Qualified Plans/Retirement

Qualified Plans

Qualified Plans are used specifically by the Internal Revenue Code to designate certain retirement plans that meet the requirements of the codes. They include the following types of plans commonly used by employers: profit sharing plans, money purchase plans, defined benefit plans, Keoghs, stock bonus plans, annuity plans, bond purchase plans, cash or deferred arrangement (CODA)/401K plan, ESOP's or employee stock ownership plans.

These plans are highly promoted by the federal government as a supplement to the social security system. The tax benefits that they offer are much greater than other nonqualified retirement plans. These plans also cover the majority of employees in private businesses and corporations. The aggregate benefits of these plans at retirement sustain the livelihood of a large percentage of our retired workers.

 A recent study found that about 30% of corporate wealth in the United States is invested in retirement plan obligations, and the percentage is projected to increase to 40% and 50% in the next five and ten years respectively as our working population ages. A predominant percentage of the assets in these qualified plans are invested in securities;only a minor portion is invested in tangible properties such as real estate, gold coins, and precious metals.

Types of Retirement Plans

Defined Contribution Plans

These plans distinguish themselves by their contribution formulas. Their benefits accrue solely from: 

• a. amounts contributed to each participants account based on pre-set formula in relation to the participant's earnings, and 
• b. income, expenses, capital gains and losses per participant's account, and 
• c. shares of forfeitures from other participant's account due to nonvesting of benefit and other provisions in the trust document.

A defined contribution plan may be a profit sharing plan, money purchase, or a stock bonus plan. A profit sharing plan's contribution formula may be declared annually, and this allows the employer the flexibility to contribute any amount that its earning o reserve permits. The contribution formula for money purchase plans is set by the original adoption agreement or subsequent amendment to the trust documents. Therefore, the employer may be forced to contribute to the plan even in periods of low or negative cash flows.

All defined contribution plan contributions are based on a percentage of the employee compensation, usually the employee's W-2 wages if the company is on a calendar year basis.

Since the Tax Reform Act of 1986, profit sharing plans are no longer required to base their annual contributions on profit. Employers can contribute to employee accounts even if the company did not make any money for the year, so long as recurring contributions are intended to be made for future years.

Defined Benefit Plans

Any retirement plan other than a defined contribution plan is a defined benefit plan. These plans differ from defined contribution plans because the target retirement benefits of the plans are being used as factors to determine the current contribution levels for empoyees. Benefits are estimated by using the employee's years of service, compensation, and several other actuarial assumptions. They are never geared to the employer's profits as defined contribution plans are.

Actuarial assumptions are projections set up by mathematicians that specialized in statistics (actuaries) employed by insurance companies. They project benefits based on factors relating to the calculations on premiums, reserves, dividends, insurance, pension, and the annuity rates, using risk factors obtained from experience tables. These experience tables are compiled from both the companies' insurance claims history and other industry and general statistical data.

Defined benefit plans are usually more advantageous to older employees who are closer to retirement age, thus, having less time to accumulate the same benefits as other employees with similar earnings. 

General Qualification Requirements

•  A plan must be written, which is evidenced by the adoption of a plan and trust document. 

•  A plan must be in effect. Obtaining a "Determination Letter" from the IRS, and having plan assets go a long way in proving that the plan is in effect. 

•  A plan must be communicated to employees. This is easily accomplished by the delivery of "Notice to Employee" about the establishment of the plan, and a "Certificate of Participation" annually to the employees. 

•  A plan must be established by the employer. By signing the plan adoption agreement and corporate or business resolution, the employer agrees to set up a plan for the benefit of the employees. 

•  Contributions must be made by the employer, the employees or both. Contributions are usually made by the employer for the employees, but some plans also allow voluntary contribution by the employees up to the stature limitation. 

•  A plan must be for the exclusive benefit of the employees. 

•  A plan must be permanent. Any plan can be amended from time to time as circumstances change, but the plan must be for a permanent purpose. 

•  Any life insurance benefits must be incidental. The tax code limits on how much life insurance (term or whole life) an employee may purchase through his/her plan. 

•  Minimum participation standards must be met. This is especially emphasized in defined benefit and 401K plans. 

•  A plan must not discriminate in coverage. 

•  A plan must not discriminate in contributions or benefits on the basis of income or gender. 

•  Annuity payments under a plan must be available in the form of a joint and survivor annuity. 

•  Comprehensive vesting standards concerning the vesting of an employee's benefits must be followed. 

•  Minimum funding standards must be met. Contributions must be actuarially adequate to meet the projected benefit payments at retirement for defined benefit plans. An insurance policy from Pension Benefit Guarantee Corporation would have to be purchased to cover any future funding inadequacies. 

•  A plan must comply with the limitations on contributions and benefits. 

•  There must be no assignment of benefits. 

•  A plan must meet Social Security integration rules. Not all plans provide this integration. 

•  A plan must meet rules for merger, and consolidations. 

•  A plan must meet the rules for multi-employer plans. 

•  A plan must meet the rules pertaining to the reduction of benefits because of Social Security. 

•  A plan must fulfill plan termination requirements. 

•  A plan must fulfill special requirements for particular plans. 

•  A top heavy plan must contain contingency provisions. Top heavy and key employees in a plan creates special problems especially for small to medium sized plans.