Retirement Plan Fundamentals: Module 1: Lifecycle of a Plan

Qualified Plan descriptions will often say in the first few pages:

"This retirement plan is intended to be a qualified plan under Section 401(a) of the Internal Revenue Code."

The average monthly amount paid by Social Security is ________________________________$

$1,555

Profit-sharing plan features

(1) Discretionary employer contributions up to 25 percent of eligible compensation. (2) Withdrawals allowed after monies remain in the plan for a specified period of time, not less than two years.

What are the main Defined Contribution Plan Types?

(1) Profit Sharing Plans (2) 401(k) Plans (3) Individual Retirement Account Plans (IRA)

What are the three types of IRA plans?

(1) The simplified employee pension plan (SEP) (2) The SIMPLE IRA (3) The SIMPLE 401(k)

After ERISA was passed in ___________, two types of retirement plans emerged for for-profit employers to provide benefits to their employees: _____________________ and ___________________.

1974; defined benefit plans; defined contribution plans

QDRO (Qualified Domestic Relations Order)

A DRO that means certain requirements specified in the IRS rules that has been "qualified" by the Plan Administrator, the fiduciary responsible for the plan's day to day operation. A QDRO creates or recognizes or assigns to someone other than the participant, an alternate payee, the right to receive plan benefits payable to a participant. The alternate payee may be the participant's spouse, former spouse, or dependent.

Nonelective Contribution

A contribution made by the employer on the participant's behalf. No "election" by the participant is required (unlike matching contributions). A profit sharing contribution is a nonelective contribution

Safe Harbor Contribution

A contribution type required for safe harbor plans. Both matching and profit sharing contributions can be "safe harbor." A safe harbor contribution is 100% vested.

457 Plan

A defined contribution plan for government entities that is similar to a 401(k) plan. Like a 401(k) plan, the 457 plan always has employee contributions and may have an employer contribution component.

403(b) Plan

A defined contribution plan very similar to 401(k) plans that is designed for tax-exempt plan sponsors.

401(k) Plan

A defined contribution profit sharing plan design that allows for employees to choose to contribute part of their paycheck to the plan. It always has employee contributions and may have an employer contribution component.

Summary of Material Modifications (SMM)

A detailed summary to notify participants of minor plan changes to the plan document.

Summary Plan Description (SPD)

A detailed, but easily understood, summary describing a qualified plan's provisions. It must be provided to participants and beneficiaries. The SPD must be provided within 90 days of the employee becoming eligible.

Hardship Event

A distribution that is on account of an immediate and heavy financial need that must be necessary to satisfy that financial need.

Adoption Agreement

A document used in conjunction with a base plan document to allow individual employers to customize the plan's provisions.

Trust

A fund established under local trust law to hold and invest the assets of a plan. A retirement plan also has a companion trust. A trust is an arrangement that allows a trustee to hold assets on behalf of people other than the trustee. A trust must be either part of a retirement plan document, or the document must reference another trust document to meet the ERISA exclusive purpose rule.

Defined Benefit Cons

A larger, fixed contribution Higher required employer contributions for employees than 401(k) plans More complex and expensive administration Employee demographic changes can undermine the original goals of the design

Plan Document

A legal document detailing the specific plan provisions selected by the plan sponsor to meet retirement plan and business goals.

Rollover

A method of transferring assets from one plan to another (either an IRA or another qualified plan), allowing for continued tax-deferral.

Lump Sum

A one-time payment of all of the participant's assets, rather than a series of payments. Most common distribution type.

Base Plan Document

A plan document issued by a document provider that has been approved by the IRS. It is customized for individual employers with the use of an adoption agreement.

Individually-Designed Plan

A plan document written by an ERISA attorney for use by one (usually large) company.

What happens to the plan if the employer closes or sells the business?

A plan may be terminated due to business acquisition, mergers, closure, inability to pay plan expenses, or any other valid business reason. The plan must follow all the required steps, some of which include notifying participants and providing full vesting of their accounts, distributing benefits and accounts to participants and beneficiaries, and filing with the DOL and IRS. Some DB plans must also take action with the PBGC.

Salary Deferral

A portion of an individual's salary contributed to a retirement plan (e.g. 401(k) plan) that is "deferred" and will be received at a later date.

Defined Contribution Plan (Complex definition)

A qualified retirement plan that allocates contributions, earnings and forfeitures to individual participant account balances. Contributions can be either fixed or discretionary, and depending on the type of defined contribution plan, contributions can be made by the employer or employee, or both. Retirement benefits are not defined as in a defined benefit plan, but instead are based on the value of the participant's account balance when the participant reaches retirement.

Defined Contribution Plan

A qualified retirement plan that allocates contributions, earnings, and forfeitures to individual participant account balances.

