Retirement Plan Disclosure

 

This Retirement Plan Disclosure is a summary of frequently encountered retirement plan rules. It is not a complete statement of all requirements under the Internal Revenue Code, ERISA, or related regulations, notices, and other government guidance. Laws and regulations change over time. The PLAN SPONSOR/TRUSTEE is responsible for monitoring applicable IRS, DOL, and PBGC guidance, consulting with its own legal, tax, and other professional advisors, and ensuring that the PLAN is operated in compliance with all current requirements. The fact that a particular rule, deadline, or requirement is not described in this Disclosure does not shift responsibility for that rule from the PLAN SPONSOR/TRUSTEE to TPA.

1. Contribution Limits

Employee Elective Deferrals

1. Annual Contribution Limits:
   • The IRS sets annual limits on the amount employees can defer from their salaries into a 401(k) plan. For 2024, the maximum elective deferral limit is $23,000.
   • Catch-Up Contributions: Employees aged 50 and older can make additional catch-up contributions. For 2024, the catch-up contribution limit is $7,500, making the total possible contribution $30,500 for those eligible.
2. Pre-Tax and Roth Contributions:
   • Employees can choose to make contributions on a pre-tax basis, which reduces their taxable income for the year, or to a Roth 401(k) account, which is funded with after-tax dollars but allows for tax-free withdrawals in retirement.
   • The combined total of pre-tax and Roth contributions must not exceed the annual limit.

Employer Contributions

1. Matching Contributions:
   • Employers can match a portion of employee contributions. For example, a common match is the safe harbor 401k match.  Another matching formula may be 50% of employee contributions up to 6% of the employee’s salary.
   • Matching contributions are subject to the same total contribution limits as other employer contributions.
2. Non-Elective Contributions:
   • Employers may also make non-elective contributions, which are contributions made to all eligible employees regardless of their own contributions.
   • These contributions help employers satisfy certain IRS nondiscrimination requirements and can be used to qualify for safe harbor status.

Total Contribution Limits

1. Annual Additions Limit:
   • The total of all contributions (employee deferrals, employer matching, and non-elective contributions) to a 401(k) plan for any employee cannot exceed the lesser of 100% of the employee’s compensation or $66,000 for 2024 (plus any catch-up contributions for those 50 and older).

Compensation Limits

1. Annual Compensation Limit:
   • For determining contributions, only the first $330,000 of an employee’s compensation can be considered for 2024.

2. Nondiscrimination Testing

Actual Deferral Percentage (ADP) Test

1. Purpose:
   • The ADP test ensures that the 401(k) plan does not disproportionately benefit highly compensated employees (HCEs) over non-highly compensated employees (NHCEs).
2. Calculation:
   • The average deferral percentage for HCEs is compared to the average deferral percentage for NHCEs. The contribution rates for HCEs must not exceed NHCEs’ rates by more than certain specified percentages.

Actual Contribution Percentage (ACP) Test

1. Purpose:
   • The ACP test is similar to the ADP test but focuses on employer matching contributions and employee after-tax contributions.
2. Calculation:
   • The average percentage of contributions (both matching and after-tax) for HCEs is compared to NHCEs to ensure fairness.

Top-Heavy Test

1. Purpose:
   • The top-heavy test checks if more than 60% of the plan’s benefits are accrued by key employees.
2. Requirements:
   • If a plan is top-heavy, it must meet minimum contribution and vesting requirements to ensure that non-key employees receive a fair share of the plan’s benefits.

Safe Harbor 401(k) Plans

1. Safe Harbor Provisions:
   • Employers can design their 401(k) plans to automatically meet ADP and ACP tests by making either matching or non-elective contributions that meet specific criteria.
2. Types of Safe Harbor Contributions:
   • Basic Match: 100% match on the first 3% of compensation deferred, plus 50% match on the next 2%.
   • Enhanced Match: Must be at least as generous as the basic match.
   • Non-Elective Contribution: At least 3% of compensation to all eligible employees, regardless of their own deferrals.

3. Vesting Rules

1. Vesting Schedules:
   • Employee contributions to a 401(k) plan are always 100% vested. However, employer contributions may be subject to vesting schedules.
   • Cliff Vesting: Employees become 100% vested after a specified period (e.g., three years).
   • Graded Vesting: Employees become vested gradually over time (e.g., 20% per year over five years).
2. Safe Harbor Contributions:
   • Employer contributions in safe harbor 401(k) plans are always 100% vested immediately.

4. Distributions and Withdrawals

Qualified Distributions

1. Age 59½ Rule:
   • Participants may be able to take distributions from their 401(k) plans without penalty once they reach age 59½. Some plans do not allow for this type of distribution.
2. Required Minimum Distributions (RMDs):
   • Participants must begin taking RMDs by April 1 of the year following the year they turn 73. Failure to take RMDs results in significant penalties.
3. Roth 401(k) Distributions:
   • Qualified distributions from Roth 401(k) accounts are tax-free if the account has been held for at least five years and the participant is 59½ or older, disabled, or deceased.

Early Withdrawals

1. Penalties:
   • Distributions taken before age 59½ are generally subject to a 10% early withdrawal penalty in addition to regular income tax.
2. Exceptions:
   • Certain exceptions to the early withdrawal penalty include distributions for medical expenses exceeding 7.5% of adjusted gross income, permanent disability, or substantially equal periodic payments.

 

Hardship Withdrawals

1. Eligibility:
   • Participants may take hardship withdrawals for immediate and heavy financial needs, such as medical expenses, purchase of a primary residence, tuition, prevention of eviction, funeral expenses, or certain repairs to the primary residence.
2. Limitations:
   • Hardship withdrawals are limited to the amount necessary to meet the need and are subject to income tax and potentially the 10% early withdrawal penalty.

Loans

1. Loan Limits:
   • Participants may be able to borrow up to 50% of their vested account balance or $50,000, whichever is less. The 401k plan must allow for loans.
2. Repayment:
   • Loans must be repaid within five years, although the term can be longer if the loan is used to purchase a primary residence. Failure to repay results in the loan amount being treated as a taxable distribution.

5. Plan Administration and Compliance

Plan Documentation

1. Plan Document:
   • Every 401(k) plan must have a written plan document that outlines the terms and conditions of the plan. This document must comply with IRS and ERISA regulations.
2. Summary Plan Description (SPD):
   • Employers must provide participants with an SPD, which is a plain-language summary of the plan’s terms, including eligibility, benefits, and claims procedures.

Reporting Requirements

1. Form 5500:
   • Employers must file Form 5500 annually to report on the plan’s financial condition, investments, and operations. This ensures transparency and regulatory compliance.
2. Participant Statements:
   • Participants must receive periodic statements (at least quarterly) detailing their account balance, contributions, earnings, and fees.

 

Fiduciary Responsibilities

Fiduciary rules for 401(k) plans are critical to ensuring that these retirement savings plans are managed in the best interests of the participants and beneficiaries. These rules are established under the Employee Retirement Income Security Act (ERISA) and enforced by the Department of Labor (DOL). Here is a concise summary of the key fiduciary responsibilities and obligations that apply to 401(k) plans.

