IRS Announces "Pretend Salary" Maximum for 2015

Each year around Halloween time, the IRS announces what I call the "Pretend Salary" maximum". For 2015 the amount is $265,000. Government regulators must be so jealous of those in private enterprises that have figured out how to make a pot full of money each year, that they have decided to pretend that nobody makes more than $265,000 per year. That way, the person who actually makes $530,000 will be treated as if they make half that amount for all retirement plan purposes.

"So what?", you may ask! (You did ask that, right?) Well, when you take their desired salary deferrals of $24,000 divided by their Pretend Salary maximum of $265,000, the Deferral Percentage is a fictitious 9.06% instead of the actual much lower salary deferral of 4.53% ($24,000 / $530,000). The name of that game is that you cannot do that much (the fictitious 9.06%) unless the Plan Sponsor is providing a Safe Harbor Plan or the rank-in-file employees are saving a ton, which isn't likely. Once again, the problem is the infamous ADP test (average actual deferral percentages of the Non-HCEs as compared with the average actual deferral percentages of the HCEs - normally, a 2% spread is all that is allowed). The Pretend Salary maximum also comes into play, if the business owner wants to max out for the year (2015) at the $59,000 overall limit.

Let's do a little Common Core Math word problem, shall we?

Suppose a business owner has a corporate salary of $700,000 and wants to get a Profit Sharing allocation of $35,000 added to his or her retirement plan account, then what percentage of Profit Sharing must be made by his or her company for the the staff? [Note that the salary deferral limit of $24,000 (over age 50) plus the $35,000 of Profit Sharing would get the business owner to the total limit of $59,000]. Your very bright 6th grader studying California Common Core Math would say to you "Well, that's easy! On a salary of $700,000, the $35,000 of Profit Sharing would represent a 5% of salary contribution for the owner. I got that using the "Ladder Method" instead of the "Standard Algorithm Method". So the Profit Sharing percentage for everyone would have to be 5% of their pay, right? I mean that seems fair, right?"

Not wanting to admit that you have no idea what the "Ladder Method" or the "Standard Algorithm Method" is that your 6th grader is referring to, even though you have an undergraduate degree in Math and an MBA, you meekly respond "Yes, Sweetie, that would seem to make sense normally, but you see, we cannot use the business owner's real salary. We have to use his or her Pretend Salary of $265,000, so we have to pretend the business owner is getting a 13.21% Profit Sharing allocation even though they are not. If we have a straight "Pro Rata Profit Sharing Allocation Method" called for in the plan document, then the business must contribute 13.21% for everyone!"

"No way, Dude!" your kid exclaims. "That's just crazy!" To which you respond, "Welcome to my world of a lot of IRS regulations that don't always make sense!"

Just so you know, with a Safe Harbor Cross Tested 401(k) Plan (wow, that is a mouthful!) for a successful small business, the contribution for the employees could be as low as approximately 4.40% (3% Safe Harbor plus 1.4% Profit Sharing) assuming the business owners are somewhat older than approximately 50% of the support staff.

For a nice handy, dandy chart of all of the 2015 retirement plan limitations including the Pretend Salary limit, go to this link: 401(k) Academy Materials and then click on the Retirement Plans Limitation Chart.

Annual Cost of Living Announcement Fest - A Satirical Explanation of the New Retirement Plan Limits

Each October brings three wonderful things - (1) Oktoberfest which according to Wikipedia is "the world's largest fun fair held annually in Munich, Bavaria, Germany. (2) Halloween which also according to Wikipedia is "a yearly celebration observed in a number of countries on 31 October, the eve of the Western Christian feast of All Hallows' Day. And (3) usually sandwiched somewhere in between these two annual diversions from working world drudgery is what I call the "Annual Cost-of-Living Announcement Fest". This is the time of the year when the IRS announces the various retirement plan limits and then every online newsletter writer and every retirement plan blogger races to be among the first to publish the limits in various places to be seen by their target audiences. 

