InFRE Retirement Plan Administrator Series Review Fundamentals of Retirement Plan Design. Presenter Mary Willett, Willett Consulting

Transcription

1 InFRE Retirement Plan Administrator Series Review Fundamentals of Retirement Plan Design Presenter Mary Willett, Willett Consulting

2 Workshop Overview A basic understanding of the design and features of defined benefit (DB) and/or defined contribution (DC) retirement plans is necessary for all parties responsible for the program and, in particular, those who have a fiduciary role. This workshop provides an overview of all the various types of retirement plans and is designed to meet the needs of plan administrators, board or committee members and other fiduciaries. 1/1-1

3 Course Agenda Introduction to Retirement Plans Compensation Planning and the Role of Retirement Plans Key Legislation Rules Governing Qualified Plans Defined Benefit Plans Defined Contribution Plans Part I and Part II Hybrid Plans Governmental and Non-Profit Employer Plans Keogh Plans, SEPs and IRAs Nonqualified Deferred Compensation Plans Implementing a Retirement Plan 1/1-2, 3

4 Chapter 1 Introduction to Retirement Plans

5 Background First retirement plans date back to late 1800 s Industrial revolution was key factor in the development of public and private plans In 1871, public retirement plans became mainstream in Germany Participation was mandatory Workers and employers were required to contribute Workers may be entitled to benefits at age 70 1/1-4, 5

6 The U. S. Experience In 1934, Committee on Social Security proposed a program that would Cover workers up to a certain income limit Require both employer and employee contributions Assets be held in trust to guarantee benefits Social Security Act of 1935 was enacted with normal retirement age set at 65 In 1937, changes from trust to pay-as-you-go system 1/1-6, 7

7 Qualified Retirement Plans IRC Benefits Contributions are tax deferred Investment earnings are tax deferred Corporate employer receives tax deduction Compliance Plans that fail to comply with laws and regulations can be disqualified 1/1-8

8 Basic Requirements Plan and Trust Documents Custom plan document Master and prototype plan Volume submitter plan Certain disclosures are required by ERISA State statutes and/or constitution may establish plan as permanent Plans cannot be discriminatory 1/1-8-11

9 Basic Requirements Vesting: participants absolute right to receive future benefits Benefit accruals cannot be reduced or stopped The IRC sets annual contribution and benefit limits Distributions are subject to IRC rules 1/1-11, 12

10 Nonqualified Deferred Compensation Plan (NQDC) Fails to meet one or more requirements of a qualified plan; may be discriminatory May provide additional benefits to key employees; often used in combination with a qualified plan Section 457 plans are a form of nonqualified plan Section 457(b) eligible governmental deferred compensation plan Section 457 (f) ineligible plan 1/1-12, 13

11 NQDC Plans Advantages ᅳ Easier than qualified plans to implement and administer ᅳ Attractive for key employees ᅳ Fewer compliance rules Disadvantages ᅳ Less favorable tax treatment for employee ᅳ Income taxes due when benefit is vested and/or payable ᅳ Fewer legal protections for employee 1/1-13

12 Retirement Plan Categories Plans generally fall into three broad categories Defined benefit plan (DB) Defined contribution plan (DC) Hybrid plan 1/1-14

13 Defined Benefit Plans Retiree benefit levels established in the plan document Formula based on service/earnings Employer responsible to fund the benefit Contributions determined by actuarial analysis Employer invests trust assets Earnings/losses impact level of contributions 1/1-15

14 Defined Contribution Plans Individual accounts are established; value determines retiree benefit Participant makes investment decisions and investment gains/losses impact account value Often considered supplemental benefit in public sector 1/1-16, 17

15 Hybrid Plans Combine features of defined benefit and defined contribution plans Money purchase plan Target benefit plan Cash balance plan Floor offset plan DB(k) plan (private sector only) 1/1-17, 18

16 DB versus DC Growing trend to replace DB with DC plan ᅳ Employer cost can be lower in DC plan ᅳ Employer has more flexibility on contributions ᅳ Employees have control over investments ᅳ DC plans offer more portable benefits 1/

17 Public Sector Plans Subject to IRC qualification rules Exempt from ERISA Primary benefit generally is a DB plan DC plans often provided as a supplement Section 457(b) governmental plans Section 403(b) tax sheltered annuities 1/1-20

18 Plan Administrator s Role Person responsible for design, administration and plan management Functions may be outsourced or handled by inhouse personnel Administrator is generally a fiduciary Responsibilities may involve Record keeping Reporting and disclosure Management of plan assets 1/1-21

19 Fiduciary Responsibility Many individuals/parties may be considered a fiduciary to the plan Fiduciary responsibilities are defined in federal and state laws; ERISA for private sector plans Assets must be held in trust, with trustee being a named fiduciary Investment managers and record keepers may also have a fiduciary duty to the plan 1/1-21, 22

20 Plan Trends Future of DB plans Auto everything in DC plans Disclosure of plan costs and expenses Investment education and advice Technology enhancements Simplified investment choices in DC plans 1/

21 Retirement Crisis Shift away from DB plans and guaranteed benefits Aging of the workforce Potential changes to Social Security Workers are not prepared for retirement Legislative and regulatory activity increasing Next big issue: managing retirement income accumulated in DC plans 1/

