401(k) plan

From section 401(k) of the Internal Revenue Code, it is an employer-sponsored plan which allows eligible employees to set aside money for retirement on a pre-tax basis. Employers may match a percentage of employee contributions to the plan. To encourage saving for retirement through these plans, the federal government created special tax advantages for 401(k) plan contributions and earnings. The reduced cost and liability of 401(k) plans appeals to many employers.

401(k) Loan

A 401(k) loan is taken from a 401(k) retirement account. Plans may limit the percentage of the account balance that may be withdrawn. The loan is paid back, with interest, through payroll deductions. If an employee leaves an employer with an outstanding loan, the full amount of the loan is generally due. If the loan is not repaid, it is considered a distribution and subject to income taxes.  An early withdrawal tax penalty may apply for individuals under the age of 59½.

403(b) plan

A 403(b) plan, also known as a tax-sheltered annuity (TSA) plan, is a retirement plan for certain employees of public schools, employees of tax-exempt organizations, and ministers. 

Adoption agreement

The adoption agreement is a contract between the plan owner and the financial institution which establishes an employee retirement plan.  It includes provisions such as the effective date, participant eligibility requirements, and contribution and distribution details.

Affiliated service group

This is a group of 2 or more businesses with common ownership that work together in performing services. They are treated as a single entity for purposes of nondiscrimination testing, maximum benefit limits, and detectability of contributions. 

Age-weighted

An age-weighted feature in a retirement plan allows a higher percentage of plan contributions for older employees. It assumes that older employees have less time before they retire and therefore less time to accumulate retirement savings.

Beneficiary

The beneficiary is the person named in a will, life insurance policy, retirement plan, or annuity who is eligible to receive benefits upon the death of the insured or the plan participant.

Catch-up contribution

Catch-up contributions are the additional amounts participants turning age 50 during a calendar year can contribute in salary deferral or IRA contributions.

Compensation

Compensation is the amount of a participant’s taxable and non-taxable wages, fees or earned income as defined in the plan document.

Controlled group

A controlled group consists of two or more corporations whose stock is substantially held by five or fewer persons. They are subject to special rules for computing the alternative minimum tax exemption, the accumulated earnings credit, and the environmental tax exemption.

Deferral

A deferral is the portion of a participant’s wages that is contributed to a retirement plan. This payroll deduction is not subject to Federal Tax and certain State’s taxes but is subject to Social Security Taxes. Employee contributions are always 100% vested (fully owned by the plan participant).

Defined benefit plan

Also known as a pension plan, this employer-funded retirement plan provides a pre-determined benefit during retirement. Employer contributions are adjusted annually, and the employer is responsible for all investment decisions.  The benefit is based on years of service and earnings, and the amount received after retirement is fixed (or “defined”).  Types of defined benefit plans include: Excess Plans, Offset Plans, and Cash Balance Plans.

Defined contribution plan

This employer-sponsored retirement plan sets aside a portion of an employee’s salary and a fixed (or ”defined”) employer match. The benefit after retirement depends upon contributions and the return from the investment options elected by the participant. Investors don’t owe any income taxes on pre-tax contributions within plan limits or on any earnings until they take a withdrawal or distribution from their plan account.  Types of defined contribution plans include: Profit Sharing Plans, 401(k) Plans, Money Purchase Plans, and Target Benefit Plans.

Direct rollover

A direct rollover is the tax-free transfer of money or property from the trustee or custodian of one qualified retirement plan or account to another.

Distribution

Distribution refers to the withdrawal of a participant’s vested funds from a retirement account. It is usually connected with events such as retirement, death, disability or termination of employment unless it is a hardship withdrawal. (See definition of Hardship withdrawal) 

Eligibility requirements  

Generally, a participant in an employer-sponsored retirement plan must be 21 years of age and have completed one year of employment in order to receive benefits. 

Employee Plan Compliance Resolution System (EPCRS)

The EPCRS is the IRS program of voluntary correction for errors in employee retirement plans. This correction system allows plan sponsors to correct any compliance failures without endangering the qualified status of their plans. For more information, click here.  

Forfeitures

If a participant terminates employment prior to becoming fully vested under the plan’s vesting schedule, s/he forfeits part or all of the employer’s contribution. Forfeitures may be used by the employer to reduce future employer contributions or to pay plan expenses, or they may be allocated to the accounts of remaining participants.

Hardship withdrawal

Some 401(k) retirement plans allow a participant to withdraw funds if there is a financial hardship.  Some examples might be: the purchase of a primary home, prevention of eviction from or foreclosure on the primary home, medical costs, or college expenses for the participant, spouse, or eligible dependents. Hardship withdrawals will be taxed as ordinary income in the year distributed and may be subject to a penalty when filing income tax returns.

Highly Compensated Employee (HCE)

In performing nondiscrimination tests on benefit plans, a highly compensated employee is one who receives compensation in the top 20% of employees, is a 5% owner of the business, or exceeds certain annual compensation levels.