Hybrid Plan

A qualified retirement plan that combines DB and DC plan features.

Defined Benefit Plan (Complex definition)

A qualified retirement plan that provides participants with a pre-determined retirement benefit at a specific retirement age. ERISA specified a maximum benefit as well as allowable retirement ages. All contributions and earnings on those contributions are part of a single trust account, and participants generally do not have individual account balances as they do in defined contribution plans (with the notable exception of cash balance plans described below). If participants terminate their employment before retirement age, they are entitled to a portion of their retirement benefit.

Defined Benefit Plan (simple definition)

A qualified retirement plan that provides participants with a specifically defined retirement benefit payable at a stated retirement age. How the benefit is paid and over what period of time is defined by the plan document.

Employer-sponsered plan

A retirement plan set up and overseen by an employer for the benefit of its employees.

Qualified Plan

A retirement plan that meets the requirements of IRC §401(a) and, therefore, provides special tax advantages to the plan sponsor, the trust, and the plan participants Remember that these tax benefits include: - Employer contributions that are deductible and not includible in the employee's income; - Employee contributions that can be made on a pre-tax basis; - Investment earnings not currently taxable to the employee or the employer.

Annuity

A series of periodic payments, usually level in amount or adjusted according to some index (e.g., cost-of-living), that continues for the lifetime of the recipient.

DRO (Domestic Relations Order)

A state judgment, decree or order (including approval of a property settlement agreement) which relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child or other dependent of a participant. Upon qualification, a DRO becomes a QDRO

Trustee Direction

A trustee controls selection of investments for the plan and how assets are invested.

Loan

A withdrawal from a participant's account that must be paid back, allowing the participant to "borrow" from the account.

In-service Withdrawal

A withdrawal of vested money from a qualified plan to an employee who is still actively employed. Also referred to as an in-service distribution.

Termination by the employer is voluntary (other than in certain bankruptcy situations for specific types of defined benefit plans), but the law does require that specific steps be followed:

Adopt a business or corporate resolution terminating the plan. Notify the plan participants and beneficiaries of the termination. Vest all participants 100% in their accounts or benefits. Amend and update the plan document for all legislative and regulatory changes. Distribute all benefits and accounts due to participants and beneficiaries (including providing distribution election forms) File final forms with the IRS and DOL indicating that all assets have been distributed.

After-tax

Amounts that a participant voluntarily contributes to a plan in addition to the contributions made by the employer. After-tax employee contributions, unlike employer contributions, are not deductible on either the employee's or the employer's tax return. This concept is alternately referred to as voluntary contributions, post-tax contributions, or employee after-tax contributions; not to be confused with "designated Roth contributions."

Nonqualified Plan

An agreement or promise by an employer to certain employees to pay benefits at some future date for services performed currently. These plans do not qualify for the special tax treatment given to qualified plans.

Matching Contribution

An employer contribution that is made to the plan based on a participant's contribution. The employer may match all or part of the employee's pre-tax, catch-up, designated Roth, and/or after-tax employee contributions.

Elective Contribution

An employer contribution that is made to the plan based on a participant's elective deferral

Distributable Event

An event or situation that permits a participant to withdraw assets from a plan.

Participant

An individual who has met plan eligibility requirements and entered into the plan. An employee becomes a participant upon plan entry.

Employee

An individual who provides services for compensation to an employer and whose duties are under the control of the employer; compare to "participant."

Elective Deferral

Another term for "salary deferral."

Fiduciary

Any person (individual or corporation) who exercises discretionary authority or control over the management or disposition of plan assets, renders investment advice for a fee or has discretionary authority or responsibility for the administration of the plan.

Nonqualified Plan Cons

Assets of the plan belong to the employer (not to the participant as in ERISA plans) and are subject to the employer's creditors No current tax deduction for the employer when it makes contributions to the plan No tax deferred rollover feature for the employees

Employer-sponsored IRA plans Disadvantages

Can limit retirement plan savings due to lower employee contribution limits Unfavorable to owners and principal employees May have required employer contributions Inflexible to changes - the only plan an employer may have in a plan year Places the burden of compliance fully on the plan sponsor as there is usually no retirement plan consultant doing some of the administrative work

Designated Roth Contribution

Compensation deferred to the plan at the participant's election on an after-tax basis. At the time of distribution, if the designated Roth contributions meet certain requirements, earnings on the designated Roth contributions may be withdrawn tax-free.

