Glossary
We've compiled a list of some of the most common terminology used in the industry for your reference. Please contact us for more information.
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401(k) plan
A 401(k) plan provides significant advantages to both employers and employees. Not only does a 401(k) plan attract and retain qualified employees, but it also provides a low-cost means of providing visible and appreciated retirement benefits to employees. Employees have a real opportunity to participate actively in saving for retirement on a tax-deductible basis. en employer contributions are made, funds are allocated to participants before federal and state income taxes are imposed on such funds.
Employees choose to contribute a certain dollar amount (or percentage) to their retirement account. These contributions are made directly from pay before federal and state income taxes are imposed. These contributions earn a pre-tax investment income, and a discretionary matching or profit sharing employer contributions may be made. Forfeitures from terminated employees can be added to the employee accounts or can be used by the employer to help defray the administration costs. A 401(k) plan has a high degree of flexibility in its design and can also include hardship withdrawals and participant loans, among other options.
403(b) plan
A 403(b) plan, also called a tax-sheltered annuity (TSA) plan, is available to certain employees of public schools, tax-exempt organizations and ministers. The features of a 403(b) plan are similar to a 401(k) plan. Plan investments can include annuities, mutual funds or a retirement income account for church employees.
457 plan
A 457(b) plan is nonqualified retirement program available only to government employees or highly compensated employees of non-profit corporations, depending on the type of 457 plan. In some ways, the plan operates like a 401(k) plan. Plan assets are held in a trust or custodial account for the exclusive benefit of plan participants, and contributions and earnings are tax-deferred. However, major differences still exist:
- The plan is nonqualified and not subject to the same federal legislation as qualified plans
- Not all employees need to be included in the plan, and independent contractors may be included.
- Employee contribution limits are not combined with other plan contributions, allowing employees to contribute the maximum amount per year to BOTH a qualified plan and a 457 plan, doubling traditional contribution limits.
- There is no 10% early withdrawal penalty for employees who retire from service before reaching age 59½.
Automatic enrollment
Automatic enrollment, also referred to as "negative" or "passive" election, requires participants to elect NOT to have their pay contributed to their employer's retirement 401(k) plan. (Automatic enrollment can also be used by certain 403(b) and 457 plans.) Using automatic enrollment as the plan's default feature, participants who fail to make an election will have a certain percentage of pay automatically contributed to the plan. This feature can increase participation rates and positively impact compliance testing results. An annual notice must be prepared according to specific guidelines and distributed to existing and future participants.
Cash balance plan
A cash balance plan is a type of defined benefit plan that defines the retirement benefit in terms of a stated account balance. Each year, an employee may accrue a pay credit (equal to a percentage of pay or a flat-dollar amount) and an interest credit (usually linked to an index). The investment risk and return is borne solely by the employer, and the plan accounts are maintained by an actuary.
In return, cash balance plans offer owners and partners significant tax reductions. Contributions to a cash balance plan can have the same financial impact as a deduction that reduces ordinary income dollar for dollar. Many businesses can benefit from a cash balance plan, and we recommend you speak with one of our plan design specialists to see if this plan type will work for your client. Excellent potential candidates include situations where:
- An owner or partner who wishes to contribute more than $45,000/year to retirement
- An owner or partner who wants to "catch up" or accelerate his/her retirement savings
- When the client already makes 3% employee contributions
DB(k)
A DB(k) plan or "eligible combined plan" incorporates aspects of both a defined benefit plan and a defined contribution plan.
Plan administration is simplified: all plan assets are held in one trust; there is one plan document, one Summary Plan Description, one Form 5500 and one audit (if required at all); the plan is also not subject to nondiscrimination testing.
Key elements of this plan include:
- A 1% of final average pay for each year of service, up to 20 years
- An automatic enrollment feature with a 4% of pay employee contribution (unless the employee opts out)
- An employer match of at least 50% of employee deferrals, up to a maximum of 2% of pay
This plan type is only available for employers with no more than 500 employees.
Defined benefit plan
A defined benefit plan essentially offers employees a guaranteed paycheck for the remainder of their lifetime. Retirement benefits earned under this type of plan must be definitely determinable. For example, a plan that entitles a participant to a monthly pension for his or her post-retirement lifetime equal to 30% of monthly compensation is a defined benefit plan. Employer contributions are actuarially determined, certain benefits may be insured by the Federal Pension Benefit Guaranty Corporation (PBGC) and special rules apply upon termination of this plan.