Definition of a Fiduciary

A fiduciary in the context of a 401(k) plan is any individual or entity that exercises discretionary control or authority over plan management or plan assets, provides investment advice for a fee, or has discretionary authority or responsibility in the administration of the plan. This typically includes plan sponsors, trustees, investment committee members, and sometimes service providers.

Key Fiduciary Responsibilities

1. Duty of Loyalty
   • Fiduciaries must act solely in the interest of plan participants and beneficiaries, prioritizing their financial interests above all else.
   • Example: A fiduciary must avoid conflicts of interest, such as selecting plan service providers that benefit the fiduciary rather than the participants.
2. Duty of Prudence
   • Fiduciaries are required to act with the care, skill, prudence, and diligence that a prudent person familiar with such matters would use under similar circumstances.
   • Example: A fiduciary must thoroughly evaluate investment options and fees, ensuring they are reasonable and in the best interest of participants.
3. Duty to Diversify Plan Investments
   • Fiduciaries must ensure that plan investments are adequately diversified to minimize the risk of significant losses.
   • Example: Offering a range of investment options, including various asset classes like stocks, bonds, and mutual funds, helps participants build diversified portfolios.
4. Duty to Follow Plan Documents
   • Fiduciaries must operate the plan in accordance with the plan documents, as long as those documents are consistent with ERISA.
   • Example: Adhering to the plan’s specific terms regarding eligibility, contributions, and benefit distributions.

Prohibited Transactions

Fiduciaries must avoid engaging in prohibited transactions, which include activities that could result in conflicts of interest or self-dealing. Prohibited transactions generally include:

• Transactions between the plan and a party in interest: Such as sales, exchanges, or leases of property.
• Furnishing goods, services, or facilities: Between the plan and a party in interest.
• Transfers of plan assets: To a party in interest.

Fiduciary Liability

Fiduciaries are personally liable for any losses to the plan resulting from a breach of their fiduciary duties. This underscores the importance of adhering strictly to fiduciary standards and ensuring that all actions taken on behalf of the plan are in the best interest of participants and beneficiaries.

Limiting Fiduciary Liability

1. Hiring Service Providers
   • Fiduciaries can limit their liability by hiring competent service providers to handle certain fiduciary functions, such as investment management or recordkeeping. However, fiduciaries are still responsible for prudently selecting and monitoring these service providers.
2. Fiduciary Insurance
   • Many plans purchase fiduciary liability insurance to protect fiduciaries from personal liability arising from their fiduciary duties.
3. Documenting Decisions
   • Maintaining thorough documentation of all decisions and actions taken regarding the plan can help demonstrate that fiduciaries acted prudently and in accordance with ERISA requirements.

Yes, a 401(k) plan must have a written plan document. The written plan document is a formal and legal requirement under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. Here are the key reasons why a 401(k) plan needs a written plan document:

1. Compliance with Legal Requirements: The written plan document ensures that the 401(k) plan complies with all applicable laws and regulations. This includes provisions of ERISA, the Internal Revenue Code, and other relevant federal and state laws.
2. Plan Operations and Administration: The document outlines the rules and procedures for operating and administering the 401(k) plan. This includes details on eligibility, contributions, vesting, distributions, loans, and other key aspects of the plan.
3. Participant Rights and Responsibilities: The plan document provides clear information to participants about their rights and responsibilities under the plan. This helps ensure that participants understand how the plan works and what benefits they are entitled to.
4. IRS and DOL Audits: In the event of an audit by the Internal Revenue Service (IRS) or the Department of Labor (DOL), the written plan document serves as evidence that the plan is being administered according to the established rules and regulations.
5. Plan Amendments and Updates: The plan document provides a framework for making amendments and updates to the plan as needed. This is important to ensure the plan remains in compliance with changing laws and regulations and meets the needs of the employer and employees.

Employers are required to adopt the written plan document and make it available to plan participants. The document must be kept current and updated to reflect any changes in the law or in the plan's terms. Additionally, employers must provide participants with a Summary Plan Description (SPD), which summarizes the key features of the plan in an easy-to-understand format.

 

Types of Plans

What is a Defined Benefit Plan?

A Defined Benefit Plan is a type of retirement Plan. Defined Benefit Plans must be employer-sponsored. They are not individual accounts (like IRAs, for example). However, self-employed individuals may set up a Defined Benefit Plan.

Rather than simply providing an annual contribution that will grow to an unknown amount at retirement, Defined Benefit Plans predefine the benefit a participant will receive at retirement. This means that the employer bears the investment risk. Year-over-year asset fluctuations are taken into account when the Defined Benefit Plan actuary annually determines the required and maximum contribution amounts. There are two main types of Defined Benefit Plans: Traditional and Cash Balance Plans.

Traditional Defined Benefit Plans

Traditional Defined Benefit Plans provide a lifetime benefit at the retirement age specified in the Plan. Benefits often are a function of pay and length of service. For example, a formula of 10% of compensation per year of service would provide an annual retirement benefit equal to 100% of the employee's compensation after only 10 years (10% x 10 years x compensation = 100% of compensation). Defined Benefit Plans often define the retirement age to be age 62 or 65. It is common for smaller Plans to allow participants to take the actuarial present value of the payments in a single sum payment rather than receiving a set amount as payments for life.

 

Cash Balance Defined Benefit Plans

Unlike Traditional Defined Benefit Plans, a Cash Balance formula is expressed as an account balance rather than a stream of lifetime payments. In a Cash Balance Plan, the employer credits each participant's "notional account" with a predefined amount. This amount may be a flat dollar amount or a percentage of pay, but it only is granted if the participant has met the annual requirement (e.g, worked 1,000 hours in that year). These annual employer credits grow by a predefined interest rate. This rate may be a fixed percentage, tied to an index, or even equal the growth of Plan assets. It's important to clarify that participants do not have individual accounts in a Cash Balance Plan. Rather, each participant has a hypothetical account that is backed by the assets for the entire Plan. Thus, the employer must ensure that Plan assets are sufficient to pay benefits. At separation from service, vested annual credits accumulated with the specified interest rate is available to the participant.

 

Defined Benefit Rules for Counting Benefit Service

Whether a participant's benefit increases due to service depends on whether they are granted a year of benefit service. For example, in a Traditional Plan where the formula provides a lifetime benefit at retirement age equal to 10% of compensation per year of service, a participant would receive a benefit equal to 10% of compensation after one year of benefit service, 20% of compensation after two years of benefit service, and 100% of compensation after 10 years of service. However, a year of benefit service only is granted if the Plan's conditions are met. Similarly, in a Cash Balance Plan, a participant only would receive a credit to their notional account, as described above, if they met the conditions for earning a year of benefit service.

For determining if a year of benefit service is earned, Defined Benefit Plans must at least credit a participant with a partial year of benefit service if they work 1,000 hours in a year. However, the Plan may require that the participant work additional hours in a year to receive a full year of benefit service.

