Publication: Journal of Pension Benefits
Volume/Issue: Vol. 23, No. 1, Autumn 2015
The Triple Stack (Match) – It’s Not Just for Pancakes Anymore!
Ilene H. Ferenczy, Esq.
So, you’re working on the profit sharing plan for your favorite doctor’s practice, and you find out that Dr. Snipits, who is 105, finally decided to retire. Dr. Laser, a squeaky clean new physician, is buying the practice. Dr. Laser, known to his friends as “Doogie Howser” and to his new staff as “that young whippersnapper,” is 32 years old.
It comes as no surprise that your carefully designed cross-tested plan that has afforded Dr. Snipitz contributions at his Section 415 maximum for many years has become an unmitigated disaster for Dr. Laser. No amount of tinkering with formulas will make this plan pass nondiscrimination testing anymore, because Dr. Laser is at least 20 years younger than all his medical staff (who remained with the practice when the prior owner retired).
Dr. Laser was a scholarship student (no debt), is single, and has more money than he knows what to do with. So, he is interested in saving the maximum amount he can. And, he is not enthusiastic about an employee retirement plan cost that approaches 17 percent of payroll, as it will if he does a permitted disparity design that will get him to his $53,000 maximum. What to do?
This is one of the rare instances in which a triple stack match formula is likely to be of help. Far from being a dish served at the local IHOP, the triple stack match is a 401(k) plan design that will allow Dr. Laser to get his maximum contribution under Section 415 without any nondiscrimination testing.
Here’s how it works:
First, Dr. Laser starts a new 401(k) plan (or amends the current plan of the practice he purchased, taking care to do so only before the beginning of a plan year) to be a safe harbor 401(k) match plan.
The doctor will defer $18,000 (his Section 402(g) maximum, as he is under age 50), which will equal 6.7925 percent of his compensation (which is at the maximum used for pension purposes under Code Section 401(a)(17), $265,000).
The First Stack
The first stack of the match is the basic or enhanced match to meet the ADP test. Under either structure, Dr. Laser will get a matching contribution equal to 4 percent of his compensation, or $10,600. (This contribution is equal to 100 percent of deferrals up to 3 percent of compensation, then 50 percent of deferrals up to an additional 2 percent of compensation. If someone contributes at least 5 percent of pay, this is will equal a match of 4 percent of compensation.)
The Second Stack
The second match will be a safe harbor discretionary matching contribution. Under the safe harbor rules, this contribution cannot match deferrals in excess of 6 percent of pay, and cannot exceed 4 percent of pay.
This discretionary match, then, may equal 66.67 percent of deferrals up to 6 percent of compensation. (66.67 percent of 6 percent is 4 percent, the maximum discretionary matching contribution).
Under this option, Dr. Laser’s allocation is equal to another $10,600.
After this step is completed, Dr. Laser’s total contributions in the plan equal his $18,000 deferral, plus two contributions of $10,600 each, for a total of $39,200.
The Third Stack
The third element of the plan design is a fixed matching contribution. The amount of this matching contribution must be established before the beginning of the plan year so that any required amendment can be prepared and signed before the year begins, and the safe harbor notice can include correct information about the fixed match.
Dr. Laser was eligible to receive a total of $39,200 from the first steps of the process. This leaves a remaining amount allocable to him under Code Section 415 of $13,800 (i.e., $53,000 – $39,200).
A fixed matching contribution qualifies as a safe harbor matching contribution so long as it does not match deferrals in excess of 6 percent of compensation. Six percent of Dr. Laser’s compensation is $15,900. This is the maximum deferral that can be matched. If we divide the desired matching contribution ($13,800) by the deferral to be matched ($15,900), we find that the matching formula for the fixed match is 86.79 percent. So, the fixed matching contribution will equal 86.79 percent of deferrals up to 6 percent of compensation.
Because all of the contributions made in this triple stack are safe harbor contributions, no nondiscrimination testing is needed. Therefore, if no other employee defers under the plan, no other contributions are required for anyone, including top-heavy contributions.
You must remember the key tenets of safe harbor matching contributions, or else you will be led astray:
- The match that is used to meet the ADP testing must be either a basic match (i.e., 100 percent of deferrals up to 3 percent of compensation; then 50 percent of additional deferrals up to 5 percent of compensation) or an enhanced match (i.e., 100 percent of deferrals up to 4 percent of compensation).
- No match may be denied to any participant due to a failure to be employed at year end or to have 1,000 hours.
- No match may be made on deferrals in excess of 6 percent of compensation.
- No discretionary match may exceed 4 percent of compensation.
- The ADP safe harbor match must be fully vested, but the other two matches may be subject to a vesting schedule.
- The rate of match cannot increase as deferrals increase. Note that the rate of match in this example actually decreases as deferrals increase:
A participant’s deferrals in excess of 6 percent of compensation are unmatched; therefore, the rate of match continues to decrease as deferrals increase above 6 percent.
Assuming that the Section 415 limit and the Section 401(a)(17) compensation limit both go up in the same year, the ratios for the fixed matching contribution will remain the same. Therefore, an amendment to the fixed formula should not be needed. But, if this relationship is not maintained because of the rounding rules for cost-of-living increases, an amendment may be needed to keep the principal at the Section 415 limit.
Illustration of Triple Stack Match
If we assume that Dr. Laser has two employees, one who is paid $30,000 who defers at the rate of 4 percent of pay and one who is paid $20,000 who does not defer at all, this design looks like this:
In this situation, Dr. Laser gets his $53,000, for a total employee cost of $2,892, which is about 5.8 percent of his total payroll.
Of course, if the employees defer more aggressively, the cost of this program can skyrocket. Check out what happens if Margaret defers 6 percent, rather than 4 percent, and Millicent starts deferring 10 percent of her pay:
The employee cost rose from 5.8 percent of payroll up to 13.2 percent … nearly double. (But, still not as bad as a permitted disparity formula would be if Dr. Laser still got his $53,000 maximum.)
This illustrates that the biggest risk to this plan design is that the rank-and-file employees will make significant deferrals. And, in truth, if an employer is matching deferrals at a rate exceeding 200 percent, even the poorest employee should be compelled to defer. Nonetheless, employees do not always do what is best for them, and a company with lower-paid employees may find that this works to its advantage.
To be blunt, therefore, what you are counting on to some extent is that a significant number of the employees will not defer, notwithstanding the incredible upside of doing so. This expectation must be carefully managed, and the plan’s service provider must advise the plan sponsor of what it cannot do to discourage aggressive participation. The employer may not succumb to any temptation to “forget” to provide the safe harbor notice, nor can it fire people who “catch on” because it wants to avoid communication to the other employees. The former will disqualify the plan; the latter can lead to a lawsuit for interfering with ERISA rights of the employees.
In a given year, if the cost of the plan is too high, the employer can choose not to make the discretionary matching contribution. In the following year, the employer can amend the plan to eliminate or modify the fixed match. If desired, the plan can be amended to be a regular profit sharing plan with permitted disparity. So, the worst risk is generally limited to one year, unless the employer is inattentive.
For a service provider, the most significant risk is that the employer will not remember all the caveats about what could happen if participants defer aggressively. Probably the best defenses against this type of problem is to outline the concerns and the “dos and don’ts” in writing, and to stay in close contact with the client as the plan progresses, being ever ready to timely modify the plan if needed.
The situations in which a triple stack match will work are very few. You need a case where a cross-tested plan does not fly. If cross-testing works, it is a much more manageable way to design a plan. If it does not work, then this design may be of help. However, you must carefully control how the plan is communicated to your client, as well as your client’s understanding of what may and what may not be done to encourage or discourage employee participation.