Retirement Plans
General Rules and Regulations
Employer-sponsored retirement plans have become a necessity for any employer looking for a competitive advantage when hiring new staff, and a valuable way to reward profitability and hard work. In some cases, an employer-sponsored retirement plan may be the only financial investment an employee makes in their future. Retirement plans allow eligible employees to reduce their immediate take-home salary through pre-tax contributions through a variety of retirement plan options. The employee gets the benefit of reducing taxable income today, while allowing the contributions to grow tax-deferred in a personal retirement account until they are ready to retire. The recent addition of a Roth provision to selected retirement plans also allows the contributions to be made after-tax. This is a desirable feature for younger, more highly paid individuals. Retirement plans can be very affordable to administer and are usually a valuable recruiting tool to attract the best employees, since employers can reward employees by providing a match or profit sharing contribution. Retirement plans are governed by ERISA, the Employee Retirement Income Security Act of 1974, and are subject to review and guidance by both the Internal Revenue Service and Department of Labor. A Form 5500 is required to be filed annually, and plans are usually subject to annual nondiscrimination testing. We can provide resources to help you administer and maintain your retirement plan to ensure compliance.
401(k)
Easily the most popular retirement plan, a 401(k) plan can be implemented by companies of all sizes, from sole proprietors and self-employed individuals to large, publically traded firms. 401(k) plans can be customized to include a wide variety of employer contributions, such as a match or profit sharing contributions.
Salary Deferrals
An employee may contribute the lesser of 100% of their compensation or $16,500 to a 401(k) plan in 2009. If the employee is over age 50 or becomes age 50 during 2009, the employee may contribute another $5,500 to the 401(k) plan. Some plans may impose lesser limits within the plan document or summary plan description, so it is important to check with your plan administrator. Additionally, highly compensated individuals and key employees may be subject to additional limitations. Traditional salary deferrals have always been pre-tax contributions to the retirement plan. Since January 1, 2006, retirement plan administrators have been able to amend their plans to include a Roth provision. Roth salary deferrals are contributed to the plan after taxes have been withheld. Contributions then will grow tax-free until the participant is eligible to withdraw the funds, and the earnings are also tax-free. The allowable contribution limits allowed annually are the same for Roth deferrals and pre-tax salary deferrals.
Match
If an employer decides to offer a match as part of its 401(k) plan, it may be discretionary and vary from year to year. A discretionary match may have additional requirements, such as the employee must work 1,000 hours during the year or be employed on the last day of the plan year. These requirements can generally be customized as each employer wishes, but are subject to federal guidelines. A discretionary match can also be subject to a vesting schedule, but can be no more restrictive than a six-year graded or three-year cliff schedule. Both schedules are shown in the table below:
| 1 |
0% |
1 |
– |
| 2 |
20% |
2 |
– |
| 3 |
40% |
3 |
100% |
| 4 |
60% |
|
|
| 5 |
80% |
|
|
| 6 |
100% |
|
|
The company may also specify the matching percentage that will be made through a Safe Harbor contribution, which means that employees are notified 30 days ahead of the plan year so they have enough time to participate in the match. Safe Harbor contributions are always 100% vested immediately and typically follow a pre-determined format, such as 100% match up to 3% of the employee's compensation. Safe Harbor contributions are attractive to companies who may find they are struggling to pass certain required testing, since Safe Harbor plans are generally exempt or automatically pass with the Safe Harbor provision in place. An hours requirement or last-day employed stipulation is not allowed in a Safe Harbor plan.
Profit Sharing
Instead of having a separate profit sharing plan, it is possible to include a profit sharing provision within a 401(k) plan. Once a company has determined a dollar amount or percentage to fund to each eligible employee's account, it can be allocated in a salary proportional manner, meaning that each employee will share in the same percentage of their salary. It is very important in these plans to ensure that the definition of compensation used to calculate the profit sharing contributions matches the definition of compensation as defined in the plan document or summary plan description.
