The past several years have seen changes to those sections of the tax code that govern qualified retirement plans, the largest and most significant of which concern 401(k) plans. The forces behind this liberalization, when properly understood, will not only help maximize the benefit that clients derive from these changes, but also put you on the cutting edge of the next round of legislative enhancements.

Underpinning the changes are a decrease in the savings rate and a weakening of the confidence in governmental programs, notably Social Security. Add in support for the small business owner and you have a recipe for liberalized pension limits. The net effect has been a boom in retirement planning, both in terms of plans started and overhauls of existing plans.

Three primary changes to 401(k) regulations have fueled this growth, including:

o The increase in maximum deferrals ($14,000 for 2005 and $15,000 for 2006);

o The creation of catch-up provisions ($4,000 for 2005 and $5,000 for 2006); and

o The ability to defer up to 100% of pay (subject to the previous limits) into a plan.

Each of these changes, when paired with secondary changes, has created an opportunity for well-advised clients and sophisticated advisors to maximize their savings rate and build flexibility into their long-range planning.

A) Profit-Sharing Plan changes

Coupled with the first change–the dramatic increase in deferral limits (the maximum was $10,000 just a few years ago) –has been a liberalization of profit-sharing plans, in general. Truth be known, 401(k) plans are actually a subset of profit-sharing plans.

Formerly, the limit in these plans was 15% of pay (as opposed to the defined contribution limit of 25% of pay). This forced the plan sponsor who wanted to cap out at 25% of pay to offer either only a money purchase plan, or pair a 15% profit-sharing plan with a 10% money purchase plan.

Once profit-sharing plan limits were increased to the lesser of 25% or $42,000 (2005 limit under Section 415), more “room” became available under these plans. With the 401(k) deferral limit at $14,000, $28,000 was left for an employer-funded profit-sharing deposit.

Overall, this represents a lower percentage of pay (also capped at $210,000 for 2005) than just a straight profit-sharing plan. (Here is the math: $42,000 is 20% of $210,000 and $28,000 is 13% of $210,000.) The net effect is that a profit-sharing/401(k) combination can save the business owner who wants to make a maximum deposit roughly 7% of pay.

B) Better allocation formula methods–SafeHarbor Plans

The second primary change, the addition of a catch-up provision for employees over age 50 as of Dec. 31 of the prior year, added a new element to the 401(k) plan. As a result, people of a certain age had a different set of rules applied to them. In addition, the catch-up provision is not based upon either tenure with the firm, status as a highly compensated employee (it is open to anybody) or testing (these amounts are not factored into the average deferral percentage and discrimination testing).

Enter the safe harbor approach. Prior to having this feature, all 401(k) plans (with or without matching contributions) were subject to a separate and distinct discrimination. Whether for deferral alone or match, as well, all discrimination tests have the common objective of keeping the benefits gained by highly compensated employees in check with the benefits provided to the non-highly compensated employees. The inability to pass this test is the greatest challenge facing most 401(k) sponsors. This is avoided with the 401(k) safe harbor plan.

The “price tag” for receiving safe harbor treatment is an employer contribution to the plan. The employer contribution can be either:

==a 3% contribution for all eligible employees; or

==a matching contribution using a specific formula (dollar for dollar on the first 3% deferred and 50 cents per dollar on the next 2%).

To qualify as a 401(k) safe harbor plan for a given plan year, two requirements must be met:

==Notice must be provided to each eligible employee describing the safe harbor contribution (existing 401(k) plans must provide notice at least 30 days prior to the beginning of each plan year); and

==All safe harbor employer contributions must be 100% vested at all times.

In addition, sophisticated profit-sharing allocations such as new comparability and age-weighted profit-sharing formulas allow for an even greater allocation of company deposits to key people. These techniques are fully detailed in the new book, “The 401(k) Advisor,” published by the National Underwriter Company and due out this month.

C) Unit KPlans

The third change opened the playing field even wider, in particular for the small, closely held business owner. Employees can defer up to 100% of their pay (subject to the annual dollar limits listed above), thereby enabling self-employed individuals to have their own 401(k) plans.

In addition, it now became fashionable (and totally legal) to hire one’s spouse (assuming that person has a function within the organization) and provide him or her with a benefit under the plan. For the happy, loving couple with joint income, this means $28,000 deferred in 2004 (prior to matching, profit-sharing or potential catch-up deposits).

For financial advisors with a solid working knowledge of these rules, a multitude of marketing opportunities arise. For the asset gatherers, there is the opportunity for large rollovers and asset-based compensation on deposits. Those who focus on risk-based products gain wonderful entr?e into deeper planning opportunities for the owners and/or management team. The next time you are reviewing a prospective client’s benefits, pay special attention to the power of the 401(k) plan and keep these three primary changes in mind.

Anthony J. Domino Jr., MSFS, CLU, ChFC, is president of Associated Benefit Consultants, White Plains, N.Y. He is also president of the Society of Financial Service Professionals for 2004-2005. He can be reached by e-mail at ajdjr@msn.com.

For financial advisors with a solid working knowledge of these rules, a multitude of marketing opportunities arise