Frequently Asked Questions Qualified Retirement Plans What is a qualified retirement plan? A qualified retirement plan is an arrangement hat meets specific requirements found in the Internal Revenue Code. If these requirements are met, the employer is entitled to a current deduction for plan contributions (within limits) and employees are not taxed on plan benefits until they are distributed. There are two general categories of qualified retirement plans: defined contribution plans and defined benefit plans. What is a defined contribution plan? A defined contribution plan provides for an individual account for each participant. The value of the participant’s benefit is the sum of contributions made to the account plus or minus any income, expense, gain or loss, and any forfeiture of accounts of other participants. Defined contribution plans include, but are not limited to, the following: a. Money purchase pension plans; b. Target benefit plans c. Profit sharing plans; and d. 401(k) plans What is a money purchase pension plan? A money purchase pension plan is a defined contribution plan in which the employer's contributions are mandatory and are usually based solely on a percentage of participants’ compensation. The obligation to fund the plan makes a money purchase pension plan different from other defined contribution plans. Failure to make a contribution can result in the imposition of a penalty tax. Contributions must be made, even if the employer has no profits. Retirement benefits are based on the amount in the participant's account at the time of retirement, i.e., whatever pension the money can purchase. What is a target benefit plan? A target benefit plan is a cross between a defined benefit plan and a money purchase pension plan. It is like a defined benefit plan in that the annual contribution is determined by the amount needed each year to accumulate (at an assumed rate of interest) a fund sufficient to pay a projected retirement benefit -- the target benefit -- to each participant on reaching retirement age. It is like a money purchase plan, in that the contribution is allocated to each participant’s account. If earnings of the fund differ from the assumed rate of interest, this does not result in any increase or decrease in employer contributions; instead, it increases or decreases the benefits payable to the participant. What is a profit sharing plan? A profit sharing plan is a defined contribution plan to which the employer agrees to make "substantial and recurring" contributions although generally discretionary. Amounts contributed to the plan are invested and accumulate tax deferred until distribution to participants or their beneficiaries either at retirement, or upon the occurrence of some specified event, such as, disability, death, or termination of employment. A profit sharing plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants. This formula may either be integrated, or non-integrated. An integrated formula provides an additional allocation for compensation in excess of a certain level. The integrated allocation formula and excess compensation level must be defined in the plan document. A non-integrated formula provides a pro-rata allocation, based on the ratio of each participant’s compensation to the total compensation of all participants. As with other defined contribution plans, retirement benefits in profit sharing plans are based on the amount in the participant's account at retirement. Unlike defined benefit plans, forfeitures in profit sharing plans arising from participant turnover may be reallocated among remaining participants. What is a 401(k) plan? A 401(k) plan technically is not a separate type of plan; it is a profit-sharing or stock bonus plan that contains a "qualified cash or deferred arrangement." (CODA) Under a qualified CODA, plan participants may elect to contribute a portion of their current compensation, on a pre-tax basis, to the plan. Such contributions are commonly referred to as salary deferrals or elective contributions. Special rules apply to 401(k) plans, including nondiscrimination requirements and limits on the amount an employee can elect to contribute. Employer contributions to a 401(k) plan can be either profit sharing contributions or matching contributions. Matching contributions are made to participants who make salary deferral contributions. Employers are not required to offer a match; however, many employers provide a match because doing so makes it easier for the plan to satisfy applicable nondiscrimination rules. What is a defined benefit plan? A defined benefit plan is any retirement plan that is not a defined contribution plan. Under a defined benefit plan, retirement benefits must be definitely determinable, e.g., a proposed monthly pension for life equal to 30% of monthly compensation. A plan formula is geared to retirement benefits; the annual contribution is usually actuarially determined; certain benefits may be insured by the Pension Benefit Guaranty Corporation; early termination of the plan is subject to special rules; and forfeitures reduce the employer's cost of providing retirement benefits. Fiduciary Bonding Requirements Who is a fiduciary? Plan fiduciaries include anyone who exercises authority with regard to the management of plan assets. These fiduciaries must act prudently and solely in the interest of participants and beneficiaries. What is the role of the "named fiduciary"? The plan must provide for one or more "named fiduciaries" who control and manage the operation and administration of the plan. Each plan must have at least one named fiduciary and, if plan assets are held in trust, the plan must have at least one trustee. Otherwise, no limits apply for the number of fiduciaries a plan may have. If the plan so provides, any person or group of persons may serve in more than one fiduciary capacity, including serving both as trustee and plan administrator. Also, a named fiduciary may appoint an investment manager to manage