Clients Love It When Their Proactive CPA Tells Them How to Save Money - Here Is A Possible Way of Doing So

"QACA" -  One of our favorite acronyms because it sounds so much like a funny duck quack of some sort. It actually stands for "Qualified Automatic Contributions Arrangement". CPA's should develop some understanding of this concept because it is an something that could save certain clients of yours some money in the form of lower matching contributions to their 401(k) Plan.

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 Highly Compensated Employees (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 TPA or financial advisors. I have to imagine they would be most impressed if their proactive CPA brought up the idea, whether adopted or not.

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. That is not that hard to do for any company with only a few new employees being added each year. 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 a CPA to discuss this with their clients or to include it in your ongoing communications (newsletter, etc.).

SIMPLE or SEP Plan May Not Be The Most Cost Effective

Many small business owners would do much better by using a Safe Harbor Cross Tested 401(k) Plan instead of a SIMPLE or SEP.  For example, suppose the business owner of a corporation takes $260,000 in compensation and wants the maximum contribution of $52,000 in an SEP. That would be a 20% of compensation contribution. In an SEP,  if you want to put away 20% for the owner, you generally have to contribute 20% of salary for each eligible employee. If you had just two employees making $50,000 each, that would be $10,000 each or $20,000 total in contributions for them.

Alternatively, with a Safe Harbor Cross Tested 401(k), it might be possible to contribute 5% of pay or less for the support staff while still maxing out for the owner at $52,000.  The Cross Tested 401(k) will even be more effective than an SEP for a business owner or partnership with modest self-employment income.

The SEP is an okay solution for many companies but the Safe Harbor Cross Tested 401(k) might be a far better solution for many others. Even with only one or two support employees, the savings could be thousands of dollars. In our example, if the contribution was 5% for each employee, the total would be $5,000. This would be $15,000 in savings. Yes, you would have to pay to administer the 401(k) plan, but if that was $2,000 a year, the business owner would still have $13,000 per year in savings. For the concept to work, we need about half of the employees to be somewhat younger than the business owner.

As a CPA, you may want to identify all of your clients using an SEP, particularly if they have eligible employees, and encourage then to contact us for a free illustration of how a Safe Harbor Cross Tested 401(k) Plan might be far more effective - perhaps saving them a lot in the contributions for staff category.

All we need is a simple census of name, date of hire, date of birth and compensation estimate for their staff and some indication of their expected Schedule C, K-1 or corporate compensation.  If deductions beyond $57,500 are desired, then we can show the your client how a Cash Balance 401(k) Combo might work.  Depending upon the business owner's age, deductions of $200,000 or more may be possible.