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Chapter 19: savings/match plan.


A savings plan (or "thrift plan") is a qualified defined contribution plan that is similar to a profit sharing plan, with features that provide for and encourage after-tax employee contributions to the plan.

A typical savings plan provides for after-tax employee contributions with matching employer contributions. Each employee elects to contribute a certain percentage of his or her compensation, and these employee contributions are matched--either dollar for dollar or under some other formula--by employer contributions to the plan. Employee contributions are not deductible--the employee pays tax on the money before contributing it to the plan.

Although savings plans with only after-tax employee contributions and employer matching contributions were very popular in the past, the after-tax employee contribution approach has more recently been used only as an add-on to a Section 401(k) plan. Some employers adopt a plan that combines all the features of a regular profit sharing plan, a savings plan, and Section 401(k) salary reductions. Some employers may replace the savings plan component with a Roth 401(k) feature, which allows after-tax contributions and tax-free withdrawals after certain requirements are met. See Chapter 20 for details.

"Pure" savings plans, featuring only after-tax employee contributions are rare. However, a savings plan with after-tax employee contributions (often matched by the employer) is sometimes part of a Section 401(k) plan or profit-sharing plan.


1. As an add-on feature to a Section 401(k) plan to allow employees to increase contributions beyond the annual limit on salary reductions under Section 401(k) plans. Unlike Roth 401(k) contributions (see Chapter 20), thrift plan contributions are not subject to the dollar limit on elective deferrals ($16,500 in 2009). However, after-tax contributions are subject to their own complex limitations as discussed under "Tax Implications," below.

2. When the employee group has the following characteristics:

* Many employees are relatively young and have substantial time to accumulate retirement savings.

* Many employees are willing to accept a degree of investment risk in their plan accounts in return for the potential benefits of good investment results.

* There is a wide variation among employees in the need or desire for retirement savings.

3. When the employer wants to supplement the company's defined benefit pension plan with a plan that features individual participant accounts and the opportunity for participants to save on a tax-deferred basis. The use of a combination of plans provides a balanced retirement program. The defined benefit plan appeals to older employees with a desire for secure retirement benefits, while the savings plan (or other defined contribution plan such as a profit sharing or Section 401(k) plan) generally appeals to younger employees who prefer to see their savings build up year-by-year rather than anticipating a projected benefit when they retire.


1. As with all qualified plans, a savings plan provides a tax-deferred retirement savings medium for employees. The tax on the employee contributions themselves is not deferred (since they are made on an after-tax basis); however, income taxes on subsequent investment earnings are deferred until distributions are made to employees from the plan.

2. The plan allows employees to control the amount of their savings. Employees have the option of taking all their compensation in cash and not contributing to the plan. (However, if they do so, they generally lose any employer matching contributions under the plan.)

3. Individual participant accounts allow participants to benefit from good results in the plan fund.


1. The plan cannot be counted on by employees to provide an adequate benefit. First, benefits will not be significant unless employees make substantial contributions to the plan on a regular basis. Furthermore, employees who enter the plan at older ages may not be able to make sufficient contributions to the plan, even if they wish to do so, because of (a) the limits on annual contributions discussed under "Tax Implications," below, and (b) the limited number of years remaining for plan contributions prior to retirement.

2. Employees bear investment risk under the plan. Bearing the investment risk is a potential disadvantage to employees, but from the employer's perspective the shift of risk is a positive feature. Employer costs are lower for a defined contribution plan such as a savings plan, as compared with a defined benefit plan.

3. Since employee accounts and matching amounts must be individually accounted for in the plan, the administrative costs for a savings plan are greater than those for a money purchase or a profit sharing plan without employee contributions.

4. The annual addition to each employee's account in a savings plan is limited to the lesser of (a) 100% of compensation or (b) $49,000 (in 2009 as indexed). (1) This may limit the relative tax advantage available to highly compensated employees under a savings plan or any other defined contribution plan.


Typical savings plans provide after-tax employee contributions with employer matching contributions. Participation in the plan is voluntary; each employee elects to contribute a chosen percentage of compensation up to a maximum percentage specified in the plan. The employee receives no tax deduction for this contribution and the contribution is fully subject to income tax as if it were in the employee's hands.