Another popular method is the FICA integrated, or "Permitted Disparity" profit sharing formula. This method of allocating a profit sharing contribution allows slightly higher contributions to be funded to employees who have compensation that exceeds the Social Security taxable wage base. The ideology behind this is that they will not have the benefit of social security wages to supplement their income at retirement. The formulas change each year and it is generally recommended that a third party administrator perform the allocation requirements to ensure accuracy.
Age-weighted profit sharing plans use a combination of age and compensation to determine each eligible employee's contribution amount. This is a beneficial formula to use for older employees or owners who have less time to accumulate wealth before their retirement. However, there has been a shift away from age-weighted towards the New Comparability profit sharing model, which can accomplish the same goal. A new comparability plan allows a company to separate employees into non-discriminatory groups (such as hygienists, nurses, and dentists) and give a separate contribution amount to each group, with an objective to give the highly-paid owner the highest allowable contributions while minimizing the required contribution to the staff members. This method can be very attractive to a wide variety of business owners, but does require additional testing and complex calculations. It is imperative that these are performed with accuracy on an annual basis.
Loans and Hardships
A 401(k) plan can be designed to include a provision for loans and/or hardships to be taken by participants. Limitations and guidelines for both loans and hardships are required to be followed by plans subject to ERISA, but a plan may impose more stringent requirements. Both loans and hardships should be monitored to ensure compliance with federal requirements.
403(b)
A 403(b) plan functions in much of the same manner as a 401(k) plan, with the exception of who is able to participate in the plan. A 403(b) plan designed for employees of public schools, employees of certain tax-exempt organizations through IRS Code 501(c)(3), and certain ministers. The investments in a 403(b) plan are generally in the form of annuity contracts or mutual funds.
Previously, 403(b) plans were exempt from many of the document, recordkeeping, and reporting requirements that other retirement plans were subject to. However, with the passage of the Pension Protection Act on August 17, 2006, this changed. Most 403(b) plans are now required to maintain plan documents, and file annual Form 5500s.
Additionally, 403(b) plans are now required to have a vesting schedule not to exceed six-year graded or three-year cliff for both profit sharing and matching contributions. Employee contributions to the plan are always immediately 100% vested.
FAQs
Where can I learn more about how my specific 401(k) works?
Talk to your plan administrator or ask them for a copy of your plan's Summary Plan Description.
What information is my employer required to provide to me?
A Summary Plan Description must be provided within 90 days of becoming eligible for the plan. Updated SPDs must be distributed every five years if changes are made or the plan is amended, otherwise they must be furnished every 10 years.
A Summary of Material Modifications must be provided when a material change is made to the plan automatically to participants and pension plan beneficiaries receiving benefits; not later than 210 days after the end of the plan year in which the change is adopted.
A Summary Annual Report is provided automatically to participants and pension plan beneficiaries receiving benefits within nine months after end of plan year, or two months after due date for filing Form 5500 (with approved extension).
When can I withdraw my retirement plan income?
Generally, you must wait until you are at least 59 ½ to avoid the 10% early withdrawal penalty.
Under what circumstances can I take a hardship distribution?
Each plan is different. Some plans may not allow hardship distributions. You should always verify that your plan allows hardship distributions by reviewing the Summary Plan Description (also known as an SPD). Federal law requires one of the following conditions to be met in order to take a hardship distribution.
- Un-reimbursed medical expenses for you, your spouse, or dependents
- Purchase of a principal residence
- Payment of college tuition and related educational costs such as room and board for the next 12 months of post-secondary education for you, your spouse, dependents, or children who are no longer dependents
- Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence
- Payment for burial or funeral expenses for the employee's deceased parent, spouse, children or dependents
- Expenses for the repair of damage to the employee's principal residence that would qualify for the casualty deduction
Will a 401(k) loan appear on my credit report?
Loans from your 401k are not reported to the credit-reporting agencies, but if you are applying for a mortgage, lenders will ask you if you have such loans and they will count the loan as debt.
Additional Resources and References
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