22 Recap: Introduction History of retirement benefits and Social Security Qualified versus nonqualified plans explanation Defined benefit and defined contribution plan basics Plan administrator and fiduciaries role Trends and their importance to plan administrators

23 Chapter 2 Compensation Planning and the Role of Retirement Plans

24 Human Resource Management Functions may include ᅳ Planning and forecasting ᅳ Recruitment and selection ᅳ Training and development ᅳ Performance evaluation ᅳ Compensation/benefits 1/2-4

25 Compensation Administration Influenced by ᅳ Other governmental benefits ᅳ Local labor force ᅳ Company's requirements for skills, knowledge, and abilities ᅳ Federal and state legislation 1/2-6

26 Design of Benefits Packages Employer s philosophy on retirement and other benefits Employer s belief in compensation equity Goals may be to Reward loyalty and long-term service Reward performance Compete for skilled workers 1/2-7

27 Benefits Administration Designing and managing benefits by ᅳ Controlling and evaluating benefit costs ᅳ Selecting and introducing new benefits ᅳ Communicating benefit information ᅳ Evaluating benefit procedures ᅳ Administering and monitoring compliance with state and federal laws 1/2-8, 9

28 Retirement Benefits Establish employer objectives for plan design Identify types of plans that meet objectives Evaluate feasibility, advantages, and disadvantages of alternate plans Forecast costs and benefits Identify a process for selecting and administering a plan or plans 1/2-10

29 Defined Benefit Plans Provide a guaranteed benefit at retirement Reward long-term employees Can fund additional benefits (disability, death, etc.) Can be more complex, costly, and potentially difficult to communicate 1/2-10,11

30 Defined Contribution Plans Individual accounts are established; value determines retiree benefit Participant makes investment decisions and investment gains/losses impact account value Often considered supplemental benefit in public sector 1/1-16, 17

31 Hybrid Retirement Plans Combine features of both DB and DC plans Often provide minimum guaranteed benefit and cash balance component Can provide employer with additional flexibility in structuring benefits and compensation package 1/2-13

32 Role of Social Security Covers approximately 75% of public sector employees Benefits are designed to replace about 42% of average lifetime earnings Retirement age is increasing from 65 to 67 Employer cost must be considered in total compensation package 1/2-13, 14

33 Employee Benefit Statistics Job market cycles are important to understand when evaluating compensation packages Bureau of Labor Statistics conducts two surveys providing important statistical information Employee Benefits Survey Employment Cost Index Survey 1/2-15

34 Recap: Compensation Planning Human resource and benefits management Benefits design is an important part of compensation planning Type of plan can provide advantages in workforce management Employee demographics and workforce statistics are important considerations

35 Chapter 3 Key Legislation

36 Legislative History Understanding historical changes can help you Interpret plan requirements Flag outdated plan provisions Evaluate proposed legislation that may affect current and future benefits 1/3-3

37 Historical Legislation Social Security Act of 1935 created Social Security and Medicaid The Employee Retirement Income Security Act of 1974 (ERISA) regulates the administration of private sector retirement plans Tax Reform Act of 1986 (TRA) established faster minimum vesting schedules, changed Social Security integration rules, and amended coverage rules 1/3-4, 5

38 Historical Legislation Uniformed Services Employment and Reemployment Rights Act of 1994 (USERRA) prohibits discrimination against employees called into service Small Business Job Protection Act of 1996 (SBJPA) provided pension simplifications to ease governmental plan compliance with federal tax laws Taxpayer Relief Act of 1997 impacted many types of retirement plans and enacted a permanent moratorium on discrimination testing in governmental plans 1/3-6

39 Historical Legislation Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) - changed virtually every type of retirement plan in some way Sarbanes-Oxley Act of 2002 addressed corporate governance, disclosure and accountability Pension Protection Act of 2006 (PPA) significantly impacted qualified defined benefit (DB) plans and provided incentives for employers to enhance defined contribution (DC) plans 1/3-7, 8

40 Current Legislative Issues Social Security Reform Disclosures of plan fees and costs Portability and distributions Consolidating retirement assets Lifetime income distributions Investment education and advice 1/3-8-11

41 Qualified Plan Requirements Internal Revenue Code ᅳ Creates rules and requirements for qualified plans to Maintain favorable tax treatment Ensure benefits are available to workers when they retire Make plans non-discriminatory 1/3-12, 13

42 ERISA Safeguard pension rights of plan participants and beneficiaries Ensure benefits would be available when a participant retired Make sure that participation, coverage, and vesting schedules were attainable Ensure greater reporting and disclosure requirements on employee benefit plans 1/3-14, 15

43 Covered Plans and Employers Covered plans are corporate employers that Engage in commerce; industry or activity relating to commerce Represent employees of companies engaged in commerce, related industry or activity Exempt plans Governmental plans (federal, state or local) Certain tax-exempt church plans Plans maintained outside the United States Nonqualified plans 1/3-15, 16

44 Fiduciary Responsibility Although state and local governments are exempt from ERISA, fiduciary standards are often found in state laws and/or local ordinances Fiduciary standards Safeguard plan assets Ensure the plan is administered for the exclusive benefit of participants and beneficiaries Apply to all actions of a fiduciary whether they involve managing plan assets or plan administration A fiduciary may be personally liable for any losses resulting from a breach of duties 1/3-17, 18