Defined Benefit Rules for Hours Equivalency Rather Than Actual Hours

If the employer does not track the number of hours worked, the Plan may estimate a participant's hours based on the number of days, weeks or months he or she works. Defined Benefit Plan rules provide guidance on the minimum number of hours a Plan must credit a participant based on the unit of time chosen by the Plan. For example, if a set number of hours is assumed based on the number of months a participant works, the Plan would credit 190 hours for each month in which the participant worked at least one hour. On the other hand, if the employer uses a shorter unit of measurement, such as a week, the Plan must credit 45 hours for each week in which a participant works at least one hour. Hours equivalency may be used for not only benefit service but also vesting and eligibility service.

 

Defined Benefit Plan Compensation

For purposes of applying the benefit formula and benefit maximum, a Plan may only count earned income. In general, earned income is compensation subject to FICA or self-employment tax. For employees, this would be W-2 income. Compensation for business owners depends on how the business entity is taxed. For example, W-2 income paid to owners counts as Plan compensation for entities taxed as a corporation. Whereas, Plan compensation for a Sole Proprietor or a Partnership is based on the amount shown on the Schedule C or K-1, respectively. Note that when calculating the Plan formula, an employer may exclude some elements of compensation. For instance, the Plan may exclude bonuses, overtime and sick pay, as long as the revised definition is not discriminatory against non-highly compensated employees. However, for other purposes, including determining who is highly compensated, the employer must use compensation without exclusions.

 

Defined Benefit Plan Distributions

For a participant to receive payment of their benefit, they must have a distributable event, such as separation from service. With some exceptions, the benefit cannot be paid to the participant while they still are employed with the employer sponsoring the Plan. In general, benefits are not paid until the Plan's specified retirement age. This often is age 62 or 65. However, many small Plans allow the participant to "cash out" their benefit, regardless of age, by electing a lump sum distribution in lieu of annual lifetime payments. However, these lump sum payouts are reduced for each year that the payout occurs prior to the Plan's retirement age.

Many larger Traditional Defined Benefit Plans do not provide lump sum payouts unless the single sum distribution is under $7,000. Instead, these types of Plans require participants to wait for monthly lifetime benefits until the age specified in the Plan (e.g., age 62 or 65). In almost all cases, regardless of the size of the Plan, Cash Balance Plans allow participants to take their benefit as a single sum distribution. Often, larger Plans also allow the participant to commence payments early if certain conditions are met (e.g., attained age 55 with 10 years of service). The Plan document will specify how much the benefit is reduced for early payment. In some cases, the early retirement benefit is actuarially equivalent to the normal retirement benefit (i.e., the two payment streams have the same actuarial present value). In other cases, the early retirement benefit may be subsidized, so that it is more valuable than the normal retirement benefit.

 

 

What Is the Benefit at Death?

If a participant dies prior to commencing benefits, Defined Benefit rules require that the Plan provide a minimum benefit to the participant's spouse. The minimum death benefit equals the spousal portion of the benefit assuming the participant terminated employment, survived to the Plan's retirement age, elected a Joint & Survivor 50% form of payment, then died the next day. Depending on the age of the participant, the surviving spouse and the Plan's actuarial equivalence basis, the survivor benefit may equal approximately 45% of the original monthly payout. For example, if the participant received $1,000 per month payable for life starting at age 65, the surviving spouse would be expected to receive $450 per month starting at the date the participant would have turned age 65.

 

Note that Defined Benefit Plan rules do not require the Plan to provide a minimum benefit for unmarried participants or if the participant has been married for less than one year. Many Plans provide more generous death benefits than those required by law. For instance, Cash Balance Plans generally would pay the entire balance to the participant's beneficiary. Small Traditional Defined Benefit Plans also typically pay out the entire value of the benefit to the beneficiary. In both types of Plans (Cash Balance and small Traditional Plans), payout often occurs to the beneficiary whether or not he or she is the participant's spouse.

 

Alternate Forms of Payment at Distribution

The Defined Benefit Plan must specify the form of payment relating to the benefit formula. For instance, a Traditional Plan often will provide a monthly benefit starting at the Plan's retirement age for the life of the participant. Payments cease upon the participant's death and further amounts are not provided to a beneficiary.

 

On the other hand, Cash Balance Plans are expressed as account balances, so the formula is in terms of a lump sum payout. Under either type of Plan, the participant must have additional forms of payment from which to choose. For example, all Defined Benefit Plans must provide a lifetime annuity that ceases upon the participant's death and a spousal annuity option (e.g., an annuity paid for the life of the participant that reduces to 50% of the original payment upon the death of the participant and is paid for the life of the surviving spouse).

 

Additionally, the Plan may provide other forms of payments, such as a single sum payout in a Traditional Plan or a lifetime annuity that guarantees a minimum number of payments even if the participant deceases before that period of time. When the participant separates from service and is eligible for immediate payment, the employer must provide the participant a calculation of their benefit and the optional forms of payment available. They also must tell the participant that they may defer the payment, if applicable. Based on this information and other disclosures, the participant elects a form of payment and sends the paperwork to the employer for processing and the payout of their benefit.

 

Actuarial Equivalence

Forms of payment may be adjusted to reflect that they differ in value. For instance, a lifetime annuity that ceases upon the participant's death would be expected to be less valuable than an annuity that provides a 10-year guarantee of payments regardless when the participant deceases. Of course, if the participant lives for more than 10 years, the streams of payment end up being equivalent. However, when payments commence, there is a probability that the participant will die within 10 years, making the guaranteed payment form more valuable than the life only form of payment. As a result, Defined Benefit Plans generally will adjust alternate forms of payment such that the actuarial present values are equal. In our example above, the guaranteed payment would be reduced to reflect that it may be paid longer than the life only benefit. Just how much would it be reduced? The reduction will depend on the interest and mortality rates specified in the Plan document. Additionally, the amount will be adjusted based on the participant's age. Older participants are more likely to decease prior to the 10-year period than younger participants, so that the guaranteed payments are more likely to come into play. Thus, a larger reduction is required for an older participant to make the forms of payment actuarially equivalent.

 

An employer is able to change the Plan's actuarial equivalence basis but they generally must grandfather the benefit earned at the time that the basis was changed to reflect the original definition of actuarial equivalence. In some cases, Plans may subsidize certain forms of payment, such as the default spousal survivor payment. In such a case, the subsidized payment may not be reduced even though it is more valuable.

 

Regardless, Defined Benefit Plan rules indicate that interest and mortality rates must be "reasonable". Additionally, the most valuable form of payment must be the default spousal survivor payment. Recently, lawsuits have alleged that certain pension plans do not have reasonable assumptions (mostly because they have not updated interest and mortality rates for several years or even decades).

