Text Box: A LESSON IN QUALIFIED RETIRMENT PLANS The information contained in these page focuses on pension benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA), particularly those plans considered qualified for special tax considerations under the Internal Revenue Code. These plans are commonly referred to as “qualified plans.” Defined Benefit Plans A defined benefit plan promises to pay a specified benefit at retirement age. It defines the amount of retirement income to be paid. The actual monthly (or annual) income is calculated using a formula stated in the plan document. The benefit is usually payable at a specified time, such as attainment of age 65. Some plans also provide benefits upon the disability or death of the participant before retirement. Defined benefit plans usually express the benefit to be paid as an annuity, commencing at the plan’s normal retirement age, with payments ending at the death of the participant. This is known as a life annuity. An example of this type of defined benefit plan formula is: “…monthly income equal to 25 percent of the participant’s average compensation, commencing at age 65 and continuing for the life of the participant.” There are limitations on the amount of annual benefits that can be accumulated under defined benefit plans. As contrasted with a defined contribution plan, the employer assumes investment risk by agreeing to pay the specified benefit. Gains or losses on plan funds decrease or increase employer costs. Gains or losses do not affect the benefit payable to the participant. Since the enactment of ERISA, participants in most defined benefit plans are further guaranteed their benefits from the plan. This guarantee is provided through insurance, under a program administered by a government agency called the Pension Benefit Guaranty Corporation (PBGC). It should be noted that there are limits as to benefits covered under the PBGC’s termination insurance program. A decision to use a defined benefit plan as the retirement program depends upon the goals and objectives of the plan sponsor. The cost of funding a defined benefit program will depend upon the employee demographics. In general, if the employee population is older, the annual funding requirement is higher for the same benefits than if the employee group is younger. An employee closer to retirement age usually favors the guaranteed retirement income aspect of the defined benefit plan. Text Box: Combination of Plans for One Employer Often an employer will use a combination of defined benefit plans and defined contribution plans to provide retirement income for it’s employees. In this situation, an employee who participates in more than one plan of the same employer (or a related employer) cannot receive the maximum benefits permitted by law from each plan. There are complicated rules that limit the benefits and contributions an individual may receive from multiple plans of the same employer, even when one plan has been terminated previously. These rules eliminate the availability of both the statutory maximum defined benefit and defined contribution amounts for a single participant. Small employers frequently use both a money purchase plan and a profit sharing plan to provide benefits. This technique allows the employer to provide up to the maximum defined contribution allocations to participants, but also allows the employer to vary contributions according to profits. Text Box: Integrated and Non-Integrated Plans The plan design process begins with lengthy discussions between the employer/plan sponsor and the pension consultant to establish the feasibility, goals, and objectives of the proposed plan. One technique frequently used in plan design that considers employer FICA contributions is known as integration. Social Security provides income to most retired persons. During an employee’s working years the employer and employee share the cost of Social Security by paying a payroll tax commonly known as FICA (Federal Insurance Contribution Act). In 2000, an employee’s paycheck is reduced by 7.65 percent of wages up to $68,000 for FICA tax. The wage base used to determine FICA tax is called the Social Security Wage Base, or simply the Taxable Wage Base. When a plan considers the benefits to be provided under Social Security or the employer’s contributions to Social Security, as part of the formula for calculating the plan’s benefits or allocation of contributions, the plan is said to be integrated with Social Security. The Internal Revenue Code (IRC) refers to “permitted disparity” in describing the manner in which plans may be integrated. Bear in mind that the use of integration in a pension plan is intended to be a method by which the employer counts his or her FICA contributions for an employee as part of the employee’s total retirement benefits from the employer. Either defined contribution or defined benefit plans may employ this feature in plan design to facilitate the objectives of the employer. As a practical matter, an employer maintaining multiple qualified retirement plans utilizes permitted disparity in the design of only one plan. For example, it is common for an employer to maintain an integrated defined benefit plan and a non-integrated profit sharing plan.¨
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