45 Trust and Investment Requirements Pension assets must be held in trust Not applicable to all participant-directed plans Investment decisions generally must follow the prudent expert rule Plan assets may not be used for anything other than Paying benefits to participants / beneficiaries Paying reasonable expenses 1/3-18, 19

46 Reporting and Disclosure Form 5500 Detailing plan assets and liabilities, plan changes, and participation and coverage statistics. Summary Plan Description (SPD) Providing plain language explanation of the plan and its rules Summary of material modifications (SMM) Describing any material modifications to the plan Individual participant benefit statements On a frequency dictated by plan type; Containing latest information on benefits 1/

47 Sanctions and Penalties IRS, DOL and courts enforce laws governing retirement plans Fiduciaries can be held legally responsible for actions Tax status of plan assets can be jeopardized 1/3-23, 24

48 Recap: Key Legislation Understanding historical legislative and regulatory initiatives can help you better understand your current plan Public sector plans are subject to federal tax laws and regulations governing retirement plans and benefits Although public sector employers are not subject to ERISA, similar laws are often adopted in state or local laws

49 Chapter 4 Rules Governing Qualified Plans

50 Background Benefits of qualified plan status Earnings on plan assets accrue on a tax-deferred basis Taxes on plan benefits are deferred until distributed to the plan participant Employee contributions may be made from pre-tax earnings Tax deductions for employer paid contributions (corporate employer plans) 1/4-3

51 Plan Must be in Writing IRS favorable determination letter provides assurance to employer that the plan meets IRC qualification rules Plan document may be instituted through Custom plan: specific to the employer plan Master and prototype plan: generic plan preapproved by IRS Volume submitter plan: hybrid between custom and prototype plan 1/4-4, 5

52 Assets Must be Held in Trust For the exclusive purpose of providing benefits Assets may be used to pay reasonable plan expenses Administrative costs Investment management fees 1/4-6

53 Basic Requirements Terms and requirements of the qualified plan must be communicated to employees Within 90 days after the employee becomes a participant, - or 120 days after the adoption of the plan Plan must be permanent State laws may set forth contractual rights of participants 1/4-6

54 Nondiscrimination Rules Qualified plans cannot discriminate in favor of highly compensated employees State and local government plans are exempt from nondiscrimination testing For employers with multiple plans, each qualified plan is generally tested separately and independently 1/4-7-9

55 Eligibility Requirements Must be defined in plan document Minimum age and service requirements Covered after reaching a certain age and/or Completing one year of service Exclude certain categories of employees 1/4-10, 11

56 Vesting Rights Employees must be vested or have a non-forfeitable right to the benefit within a specified period of time. Five year cliff vesting Three-to-seven year graded vesting Years of Service Vesting 1 0% 2 0% 3 20% 4 40% 5 60% 6 80% 7 100% 1/4-11,12

57 Benefit Accrual Rate that benefits are earned by employees in a retirement plan In a DC plan, the accrued benefit is the participant s account balance In a DB plan, the accrued benefit is the present value as determined by the benefit formula established by the plan 3% rule 133 1/3% rule Fractional rule 1/

58 Distribution Requirements Subject to Sec. 401(a)(9) minimum distribution requirements Distributions are taxable in the year the income is received Subject to mandatory 20% withholding unless rolled into another eligible account 1/4-16

59 Distribution Requirements Qualified joint and survivor annuity (QJSA) applies to married participants Qualified preretirement survivor annuity (QPSA) applies to married participants who dies before retirement benefits are initiated Qualified domestic relations order (QDRO) divides a participant s rights and benefits 1/4-17

60 Elective and Catch-Up Contributions Annual elective deferral limits are subject to Section 402(g) Optional provision to permit participants age 50 and up to make an additional elective contribution Limits are updated each fall and posted on IRS Web site at /4-20

61 Recap: Qualified Plans Basic plan requirements Coverage and participation rules Eligibility and vesting Distributions Maximum contribution and benefit limits

62 Chapter 5 Defined Benefit Plans

63 Background Single employer, multiemployer, multiple employer plan Pension Benefit Guarantee Corporation insures private sector DB benefits Public sector benefit guarantees are normally found in state statutes or constitution DB plans decreasing in private sector; public sector continuing to retain as primary benefit 1/5-4

64 DB Plan Attributes Income replacement plans that provide a predictable and secure benefit for life Employer must contribute a sufficient amount to fund current and future benefits Contributions must be held in trust for the exclusive benefit of participants and beneficiaries Employer bears investment risk 1/5-5

65 Why Consider a DB Plan? Retain skilled employees Reward longer-term employees Motivate employee behavior e.g., early retirement window Potential to lower employer contributions through favorable investment performance 1/5-6

66 Normal Retirement Age NRA is the age a participant receives an unreduced benefit Cannot be later than age 65 or the fifth anniversary of date employee became a participant Can be as early as age 50 for a system covering qualified public safety employees 1/5-7, 8

67 Early Retirement Age Generally subject to minimum age and service requirement Produces a reduced benefit because Full value of benefit has not yet accrued Duration of benefits will be longer based on the earlier age 1/5-9

68 Benefit Calculation Formulas generally consider employee earnings Final pay or career pay Benefit formulas are Percentage of earnings per year of service (unit benefit or unit credit plan) Flat amount formula (fixed benefit plan) Flat percentage of earnings / flat amount per year of service (flat benefit plan) 1/