Employee stock ownership plan (ESOP)
An employee stock ownership plan is a special type of plan whose funds must be invested primarily in employer securities (stock). This type of arrangement benefits the employer in three ways: (a) providing a market for the company's stock, (b) giving the employer tax deductions without affecting cash flow and (c) keeping company stock in friendly hands in the event of a hostile takeover of the company.
Fiduciary
The DOL has prepared a brochure entitled "Meeting Your Fiduciary Responsibilities." A copy can be obtained from the Employee Benefits Security Administration's (EBSA) website at www.dol.gov/ebsa/publications/fiduciaryresponsibility.html.
The brochure is a good overview of the responsibilities of plan fiduciaries, including their duties to:
- Prudently select and monitor service providers
- Carefully evaluate the fees being charged to ensure that they are reasonable relative to the particular services and investments
- Inform participants of various aspects of the plan; for example, via the Summary Plan Description (SPD)
While the brochure is too basic for an experienced fiduciary, it provides a good starting point for new plan sponsors or retirement committee members to learn about the responsibilities of their job. In fact, in the brochure the Department of Labor notes that, "An employer... when using [a] committee, should educate committee members on their roles and responsibilities."
Hardship distribution, hardship withdrawal
Currently, there are six permitted events that allow participants to apply for and receive a hardship withdrawal. However, the options available to a plan participant are governed by the plan's document. The six permitted events, along with our suggestions of appropriate supporting documentation for each item, are:
- Medical Expenses for Participant or Dependent. The participant should provide a copy of bill, along with an insurance company benefit statement denying coverage for at least the amount being requested. If the expense has not yet been incurred, you could require a signed letter from a doctor or other health care provider verifying the need for treatment and the approximate cost.
- Purchase of Principal Residence. The participant should provide a copy of the signed purchase agreement.
- Twelve Months Tuition and Related Costs. The participant should provide a bill or letter from the educational institution, verifying enrollment of the participant or his/her dependent and the estimated costs of tuition, room, board and related expenses.
- Payments to Prevent Eviction or Foreclosure. The participant should provide a copy of the formal legal document giving notice of the eviction or foreclosure. This notice typically states when the overdue rent or mortgage payment is in order to prevent eviction or foreclosure.
- Burial or Funeral Expenses. The participant should provide copies of the death certificate and the bill from the funeral home showing costs of the burial or funeral.
- Repair to Employee's Principal Residence That Qualifies as a Casualty Deduction. The participant should provide evidence of the casualty (a description or photograph), a copy of the repair bill, and proof that insurance proceeds did not cover the amount of the casualty expense claimed as a hardship.
In-service distribution
In-service distributions occur when the participant is paid from his/her retirement account while still employed by the plan sponsor. In some plans, an in-service withdrawal is allowed for employees over age 59½, usually with a minimum withdrawal amount of $1,000. Some plans also allow for hardship distributions while the employee is still employed. All in-service withdrawals will generally be considered taxable income during the year the distribution is received.
Loan (participant)
An option some plans provide is a participant loan provision. This provision allows participants to borrow against their account balances. Some plans only allow loans for specific reasons (typically the same reasons that apply to hardship withdrawals), although some plans place no specific restrictions on what the need or use will be. Loan repayments are made through payroll deduction. There are specific advantages and disadvantages of plan loans, and we encourage you to contact our office for additional information.
Money purchase plan
A money purchase pension plan is a retirement arrangement in which employer contributions are mandatory and usually based on a percentage of each eligible employee's compensation. A contribution formula is determined by the employer at the inception of the plan. These employer contributions are tax-deductible and are contributed on each employee's behalf to be distributed at retirement, disability, death, or termination of employment. As with profit sharing plans, the employer contributions may be made subject to a vesting schedule.
New comparability plan
A new comparability plan or "age-weighted" plan is a type of profit sharing plan where employers have the ability to weight contributions in favor of key employees who are older than the remainder of the employees. Employees are divided into groups, and each group receives a different employer contribution amount. This feature can be included in a 401(k) plan and is helpful when employees are not deferring at high enough levels to allow highly compensated employees to contribute as much as they would like. Compliance testing is much more complex and performed on a cross-tested basis. Please contact us to see if this plan type is right for you.