The employer makes a matching contribution to the savings plan. The employer match can be dollar-for-dollar, or the employer may put in some percentage of the employee contribution. A typical plan might permit an employee to contribute annually any whole percentage of compensation from 1% to 6%, with the employer contributing at the rate of half the chosen employee percentage. In this example then, if the employee elected to contribute 4% of compensation, the employer would be obligated to contribute an additional 2%.

Employer matching contributions are subject to the same vesting requirements as are applied to other defined contribution plans; that is, 100% cliff vesting after three years, or graded vesting starting with 20% after two years, increasing by 20% each year until 100% is reached after six years. (2)

In general, higher paid employees are in a position to contribute considerably more to this type of plan than lower paid employees. To prevent discrimination in savings plans, Section 401(m) imposes tests that effectively limit contributions by highly compensated employees (discussed under "Tax Implications," below). One of the principal administrative burdens in a savings plan is a need to monitor employee contribution levels to be sure the Section 401(m) nondiscrimination tests are met.

Apart from the employee contribution features, savings plans have features similar to profit sharing plans. Emphasis is usually put on the "savings account-like" features of the plan. Usually there are generous provisions for employee withdrawal of funds and for plan loans. Savings plans often feature participant-investment direction or earmarking. Earmarking is usually provided by allowing employees a choice among several specified pooled investment funds (such as mutual funds). However, it is possible, although administratively burdensome, to allow participants to direct virtually any type of investment for their account. If certain Department of Labor regulations are satisfied, the plan trustee and the employer are relieved of fiduciary liability for unsatisfactory investment results from investments chosen by the participant under a participant-directed investment provision.3 The regulations include the requirement that at least three different diversified investment alternatives be made available to the employee. Life insurance can be used in the plan, as discussed in Chapter 13.

As noted above, many employers adopt a plan that combines all the features of a regular profit sharing plan, a savings plan, and Section 401(k) salary reductions. These combined plans can have one or more of the following features:

* employee after-tax contributions

* employer matching of employee after-tax contributions

* employee (before-tax) salary reductions (Section 401(k) amounts)

* employer matching of Section 401(k) amounts

* employer contributions based on a formula

* discretionary employer contributions

* Roth 401(k) contributions

These are discussed further in Chapter 20.


1. Employer contributions to the plan are deductible when made so long as the plan remains "qualified" and separate accounts are maintained for all participants in the plan. (4) A plan is qualified if it meets eligibility, vesting, funding and other requirements discussed in Chapter 7.

2. Employee contributions to the plan, whether or not matched, are not tax deductible. (Before-tax employee salary reductions must meet the requirements of Section 401(k) discussed in Chapter 20.)

3. Assuming a plan remains qualified, taxation of the employee is deferred with respect to (a) employer contributions to the plan and (b) investment earnings on both employer and employee contributions. These amounts are nontaxable to plan participants until a distribution is made from the plan. (5)

4. In order to be deemed nondiscriminatory (i.e., to prevent the plan from discriminating in favor of highly compensated employees), the plan must meet an actual contribution percentage (ACP) test under Code section 401(m). This test is applied to employee contributions, as well as to matching contributions; however, employee contributions must be tested under the first alternative (alternative (a), below), while matching contributions can meet the ACP test in any of the following three alternative ways:

(a) The ACP test is satisfied for a plan year if, for highly compensated employees, the average ratio (expressed as a percentage) of employee contributions (both matched and non-matched) plus employer matching contributions to compensation for the plan year does not exceed the greater of: (6)

(i) 125 percent of the contribution percentage (i.e., ratio) for all other eligible employees for the preceding plan year, or

(ii) the lesser of (a) 200 percent of the contribution percentage for all other eligible employees, or (b) such percentage plus two percentage points for the preceding plan year.

For example, if employee contributions and employer matching contributions for nonhighly compensated employees equaled 6% of compensation in 2007, those for highly compensated employees could be up to 8% (6% plus 2%) in 2007. Under the Code and regulations, the employer may take into account certain 401(k) salary reduction contributions and certain employer plan contributions in meeting this test. (7)

(b) The ACP test can be satisfied with respect to matching contributions by meeting the requirements for a SIMPLE 401(k) plan (see Chapter 20).

