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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