69 Permissive Service Credit Employees are permitted to buy additional years of service considered in benefit calculation Service that can be purchased includes: Qualified: attributed to military service, service performed for other governmental employers, certain leave periods where no service was granted Nonqualified: airtime, service used in calculation of benefits from another employer 1/5-13

70 Permissive Service Credit Employees are permitted to buy additional years of service considered in benefit calculation Service that can be purchased includes: Qualified: attributed to military service, service performed for other governmental employers, certain leave periods where no service was granted Nonqualified: airtime, service used in calculation of benefits from another employer 1/5-13

71 Death and Disability Benefits Ancillary benefits are optional, but typically part of a DB plan design Benefits are funded through the DB plan trust Death benefits must be incidental to the plan s primary purpose of providing retirement benefits Disability benefits are normally provided on a self-funded basis 1/5-14, 15

72 DB Plan Funding Trustee is responsible for: Administration & investment of trust assets Investment earnings Payment of benefits Employer contributions are required to fund the benefit Employees also may be responsible for a portion of the required contribution 1/5-16

73 Actuarial Assumptions Actuarial analysis determines rate of contributions to fund promised benefits Assumptions have a direct impact on contributions Employee demographics Benefit assumptions Interest rate applied on trust assets Current and future employee earnings 1/5-20, 21

74 Actuarial Cost Methods Accrued benefit cost method: used primarily for unit benefit formula Projected benefit cost method: characterized as level cost method Method determines the contribution required to meet funding standards 1/5-21, 22

75 Deferred Retirement Option Plan Provides flexibility to employees as they reach retirement age Encourages continued employment beyond retirement age Additional costs to fund benefits may be difficult to determine Advantages and disadvantages need to be closely examined 1/

76 Recap: Defined Benefit Plans DB plan attributes Normal retirement age and benefit formulas Death and disability benefits Funding the benefit Actuarial analysis

77 Chapter 6 Defined Contribution Plans Part I

78 Profit Sharing Plan Requirements Subject to IRC and ERISA requirements for qualified DC plans Tax advantages apply to employers and employees Goals of a profit sharing plan includes Motivate employee performance Enhance employee benefit package Permit flexibility in determining contributions 1/6-4, 5

79 Profit Sharing Plan Requirements Must be maintained for exclusive benefit of employees and beneficiaries Cannot discriminate in favor of highly compensated employees Typically less restrictive eligibility requirements than other plan types 1/6-5

80 Contributions Employers can vary contributions from year to year Contributions must be recurring and substantial or risk plan termination Annual employer contributions may either be determined by formula or a discretionary approach Sec. 415 annual addition limit applies 1/6-6, 7

81 Profit Sharing Plan Features Distributions are typically more flexible than other qualified plans Distributions are taxed as ordinary income in the year received May purchase life, health, and accident insurance as part of its benefits, but must be considered incidental to the plan 1/6-8, 9

82 Stock Bonus Plans It s assumed that plans will invest exclusively in employer stock Participants must be given the choice of benefits either in cash or employer securities This plan is a necessary component of an employee stock ownership plan (ESOP) A profit sharing plan cannot be an ESOP 1/6-10

83 Specific Requirements Purpose of the trust is to buy and hold employer stock Voting rights for shares of employer securities must be passed through to plan participants, referred to as pass-through voting Participants must be given the right to receive benefits in the form of employer securities 1/6-11

84 Employee Stock Ownership Plan Employees are owners of company stock Employers receive tax deduction for dividend payments Employers can borrow to purchase securities Benefits are directly tied to company s performance Must allow certain employees the option to diversify 1/

85 Chapter 7 Defined Contribution Plans Part II

86 Auto Enrollment Employees automatically enrolled in the plan unless they opt out Proven to improve employee participation in elective deferral plans IRC and ERISA provide guidance on this plan design Participants who are automatically enrolled have 90 days after first deferral to receive a refund of deferrals 1/7-4, 5

87 Automatic Deferral Requirements DOL published guidance for qualified automatic contribution arrangement Minimum deferral with auto escalation Requirements on employer matching contributions Employer contributions must vest within two years Certain notices and disclosures are required 1/7-5, 6

88 Default Investment Option DOL established requirements for a qualified default investment alternative Default must be one of the following Target date or lifecycle fund Balanced fund Managed account Although safe harbor does not apply to public sector, typically considered best practice guidance 1/7-6

89 Challenges for Public Sector State law changes may be needed Payroll and enrollment process may need to be automated which can be difficult in large, governmental employers with decentralized payroll systems Defined benefit often requires employee contributions and auto enrollment seen as another mandatory contribution 1/7-7, 8

90 Investment Advice 2006 Pension Protection Act addressed investment advice in defined contribution plans subject to ERISA Defined a qualified fiduciary adviser as A registered investment adviser A bank or similar financial institution An insurance company qualified to do business under State law. A registered broker or dealer 1/7-9

91 Investment Advice Rules Fee-Leveling Advice Fees cannot vary based on recommendations Must be based on generally accepted investment theories Take into account fees and expenses Specific participant information must be considered Computer Model Advice must follow above and Cannot be designed to favor certain investments Must consider all investment options Must be certified by independent investment expert 1/7-10