Nonqualified
Nonqualified plans, such as deferred compensation plans and executive bonus plans, are tax-deferred, employer-sponsored retirement plan that falls outside of employee retirement income security act (ERISA) guidelines. Nonqualified plans are designed to meet specialized retirement needs for key executives and other select employees. These plans also are exempt from the discriminatory and top-heavy testing that qualified plans are subject to.
The contributions made to these plans are usually nondeductible to the employer, and are usually taxable to the employee as well. However, they allow employees to defer taxes until retirement, when they are presumably in a lower tax bracket. Non-qualified plans are often used to provide specialized forms of compensation to key executives or employees in lieu of making them partners or part owners in the company or corporation
A retirement plan that does not meet the IRS (or ERISA) requirements for favorable tax treatment. Non-qualified retirement plans are funded by employers and are more flexible than, but do not have the tax benefits of, qualified retirement plans. Benefits are paid at the retirement age in the form of annuities, which are taxed as ordinary income tax, or in lump sum payments, which can be transferred into an IRA to defer taxes.
Participant
The IRS defines a "participant" as an employee who has satisfied the eligibility requirements to enter the plan. If you have a 401(k) plan, you may have both contributing and non-contributing participants. Even if an eligible employee doesn't sign up to make contributions, he/she is still counted as participating in the plan and is designated as a "participant." We must use the IRS definition when counting participants to report on Form 5500, and we use this same method when preparing our invoices for plan administration.
Plan Administrator
The person (or organization) that is identified in the plan document as having responsibility for running the plan. It could be the employer, a committee of employees, a company executive, or someone hired for that purpose. Although Randall & Hurley provides plan administration, we are not the Plan Administrator and do not sign the Form 5500 as such.
Plan Limits
Plan limits change each year and are determined by the IRS. Changes are based on the cost of living increase during the prior year, and are announced in mid-October for the upcoming year. Find the most current plan limits in our What's New section.
Profit sharing plan
A Profit Sharing Plan is a retirement arrangement in which the company may make a discretionary contribution each year. These contributions are invested in a tax-deferred, creditor-proof trust. Tax-free earnings accumulate until the eventual distribution to participants or their beneficiaries. This payout usually occurs at retirement or some other specialized event (disability, death or termination of employment). Contributions are normally keyed to yearly profits, although profits are not required for a contribution to be made. Retirement benefits paid to employees are based on the amount in the participant's account at retirement. Note that a profit sharing plan can include 401(k) features.
Profit sharing contributions may be allocated to each participant in proportion to pay, integrated with the Social Security Wage Base, or weighted on age and/or service with the employer.
Qualified
A qualified plan offers benefits to all eligible employees on a non-discriminatory basis, whereas a nonqualified plan is offered only to executive employees. The retirement funds in a qualified plan are not subject to the company's liabilities, which means that even under a dramatic circumstance such as bankruptcy, these funds are wholly protected from creditors. They are "guaranteed," so to speak. If a plan is determined qualified by the IRS, many specific tax advantages are also given to the company. One tax advantage is an income tax deduction for contributions.
Qualified Domestic Relations Order (QDRO)
All or part of your retirement plan may be transferred to your spouse if the transfer is made under a qualified domestic relations order (QDRO). A QDRO is a court order, judgment, or decree that relates to child support, alimony, or property rights of a spouse or former spouse, child, or dependent of the participant made pursuant to an applicable state's domestic relations law.
To qualify as a QDRO, all of the following criteria must be met: (1) The instrument must be a judgment, decree, or order of a court (including an approval of a property settlement agreement) that (a) relates to the provision of child support, alimony payments, and marital property rights of your spouse, child, or other dependent and (b) is made pursuant to your state domestic relations law, including a community property law. (2) The domestic relations order must create or recognize the existence of an alternate payee's right to receive, or it must assign to an alternate payee the right to receive, all or a portion of the benefits payable to you or payable on your behalf; the term alternate payee means your former spouse, child, or other dependent who is recognized by the order as having a right to receive all or part of your benefits under the plan
The QDRO must not: (1) require the plan to provide any type of benefit or any option not otherwise provided for in the plan; (2) require the plan to provide more benefits (determined on the basis of actuarial value) to the alternate payee than you would be entitled to require the plan to pay one alternate payee benefits that are required to be paid to another alternate payee under another order previously determined to be a QDRO.
The QDRO must clearly specify all of the following information: (1) your name and last known address and the name and mailing address of each alternate payee covered by the order; (2) the amount or percentage of your benefits to be paid by the plan to each alternate payee or the manner in which such amount or percentage is to be determined; (3) the number of payments or the period to which the order applies; and (4) the name of each plan covered by the order.