 

Defined Benefit Plan Rules for Disability Benefits in a Plan

If a participant separates from service due to disability, they may be able to receive their benefit. Whether they are eligible to receive benefits immediately depends on the Plan provisions. If the participant has reached the Plan's early or normal retirement age, they may receive payout under the applicable provision. However, if they separate from the service prior to the Plan's retirement age, they may not be able to commence payments immediately.

As mentioned, most small Traditional and Cash Balance Plans allow participants to elect a single sum payout in lieu of a future stream of lifetime payments. A disabled participant, who separated from service, would be able to take a payout under this provision.

Larger Traditional Plans, on the other hand, typically do not allow large single sum payouts. However, they may provide a special disability benefit. Specifically, the Plan may credit benefit service that would have been earned had the participant worked to retirement. Additionally, the Plan may allow for immediate payment of the benefit. To reflect that additional payments will be made to the participant because of early commencement, the Plan may reduce the benefit so that it is equivalent to the unreduced payments that would start at the Plan's retirement age. In some cases, the Plan may subsidize disability benefits so that they are not fully reduced or not reduced at all for early payment. These type of special disability benefits may be expensive, and, when valuing the Plan, the actuary will account for the increased cost and the probability of their occurrence.

 

Benefit Cutbacks Are Not Permitted

In general, Defined Benefit Plan rules do not allow an employer to reduce benefits that the participant has already earned. However, employers may amend the Plan to reduce or even cease future benefit increases. To significantly reduce future benefit increases, the employer must provide notice to the affected participants several days in advance of the prospective cutback. Note that there are exceptions for reducing certain ancillary benefits, such as disability and death benefits. These types of benefits are not protected from cutbacks.

 

Freezing Defined Benefit Plans

As mentioned, an employer may reduce or even stop future benefit increases. When an employer completely stops future increases, benefits are "frozen". A hard freeze means that benefits will not increase for additional service or increases in compensation (applies to a Traditional Plan). Alternatively, the employer may freeze additional service but allow participant benefits to increase with future compensation. This essentially provides a COLA adjusted benefit through the date the participant separates from service. Sometimes this is called a soft freeze. Typically, when a Defined Benefit Plan freezes, the employer closes the Plan to any new participants. This creates a closed group of participants that decreases over time as participants are cashed out or become deceased.

Should the TRUSTEE decided to unfreeze the PLAN, then SPONSOR would be required to make up all contributions that were not made during the freeze.

 

 

 

Employee Contributions

Defined Benefit Plans may allow, or even require, participants to make contributions to the Plan. This is rare in small Plans, slightly more common in large Plans, but often more prevalent in governmental Plans, which are not addressed in this article. If contributions are mandatory, a participant must elect to make a contribution to receive a year of benefit service. These contributions are immediately vested and receive a guaranteed rate of interest. When the participant retires, he or she must receive no less than the value of the accumulated contributions.

When a Plan allows voluntary contributions, the contributions also must be vested immediately. The employee contributions also will be credited with a predefined rate of return based on a fixed percentage or an index. Upon separation from service, the accumulated contributions will provide an additional benefit to the participant.

 

 

 

Traditional and Roth 401(k) plans are defined contribution plans. Both the employee and employer can contribute to the account up to the dollar limits set by the Internal Revenue Service (IRS). Employees' contributions to a traditional 401(k) plan are made with before-tax dollars and reduce their taxable income and their adjusted gross income. Contributions to a Roth 401(k) are made with after-tax dollars and do not impact taxable income further.

 

Employees are also responsible for choosing the specific investments held within their 401(k) accounts from a selection that their employer offers. Those offerings typically include stock and bond mutual funds and target-date funds designed to reduce the risk of losses as the employee approaches retirement.

Contribution Limits

The maximum amount an employee or employer can contribute to a 401(k) plan is adjusted periodically to account for inflation, which measures rising prices.  For 2024, the annual limit on employee contributions to a 401(k) is $23,000 annually for workers under age 50. However, those aged 50 and over could make a $7,500 catch-up contribution.

If your employer also contributes or if you elect to make additional, nondeductible after-tax contributions to your traditional 401(k) account, there is a total employee-and-employer contribution amount for the year:

 

For workers under 50 years old, the total employee-employer contributions can't exceed $69,000 per year. If the catch-up contribution for those 50 and over is included, the limit is $76,500.

Employer Matching

Employers who match employee contributions use various matching formulas including a safe. For instance, an employer might match dollar for dollar up to 3% and then 505 of the next 2% of pay. Other matching formulas may be $0.50 for every $1 that the employee contributes, up to a certain percentage of salary.

 

 

Minimum Coverage and Benefits

Employee Eligibility

Only employees are eligible to participate in a Defined Benefit Plan. Independent contractors are not eligible. Employers may exclude any employee group but must be able to meet minimum participation, coverage and nondiscrimination requirements. However, some employee groups, such as certain union employees or nonresident aliens, may be excluded without it counting against the employer. If the Plan document does not exclude an employee group, the employer may require a minimum age of 21 and a one year waiting period. Additionally, the employer may require the employee to have worked at least 1,000 in a year. The waiting period may be extended to two years if the benefit is fully vested when the employee enters the Plan. After the employee meets these requirements, the employer may further delay Plan entry until the following January 1st or July 1st (for a calendar year Plan).

 

 

 

Vesting of Employee Benefits

An employee is vested in their Defined Benefit if all or a portion of their benefit is not forfeited when they separate from service. For purposes of vesting, the employer may require a participant to work as many as 1,000 hours in a year to earn a year of vesting service. When the participant terminates, whether they are vested depends on how many years of vesting service they have. In a Traditional Defined Benefit Plan, the employer may require the participant to earn up to five years of vesting service using a "cliff" schedule (i.e., 0% vesting for the first 4 years and 100% vesting at 5 years). Alternatively, the employer may require up to seven years of service for full vesting using a "graded" schedule (i.e., 20% after 3 years, 40% after 4 years,..., 100% vesting after 7 years).

 

On the other hand, for Cash Balance Plan benefits, the employer may require no more than three years of service for full vesting using a "cliff" schedule. Unlike their traditional counterparts, extending the vesting schedule using "graded" vesting is not permitted. Regardless of years of service, the employer must provide full vesting once the participant reaches Normal Retirement Age, as defined in the Plan. Normal Retirement Age can be not exceed the later of age 65 and five years from when the employee participated in the Plan.

 

Vesting in a Top Heavy Defined Benefit Plan

If a Plan is top heavy, the required vesting schedule is accelerated.

 

A Plan is top heavy if more than 60% of the value of benefits are attributed to "Key" employees. In most cases, small Defined Benefit Plans are top heavy. Top heavy Traditional and Cash Balance Plans may require no more than three years of service for full vesting. However, Traditional Plans may extend the vesting schedule up to six years if the participant earns at least 20% vesting per year of services starting in the second year (20% after 2 years, 40% after 3 years,..., 100% vesting after 6 years).

