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A
qualified retirement plan can provide many benefits
to employees as well as the sponsoring employer.
Employees are ultimately provided with income to
help sustain their lifestyle in their
post-retirement years. Employers are given a tax
deduction for contributions made to the plan, which
helps them provide a valuable fringe benefit and
boost employee morale.
In 1974 Congress passed the Employee Retirement
Income Security Act (ERISA), which provided much
needed protection for workers' retirement benefits.
That law, as well as applicable sections of the
Internal Revenue Code (IRC), established a host of
administrative rules which must be followed in order
for a plan to maintain its qualified status and
avoid excise taxes and fiduciary penalties.
Following is a summary of the ongoing compliance
requirements for qualified plans.
Nondiscrimination Testing
One of the basic requirements of a
qualified plan is that it not discriminate in favor
of employees who are considered "highly compensated
employees" (HCEs). HCEs are employees who own more
than 5% of the employer in the current year or the
previous year (including family attribution rules)
or who earned more than $90,000 in the previous
year.
Coverage Requirements
The first area of possible
discrimination involves the coverage requirements of
IRC section 410(b). This comes into play where a
plan is established for only a portion of the
employer's staff and not the entire company. Testing
is done on an annual basis to insure that the
percentage of the company's non-HCEs covered under
the plan is at least 70% of the percentage of the
company's HCEs that are covered. Alternatively, the
plan can pass a more complicated "average benefits
test" which illustrates that the benefits provided
do not discriminate in favor of the HCEs.
Employer Contributions
Money purchase pension plans and
profit sharing plans contain a formula for
allocating employer contributions, although in
profit sharing plans contributions are often
discretionary (optional) from year to year. Such
contribution allocations must not violate
nondiscrimination rules. While the formula
established under the plan generally must prohibit
discrimination, certain facts and circumstances need
to be considered each year. For example, a plan may
require employment on the last day of the plan year
to be eligible to share in the contribution, as well
as completion of up to 1,000 hours of service. But
if a significant number of employees who worked over
500 hours are eliminated from the allocation because
of these rules, the plan may be considered
discriminatory. This could result in having to
include some of the otherwise ineligible
participants in the allocation.
401(k) Plans
Plans that allow salary deferrals,
matching contributions and/or other employee
contributions must test these contributions for
discrimination at the end of each plan year (except
safe-harbor 401(k) plans). The ADP (actual deferral
percentage) and ACP (actual contribution percentage)
tests compare contributions made on behalf of the
HCEs with contributions made on behalf of the
non-HCEs. Generally, the HCEs are allowed an average
percentage that is somewhat larger than the average
for the non-HCEs. The differential varies depending
upon the non-HCE contribution level.
Plans that don't pass the ADP and/or ACP test
usually satisfy the test(s) through corrective
distributions, although other methods are available
such as making additional employer contributions. A
failed test must be corrected within 12 months of
the end of the plan year. However, corrective
distributions made more than 2½ months after the
plan year-end will be subject to a 10% excise tax.
Contribution and Benefit
Limitations
IRC section 415 provides the
maximum benefit and annual additions limitations for
each participant. For plan years beginning in 2004,
the maximum annual retirement benefit that can be
provided in a defined benefit pension plan is
$165,000. In defined contribution plans, the maximum
annual additions (i.e., total contribution and
forfeiture allocations) is the lesser of 100% of a
participant's compensation or $41,000. For benefit
and contribution calculation purposes, the maximum
compensation that can be utilized is $205,000.
The maximum salary deferral for 2004 is $13,000.
If permitted by the plan, those age 50 and older can
defer an additional $3,000 as a catch-up
contribution (even if it causes the annual additions
to exceed $41,000). In Simple 401(k) plans, the
maximum deferral is $9,000, and the catch-up limit
is $1,500.
The plan administrator must make sure that these
limits are not exceeded. Excess annual additions
must be distributed to the participant, reallocated
or transferred to a suspense account, in accordance
with the plan provisions. Excess deferrals must be
distributed by April 15th following the calendar
year of the excess. Since the deferral limit
includes all plans in which an employee participated
during the calendar year, it is the employee's
responsibility, if he participated in salary
deferral plans of more than one employer, to notify
such employers of any excess.
Top Heavy Testing
Each retirement plan must perform
an annual test to determine if it is "top heavy." A
plan is considered top heavy if key employees
(generally owners and highly paid officers) have
more than 60% of the total account balances (defined
contribution plans) or present value of accrued
benefits (defined benefit plans) of all plan
participants. The determination date for the
calculation of top heavy status is the last day of
the previous plan year.
If a plan is determined to be top heavy, the
employer must provide certain minimum contributions
or benefits, and meet one of the enhanced vesting
schedules.
