their respective benefits/while staying in compliance with non discrimination guidelines.

• Percentage of contribution to Owners – 91%
• Total Cost of Plan – $147,800
• Total Tax Savings (assuming 37% rate) – $54,686
• Net After Tax Cost of the Plan – $93,114

*Assumes that the plan consists of two subgroups. Group 0-Owners will consist of John and Susan and they will receive an allocation equivalent to 10.5% of pay. Group-Non-Owners will consist of the two hygienists and the office manager and they will receive an allocation equivalent to 2% of pay.

Assumes that John and Susan contribute the maximum salary deferral limit of $20,500 plus a $6,500 catch up for individuals 50 and over and that all others defer 3% of salary. Please refer to the IRS website for current contribution limits. Retirement Topics – Contributions | Internal Revenue Service (irs.gov)

If John and Susan are looking to contribute more than what the profit-sharing plan allows, implementing a fully insured 412(e)(3) plan would help to create the largest possible tax deductible contribution for John and Susan’s business.

• Percentage to Owners – 87%
• Total Cost of Plan – $740734
• Total Tax Savings (assuming 37% rate) – $274072
• Net After Tax Cost – $466,662

*This plan assumes a combination of the Totalsecure Whole Life (standard non-tobacco rating) as well as the Fit Secure Growth annuity is used for all participants with funding done for the greater of five years or attainment of age 62. It is also assumed for the purposes of this design that the salaries in figure 1 represent an average of the three highest consecutive years of compensation.