The IRS also oversees qualified plan rules under Title II, including those in the IRC, such as:

Coverage - plans must cover a certain percentage of eligible employees to be qualified Contribution limits - employer and employee contributions are subject to specific limits under IRS regulations Minimum contributions - certain types of plans must contribute monies on behalf of plan participants Non-discrimination - qualified plans are subject to tests to prove that contributions do not disproportionately benefit owners and highly paid employees

Nonqualified Plan Pros

Deferred taxation to the employee on employer contributions and earnings on those contributions Minimal regulation of the amounts and timing of the contributions Ability to target a small group of management employees (i.e., discrimination is allowed) Customize timing of when monies are available to employees Tax deduction by the employer when accounts are available to the employee Allow for stock options and stock bonuses tied to the employee's and the employer's performance

Profit-sharing plans are qualified _________________________ plans.

Defined Contribution

In general, the ___________________ is responsible for protecting participants and beneficiaries.

Department of Labor (DOL)

How could participating in a work-sponsored retirement plan help employees save money?

Depending on the plan type and options available in the plan, employees can save more through the ease of the plan (automatic payroll deductions), tax benefits (tax-free earnings or taxdeferred contributions and earnings) and employer contributions.

Plan Documet

Details the specific plan provisions selected by the plan sponsor to meet retirement plan and business goals. The document also contains ERISA.

Title I of ERISA Requirements

Eligibility - minimum waiting periods to get into a plan are set by law and regulation and not only by the employer; Vesting - employees are entitled to their plan accounts based on a specific set of rules, and once they are entitled to that account, those monies always belong to the employee (and his or her beneficiaries); Reporting and disclosure - qualified plans must report plan information to the government and disclose plan information to plan participants and beneficiaries; Fiduciary standards - plan fiduciaries (employers and others responsible for the qualified plan) must operate the plan exclusively on behalf of participants and beneficiaries, using a prudent oversight process of the plan's operation, investments, service providers and service provider compensation.

Employee Benefits of Retirement Planning

Employee contributions can reduce current taxable income. Contributions and investment gains are not taxed until distributed. Contributions are easy to make through payroll deductions. Interest accrues over time, which allows small, regular contributions to grow to significant retirement savings. Retirement assets can be carried from one employer to another. The saver's credit may be available to some employees. Employees can improve financial security in retirement.

Pre-tax Contribution

Employee money contributed to a plan from a paycheck that is not taxed at the time it is contributed; it is taxed upon withdrawal.

401(k) Plan Attributes

Employees can contribute money from their paychecks on a pre-tax basis; Employee contributions may be matched by the employer; Employers can elect to make profit sharing contributions; Additional nondiscrimination tests to assure that contributions are not discriminating in favor of highly compensated employees. Employers can elect to make "safe harbor" contribution(s) that can eliminate the need for nondiscrimination testing

Salary Deferral Safeguards

Employees must make a written election (can be electronic) to defer (unless the plan provides for automatic enrollment). Employees must have the option to stop or change contributions at their election (although the frequency of those changes can be limited). Employee contributions are always 100 percent vested. Employers cannot require more than one of year of service to be eligible for 401(k) elective deferrals.

Business Benefits of Retirement Planning

Employer contributions are tax-deductible. Assets in the plan grow tax-free. Plan options are flexible. Tax credits and other benefits for starting a plan may help reduce costs. Retirement plans can attract and keep better employees, which reduces new employee training costs.

What kinds of laws and limitations must an employer follow when providing a retirement plan?

Employer-sponsored plans that are qualified are regulated by the DOL and the IRS under ERISA (the Employee Retirement Income Security Act). ERISA ensures that plans do not discriminate against lower-paid employees. It also requires certain notifications and disclosures, and sets limits on how much money can be contributed to the plan.

Are employer-sponsored retirement plans actually effective in helping people save for retirement?

Employer-sponsored retirement plans make it easy for individuals to save for retirement. Employees are much more likely to save through an employer-sponsored retirement plan than on their own.

401(k) Advantages

Encourage employees to save for retirement on a pre-tax basis May allow employees to select their own investments Employers have the option to provide a match on the employees' contributions Employers can elect to make profit sharing contributions

Qualified Plan Examples

Examples of qualified plans include 401(k) plans, 403(b) plans, defined benefit plans, profit sharing and other defined contribution plans.

Settlor Functions

Fred will make business decisions in selecting and designing his plan. These business decisions not only include considerations of the types of contributions Fred and his employees may make, but also whom should be covered by the plan. Settlor functions are not subject to the fiduciary rules of ERISA, which means Fred is free to select the plan and the design that is appropriate for himself and his business.