A plan administrator is required to determine whether a domestic relations order is a QDRO within a reasonable time after the receipt of the order and is required to notify you and each alternate payee of the determination. Every plan is required to have written procedures for making these determinations, and these written procedures should be available to you.
In addition, Randall & Hurley has an ERISA attorney on staff who can prepare a QDRO that meets all the requirements specified in your plan's document.
Required minimum distribution
RMDs are the minimum amounts that the IRS generally requires you to withdraw from your retirement account each year once you turn age 70½ or when you retire, whichever is later. The RMD rules ensure that you withdraw at least a minimum amount from your account each year.
To calculate the amount of your RMD, all you need is your current age, your ending account balance for the previous year and the life expectancy factors found in the IRS Uniform Lifetime Table. To determine your RMD, divide your account balance by the IRS life expectancy factor corresponding to your age in the table. However, if you've named your spouse as the only beneficiary on your account and he or she is more than 10 years younger than you, then you need to use the joint life expectancy factors in the IRS Joint Life and Last Survivor Expectancy Table to calculate your annual distributions. (This calculation can be complicated, and Randall & Hurley, Inc. will prepare this amount for you each year, if you are participating in a retirement program administered by us.) Of course, you may request to receive more than the minimum amount in any given year.
Once you receive the distribution, you are responsible for the income taxes on that account. You can also elect to have a particular amount deducted from your RMD and withheld for income taxes. You may not roll your RMD into another tax-deferred account, like an IRA. More information is available in your Summary Plan Description. Login to your account to view this document or contact your employer for a copy.
Revenue sharing
When third-party administration firms, like Randall & Hurley, perform some of the recordkeeping duties typically provided by a fund platform, that trust company may choose to remit “Sub-Transfer Agency” and “12b-1” expense amounts back to Randall & Hurley. This money comes from the internal expense ratios inherent in the fund.
When Randall & Hurley receives revenue sharing, these payments are fully disclosed by Randall & Hurley and provide a direct reduction or offset against our annual plan administrative charges, after a $500/year monitoring charge. We will apply 100% of the remaining Sub-TA fees to reduce your annual billing charges. Excess annual Revenue Sharing payments can be directed to pay other plan related costs, e.g., custodial fees.
Termination distribution
Once you terminate employment with your plan sponsor, you may receive a distribution of your entire plan balance. This is a complicated matter with serious tax consequences, and we recommend you speak with a tax advisor or financial professional to ensure you make the choices appropriate for your situation. The following information is provided as a general guideline; you should consult your plan document or summary plan description for information specific to your retirement program.
Total Distribution Amount. You are typically able to withdraw 100% of your vested plan account balance. This would include all of the money you have contributed to the plan. Employer-contributed money held in your account is typically subject to some type of vesting schedule, based on the number of years you have worked with your employer. On your account statement, you should see two figures, "account balance" and "vested account balance." Your vested account balance is how much you would be eligible to withdraw.
If you have an outstanding plan loan, the amount of money eligible for withdrawal would be calculated differently. Again, you would start with your vested account balance. However, you will need to subtract the total outstanding loan amount (since you already received this money). You will, however, be liable for income taxes on the outstanding loan amount. For more information, see our section on participant plan loans.
Qualifying Circumstances. In order to qualify for a termination distribution, you must have the intention of permanently severing your employment relationship. Examples include quitting, being fired, being laid off and disability. Examples of severance options that do not qualify you for a termination distribution include short-term disability, maternity or paternity leave, division transfers and temporary lay-offs.
Distribution Types and Consequences. There are four different options typically available to plan participants when receiving a distribution: (1) a qualified joint and survivor annuity; (2) a lump-sum distribution directly to the participant; (3) a rollover to either a new retirement plan or an IRA; or (4) a combination of these options. Depending on plan provisions, some of these options may not be available to you.
A joint and survivor annuity is probably the least common option available for most plan participants and, if offered, is typically restricted to those with over $5,000 in the account. An annuity is a periodic and fixed payment for the life of the participant, with a periodic and fixed payment (equal to anywhere from 50% to 100%) for the life of the participant's spouse. Typically, taxes are paid only on the amount distributed each year, and a 10% early withdrawal penalty (paid to the IRS) may apply if the participant is less than 59½ years of age.