Yep, the limits have been announced for 2015 and the Announcement Fest is in full swing - unfortunately it is just a bunch of boring numbers and no beer or chocolate included. So what do some of these numbers really mean and what relevance do they have to the real world. I won't bother to list all the limits here because by now you have saved 10 different charts of these. Oh, okay, if you really need another chart to print go here: http://401kacademy.com/materials/ and then click on the Retirement Plans Limitations Chart.

Back to what these limits mean... The first one I will discuss must depress the heck out of the great majority of 401(k) and 403(b) participants - they are now being told that they can save $18,000 in salary deferrals in 2015. Must be like an annual slap in the face to remind them how much the special, smart, successful top 1% of people in the old USA can save when they can barely afford to save anything at all. Then to add insult to injury, they are told if they are old enough (age 50 by 12/31/15) then they can save $24,000 ($18,000 plus $6,000 catch-up).

There is another group that must get frustrated as well when they see these annual salary deferrals limits and that is the group of so called Highly Compensated Employees (HCEs) who are not in a Safe Harbor Plan and so are not allowed to save the maximums either and in fact they keep getting money kicked back to them with some sort of innocuous explanation from HR about something called the "failed ADP test."

In a nutshell, some of the most pertinent limits are: Salary Deferrals $18,000; Catch-up Deferrals $6,000; Total Limit from All Contributions (deferral, match, Profit Sharing, forfeitures allocated, etc. $53,000 (add $6,000 Catch-up if over 50); amount of compensation that can be counted $265,000; amount of compensation in 2015 that will make you a Highly Compensated Employee in 2016 is $120,000 and the new Social Security Taxable Wage Base $118,500. Hey at 15.3% combined for employee and employer, that's over $18,000 being paid into Social Security in one year.

Again, see the link in my second paragraph above for all the limits in a nice, organized chart form. Heck, we even colored every other line for your viewing pleasure.

A Novel Idea for Promoting Retirement Savings - But It Will Never Happen

Like Don Quixote and Sancho Panza railing against the Windmills in the Spanish novel, The Ingenious Gentleman Don Quixote of La Mancha, here I am as a lonely and deranged TPA railing against Government retirement plan regulations. Caveat:  if you are super busy, go on to your other work because I am just tilting at Windmills here and not expecting to teach you anything or give you any valuable ideas to implement, so I have broken the first rule of social media postings. Perhaps you will find my idea entertaining or interesting if you do decide to read on.  

As a Third Party Administrator for 40 years, my life has been all about compliance, compliance and more compliance. Over the years, more and more required Notices have been forced upon the retirement plan administration industry (or more properly, upon Plan Sponsors).

We have the annual ADP test, designed, I guess, to force the Plan Sponsor to promote the 401(k) plan better with the rank-in-file employees. We have to make sure participants are given a Summary Annual Report (SAR). Please, someone (anyone!) explain to me what the SAR accomplishes in the real world! Then there is the Safe Harbor Notice, the EACA Notice, the QDIA Notice, the 404a5 Fee Disclosure Notices, etc., etc. If I was to do a complete listing, it would be too long and nobody would finish reading my blog posting.

Thinking about all of these Notices and all of the compliance work, it struck me that most everything is the Government's attempt to make employees aware of the retirement plan so that they will save for retirement. To implement and enforce all of this, the Plan Sponsors are expected to, company-by-company, develop effective communications and hold effective enrollment meetings to motivate people to engage in sufficient savings. Each financial institution doing record-keeping tries to create their own motivational enrollment books (that few participants actually read) and develop websites loaded with savings tools (that nobody uses). The Government hires many people to oversee everything (do audits, invent new notices, etc.) and that also does little or nothing to solve the dramatic savings shortfall. My years of observation tells me that all of the above efforts do not work very well! Savings rates are still abysmal.

