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4-1
Chapter 4
Employer-Sponsored Retirement Plans
McGraw-Hill/Irwin
Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.
RETIREMENT PLANS
• Defined Benefits Plans
• Defined Contribution Plans
• Hybrid Plans
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PLAN CHARACTERISTICS
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Participation Requirements
Coverage Requirements
Vesting Rules
Accrual Rules
Nondiscrimination Rules Testing
Key Employee & Top-Heavy Provisions
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PLAN CHARACTERISTICS
• Minimum Funding Standards
• Social Security Integration
• Contribution & Benefit Limits
• Plan Distribution Rules
• Qualified Survivor Annuities
• Qualified Domestic Relations Orders
• Termination Rules & Procedures
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COVERAGE TESTS
• Ratio Percentage
– 70% of Participants NOT in Highly
Compensated Group
• Average Benefit Test
– Benefit Amount is 70% of Benefit Amount
for Highly - Compensated
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VESTING
• Cliff Vesting
– Vested after 3 Years Service
• Gradual Vesting
– 20% a Year After Year 2
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SAFE HARBORS
• Uniform Normal Retirement Benefit
• Uniform Post-Normal Retirement
Benefits
• Uniform Subsidies
• Uniform Vesting & Service Crediting
• No Employee Contributions
• Period of Accrual
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LIMITS & DEDUCTIONS
• Maximum Benefit
– $165,000, or
– 100% Highest Average for 3 Years
– $5,000 Indexed Starting 2006
• Employers with Less than 101
Employees Use Different Computation
Methods
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DEFINED CONTRIBUTION PLANS
• Employees & Employers Contribute
• Employers Invest Contributions in
Stocks and Bonds
• No Guarantee of Benefits Amounts
• Possible Types
– Profit - Sharing Plans
– Stock Bonus Plans
– Employee Stock Ownership Plans
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INDIVIDUAL ACCOUNTS SOURCES
• Employer’s Contributions a % of
Salary/Wages
• Employee’s Contributions a % of
Salary/Wages
• Forfeitures
• Return on Investments
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DEFINED CONTRIBUTION PLANS
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Section 401 (k)
Profit Sharing
Stock Bonus
ESOPs
SIMPLE
Section 403 (b) Tax Deferred Annuities
Section 457
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SECTION 401(k) PLANS
• Also Cash or Deferred Arrangements
(CODAS)
• Defer Income to Defined Contribution Plan
• For Employees of Private Sector or TaxExempt Companies
• Investment Gains Taxed when Received
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PROFIT – SHARING PLANS
• Fixed First $ of Profits - Specific % Pre After - Tax Annual Profits
• Graduated First - $ of Profits –
Contributions Increase as Profits
Increase
• Profitability Threshold – Contributions
Only When Profits Fall Within Limits
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STOCK BONUS PLAN
• Invest in Company Securities
• Must Meet Nondiscrimination Test
• Employees Vote May Like Shareholders
• May be Basis for 401 (k)s
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ESOPs
• Similar to Stock Bonus Plans Except:
– Borrowed Money to Purchase Stock
– Used Money for Other Business
– May be Leveraged or Nonleveraged
– Company Repays ESOP to Repay Loan
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SIMPLE
• For Companies with up to 100 Employees
& $5,000 in Compensation
• Must be Only Retirement Plan
• Can be IRAs or 401 (k) s
• Meet Nondiscrimination & Vesting
• Limits up to $10,000 in 2005
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HYBRID PLANS
• Combinations of Defined Benefit &
Defined Contribution Plans
• Types
– Cash Balance
– Target Benefit
– Money Purchase
– Age Weighted Profits Sharing
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TARGET BENEFIT PLAN
• Individual Accounts
• Total Benefits NOT Guaranteed
• Employers Use Actuarial Calculations
• Benefits Invested by Trustee
• Less Expensive for Employers
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MONEY PURCHASE PLANS
• Benefit Based on Account Balance at
Retirement
• Contributions Based on Formula
• Contributions NOT Tied to Company’s
Performance
• Excise Tax Penalties for Failure to Make
Contributions
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INTEGRATION METHODS
• Defined Benefit Plans
– Offset Approach
– Excess Approach
• Defined Contribution Plans
– Excess Approach
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EXECUTIVE RETIREMENT BENEFITS
• Earns $300,000
• 3 - Year Average $205,000
• Exclude $95,000 from Defined Benefit
Plan Formula
• Company May Set-Up a Nonqualified
Deferred Compensation Plan Based on
the $95,000
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TOP HAT PLANS
• Unfunded
• Created for Highly Compensated or
Other Select Groups
• Exempt from ERISA Title I
– Vesting
– Funding
– Fiduciary Responsibilities
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FUNDING MECHANISMS
• General Asset Approach (Unfunded)
• Corporate - Owned Life Insurance
(Unfunded)
• Split - Dollar Life Insurance
• Rabbi Trusts (Unfunded)
• Secular Trusts (Funded)
• Employee - Owned Annuities (Funded)
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RABBI TRUSTS
• Irrevocable Grantor Trusts
• Unfunded, Exempt from ERISA
• For Executives & Key Employees
• Payments from General Assets
• Assets Reimbursed from Trust
• Not Very Secure
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