Reporting Requirements
Form 5500 Annual Report
Most plan sponsors must file an
annual report, Form 5500, with the Department of
Labor by the end of the 7th month following the plan
year-end. The deadline may be extended an additional
2½ months by filing an extension. Where the owner of
the company is the only participant, the plan is
exempt from filing a Form 5500 until total assets of
all plans of the employer exceed $100,000.
Plans with 100 or more participants at the
beginning of the year ("large plans") are required
to attach an accountant's audit report to the Form
5500. An exception applies for plans with no more
than 120 participants that were able to file as a
small plan the previous year. Small plans are only
exempt from the audit requirement if 95% of the
assets are "qualifying plan assets" or if a fidelity
bond is purchased for non-qualifying assets and a
notice requirement is satisfied in the summary
annual report (see below). Qualifying plan assets
include assets held or issued by a registered
investment company or financial institution,
qualifying employer securities, participant loans
and participant-directed investments.
ERISA requires plan fiduciaries to obtain a
surety bond for at least 10% of the value of plan
assets. The amount of the bond in force must be
reported on Form 5500.
Form 1099-R
Distributions from qualified plans
are required to be reported to the IRS on Form
1099-R with a copy furnished to the participant.
This is true even if the distribution is nontaxable,
as in the case of a direct rollover to an IRA or
other qualified plan. Form 1099-R must also be filed
for a defaulted loan treated as a distribution. The
deadline for furnishing the participant's copy is
January 31st following the calendar year of
distribution.
PBGC Premiums
Defined benefit plans that are
subject to the federal government's PBGC (Pension
Benefit Guaranty Corporation) insurance program must
pay the required annual premium accompanied by the
appropriate PBGC forms. The deadline varies
depending upon the size of the plan and its funding
status.
Participant Notifications
Certain information must be
provided to participants throughout the year. Here
is a list of the necessary notifications:
Summary Annual Report: A summary of
Form 5500 must be provided to each participant
within two months of the 5500 filing deadline
(including extensions).
Summary Plan Description (SPD):
This document which summarizes the plan provisions
should be provided to new participants within 90
days of their plan entry date. The SPD should be
updated every five years if the plan has been
amended, or every ten years if no amendments have
been adopted.
Summary of Material Modifications:
When a plan amendment results in a material
modification of one or more plan provisions, an
explanation of the amendment must be provided to
participants within 210 days of the end of the plan
year in which the amendment was adopted.
Benefit Statements: Most plans
provide benefit statements to participants at least
once a year and, if not, are required to do so upon
request. Pension plans must automatically provide a
benefit statement when a participant terminates
employment or has experienced a one-year break in
service within 180 days of the close of the plan
year in which such termination or service break
occurred.
Safe-Harbor Notice: 401(k) plan
sponsors who elected to make safe-harbor
contributions to avoid ADP and ACP testing must give
out a safe-harbor notice within a reasonable time
before the start of the plan year. A notice
distributed between 30 and 90 days before the first
day of the plan year will automatically be
considered timely.
Distribution Forms:
Participants who are entitled
to a distribution of their benefits should be
provided with appropriate distribution forms as well
as tax and rollover information. Plans that contain
annuity distribution options must also furnish a
notice explaining spousal rights and comparing
equivalent values of optional forms of benefits.
Qualified Pre-Retirement Survivor Annuity
(QPSA) Forms: Plans that offer annuity
distribution options must provide a written
explanation of the QPSA and a waiver form to each
participant between the ages of 32 and 35. Where the
QPSA first becomes available after age 35 (as with
participants hired after that age), the materials
must be provided within one year of applicability.
Participants who terminate employment before age 35
should be notified within one year of separation.
Investment Information:
Many plans today,
particularly 401(k) plans, allow participants to
direct the investments in their accounts. In order
for plan fiduciaries to limit their liability for
poor investment results in such accounts, ERISA
section 404(c) requires that participants be given
the opportunity to exercise control over their
accounts. Consequently, they must be furnished with
sufficient information about the investments
available to them under the plan. Prospectuses and
other reports about available investments must be
provided on a regular basis (and upon request), and
statements showing account balances and activity
should be provided at least once every three months.
Blackout Notice: When investment
direction, loans or distributions will be
unavailable to participants, as in the case of the
transfer of plan assets from one custodian to
another, a blackout notice must be provided between
30 and 60 days before the blackout period begins.
Conclusion
There are numerous administrative
procedures and reporting requirements that must be
followed throughout the year to keep a qualified
retirement plan in compliance with ERISA and the
Internal Revenue Code. Failure to comply can result
in fines, excise taxes and even plan
disqualification. A properly administered plan can
be a valuable fringe benefit for employers and
employees.
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