In the case of a lump-sum distribution directly to the participant, the participant will receive his/her account balance, less any fees and outstanding loans, in a cash distribution. The gross amount of your distribution (including any outstanding loans) will be considered taxable income in the year in which it is distributed. You will be liable for federal (and any state) income taxes. If your account balance is over $200, the IRS requires that 20% of your account balance be withheld (and remitted to the IRS) for federal income taxes. (When you file your income taxes, you may owe more or receive a refund of part of this amount.) Additionally, if you are under age 59½, the IRS will impose a 10% early withdrawal fee on your gross distribution. You will be responsible for this amount when you file your income taxes. (There are a few, very limited exceptions to the early withdrawal penalty, the most common of which is a distribution made to an "employee after separation from service after attainment of age 55.")
To avoid federal (and state) income tax liability, as well as the 10% early withdrawal penalty, participants can "rollover" their plan balance to another employer-sponsored plan or to an IRA. You will need to contact the plan administrator of the plan you wish to transfer the money to ensure they will accept the funds. The receiving plan must be of the same plan type (e.g., you cannot roll money from a defined benefit plan to a 401(k) plan). If you do not have an employer-sponsored retirement program that will accept your rollover, and you still wish to avoid income tax liability, you may rollover your plan account into an IRA. You should consult a tax advisor or trained professional associated with an institution that offers IRAs to be ensure the right type of IRA is set up to accept your funds.
In most cases, you are able to split your account among several of these options. For instance, you may choose to take a partial lump-sum distribution and a partial rollover, leaving you with a portion of the account balance (and taxes and penalties) and placing the rest in a rollover IRA.
Doing Nothing. If your account balance is under $1,000, many employers opt to "force out" participants so they are not responsible for the administrative fees that accompany the maintenance of these accounts. So, if you do not make a decision about what to do with your account, chances are you could receive a lump-sum payment made directly to you. You will be responsible for income taxes and the early withdrawal penalty.
If your account balance is between $1,000 and $5,000 and you do not make an election, the employer has several options which vary from plan to plan. Your employer may choose to "force out" the account balance, as described above; leave the account balance in the plan; or transfer the account to an IRA. The action taken on your account is stated in the plan's administrative procedures. You should consult your plan administrator to find out which option will be taken if you do not make a decision.
If your account balance is over $5,000, the employer is required to leave your account in the plan, with few exceptions (such as a plan termination). However, you may be charged a reasonable administrative fee to help defray the costs of maintaining this account. More information is available in your Summary Plan Description. Login to your account to view this document or contact your employer for a copy.
Unbundled
An "unbundled" plan uses multiple entities to provide plan services, thus ensuring the best fit in each area of expertise. Essentially, plan services are provided by those who are able to do so at the lowest cost and with the greatest level of efficiency and expertise. A third party administrator, like Randall & Hurley, provides the consulting, recordkeeping and compliance services needed to properly account for participant plan balances and to insure that the federal pension rules are properly applied to the retirement plan. An investment custodian independent of the administrator provides the critical facet of plan maintenance, making prudent investments available to the employees.
There are several key advantages in utilizing an unbundled administrator, including:
- More flexibility. The sponsoring employer and participating employees may choose among any and all prudent investments when an unbundled approach is selected. Plan provisions may be individually designed to meet specific client objectives.
- Greater expertise and familiarity with IRS and DOL rules. Randall & Hurley is the only firm in the Inland Northwest to employ an ERISA attorney and several actuaries in-house.
- Lower, ascertainable costs. Unbundled third party administrative fees are determined separately from asset-based charges. Our fees are easy to understand and future charges may be projected with a high degree of certainty. This is different from "bundled" charges, where as plan assets grow, plan charges similarly increase and materially lower participant investment returns and fund accumulations over time.
- No conflicts of interest. Unbundled third party administrators remain independent of products and services (e.g., investments, insurance, internal audits) that may not be in the best interest to the client.
Vesting
Most plans require you to meet certain requirements before you are entitled to any employer contributions--even if they have already been deposited into your account. These requirements normally involve working a specific number of hours each year for the company. This means that if you terminate your employment before you are fully vested, you are only entitled to a percentage of the value of your employer contributions.
A vesting schedule can only apply to employer contributions, and will never apply to any safe harbor contributions made by the employer or any contributions made by you.
More information is available in your Summary Plan Description. Login to your account to view this document or contact your employer for a copy.
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