92 Disclosure of Fees and Costs Legislation proposed to mandate certain fee disclosures to plan sponsors and participants DOL regulations have been released to require: Disclosures to plan sponsors from providers prior to contracting Itemized fee and cost disclosures to participants 1/7-11

93 Cash or Deferred Arrangements Generally referred to as 401(k) plans Established in 1978 to encourage more private sector employers to offer retirement benefits Corporate and tax exempt employers may offer State and local government employers that adopted a plan before May 6, 1986 are grandfathered 1/7-11

94 General Requirements Contributions can made via Pre-tax employee elective deferrals After-tax employee contributions Employer matching contributions Non-elective contributions Individual accounts are established for each participant 1/7-12, 13

95 Eligibility Minimum requirements can be established for employee eligibility Employees enter into a salary reduction agreement to elect participation in the plan Automatic enrollment arrangement can be established to improve employee participation 1/7-13

96 Crediting Contributions Section 415(c) annual addition limitation applies Elective deferrals limited by Sec. 402(g) and must be coordinated with other plans except 457(b) plans Participants can make an additional contribution at age 50 and up Excess contributions must be included in employees taxable income 1/7-16

97 Vesting Employees must always be 100% vested in their own contributions Matching or employer discretionary contributions may be subject to vesting requirements Cliff vesting Graded vesting Only vested amounts can be considered in nondiscrimination testing 1/7-19

98 Non-Discrimination Testing Only applies to employers subject to ERISA Must be met to ensure highly compensated employees do not have disproportionate amount of plan benefits Certain safe harbor provisions can be adopted to satisfy nondiscrimination rules without complicated testing 1/7-19, 20

99 Investments Compliance with ERISA 404(c) can provide private sector plans with a fiduciary safe harbor Public sector plans generally follow as best practice guidance Requirements include: Broad range of investments must be available Opportunity to redirect investment decisions must be provided Sufficient information must be provided 1/7-23

100 Distributions Distribution rules under IRC Section 401(a)(9) applies Distributable event includes Age 59½ Severance of employment, retirement, death or disability Plan terminations Hardship withdrawals and plan loans are permitted 1/7-24

101 Hardship Withdrawals Immediate and heavy financial need of the employee, spouse or dependent Participant must have no other reasonable resources Certain types of expenses are deemed to meet the need requirement Distribution cannot exceed the amount of need 1/7-25

102 Loans Procedures and requirements must be included in the plan document Loans must be made available to all participants and beneficiaries on a reasonably equivalent basis The plan s loan policy cannot be discriminatory Loans must be assessed a reasonable interest rate and adequately secured 1/7-26

103 Designated Roth 401(k) Permits after-tax contributions with earnings accumulating tax-free Aggregate of Roth and traditional contributions cannot exceed annual limits Roth contributions and earnings must be maintained in separate account Employer match can be based on total contributions but can only contributed to traditional account 1/7-26, 27

104 Savings Incentive Match Plan for Employees (SIMPLE) Less complex and costly to administer than other qualified plans Employers eligible to offer a SIMPLE must Have 100 or less employees Not offer any other retirement benefit All employees with $5000 for a two year period and expected to earn $5000 in the next year must be eligible to participate 1/7-28

105 SIMPLE Structure Not subject to nondiscrimination testing if certain requirements are met IRC contribution limits are lower to a SIMPLE than other qualified plans Structure of plan can either be a SIMPLE IRA SIMPLE 401(k) 1/7-29, 31

106 Recap: Defined Contribution Plans Private sector employers have a variety of DC plan structures they can offer to employees Many of the current issues facing private sector plans also impact public sector employers

107 Chapter 8 Hybrid Plans

108 Background Hybrid plans are generally categorized as either a DB or DC plan in regard to the IRC rules that apply Three main types of hybrid plans Cash balance plans Money purchase plans Target benefit plans 1/8-4

109 Cash Balance Plan Design Categorized as a DB plan but has hypothetical participant accounts Retirement benefits are based on account balance arrived from employer contributions and interest credits Provides participant a more predictable and stable benefit than a DC plan 1/8-5, 6

110 General Requirements Benefits determined through a formula with a specified level of benefit at retirement Participant contributions are typically not required The sponsor is responsible for investment decisions and subject to investment risk Benefits must be available as an annuity; joint and survivor and consent rules apply 1/8-7

111 Plan Administration Annual additions to account balance includes Employer sponsored annual credit Interest or earnings credit Participants must be 100% vested upon completion of three years of service Participant statements typically show Value of account Projection of benefit at retirement age 1/8-7, 8

112 Distribution Requirements Annuity and lump sum options are permitted Annuity is based on the actuarial equivalent of hypothetical account balance Joint survivor options must be available Lump sum distributions can be rolled to another eligible plan or IRA 1/8-8, 9

113 Money Purchase Plan Generally categorized as a DC plan Individual accounts are established with employer and employee contributions Investment risk borne by participants Accounts subject to the annual addition limits of 415(c) Benefits are based on vested account balance 1/8-14

114 Distributions Must be offered in the form of annuity Joint survivor and consent rules apply Alternate distribution forms, including lump sum options are also permitted Distributed assets can be rolled to other eligible plans and IRAs 1/8-15