How about a completely new, outside of the box, approach? Let's redirect some of the enforcement and audit dollars of the Government to developing a few really, really good movies or videos that can properly communicate about the wisdom of saving. Hire the best creators and movie makers from Hollywood to craft the message.  Get some A-list actors and actresses to volunteer their time "for the good of America." (yea, right!)

I am betting a team of professional screen writers, combined with professional directors and actors could come up with a handful of really effective short videos or movies that could actually educate and motivate the average participant to get off their butts and start saving. Create a movie showing a saver and a non-saver later in life - you know, at retirement. One struggling to make ends meet and one enjoying life based on decisions they made about saving years ago.  Instead of Plan Sponsors inventing their own education, just have them host meetings (on company time) to screen the movies or videos. Have record-keepers build prominent links to the movies on their websites. Pay NetFlix and Amazon to host the movies for free. Throw some advertising dollars into the promotion.  And consider even doing some rap videos - have some rap star rail against the stupidity of not doing something for the family.  You get my drift - do anything but a boring enrollment book nobody will read.

In other words, make really, really good effective, motivational movies or videos and then promote the heck out of them. Or is that just too simple of an idea?  Small plan sponsor will never fork over their hard earned dollars for the superb videos already available from some for-profit companies.

Yeh! You're right - that is crazy thinking - let's just force a few more inane notices upon everyone.  That will work! Right?

What is QACA - Some Sort of Duck Call or a Way for Employers to Save Money?

"QACA" -  One of our favorite acronyms because it sounds so much like a funny duck quack of some sort. In reality it can be a "door opener" for you as an advisor who handles retirement plans.

Do you know any companies who would like to save money? Are any of your prospects or clients interested in contributing more than they have to in order to have a Safe Harbor 401(k) Plan? Probably not, right? If you could show them a way, they would love to contribute less - employees don't really appreciate their contribution that much anyway. Nine out of ten employees don't even understand their matching formula (yes, I just made up that statistic like most quoted statistics). Cannot begin to tell you how many Plan Sponsors I have talked to over the years who just cannot wrap their brain around a match of "100% of the first 3% plus 50% of the next 2%". Guess that sounds too much like the new Common Core math that we are using as a society to make our kids (and their parents) feel stupid. Many people's eyes glaze over when you start to throw an mathematical expression at them.

Well, quite a number of 401(k) Plan Sponsors have what is known as a Basic Safe Harbor Match. The reason for the Safe Harbor Match in the first place is to motivate employees to save for retirement and to allow those employees who are classified by the Internal Revenue Code as Highly Compensated Employees (HCE's) to not be limited in the amount that they may do as salary deferrals. By providing a Safe Harbor Match program, the HCE's can do the maximum $17,500 in salary deferrals (or $23,000 if over age 50).

HCE's are those employees who are greater than 5% shareholders or owners (and certain family members) or those employees who made over $115,000 in the prior year (the $115,000 will be increased later by a COL increase). For plans that do not offer some form of Safe Harbor contribution, HCE's might be limited in what they can do in salary deferrals because of the average deferrals being done by the Non-Highly Compensated Employees. For example, if the NHCE's average 2.5% of compensation for their salary deferrals, then the HCE's would have to average 4.5% or less - otherwise, refunds may have to be made to some of the HCE's. See one of our other posts explaining the ADP testing in more detail.

There is a fairly new type of Safe Harbor plan that could be used in lieu of the Basic Safe Harbor Match. Probably very, very few Plan Sponsors with the traditional Basic Safe Harbor Match have been presented with a discussion of the QACA alternative by their advisors. Maybe you could use this lapse in planning to open up the prospect's door for you in order to try to become the new advisor on the case. Go ahead, call up the prospect and ask them if they know what a QACA is? They won't even know what it is if you call it by its proper name - a Qualified Automatic Contribution Arrangement.