Individual Retirement Account (IRA)

An IRA is a tax-deferred retirement savings account that allows individuals to make tax-deductible contributions, invest the funds, and defer taxes on the earnings until the funds are distributed. The amount that can be contributed is limited by law. There is a 10% penalty if money is withdrawn before age 59 ½.  The distributions are fully taxed by the U.S. government, and funds must be withdrawn from the account no later than the April 1 following the year the owner turns 70 1/2.

In-service distribution

An in-service distribution is a retirement plan withdrawal by a participant that is still employed by the plan sponsor.

Matching contribution

A matching contribution is an amount contributed by the employer to a participant’s account based on the employee’s salary deferral contributions.

New comparability

A new comparability plan is a profit sharing plan which allows employers to maximize contributions to a select group of employees (such as owners or key employees). The plan must include minimum contributions for all benefiting employees to satisfy non-discrimination requirements.

Noncontributory retirement plan

A noncontributory retirement plan is a pension plan that is solely funded by employer contributions.

Nonqualified plan

A nonqualified plan is a retirement or employee benefit plan that does not meet the requirements of Section 401(a) under the Internal Revenue Code and is not eligible for favorable tax treatment.

Permitted disparity

Permitted disparity means that a qualified retirement plan allows limited discrimination for favoring highly compensated employees. Because there is a cap on wages that are considered for Social Security, employees earning over that cap can receive additional benefits for the amount of wages that exceed the Social Security wage base.

Plan administrator

The plan administrator of an employee benefit program is the person or company who ensures that the plan meets government regulations and that employees have the information needed to participate in the plan.

Plan document

The plan document is the official set of rules for a tax qualified defined contribution plan.  It is the legal description of how the plan will operate. 

Plan entry date

Once an employee has satisfied the eligibility requirements, typically s/he enters the plan the earlier of January 1^st or July 1^st in a calendar year plan.

Prevailing wage retirement plan

The Davis-Bacon Act of 1931 requires any contractor bidding on a government construction project over $2,000 to pay workers a prevailing wage based on area union wages and fringe benefits.  A portion of the wage can be paid as a retirement plan contribution for prevailing wage employees, reducing the employer’s payroll-associated expenses. Company owners and office personnel who are not subject to the prevailing wage also benefit by increasing their plan contributions without as much concern about compliance issues.

Qualified Automatic Contribution Arrangement (QACA)

A QACA requires all employees to make minimum 401(k) deferrals unless they have elected to defer or have declined to participate. The minimum employee deferral is 3% for the first and second years, increasing 1% each year thereafter to a maximum of 10% of compensation.  The employer contribution can be either a matching contribution or a non-elective contribution of at least 3%.  Employer contributions can be subject to a two year vesting requirement.  The plan is exempt from nondiscrimination and top heavy testing.

Qualified Domestic Relations Order (QDRO)

A QDRO (pronounced like “quadro”) is court order in a divorce case which gives the divorced spouse their share of an asset or retirement plan.

Qualified plan

A qualified plan is a retirement plan that meets the requirements of Section 401(a) of the Internal Revenue Code and is eligible for tax-favored treatment. Among other things, it permits contributions by employee and employer, restricts distribution of the funds so that they are used for retirement (with a few exceptions), and requires a written document describing the plan provisions.

Rollover: A rollover is a tax-free transfer of funds from one retirement plan to another.

Safe harbor 401(k) plan

This type of retirement plan requires employers to make a 3% contribution or a matching contribution to all non-highly compensated employees.  The employer is exempt from non-discrimination rules that require annual testing, and all contributions are immediately vested.

SIMPLE (Savings Incentive Match Plan for Employees) plan

A SIMPLE plan is a retirement plan that allows pre-tax employee contributions and mandatory employer matching contributions. All contributions are immediately vested in a SIMPLE plan, which can be set up as a 401(k) or an IRA.

Simplified Employee Pension plan (SEP plan)

A SEP is a retirement plan which allows an employer to contribute to the employee’s Individual Retirement Account (IRA) on a discretionary basis. For any year that the employer decides to contribute, s/he must contribute equally to all participants who actually performed work for the business, even employees who die or terminate employment before the contributions are made.

Summary Plan Description (SPD)

The SPD is a written description of the features of an employer sponsored plan.  It must be distributed free of charge to all plan participants and describe in understandable language how the plan operates and what it provides.  

Top-heavy

A retirement plan is top-heavy if, as of the determination date, more than 60% of the benefits under the plan belong to “key employees.”  A key employee is an owner of over 5% of the company, over 1% owner earning over $150,000, or an officer with annual compensation exceeding a specified amount. 

Trustee

A trustee is a person or organization with a duty to receive, manage, and disburse the assets of a plan.

Vesting

Vesting is the process where money or property held in trust belongs to a person, though it may not be available for distribution until a future date. Vested funds are fully owned by the participant in a qualified retirement plan.  Employee contributions are always 100% vested; employer contributions are normally subject to a vesting schedule based on years of service with the employer.

Year of service

A year of service is the number of hours of service an employee must perform for the employer during the plan year in order to be credited with a year of service. It is used for plan administration to determine eligibility for plan participation, vesting calculation and eligibility for employer contribution(s). The number of hours may be different for each aspect of plan administration, may not be more than 1,000 hours during a plan year, and is defined in the plan document.