(c) A safe harbor plan will satisfy the nondiscrimination test with respect to matching contributions. By design, a safe harbor plan is one that satisfies (i) a contribution requirement, (ii) a notice requirement and (iii) a matching contribution limitation, as follows:

The contribution requirement for the safe harbor test states that the employer must make either matching contributions (equal to 100% of elective contributions but not exceeding 3% of compensation, plus 50% of elective contributions that exceed 3% but do not exceed 5% of compensation; however, in no event can the rate for highly compensated employees exceed the rate for nonhighly compensated employees) OR nonelective contributions (on behalf of all employees, equal to at least 3% of compensation).

Under the notice requirement, each employee eligible to participate must, before the plan year begins, be given written notice that (i) the plan may be amended during the plan year to provide a nonelective contribution of at least 3%, and (ii) if it is, a supplemental notice will be given to eligible employees 30 days prior to the last day of the plan year informing them of the amendment. If the plan is amended, the supplemental notice must then be provided to each eligible employee at least 30 days prior to the end of the plan year (i.e., by December 1 for a calendar year). (8)

The matching contribution limitation is met if (i) no employer match can be made for employee deferrals in excess of 6% of compensation, (ii) the rate of match does not increase as the employee deferral rate increases, and (iii) matching contribution rates for highly compensated employees are not greater than those for nonhighly compensated employees. (9)

Under alternative (a), the employer must conduct annual testing to monitor the level of contributions made by nonhighly compensated employees, and then make sure that highly compensated employees do not exceed this level the following year, in order for the plan to remain qualified. Alternatives (b) and (c) are design-based so that annual testing of matching contributions is not necessary, but both include a funding requirement. The safe harbor design generally parallels the requirements for a safe harbor 401(k) plan (described in Chapter 20).

The definition of highly compensated employee for purposes of these tests is the same as that applicable to all benefit plans (and is discussed in detail in Chapter 7).

5. Certain employers adopting a new plan may be eligible for a business tax credit of up to $500 for "qualified startup costs." See Chapter 10 for details.

6. A plan may permit employees to make voluntary contributions to a "deemed IRA" established under the plan. Amounts so contributed reduce the limit for other traditional or Roth IRA contributions. See Chapter 5 for details.

7. Distributions from the plan must follow the rules for qualified plan distributions. Certain premature distributions are subject to penalties. The distribution rules are discussed in Chapter 8.

8. Certain employees born before 1936 may be eligible for a 10-year averaging tax calculation on lump-sum distributions. Not all distributions are eligible for this special tax calculation. The rules are discussed in detail in Chapter 8.

9. The plan is subject to the ERISA reporting and disclosure rules outlined in Chapter 12.


Installation of a savings plan follows the qualified plan installation procedures described in Chapter 10.


Tax Facts on Insurance & Employee Benefits, Cincinnati, OH: The National Underwriter Company, (revised annually).


(1.) IRC Section 415(c).

(2.) IRC Section 411(a)(2)(B).

(3.) DOL Reg. [section]2550.404c-1.

(4.) IRC Section 404(a)(3).

(5.) IRC Section 402(a). Recovery of the nontaxable amount differs depending on whether the after-tax contributions were made before 1987 or after 1986. See Chapter 8, Section IV, "Nontaxable and Taxable Amounts."

(6.) IRC Section 401(m)(2).

(7.) IRC Section 401(m)(3); Treas. Reg. [section]1.401(m)-2(a)(5) and (6).

(8.) Notice 2000-3, 2000-1 CB 413.

(9.) IRC Sections 401(m)(11)(a)(i), 401(k)(12)(C).
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Copyright 2009 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Defined Contribution Plans
Publication:Tools & Techniques of Employee Benefit and Retirement Planning, 11th ed.
Date:Jan 1, 2009
Previous Article:Chapter 18: ESOP/stock bonus plan.
Next Article:Chapter 20: Section 401(k) plan.

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