115 Contributions Like DB plans: subject to minimum funding requirements Like DC plans: contribution is set through an allocation formula, typically % of pay Contributions are set and mandatory Employees may be required to contribute After-tax earnings only Contribution rates are fixed 1/8-15, 16

116 Target Benefit Plan Established to provide a target benefit at retirement Employer contributions are actuarially determined If contributions/earnings insufficient to reach goal, benefit will be lower; if greater than needed to reach goal, benefit will be higher 1/8-17

117 Contributions and Benefits Determined through an allocation formula, typically stated as % of pay Target benefit may be specified as Income replacement ratio Specific dollar amount to be paid annually Actuarial assumptions used to determine employer contributions needed to fund target benefit Benefits are not guaranteed 1/8-18

118 Additional Hybrid Plans DB(k) plan: combines features of DB & 401(k) Age-weighted profit sharing plan: combines employees age with employer profitability to set contributions Pension equity plan: combines portability with the security of traditional DB plan Lifecycle pension plan: benefits generally based on years of service and salary immediately preceding retirement 1/

119 Recap: Hybrid Plans Several types of hybrid plan arrangements Combine certain features of DB and DC plans but generally categorized as one of the other Cash balance, money purchase and target benefit plans are most common hybrids Other types of hybrid plans may be used by private sector employers

120 Chapter 9 Government and Non-Profits

121 Supplement to Primary Benefit Qualified DB or DC plan is generally primary retirement benefit Two supplemental retirement plans Section 457 governmental deferred compensation plan Section 403(b) tax sheltered annuity plan 1/9-1

122 Section 457 Background Employers that are eligible to adopt a Section 457 deferred compensation plan are: States, Political subdivisions of a state, Agencies or instrumentalities of a state or political subdivision, and Tax-exempt employers Eligible plan governed by Section 457(b) Assets must be held in trust, annuity contract, or custodial account Ineligible plan governed by Section 457(f) Deferrals subject to substantial risk of forfeiture 1/9-4

123 Plan Governance & Fiduciary Role Responsibility may be assigned to Board or committee Human resource director or controller Benefits administrator Fiduciary responsibility applies to anyone who Has discretionary authority over plan & investments Exercises control over plan assets Gives investment advice for a fee 1/9-8

124 Mandatory Provisions Eligibility Only individuals who perform services for the employer may participate Trust requirements Assets must be held in trust, custodial account, or annuity Contribution rules Contributions can only be made through payroll deferrals and must comply with annual IRC limits Distribution requirements IRC Sec. 401(a)(9) regulates when and how a participant or a beneficiary must receive a distribution 1/9-10

125 Permissive Features Catch-up contributions Sick, vacation or back-pay contributions Hardship withdrawals Rollover from other retirement accounts Distribution option flexibility Roth 457 account effective 1/1/2011 1/9-10, 11

126 Plan Document & Trust Requirements Plan must be established in a written plan document Compliance with mandatory 457 provisions Permissive features incorporated, as appropriate Assets must be held in trust, custodial account or annuity 1/9-9

127 Contribution Rules Can only be made as a pre-tax deferral from employee earnings Cannot exceed IRC maximum annual deferral limits 457 deferrals are not included in Sec. 415 annual addition calculation Deferrals are not coordinated with contributions to other plans, such as 403(b) or 401(k) plans 1/9-12, 13

128 Automatic Enrollment Is permitted in 457(b) and 403(b) plans Can improve employee participation Default deferrals and investment decisions must be established by the employer Back-out provision allows deferrals to be returned to participants who opt out within 90 days of first deferral 1/9-13

129 457 Catch-Up Provision Allows participants to make up under-utilized deferrals from prior years In three years prior to designated normal retirement age Up to twice the annual maximum deferral allowed under IRC Special rule for NRA applies to police and firefighters 1/9-13, 14

130 Age 50 Catch-Up Age 50 catch-up applies to all retirement plans including 457(b) plan It does not require under-utilized deferrals If eligible for both catch-up provisions Cannot use both in the same year The one producing the higher limit applies 1/9-15

131 Additional Contribution Rules Deferring sick, vacation and back pay Permitted up to 2½ months after termination Electing must be executed before amounts paid Deferrals must be remitted promptly to trust or investment providers Excess contributions are taxable to participants in the year the deferral was made into the plan 1/9-15, 16

132 Distribution Requirements Distributions are permitted for: Severance from employment Attainment of age 70½ Unforeseeable emergency withdrawals Loans Subject to qualified plan rules under Section 401(a)(9) but early withdrawal penalty does not apply 1/9-17, 18

133 Rollovers Dollars may be rolled into or out of 457(b) plans to other eligible accounts Dollars rolled in must be tracked in a separate account and retain the features of the distributing plan Dollars must be allowed to roll out and they take on the features of the receiving plan 1/9-19

134 Unforeseeable Emergency Withdrawal More restrictive than 401(k) and 403(b) hardship withdrawals Must meet specific requirements as defined in IRC regulations Documentation is required Only the amount necessary to relieve emergency situation can be released 1/9-19, 20

135 Other Distribution Requirements Loans Must follow same rules as loans from qualified plans Distribution of small, inactive accounts Account balance must be less than dollar limit established by IRS as de minimis No deferral activity for two years No prior distribution under this provision 1/9-20, 21