Under the Basic Safe Harbor Match, the matching contribution is 100% of the first 3% plus 50% of the next 2%. So if a participant does a deferral of 3% of pay or less, they would get a dollar-for-dollar matching contribution. If a participant did 5% of pay or more in salary deferrals, then they would get a 4% of pay matching contribution. 100% of the first 3% plus 50% of the next 2% = 4%.

This is a matching contribution program combined with automatic enrollment. Automatic enrollment is no big deal for a company that has a limited number of employees and locations if Human Resources makes sure that everyone is provided with a timely enrollment package and also makes sure that everyone turns in an election form, even if they have decided not to do any salary deferrals. If everyone turns in a form, then automatic enrollment is rendered entirely moot.

The required Safe Harbor Match for a QACA is less expensive at most levels than the Basic Safe Harbor Match. Let me say that again, because that is the whole point here.  The required Safe Harbor Match for a QACA is less expensive at most levels than the Basic Safe Harbor Match.

The QACA match is 100% of the first 1% plus 50% of the next 5%. So, at the 1% level of salary deferrals, the match under both types of Safe Harbors is the same 1%. But at the 2% salary deferral level, the QACA Match is 1.5% rather than 2% for the Basic Safe Harbor - a savings for the Plan Sponsor of 0.5%. At the 2% to 5% level of salary deferrals (most participants fall in this category, by the way), the savings is a full 1%. For example, for salary deferrals of 5%, the QACA Match is 3% whereas the Basic Safe Harbor Match is 4%.

The point is if the Plan Sponsor wants a Safe Harbor plan so that HCE's are not restricted in their salary deferrals, but they would like a Safe Harbor Plan that is less expensive by as much as 1% of compensation, the QACA should be considered (and nobody has told them about that alternative). Also, you can have a 2 year vesting schedule: 1 year of service, 0% vested and 2 or more years of service, 100% vested. This would result in having no cost of a match for those employees who stay just long enough to get their first matching contribution, but then leave your client or prospect.

You cannot change a Safe Harbor Match method in the middle of a Plan Year, so assuming a Calendar Year as the Plan Year, Plan Sponsors should use the next several months to evaluate making the change before 11/30/2014 for the 2015 Plan Year.  Now would be the ideal time for an advisor to identify and approach Plan Sponsors who appear to be using the Basic Safe Harbor approach.

If you would like to discuss the concept of moving from a Basic Safe Harbor Match to a QACA Safe Harbor, please call our external Consultant who handles your firm - that would be either Chad Johansen (known around our shop as Chaylyn's proud Pop) or Mark Palmini (known around our shop as Maya's proud Pop).  They are both struggling golfers (aren't we all) but great consultants for you to work with in marketing retirement plans.  Call our main number at (650) 341-3322 and enter our voicemail labyrinth or to avoid that call Chad at his direct dial of (650) 425-7914 or Mark at his direct dial of (650) 425-7663.

Somewhere far in the distance, there are ducks landing on a pond doing marketing for you going "QACA, QACA, QACA"..........

Are we aware this is a very long Post and looks even 10 times longer when viewed on your SmartPhone while you are making your way up the 3rd fairway on your way to another triple bogey - sorry about that - takes a few words to get you properly armed to land a few clients using this ammunition.  If you are successful, then how about treating Chad or Mark to some golf lessons?

What Do You Mean "Give Salary Deferrals Back to Our Top People?" - How To Use a Failed ADP Test to Get In the Door

If you have a client or you are talking to a prospect who has failed their annual ADP test and they are upset about having to return salary deferrals to some of their top people, it is a great opportunity for you to win the case or show your worth as an advisor.  What can you do as an advisor to help the situation? Offer to get in there and motivate employees to save more.  Help them look at automatic enrollment. Motivate them to take a close look at going to a Safe Harbor plan. Reinvigorate the plan by moving to a new vendor and doing a new rollout.

To explain what the testing is all about, come with me on an adventure back in time....... It is the early 1980's and 401(k)'s have just been created.  Plan Design Consultants, Inc. has only been around for a few years at this time having been founded in 1975 by the man now affectionately referred to by our staff as "the old gray hair". Well, okay, maybe "affectionately" is not the applicable word for some of our staff. Anyway, back to our exciting story of mystery and intrigue.