 

Defined Benefit Rules for Minimum Lump Sum Payments

In lieu of lifetime monthly payments in a Traditional Plan, employers may offer a single sum distribution equal to the actuarial present value of the monthly payments. The conversion from a lifetime payment stream to a lump sum distribution is based on the Plan's definition of actuarial equivalence. However, the Defined Benefit Plan rules require that the payout be no less than the distribution calculated using the IRS' prescribed interest and mortality rates. Note that Cash Balance Plans are not subject to this requirement because their benefit already is expressed as an account balance (i.e., no conversion is necessary).

 

 

Controlled Groups and Affiliated Service Groups

In some cases, businesses must be aggregated for Plan rules. This occurs when businesses have common ownership and/or are affiliated. The rules for controlled and affiliated service groups are complicated and will not be discussed in detail here. However, if an individual has sole ownership of two businesses, for example, he or she must regard them as one business when applying many of the rules including benefit and compensation maximums, covering staff, and vesting requirements.

 

Highly Compensated Employees

Defined Benefit Plan rules divide participants into two classes: highly compensated and non-highly compensated employees. To ensure lower-paid employees receive "fair" benefits, the coverage of and benefits for the two groups are compared. Highly compensated employees are those who own more than 5% of a business in the current or prior year. For this purpose, ownership is attributed to spouses, children, parents and grandparents. However, it may not be attributed more than once (e.g., from parent to child, then from child to their spouse).

 

A participant also may be highly compensated if they earned more than a certain amount in the prior year (e.g., highly compensated in 2024 if compensation is more than $150,000 in 2023). However, the employer may make an election to limit the number of highly compensated employees to 20% of non-excluded employees. Any participant who is not a highly compensated employee is a non-highly compensated employee.

 

 

Defined Benefit Rules for Minimum Participation

Defined Benefit Plan rules require that employers provide a meaningful benefit to at least 40% of nonexcludable employees. However, the requirement is capped at 50 employees. Additionally, if there are fewer than three employees, all employees must receive a meaningful benefit. "Meaningful" is not defined in the Defined Benefit Plan rules, but the IRS has an informal threshold for Traditional Plans of 0.50% of compensation per year of service. In a Cash Balance Plan, this is equal to 2% to 5% of compensation per year depending on the participant's age (younger participants require less benefit because they have a longer period for amounts to accumulate).

 

 

 

 

 

Minimum Employee Coverage

Defined Benefit Plan rules require employers to cover at least 70% of non-highly compensated employees relative to the number of covered highly compensated employees. Thus, if the Plan covered only 50% of highly compensated employees, then it need only cover 35% of non-highly compensated employees (70% x 50% = 35%). The coverage threshold may be lowered if the average non-highly compensated benefits are at least 70% of the average highly compensated benefits. The revised threshold in this case is a function of the non-highly compensated employee concentration in the Plan. The higher the non-highly concentration, the lower the coverage threshold.

 

Nondiscrimination Testing

In addition, to minimum coverage, the employer must be nondiscriminatory in providing Plan benefit amounts. Nondiscrimination testing is satisfied, when, for each highly compensated employee, at least 70% of non-highly compensated employees receive an "equivalent" benefit relative to highly compensated employees.

 

Thus, for HCE 1, if 20% of highly-compensated employees have a benefit that is at least "equivalent" to that particular HCE, then at least 14% of non-highly compensated employees must have a benefit that is "equivalent" or greater than that HCE's benefit (20% x 70% = 14%). Note that equivalence typically is determined as a percentage of pay. Like coverage requirements, this threshold may be lowered if the average non-highly compensated benefits are at least 70% of the average highly compensated benefits. The revised threshold is a function of the concentration of non-highly compensated employees in the Plan. The higher the concentration, the lower the threshold.

 

 

Top Heavy Plans.

Minimum Benefit and Vesting.

If a Defined Benefit Plan is top heavy, the employer must provide a minimum benefit and accelerate vesting. A Plan is considered top heavy when at least 60% of the value of benefits is attributed to Key employees (employees with a certain level of ownership, compensation and/or are officers). For this purpose, ownership is attributed to spouses, children, parents and grandparents.

 

Top heavy Defined Benefit Plans must provide a minimum Traditional benefit of 2% of compensation per year of service for 10 years. The employer need only provide this minimum to non-Key employees who participate in the Plan. Cash Balance Plans must receive an equivalent benefit. The employer also must accelerate the vesting schedule as described in the vesting section above.

Aggregation of Plans

If an employer has both a Defined Benefit and Defined Contribution Plan, the Plans may be aggregated to help satisfy minimum participation, coverage, nondiscrimination and the top heavy minimum benefit. However, if they are aggregated for one of these purposes, they generally must be aggregated for all of these purposes.

 

Defined Benefit Rules for Plan Maximums

Maximum Plan Compensation

Plan compensation is used for a variety of purposes, including the benefit amount, maximum benefit and for nondiscrimination testing. Plan compensation is limited to $345,000 for 2024 and is indexed each year. For example, the limit in 2023 was $330,000. See historical limits for prior years.

 

Maximum Benefit and Payout Amounts

The maximum lifetime annual Defined Benefit is $275,000 payable for 2024. The maximum is reduced when the participant commences payments prior to age 62 and increased when payment is delayed beyond age 65.  The single sum equivalent of this lifetime annual benefit is $3.5 million payable at age 62 in 2024. This amount is adjusted if the participant receives payment at a different age. It also may be reduced depending on the participant's compensation history and years of service.

 

Maximum Deductible Contributions

Minimum Contributions under Defined Benefit Plan Rules

Defined Benefit Plans generally require the employer to make annual contributions. The amount required is equal to the value of benefit increases for the year plus a 15-year amortization of any unfunded liabilities. If the Plan is overfunded, there is no amortization. Instead, the value of benefit increases for the year is reduced to the extent assets exceed the liability.

 

Additionally, the required contribution is increased for interest if the employer makes the deposit after the valuation date. For minimum contribution purposes, the liability is less than a liability based on "market" bond rates. Funding relief reflects both current and historical rates to determine the interest rates for discounting future expected cash flows. The required amount is due 8-1/2 months after the end of the Plan year. For example, the 2024 contribution would be due by September 15, 2025 for a calendar Plan year. If the required annual contribution is late, a 10% excise tax applies. This amount may be increased to 100% under certain conditions.

 

Quarterly Contribution Requirements

Quarterly contributions may be required for underfunded Defined Benefit Plans.

 

When Plan assets exceed the Plan liability, the employer is exempt from making quarterly contributions in the next Plan year. If no exemption applies, the quarterly contribution equals one-fourth of the lesser of 100% of the prior year required contribution and 90% of the current year required contribution. When quarterly contributions are late, the annual requirement is increased to reflect delayed funding plus a "penalty". Additionally, the employer may need to report late payments to the PBGC and inform Plan participants. For small Plans, quarterly contributions are generally not made on time. Instead, for simplicity, the employer may pay the entire amount due all at once. If the Plan has fewer than 100 participants, PBGC reporting is waived for late quarterly contributions. The participant notification often is included in either the Annual Funding Notice or Summary Annual Report.