any assets; and a named fiduciary or a fiduciary may employ persons to render advice concerning any responsibility under the plan. What is a fiduciary bond? ERISA requires that a bond be established for most qualified plans for at least 10% of the current value of the plan assets. The minimum amount of the bond is the lesser of ten percent (10%) of the trust assets or $500,000. The amount of the bond is reported each year on the plan's Form 5500, Schedule H for large plans and Schedule I for small plans. Prior to April 17, 2001, small retirement plans (those with fewer that 100 participants) were exempt from engaging a Certified Public Accountant to audit the plan’s assets. Large plans have always been subject to this requirement. The Department of Labor recently issued new rules and regulations to increase the security of assets in small retirement plans. These regulations attempt to limit fraud and to provide participants with more information to monitor plan assets and fiduciaries. The new rules do not change the existing requirement of a fiduciary bond for up to 10% of the value of plan assets. Plans that cover only a sole proprietor and/or spouse, only partners in a partnership and/or their spouses or only corporate shareholders and/or their spouses are not subject to these new requirements. Plans of this type are not considered “employee” benefit plans under ERISA. However, if the business hires common law employees in the future, the plan will be subject to these rules at that time. As contributions are made and earnings accrue, the amount of the bond often must be increased due to these additions to plan assets. Therefore, we ask that this information be reviewed and updated annually. Who must be bonded under ERISA? A plan fiduciary and, in general, any other person who handles plan assets must be the subject of a bond which protects the plan assets against fraud, theft or dishonesty. What is the nature of the bond? The bond must protect the plan against loss by reason of acts of any direct or indirect fraud and dishonesty on the part of the fiduciary or the person handling the plan assets, alone or in conjunction with any other person. What are the penalties if a bond is not provided? Any violation may be the subject of a civil action brought by a participant or a beneficiary or the Secretary of Labor to enforce the requirement or to obtain other appropriate relief. And, in the case of any breach of any fiduciary responsibility, the Secretary of Labor may assess a civil penalty in an amount equal to 20% of the amount recovered with respect to the breach or violation of any fiduciary obligation. Discrimination Testing Questions What are ADP/ACP Tests? The ADP (Actual Deferral Percentage) and ACP (Actual Contribution Percentage) tests compare the average of salary deferral and employer match percentages (if any) of highly compensated employees (HCE) to the average of salary deferral and employer match percentages of non-highly compensated employees (NHCE). Eligible participants who did not contribute to the plan are included as zeros. HCE's include anyone who owns more than 5% of the company (regardless of income), the spouse, children, grandchildren or parents of a 5% owner, or anyone who received more than $90,000 in gross compensation from the employer in the previous year. If the plan fails these tests, corrections must be made by one of two methods: additional employer contributions, or refunds of contributions to HCEs. The Plan Administrator is responsible for deciding which method is to be used to correct the test. What is the top-heavy test? Each plan year, it must be determined whether your plan is "top-heavy." A plan is top-heavy if, as of the determination date, the total account value of key employees is more than 60% of the total account value of all employees in the plan. For 2003, a key employee is any employee who during the plan year was: (1) an officer of the employer who received more than $130,000 (adjusted for COL) in compensation from the employer, (2) a 5% owner of the employer, or (3) a 1% owner who received more than $150,000. When a plan is determined to be top-heavy, a minimum mandatory contribution by the employer is required on behalf of all non-key employees who are still employed as of the last day of the plan year. Top-heavy plans must provide a minimum contribution to non-key employees, generally being the lesser of (1) 3% of gross compensation, or (2) the largest contribution percentage received by any key employee. For this purpose, any salary deferral by a "key employee" is considered to be an employer contribution, but salary deferrals by non-key employees are not. As a result, a top-heavy 401(k) plan generally requires a 3% profit-sharing type of contribution by the employer in addition to any matching contributions. What are minimum coverage tests? The minimum age and service requirements of the Internal Revenue Code (IRC) set specific limitations on the maximum age and service conditions that can be used to exclude employees from a qualified plan. Plans that cover all employees meeting a 1-year service and age 21 requirement will generally satisfy the minimum coverage rules of the IRC. However, all employees meeting these requirements do not have to be covered under the plan. Employers are generally permitted to pick and choose plan provisions to direct benefits to a select group of employees as long as that coverage is not discriminatory in favor of the HCEs. These are called the "minimum coverage" rules. Plans generally are required to demonstrate each year that they are in compliance with these minimum coverage rules by satisfying the IRC requirements. Plan Participation Can we exclude part time employees? Per IRS guidelines, the maximum hours requirement for qualified retirement plans is 1000 hours per year. If a part time employee works less than 1000 hours in a year they may be excluded but if they work more than 1000 hours, they must be included in your plan.