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Employer-Sponsored Retirement Plans Employer-Sponsored Retirement Plans

McGraw-Hill/Irwin Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 4Chapter 4

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RETIREMENT PLANS

• Defined Benefits Plans

• Defined Contribution Plans

• Hybrid Plans

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PLAN CHARACTERISTICS

• 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

• 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 Tax-

Exempt 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