136 Other Optional Provisions Purchase of Permissive Service Credits Plan-to-plan transfer of assets to purchase service in a governmental DB plan Domestic Relations Orders Must meet state law requirements Divides an account pursuant to court order Alternate payee has same rights as original participant 1/9-22

137 Designated Roth Accounts Effective January 1, 2011 Designated Roth accounts are optional provisions Employers must amend plan document to adopt this provision Separate accounts must be established and maintained for designated Roth contributions and earnings 1/9-23

138 Non-compliance with 457(b) Failure to meet Section 457(b) requirements can result in plan becoming ineligible IRS audits can identify compliance issues Letter from IRS to employer will identify problems Plans would have 180 days to correct noncompliance issue 1/9-26

139 Ineligible Deferred Compensation Plan Does not meet requirements of Section 457(b) Governed by Section 457(f) Resemble non-qualified plans Assets are taxable unless a substantial risk of forfeiture applies Contributions are typically made by employers only 1/9-24, 25

140 Section 403(b) Plan Eligible employers are public school districts and universities tax-exempt organizations described in IRC Section 501(c)(3) 403(b) plans may be subject to ERISA except Governmental employers including public schools and universities Church entities unless voluntarily and irrevocably elect to have ERISA provisions apply 1/9-28, 29

141 Written Plan 403(b) plan must have a formal written plan document May be a single or multiple document IRS has issued model plan language that employers can adopt Private letter rulings on plan document can be requested from the IRS 1/9-30

142 Eligibility Requirements Eligible employees must be a bona fide employee of the employer Includes full-time, part-time and seasonal workers Excludes independent contractors, elected officials, volunteers Nondiscrimination rules may apply Plans that permit employee pre-tax deferrals must be made available to all employees unless certain situations apply 1/9-30, 31

143 Funding Requirements Individual accounts are established and participants are subject to investment risk Funding products are limited to Annuity contracts Mutual fund shares held by an IRS custodian Tax compliance and administrative functions may be delegated to product vendors or other third parties 1/9-31

144 Contributions and Deferrals Contributions to the plan may be made as Elective pre-tax employee deferrals Non-elective employer contributions After-tax employee contributions Contributions are subject to the following limits Elective deferral limits in IRC Section 402(g) IRC Section 415(c) limits 1/9-32, 33

145 Catch-up Deferrals A special provision called the 15-year catch-up applies to 403(b) plans based on specific requirements Maximum amount that can be contributed under this provision is $15,000 lifetime limit Age 50 catch-up also applies to Section 403(b) plans 1/9-34

146 Roth 403(b) Optional feature for 403(b), 401(k) and 457(b) Deferrals are made as after-tax income Plans must be amended before contributions can be made Total of Roth and regular contributions are subject to annual deferral limits Separate record keeping accounts must be maintained for Roth contributions and earnings 1/9-34

147 Distributions Distributions cannot be made before one of the following events Participant attains age 59½ Termination of employment or retirement Death or disability Financial hardship Taxable as ordinary income in the year received May be rolled over to another eligible plan / IRA 1/9-35, 36

148 Federal Employee Benefits Federal Employees Retirement System (FERS) established as a replacement for the Civil Service Retirement System FERS is a three tiered system Social Security Basic benefit, similar to a DB plan Thrift Savings Plan, which is a salary deferral plan similar to a 401(k) 1/9-37, 38

149 TSP Contributions & Distributions Contributions are pre-tax and voluntary Subject to the same IRC elective deferral limit as other DC plans Different rules apply for employees covered by CSRS and FERS Age 50 catch-up provision applies Distribution rules are similar to those that apply to qualified plans 1/9-38, 39

150 Recap: Government Plans Section 457 plans can be either eligible or ineligible plans and are typically provided by state and local governments to supplement primary benefits Section 403(b) plans are primarily offered by public education institutions and non-profits and are also, often considered supplemental plans Federal employees have a similar retirement benefits to other public sector employees

151 Chapter 10 Keogh Plans, SEPs, and IRAs

152 Keogh Plan Eligible businesses Sole proprietorship Partnership Limited liability company (LLC) May be any type of 401(a) qualified plan and all compliance rules apply 1/10-3

153 Simplified Employee Pension Most cost effective for private sector employers with fewer than 10 employees Contributions are made directly to an IRA for each participant Contributions governed by some qualified plan rules applicable to profit sharing plans Distributions are governed by IRA rules 1/10-6

154 Individual Retirement Arrangement Established for individuals only; cannot be joint accounts Financial services institutions act as trustee or custodian Fully vested at all times Exempt from bankruptcy proceeding for up to $1 million 1/10-9

155 Contributions and Distributions Annual contributions cannot exceed IRS limits Must be made by the due date of federal tax return for previous year Distributions may begin at age 59½, death or disability Early withdrawals allowed in some situations but subject to 10% excise tax penalty 1/10-10

156 Traditional IRA Provides opportunity for federal tax deduction if eligibility requirements are met Cannot be an active participant in employer s qualified plan Cannot exceed adjusted gross income (AGI) level defined by the IRS Contributions to an IRA can be made up to age 70½, when required minimum distributions must begin 1/10-11

157 Roth IRA Contributions are Not deductible but subject to AGI requirements Permitted regardless of individual s age Participation in employer plan is not a factor Distributions of contributions and earnings are not taxable as long as they are qualified distributions Minimum distributions are not required until the death of the individual 1/10-13