 

 

Defined Benefit Rules Regarding Credit Balances

If the employer has made contributions in prior years that are in excess of required contributions, these excess amounts may be applied against future contribution requirements. These excess accumulated contributions are called credit balances. To use credit balances, the employer must have made an election to "store" the excess and not have used them in the past. Additionally, to use the credit balance in the current year, the Plan must not be below 80% funded in the prior year. Unused past credit balances are increased from year-to-year at the rate of return of Plan assets.

 

 

Certification of the Plan's Funded Status

Each year, the Defined Benefit Plan actuary must certify the Plan's funded status by dividing the Plan assets by the Plan liability. If the Plan is underfunded, restrictions may apply. For example, if the funded status is less than 80%, benefits may not be increased without either fully funding the increase or contributing an amount such that the funded status is at least 80% after reflecting the benefit increases. Additionally, only half of single sum payments generally may be made to participants. If the Plan is less than 60% funded, further restrictions apply. In particular, no single sum payments may be distributed to participants until the funded status is increased.

 

What happens in the next year? The funded status is deemed to carryover from the prior to the current year until the Plan's actuary certifies an updated funded status. Additionally, if that certification is not made within 3 months of the beginning of the current Plan year, the prior year's funded status is assumed to drop by 10 percentage points until it is certified. Further, if the funded status is not certified within 9 months, the funded status is deemed to be less than 60% and certifying the funded status after that will not be reflected for the current year.

 

What Is the Maximum Deductible Contribution?

Plan contributions should not exceed the maximum deductible contribution. The maximum deductible is equal to the value of benefit increases for the year plus 150% of the Plan liability less Plan assets. Additionally, the employer may fund the value attributed to expected future compensation increases. If benefits have been increased in the last two years for highly compensated employees, the liability increase attributed to that amendment may not be fully reflected. Unlike the required contribution, the Plan liability does not reflect a historical interest rate overlay, although rates are smoothed over 24-months.

 

 

 The Complexity of Estimating Pension Liabilities

The primary issue associated with offering a DB plan begins with the estimation of an employee’s projected benefit obligation (PBO). The PBO represents the estimation of the present value of a future liability of an employee’s pension benefit. In order to understand the complexity associated with estimating this liability, take a look at the following simplified example of how it is calculated.

 

Estimating PBO: A Simple Example

Let’s assume that Company ABC was created by Linda. Linda is 22 and a recent college graduate. She is the only employee, has a base salary of $25,000, and recently completed one year of service with the firm. Linda’s company offers a DB plan. The DB plan benefit will provide her an annual retirement benefit equal to 2% of her final salary, multiplied by the number of years she has accumulated with the firm.

 

Let’s also say she will work 45 years before she retires and receive a 2% annual growth rate in compensation for every year that she works for Company ABC. Based on these assumptions, we can estimate that Linda’s projected annual pension benefit after one year of service will be as follows:

 

$1,219 ($25,000 x 1.0245 x .02)

Take note that this pension benefit estimate takes into account Linda’s estimated future salary increase over her estimated working career of 45 years.

 

However, it does not take into account Linda’s anticipated future service with Company ABC. Instead, the benefit estimate only takes into account her accumulated service to date. Once this benefit amount is determined, it is assumed that Linda will receive, at the beginning of each year after she retires, a benefit of $1,219 per year over her life expectancy, which we will assume is 30 years.

We can now determine the value of the PBO. To accomplish this goal, Linda’s annual retirement benefit needs to be converted into a lump-sum value at her anticipated normal retirement date.

Using a 4% yield on a 30-year Treasury bond as a conservative discount factor, the present value of Linda’s annual pension benefit over her 30-year life expectancy at her retirement date would be $21,079. This represents what Company ABC would have to pay Linda to satisfy her company’s retirement benefit obligation on the day that she retires.

To determine the PBO, the present value of Linda’s retirement benefit at her normal retirement date would then have to be discounted back 44 years to today’s valuation date. Again, using the yield on the 30-year Treasury bond of 4% as the discount factor, the present value of Linda’s benefit would be $3,753.

This amount is the PBO. It is the amount that corporate executives set aside in an account at the end of Linda’s first year of employment in order to be able to pay her promised retirement benefit of $1,219 per year, payable in 45 years, over her life expectancy following retirement. If Company ABC sets aside this amount of money, the Company ABC DB plan would be fully funded from an actuarial point of view.

Estimating Liabilities: Additional Assumptions

This example represents a simplified case of the complexities associated with the estimation of pension liabilities. Additional actuarial assumptions and accounting mandates would have to be taken into account in order to estimate the PBO in accordance with accepted guidelines.

With that in mind, let’s now look at 10 assumptions that we would have to take into account in order to estimate the PBO and how they would impact the accuracy of the pension liability estimate.

DB Plan Assumptions	Issues to Consider	Impact on PBO
1. Retirement benefit formula	The benefit formula may change over time.	Any type of benefit change will materially affect the estimated PBO.
2. Employee salary growth-rate estimate	Future compensation growth rates are impossible to accurately project.	A higher salary growth rate will increase the PBO.
3. Estimated length of working career	It is impossible to know how long an employee will work for an organization.	The more years of service the employee accrues, the greater the PBO.
4. Years of service used to make the PBO calculation	Actuarial guidelines mandate that the PBO take into account future salary growth estimates but ignore any potential future service.	If actuarial guidelines required the inclusion of potential future service, the estimated PBO would increase dramatically.
5. Vesting uncertainties	It is impossible to know if employees will work for the employer long enough to vest their retirement benefits.	Vesting provisions will increase the uncertainty in the estimate of the PBO.
6. Length of time employee will receive a monthly retirement benefit	It is impossible to know how long employees will live after they retire.	The longer retirees live, the longer they will receive retirement benefits, and the greater the impact on the estimate of the PBO.
7. Retirement payout assumption	It is difficult to know what type of payout option employees will select, because their beneficiary status may change over time.	The election of survivor benefits will affect the length of the time horizon over which benefits are expected to be paid. This in turn will affect the estimate of the PBO.
8. Cost-of-living adjustment (COLA) provisions	It is difficult to know if a COLA feature will be made available in the future, what the future COLA benefit rate will be, or how frequently a COLA will be granted.	Any type of COLA benefit will increase the estimate of the PBO.
9. Discount rate applied to benefits over the retirement period to the employee’s retirement date	It is impossible to know what discount rate should be applied to determine the present value of the retirement benefit at retirement.	The higher (lower) the assumed discount rate, the lower (higher) the estimated PBO. The flexibility afforded to management to set the discount rate increases the ability of corporate management to manipulate their company’s financial statements by manipulating the net pension liability amount recorded on the company’s balance sheet
10. Discount rate applied to annuity value of retirement benefit at retirement date to the current valuation date	It is impossible to know what discount rate should be applied to determine the present value of the retirement benefit today.	The higher (lower) the assumed discount rate, the lower (higher) the estimated PBO. The flexibility afforded to management to set the discount rate increases the ability of corporate management to manipulate their company’s financial statements by manipulating the net pension liability amount recorded on the company’s balance sheet.