Profit-sharing advantages

Good for employers who want a qualified plan without the complexity of 401(k) rules Flexible contributions

Defined Benefit Plan Pros

Higher tax deductible employer contributions than DC plans Greater and faster retirement savings for owners and principal employees Guaranteed benefits in retirement

Catch-up Contributions

If a participant is age 50 or older, the participant can defer an additional amount in catch-up contributions. 15 Pre-tax, designated Roth, and after-tax contributions may all be catch-up contributions

Allowable Excluded Employees

Independent contractors, union employees, nonresident aliens

Employer-sponsored IRA plans Advantages

Individual participant accounts with monies that can be accessed more easily than 401(k) accounts Simplified documentation Limited government filing requirements Fewer requirements than ERISA qualified plans Less expensive to administer than qualified plans

Profit-sharing disadvantages

Limited design options for owner-driven plans Not as many design options as in 401(k) plans for participant-driven plans

401(k) Disadvantages

More complex operation and recordkeeping due to the multiple contribution types May have required employer contributions Specific tests unique to 401(k) plans

Installment

One of a specific number of payments that will be paid whether or not the recipient lives to receive them.

Participant Direction

Participants may choose from a selection of investments to determine how their account is invested.

Nonresident Aliens

Plans can also legally exclude nonresident aliens (an employee who is not a citizen of the United States and who receives no income on which they pay U.S. taxes). Fred's non-U.S. employees may or may not be excluded under the nonresident alien rule. If they receive U.S. income, they may have to be included in the plan. An experienced consultant and/or an ERISA attorney should review Fred's specific situation before assuming that the non-U.S. workers can be excluded from the plan.

Eligibility

Requirements set by the retirement plan for employees to be able to participate; may include a minimum age requirement and a required length of service.

What benefits does an employer receive by offering a retirement plan?

Retirement plans provide important benefits that help recruit and retain employees. Employers can deduct contributions they make to the plan from taxes.

The steps for starting a 401(k) are

Select service providers like an advisor and recordkeeper. A service provider will provide plan documents to the employer. This is when the employer customizes the features of its plan. The plan documents are to be signed or "adopted." The employer must communicate the plan to employees and eligible employees may begin participating in the plan. During enrollment, employees must receive certain notices.

Amendments that make "material" changes to the plan document must be accompanied by notice to participants in the form of a __________________________________ to the SPD.

Summary of material modification (SMM)

ERISA

The Employee Retirement Income Security Act, a law passed in 1974, covering employee benefit plans. It provides protection to participants of retirement plans.

Enrollment Process

The act of informing employees in plans with employee contributions of their entry into the plan and collecting required information from them. Information may be transmitted through a formal meeting, a packet of information, or an online platform.

Forfeiture

The benefits that a participant loses if he or she terminates employment before becoming eligible for full retirement benefits under the plan.

Entry

The date upon which an eligible employee becomes a plan participant. Entry dates are defined by the plan document and may occur semiannually, quarterly, monthly, or immediately after eligibility.

Termination

The dissolution of a plan, usually due to company merger, acquisition, closing or inability to pay plan expenses.

Plan Sponsor

The employer or group of employers (or in some cases another entity such as an employee organization, association, committee, or board of trustees) that establishes or maintains the plan.

Beneficiary

The individual designated by the participant to receive any benefits due to the participant in the event of the participant's death.

Union Employees

The law allows plans to exclude union employees who have retirement benefits outside the plan that were subject to good-faith collective bargaining. Most plan documents refer to these employees as collectively bargained employees.

Trustee

The party named in the plan or trust documents that is authorized to hold the assets of the plan for the benefit of the participants.

Distribution

The payment of benefits from a plan

Vesting

The percentage of a participant's accrued benefits to which they are entitled. Vested amounts may not be forfeited (see "forfeitures").

Vesting Schedule

The rate at which a participant gains ownership of employer contributions, expressed as a percentage based on the number of year of service by the participant.

Recordkeeper

The service provider responsible for tracking contributions, distributions, and investments for all participants in the plan.

Rollover Contributions

When employees are hired, or when they enroll in the plan, some plan documents will allow them to roll in monies from a previous employer's plan or certain IRA accounts.

Most employers elect to use a qualified plan document with two parts: an _________________________ and a _______________________

adoption agreement; base plan document

Pension Benefit Guaranty Corporation (PBGC)

an entity created by ERISA to insure benefits of defined benefit plans when a company's plan assets are inadequate to pay benefits. If the defined benefit plan is covered by the PBGC, the plan termination must be filed with and approved by the PBGC before benefits can be distributed. The PBGC offers different ways for DB plans that do not have enough assets to pay benefits to still terminate. A PBGC plan termination is a complex process, and employers and fiduciaries usually work with actuaries and other service providers to determine the type of termination required, and to file with the PBGC to terminate the DB plan.

The IRS imposes a "_________________________" test to determine if an employee is an independent contractor.

facts and circumstances

Plan terminations

occurs when businesses close or cannot afford the plan contributions and expenses associated with the plan. Plans can also terminate when businesses merge or are acquired by other firms.