158 Deemed IRAs Additional feature of eligible employer plan Contributions are made via payroll deduction Traditional or Roth IRA rules apply Only voluntary employee contributions can be made Separate account must be maintained for contributions to deemed IRA 1/10-15

159 Recap Other Plans & IRAs Brief overview of Koegh and Simplified Employee Pension plans Explanation of traditional and Roth IRAs Information about deemed IRAs that can be part of eligible retirement plans

160 Chapter 11 Nonqualified Plans

161 Background Primary or supplemental retirement benefit Does not meet all requirements of qualified plan rules under IRC or ERISA Subject to Section IRC 409A Generally unfunded Assets generally remain subject to substantial risk of forfeiture 1/11-4

162 Objectives of NQDC Restore benefits limited under the employer s qualified plan (IRC Section 415) Provide additional benefits to a specific employee or category of employees Tie benefits to employee s performance or continued employment. Encourage early retirement Avoid complicated qualified plan rules 1/11-5

163 Funded or Unfunded Qualified plans must be funded Nonqualified plans are not required to be funded and most don t because of tax advantages Unfunded plan is a promise to pay compensation at a future date that is not secured 1/11-6

164 Excess Benefit Plan Established for highly compensated employees whose qualified plan benefits were reduced because of Sec 415 limits Employer must have a corresponding qualified plan Can be either a DB or DC arrangement Benefit often designed to pay at the same time and form as that in the qualified plan 1/11-7

165 Supplemental Employee Retirement Plan Covers highly compensated employees or select group of key management Corresponding qualified plan is not necessary Provides opportunity for benefits that cannot be offered through qualified plan because of nondiscrimination rules 1/11-7

166 Employee Tax Considerations Doctrine of constructive receipt: Amounts are taxable because the employee has a non-forfeitable right to the benefit regardless of receipt Doctrine of economic benefit: Amounts are taxable because the employee has ownership rights to the benefit, such as through using assets to secure a loan or benefit value is protected against bankruptcy/insolvency of employer 1/11-10

167 Securing the Promise Rabbi trust: designed to avoid economic benefit doctrine Irrevocable trust to segregate assets to fund promised benefits Assets remain property of employer and subject to claims of general creditors Cannot be diverted for employer s general use 1/11-13

168 Securing the Promise Secular trust: protects benefits from employers inability or unwillingness to pay Assets must be used for exclusive purpose of paying benefits Assets not subject to employer s general creditors Generally results in the NQDC plan being considered a funded plan for ERISA purposes unless established and maintained by the employee 1/11-13, 14

169 Recap: NQDC plans Provide a mechanism for making up qualified plan limits that were reduced as a result of IRC limits Can benefit certain key management personnel or highly compensated employees Must comply with IRC Section 409A, which can create challenges and complexities

170 Chapter 12 Implementing a Retirement Plan

171 Who is responsible? Plan sponsor the entity that establishes the retirement plan and has ultimate responsibility for its design and administration Fiduciaries anyone (including a contractor) selected or appointed that has a role in decisions relating to the administration of the retirement plan or investment of assets Trustees parties with exclusive authority to manage and control plan assets 1/12-5

172 Plan Administrator Determine employee eligibility Maintain accurate records of participant accounts Distribute enrollment forms and information to employees Monitor plan compliance with regulating laws and the plan document Assist in the development of payroll procedures Administer distribution requests including hardships and loans Establish rules on breaks-in-service, leaves of absence, and other changes in employment status Communicate rights and obligations to participants Process appeals to claims 1/12-8

173 Investment Responsibilities Framework for investment of trust assets should include: Establishing an investment policy Selecting money manager(s) and/or funds Evaluating and monitoring the performance of manager(s) and/or funds Peer group benchmarks and a market index are usually incorporated into the plan s investment policy 1/12-10

174 Outsourcing and Consultants Outsourcing is the transfer of certain administrative or investment services for the retirement plan to a third party Consultants may be used to advise plan sponsors on Establishing plan objectives Assessing plan needs Conducting investment manager and third party searches 1/12-12

175 Design and Implement the Plan Establish plan objectives: what are employer goals for offering the plan? Attract and retain employees? Minimize cost? Identify types of plans that an best meet plan objectives Defined benefit versus defined contribution plan 1/12-14

176 Forecasting Cost Administrative costs In-house costs Outsourced services Benefit funding DC plan has more discretion regarding plan funding DB funding requirements set by actuarial analysis 1/12-18

177 Selecting the Plan What restrictions exist in state or local laws? What plan can best motivate workforce and encourage desired behavior? What plan can provide best advantage in attracting and retaining skilled workforce? What plan is most cost effective and meets employer s financial goals? 1/12-19, 20

178 Implement and Monitor Implementation schedule should be established On-going monitoring is an important responsibility of the plan administrator Contract management Evaluating and monitoring performance Evaluating and monitoring plan costs Monitoring IRC regulations and industry trends 1/12-20, 21

179 Recap: Implementing a Plan There are many parties responsible for the plan that will also have a fiduciary role Often consultants will be used and certain functions will be outsourced Understanding the objectives for the plan and the goals of the employer are critical Forecasting costs involves administrative expenses and funding the benefit Administrators job does not end at implementation, as monitoring is an on-going role