 

RISKS

Under a defined benefit plan, an employer promises an employee an annuity at retirement. The employer, not the employee, bears the most risk in a defined benefit plan. If retired employees live longer than anticipated, or if the investments financing the employees’ pensions fail to meet expectations, the employer must increase contributions to make good on the promised benefits.  If the investments financing the employees’ pensions exceed expectations, then contributions may be reduced to zero.  Defined benefit plans that are not allowed to make contributions are considered overfunded, and the excess gets taxed at the normal tax rate plus a 50% excise tax.

Pension Protection Act-AFTAP

Restrictions on Distributions—If the plan’s funded ratio is less than 60%, distributions to a participant are limited. Notably, a participant cannot receive a lump-sum distribution of the full value of the accrued benefit.

Restrictions on Plan Amendments Improving Benefits—A plan may not be amended to increase benefits if its funded ratio would be less than 80% after the plan amendment, unless the employer immediately contributes the full value of the amendment to the pension fund.

Under Funding -The PPA will ultimately require plans to make contributions necessary to amortize unfunded benefit liabilities over seven years. The new rules will force sponsors of underfunded plans to contribute substantially more than under existing law. In addition, the manner in which the PPA determines contribution requirements could lead to significant volatility from year to year in required contributions, especially for underfunded plans. Even plans that are fully funded one year may become underfunded the next, depending on changes in interest rates.

Timing of Contributions As under existing law, the Act requires minimum required contributions to be made no later than eight-and-a-half months after the end of the plan year. If the plan had a funding shortfall for the preceding year, the employer is required to make quarterly contributions There are sanctions for late or missed quarterly contributions include interest penalties, notification of participants and, possibly, liens in favor of the plan, enforceable by the PBGC.

 

Defined Benefit Plan Rules: Distributions and Loans

Distribution upon Separation from Service

With a few exceptions, which we will cover in this section, distributions only may occur upon separation from service (e.g., employee termination, retirement, disability or death). Even then, the participant must meet the requirements for a distribution. For example, if the participant is younger than the Plan's retirement age, which is often age 62 or 65 with 5 years of elapsed time from the date they participated in the Plan, the Plan may not permit a distribution until the Plan's retirement age is reached. However, the Plan may provide an early retirement benefit if certain conditions are met (e.g., age 55 with 10 years of vesting service). Early retirement benefits often are actuarially reduced to reflect that lifetime payments that commence earlier have a higher expected value.

 

Typically, small Defined Benefit Plans also allow participants to elect a single sum immediate payment rather than a deferred lifetime payment stream. In such a case, the Plan also must allow the participant to elect an immediate lifetime annuity, including the Plan's default spousal survivor form of payment. Regardless of the Plan's provisions, upon separation, the employer must provide the employee with a benefit package. This package shows the participant the benefit available to them, along with other optional forms of payment and required disclosures. After reviewing the package, the participant elects a form of payment and returns the election to the employer. Once the employer receives the participant's election, the benefit amount is processed and paid from Plan assets.

 

 

Forms of Payment Available upon Distribution

As mentioned, in the previous section, at separation from service the participant may choose from several forms of payment. Although there are many potential forms of payment that the Plan may offer, these forms of payment are most common:

 

• Single life only annuity - a monthly amount paid for the life of the participant. Upon the participant's death, payments cease.

 

• Joint & 50% survivor annuity - a monthly amount paid for the life of the participant. Upon the participant's death, the surviving spouse, receives 50% of the monthly amount for his or her life. If the spouse, predeceases the participant, the monthly amount is not reduced. Upon the death of both the participant and spouse, payments cease. This benefit often is reduced to reflect that it more valuable than the single life annuity.

 

• Other joint & survivor benefit annuities - the Plan also may offer various survivor percentages. Common percentages are 66-2/3%, 75%, and 100%. These benefits often are reduced to reflect that they are more valuable than the single life annuity. In that case, the higher the survivor percentage, the larger the reduction.

 

• 10-year certain & life annuity - a single life annuity with a 10-year guarantee. If the participant deceases before receiving 10 years of monthly payments, payments will be paid to the participant's beneficiary for the remaining 10-year period. If the participant deceases after they have received 10-years of monthly payments, payments cease. This benefit often is reduced to reflect that it more valuable than the single life annuity.

 

• Other certain & life annuities - the Plan also may offer various periods of guarantees. Common periods are 5 years and 15 years. These benefits often are reduced to reflect that they are more valuable than the single life annuity. In that case, the longer the guarantee period, the larger the reduction.

 

• Single sum payout - in lieu of a stream of payments, the employer may offer a single sum payout equal to the actuarial present value of the lifetime payments. Unlike the lifetime payments, the participant may roll over this amount to an IRA. Note, however, that if the participant elects this option, they no longer are entitled to future payments from the Plan. In some cases, especially with mid-sized and larger Traditional Plans, the employer may only permit single sums under a certain threshold (e.g. under $25,000). If the present value exceeds that threshold, the participant may not elect a single sum payout.

 

 

Defined Benefit Rules Regarding Mandatory Benefit Cash-outs

If the actuarial present value of the lifetime payment stream is less than $7,000, the employer may require that the participant receive their benefit as a single sum payout. This Defined Benefit Plan rule eases Plan administration for employers, because nominal monthly payments (e.g., $20 per month for life) may be cashed out without the employee's consent.

 

 

Benefit Restrictions for Underfunded Plans

If the Plan is underfunded, employers may not be able to allow participants to elect a single sum distribution.

 

For example, if the Plan is less than 60% funded, only single sum distributions less than or equal to $7,000 are permitted. All other single sum distributions are not allowed until the Plan is better funded. If the Plan is at least 60% but less than 80% funded, only half of the single sum distribution may be paid out. However, distributions less than or equal to $7,000 would be permitted. Depending on the Plan, the remaining half may be paid immediately as an annuity or the participant may wait until the Plan is at least 80% funded to have the remaining single sum paid.

 

For employers in bankruptcy, more stringent requirements apply. Additional single sum payout restrictions apply to the 25 highest paid highly compensated employees in a Plan. In general, the Plan must be at least 110% funded after the distribution for the payout to be permitted.

 

In-service Distributions from a Defined Benefit Plan

In addition to payouts being permitted upon a participant's separation from service, pension rules may allow participants to be paid their benefit while they are still working. These so-called in-service distributions may commence as early as age 59-1/2 but only if the Plan allows for them. In-service distributions provide employees a way to access their retirement without separating from service. This may be advantageous for employers who want to retain employees, who otherwise may terminate employment, start benefits, and find employment at a competitor, as a way to continue working while drawing benefits.

In-service distributions also may be part of a phased retirement program, allowing workers to partially retire by reducing their hours and supplementing their part-time income by commencing Plan benefits.