Somewhere in the dark depths our our Nation's Capital, picture a couple of young recent graduates of Georgeton Law School slaving away deep into the night on drafting proposed legislation (yes, I know it is really spelled Georgetown Law School, but, hey, this is a fictional story).  They are anxious to impress the Congressman that was crazy enough to hire them.   Picture Kevin Spacey of the Netflix TV Series, "House of Cards" - a tough task master, as you may know.  They have been up for two days with the help of the best illegal stimulants money can buy and this point they approaching paranoia and hearing voices from somewhere in the back of head.  New legislative Analyst #1 says to #2 - "We have just this one night to come up with some rules for 401(k) plans that will drive Plan Sponsors crazy for many, many years to come.  These rules need to be incomprehensible, stupid, and most of all designed to make sure that the most successful people have a hard time retiring in style.  Give me your best thoughts!"

Analyst #2 says "How about this, let's start by creating two classifications of people.  The bottom classification will be able to save pretty much as they want without any restrictions.  We can call them the "Non-Highly Compensated Employees".   Let's call the top classification of employees the Highly Compensated Employees and let's really stick it to them with the rules and let's not forget to stick it to their family members as well.  You know.... their spouses, their kids, their parents and certainly anyone owning more than 5% of the company.

Analyst #1 says "Dude, you are on a roll - take another puff and keep going!"  To which Analyst #2 says "Wouldn't it be really perverse to come up with some crazy mathematical rule, like the top group cannot do salary deferrals on the average that are more than two percentage points above the average of the bottom group.    For example, if the bottom group averages 2% of pay, then the top group would be limited to an average of 4% of their pay.  Consider how genius that would be because the bottom group cannot afford to do hardly anything and therefore the top group will really be hampered."  The Congressman will be so impressed.  With these kinds of rules we can make sure people have to pay current income taxes.

"Yes, yes, yes..... you are really onto something terrific here!  I knew there was a reason you graduated at the top of our class.  If those top people have done too much under your two percent rule, let's make them take the money back out and, check out this.... let's apply a 10% excise tax on the company if they can't get this money returned within 2 1/2 months of the end of the year.  That will really drive them bonkers - we can upset the top people, we can upset the company and we can make them "want to shoot the messenger" who would be the TPA firm doing these calculations."

"Beautiful, awesome, outrageous, most excellent - our legislative careers will skyrocket when Congress sees the superb work we have done on this.  Give me another drag on that magic cigarette, will you? My only fear is that those legislative analysts who joined the staff of that honest, hardworking, intelligent Congressman from Kansas will create some sort of a Safe Harbor exception to our testing. They are such bleeding hearts that they will probably come up with some rule that says you can ignore our testing if you are willing to do a certain size match or Profit Sharing contribution.  If the employer will agree to do this, they might even specify that the top group can do whatever the salary deferral limit is for the year.  I heard they might let people put away $17,500 or even $23,000 if they are old geezers (over 50 by the last day of the year).

And with their work done for the night, the young grads headed of to Foggy Bottom to seek more wisdom in the realm of Budweiser (no wait, it would have to be some IPA Craft Beer that cost $2 a bottle more than domestic beer - can't be saving that money for retirement you know) - and in the morning they can go for a Caramel Creme Crunch Frappuccino with Expresso Infused Whipped Creme and Italian Roast Coffee Drizzle.   Hey, what's $6.75 for a coffee when you are not saving for the future anyway.

Client/Prospect Making Money "Hand Over Fist" (what does that really mean)?

