According to §401(a)(4), a deferred compensation plan cannot discriminate in favor of highly compensated employees (HCEs), which is a person who either owned 5% of the business at any time during the year or made more than $80,000 (inflation-adjusted) during the preceding year.
The regulations provide two safe-harbor tests for defined contribution plans (which comprise the vast bulk of 401ks). The first is a "unified allocation formula," which requires all plan contributions to be allocated in one of three ways:
While the rules do allow a C-Suite executive to benefit from the plan based on their status within the company, it doesn't allow them to benefit more than their status would allow.
The second method uses a "uniform points method" which are determined by summing "the employee's points for age, service, and units of plan year compensation for the plan year."
The main point that advisers should take from these rules is that the regulations contain very rigid, mechanical rules that prevent the top of the employee ranks from rigging the retirement plan to their benefit at the expense of the rank-and-file.
In 2009, F. Hale Stewart, JD. LL.M. graduated magna cum laude from Thomas Jefferson School of Law’s LLM Program. He is the author of three books: U.S. Captive Insurance Law, Captive Insurance in Plain English and The Lifetime Income Security Solution. He also provides commentary to the Tax Analysts News Service, as well as economic analysis to TLRAnalytics and the Bonddad Blog. He is also an investment adviser with Thompson Creek Wealth Advisors.
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