Text Box: A LESSON IN QUALIFIED RETIRMENT PLANS The information contained in these page focuses on pension benefit plans under 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.” Stock Bonus Plans and Employee Stock Ownership Plans (ESOPs) A stock bonus plan is a profit sharing plan except that participants generally receive benefits from the plan in shares of company stock, although cash may be distributed. An employee stock ownership plan (ESOP) is another type of defined contribution plan that may be either a profit sharing or money purchase arrangement. In general, an employer makes a contribution to the plan that is then used to purchase stock of the employer. Alternatively, the employer may contribute its stock to the plan. To qualify as an ESOP, the plan must be invested primarily in the stock of the employer (“primarily” should be interpreted to mean more than 50 percent). A stock bonus plan differs from an ESOP in that it is permitted, but not required, to invest in stock of the company which sponsors the plan. In addition, an ESOP may borrow from the employer or use the employer’s credit in purchasing company stock. This is another distinction between the ESOP and the stock bonus plan. There are several unique rules governing participant distributions and tax deductibility of contributions that set the ESOP apart from profit sharing plans. Legislation enacted in 1989 (OBRA‘89) put new restrictions on ESOPs; however, most of the new rules affect plan design issues rather than administrative issues and are beyond the scope of this course. Text Box: Target Benefit Plans Target benefit plans are a cross between a defined benefit plan and a defined contribution plan. While a target benefit plan is truly a defined contribution plan, it contains a benefit formula similar to that of a defined benefit plan. The employer does not promise the amount to be paid at retirement. The target, or assumed, benefit is used only for determining the annual contribution. Each participant has an individual account in a target benefit plan. Gains or losses are allocated to the account and it accumulates in the same manner as a participant’s money purchase or profit sharing account. The benefit payable at retirement will be that benefit which can be provided by the actual account balance at retirement. This is true no matter the target, or assumed, benefit used for funding purposes. The ages of the participants are key factors in determining the amount of the contributions. Because contributions are age related, the target plan appeals to the older segment of the work force. In contrast, the contribution in a money purchase pension plan generally is based solely on compensation. This means that money purchase contributions for identically compensated employees are the same despite their current ages. The target benefit plan contribution varies based on both age and compensation. In all other respects, the target benefit plan operates as a money purchase pension plan. The plan sponsor must meet the minimum funding requirements and, therefore, a contribution is required each year. An actuarial certification is not required; however, the calculation of the required contribution is an actuarial calculation based upon the years remaining to the participant’s retirement date and the target benefit under the plan. Target benefit plans are often attractive because such plans allow an employer to avoid the complicated funding and accrual rules of defined benefit plans while striving to provide a certain level of retirement income to participants. Text Box: Thrift Plans Under the Internal Revenue Code (IRC), a thrift plan (or thrift savings plan) may be a money purchase or profit sharing plan. To participate in a thrift plan, an employee is required to make contributions. These contributions do not reduce the current taxable income of the participant, as do 401(k) elective salary deferrals. The employee must contribute after-tax dollars. Any employer contributions are used to match the employee contributions. Sometimes this will take the form of a 100 percent match, or a 50 percent match, etc. The plan document generally provides to what extent the employer has agreed to match employee contributions. Both the employee contributions and the employer matching contributions are subject to the Actual Contribution Percentage (ACP) test. Since not all employees will elect to make such contributions, the cost to the employer of the thrift plan is usually less than that of a pure profit sharing, or money purchase, plan. Thrift plans have become less common since the introduction of the 401(k) plan. Most employers and employees prefer the current tax savings of the 401(k) plan. There are certain nonprofit organizations whose tax status prohibits the sponsoring of tax-sheltered annuity plans (IRC §403(b)) or 401(k) plans. For these employers, a thrift plan is the only viable qualified salary savings plan available. Text Box: Other Types of Tax-Favored Savings Arrangements Tax Sheltered Annuities (TSA), Individual Retirement Accounts (IRA), and Simplified Employee Pensions (SEP) are other forms of savings arrangements. Their operation is similar to defined contribution plans. These arrangements are not considered qualified plans under IRC §401(a); rather, these arrangements are identified with separate sections of the Code. The provisions governing TSAs are contained in IRC §403. A TSA is often thought of as a not-for-profit organization’s version of a 401(k) plan. TSAs are not subject to the nondiscrimination tests of IRC §§401(k) and 401(m) if the program contains only the employee’s elective salary deferrals. If an employer makes other contributions to the TSA program, such as matching contributions, nondiscrimination testing must be performed. Any TSA program must be offered to all employees on a nondiscriminatory basis. A TSA plan is considered to meet this requirement if the plan is offered to all employees on the same basis; that is, the plan sponsor cannot select employees who are eligible to participate in the program. IRA and SEP provisions are set forth in IRC §408. SEPs are IRA arrangements, which are used by small businesses or sole proprietorships to avoid the complications of plans qualified under IRC §401(a). The laws governing eligibility, participation, vesting, and contribution requirements for SEPs are less flexible than those of §401 (a) qualified plans. The tradeoff is that SEPs usually are not subject to the governmental filing, notification, documentation, and qualification requirements of IRC §401(a) qualified plans. These descriptions are not intended to be all-inclusive, but merely to acquaint you with other tax-favored savings arrangements that are available.¨
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