Making money hand over fist means to make a lot of money quickly. This term has a nautical history. It relates to the practice of climbing a rope hand over hand. This soon became known as hand over fist, with the fist being the hand gripping the rope. The term hand over fist soon evolved from making progress up a rope to making progress generally. Today, it relates only to financial gain.  Read more here Click this Link

Okay, so this is not a problem most of us have or will ever be lucky enough to have (except in our best dreams), but there are people out there (they might even be your client or prospect) who are making a lot of money in their business.  Think venture capitalist, attorneys, surgeons, manufacturers reps, performers and just plain smart business people who have become successful in their small business.  

What are some of your options you can suggest to them to deal with this terrible dilemma of making too much money?  You can tell them to make huge charitable donations to the 50 scam charities who called them this year (without checking to see if they are actually legitimate first, of course).  You could actually be the friend who gives their name to that pesky wine broker who keeps calling you saying that "a good friend of yours told us you enjoy a good bottle of wine."  You know, the wine broker who can never tell you who that friend is.  Okay, I am struggling here to come with anything funny.  If you can think of something, pass it on to us, will you?  Or you could just tell them to go ahead and pay a really large chunk of it to the IRS in the form of Income Taxes.  They will love that idea.

Or, you could help them take a look at a Cash Balance Plan to go along with their 401(k) Plan.  A Cash Balance 401(k) Combo might allow them to legitimately shelter an additional $100,000 to $200,000 per partner or owner without increasing the cost for employees by a large percentage over their current Safe Harbor Cross Tested 401(k) Plan. 

If you are interested in knowing a lot more about Cash Balance Plans, Click Here to Download Our Cash Balance Primer (which is absolutely void of any attempt at humor, at least at this point).

In all likelihood, a Cash Balance Plan could be utilized for 2014.  We are here to help (if we are not out playing golf, surfing, wake-boarding, playing with children or grandchildren, but even if that is the case, we will be back in the office at some point)  - so just give us a call, send us a text message through FaceBook, send us an Instagram of your client drowning in excess cash.  Use these hashtags (#oneluckyclient, #comeandgetmeirs, #yadayadayadamyclientmakesmorethanyou) and we will search for your message.  ...... do something to get us working for your client on this issue.  And don't forget, that Cash Balance Plan will be invested in a pooled account for all and somebody will need to help the client pick the investments.  Might that be you?

403(b) Sales Process Is Different from 401(k) Process

If you want to try to enter the hot 403(b) marketplace, you will need a certain level of patience.

403(b) prospects are not like a 401(k) prospects.

The corporate sponsor of a 401(k) can make a quicker decisions regarding changing their program.
You are usually presenting to one of two people or a small committee in the 401(k) corporate environment and if you show them a better widget, they can make the decision relatively quickly (after a little due diligence).

On the positive side, you will have less competition in the ERISA 403(b) space.  Fewer financial advisors understand 403(b) plans.  On the negative side, here is how the sales process usually goes:  (1) you gather data and then present to an HR director and perhaps a Controller; (2) if they like what they see, they then ask you come back and present to the Executive Director;  (3)  if he or she likes it, you are then asked to come back and present to the Finance Committee; and finally if they all like it, you might have to appear in front of the Board of Directors.

After all of this, you may run into a Board Member who has a close friend who is in this business and they might give him or her a shot at the business before saying yes to your offering.  Whew!  That is a lot different from presenting to the real decision makers at a corporation and getting an immediate "Yes".

Moral of the story - if you want to be successful in the 403(b) space, be patient during the sales process. However, once you get the plan, you could have it for a very long time (if you serve it well) because it is just as hard for someone new to get through this process.

Plan Design Consultants, Inc., understands 403(b)'s, can help you through the presentation process and help you select a good program to present in the first place.

"If you do not see yourself as a winner, then you cannot perform as a winner!"  Zig Ziglar

Report Reveals That Advisors Who Sell DC Plans are 40% More Successful

Click on the link below to see a write-up on a newly released report by Cogent Research titled "Success at Work - Capturiung Advisor-Sold Retirement Plan Dollars"

http://www.401khelpcenter.com/press_2009/pr_cogentresearch_121809.html