 

 

Required Minimum Distributions

Because participants are not taxed on the accrual of their benefits or the increase of the value of the benefit as they approach retirement, Defined Benefit Plans provide participants with valuable tax deferral. However, the IRS only allows this tax deferral temporarily. Eventually, the Plan participant will be taxed on their benefit. The required minimum distribution rules require participants to start their Defined Benefit by the April 1 following the year in which they turn age 73. However, employees who do not own more than 5% of the business may defer payment until they separate from service, if later. For this purpose, ownership is attributed to a spouse as if they had direct ownership in the business. Unlike 401(k) Plans, the amount of the minimum distribution is not simply the value of the benefit (or account balance) divided by life expectancy. Rather, the participant must commence the benefit they accrued, which is paid out for their remaining lifetime or based on an alternative form of payment (including an increasing annuity that increases by less than 5% per year).

 

 

Qualified Domestic Relations Orders (QDROs)

If a participant divorces, their ex-spouse may be entitled to a share of their Defined Benefit. A Qualified Domestic Relations Order (QDRO) is the court order that is used to split the retirement benefit between the participant and ex-spouse. In some cases, the Defined Benefit is not divided. Instead, the parties agree to allow the participant to keep the full benefit, but the value of the benefit is taken into account when allocating the remaining assets between the parties. However, when the Defined Benefit is split between the participant and former spouse (called the alternate payee), the benefit generally is divided in half, but may be adjusted if a part of the benefit was earned before or after the marriage dissolved. Dividing Defined Benefits due to divorce is complex. In most cases, the parties will hire an ERISA attorney to draft the language describing how the benefit is to be allocated. Additionally, a Defined Benefit actuary is needed to calculate the benefit split based on the QDRO language.

 

 

Defined Benefit Plan Rules for Participant Loans

In addition to Plan payouts, Defined Benefit Plan rules may allow participants to receive a loan from the Plan.

 

Defined Benefit Plan Reporting

Form 5500 and the Schedule SB

The Form 5500 is the Plan's annual report and is provided to various government agencies, which are responsible for Defined Benefit Plans. On the form, the employer must provide participant counts, asset information, and respond to a number of other questions. For Plans with at least 100 participants, more extensive information must be reported and a Plan audit is required.

 

Smaller Plans often are exempt from the CPA audit and many of the additional schedules. In fact, in many cases, the employer may file a simplified form (i.e., Form 5500-SF or Form 5500-EZ). However, the Schedule SB generally will be required for all Defined Benefit Plans. This schedule contains actuarial information regarding the Plan's funded status and certification that the employer met the annual funding requirements.

 

The Form 5500 is due at the end of the seventh month after the start of the Plan year (July 31st for a calendar year Plan). However, the filing may be extended up to 2-1/2 months by filing the Form 5558 (to October 15th for a calendar year Plan).

 

 

PBGC Premium Filing

The Pension Benefit Guaranty Corporation is a government agency that insures pension benefits for Plan participants.

 

Generally, Defined Benefit Plans are covered by the PBGC but many small Plans are not. For example, Defined Benefit Plans that only are owned by substantial owners are exempt from coverage. Professional service employers with not more than 25 active participants also are exempt.

 

For Plans that are not exempt, the Plan actuary must complete a PBGC premium filing each year. The filing calculates the premium due from the employer as a function of both headcount and funded status. For 2024, the PBGC premium is $101 per participant plus 5.20% of any unfunded vested liability. However, the premium related to underfunding is limited to $686 per participant. Additionally, for employers with not more than 25 employees, the underfunded premium is limited to $5 times the number of participants squared.

 

The filing and premium is due 9-1/2 months after the Plan year begins. For example, the due date is October 15th for a calendar year Plan.

 

The Form 8955-SSA is due at the end of the seventh month after the start of the Plan year (July 31st for a calendar year Plan). However, the filing can be extended up to 2-1/2 months by filing the Form 5558 (to October 15th for a calendar year Plan).

 

 

Reporting Defined Benefit Plan Distributions and Withholding:

Form 1099-R and Form 945Employers must file Form 1099-R for any participants who received a Defined Benefit Plan distribution over $10 in the prior year. Using Form 1099-R, employers indicate the distribution amount, the type of distribution, how much is taxable and any withholding for taxes.

 

Copies of Form 1099-R for the prior year must be provided to applicable participants by January 31. The form also must be filed with the IRS by March 1 (or March 31, if filed electronically).

 

If the employer has withheld any federal income tax in the prior year when paying out Defined Benefits, they must file the Form 945. Note that federal income tax is not withheld for a payout that a participant rolls over to an IRA. Thus, it is possible for an employer to pay a Defined Benefit Plan distribution and file the Form 1099-R but not be required to file the Form 945.

 

The Form 945 is due by January 31 (in some cases, it may be filed as late as February 10). Filings may be submitted electronically or sent by mail and, in some cases, by private delivery service.

 

 

Reportable Events:

The PBGC requires that employers apprise them of certain events that potentially could affect the employers ability to pay future Plan benefits. The notification to the PBGC is done via the PBGC Form 10.

 

While there are many events for which the PBGC requires reporting from the employer, some of the most common ones for small Plans are:

 

• Failure to make required contributions
• Distribution to a substantial owner
• Inability to pay participant benefits when due
• Active participants is reduced by more than 20% in a year

 

In some cases, reporting is waived. For example, if a failure to make a required contribution is corrected within 30 days or if the Plan has no more than 100 participants and fails to make a quarterly contribution, reporting is not required.

 

Notice of Benefit Restrictions for Underfunded Plans

Defined Benefit Plan rules require that the employer enforce restrictions on underfunded Plans. When these restrictions apply, the employer must notify affected participants and beneficiaries within 30 days from when the restriction applies.

 

 

 

Notice of Reduction in Future Accruals

When an employer significantly reduces or stops future benefit increases, they must inform participants. The so-called 204(h) notice must be distributed at least 45 days before the effective date of the Plan reduction. For small Plans with fewer than 100 participants, only a 15-day advance notice is required.

 

The notice must describe benefits before and after the Plan change. It also must contain contact information for the employer.

 

Notice of Late Required Contributions

Employers must notify their participants of any late required contributions, including quarterly contributions. If the employer deposits the required amount within 60-days of the contribution due date, they are not required to send participants a notice. The notice must be provided within a reasonable amount of time.

 

For convenience, many small Plan employers deposit the full contribution annually rather than making required quarterly installments. In such cases, the employer often adds a paragraph to the required annual notice disclosing the late contribution(s).

 

 

Miscellaneous Defined Benefit Plan Rules

Defined Benefit Plans must have a formal, written Plan document.

The Plan document explains the terms of the Plan, including who is eligible for the Plan, how benefits are calculated, when benefits are vested and when they may be distributed. Benefits must be clearly defined and "definitely determinable".

Because Plan documents may be lengthy and difficult for participants and employers to understand, employers must provide employees with a summary of Plan terms. This document, called a Summary Plan Description, is less formal and easier for participants to understand.

 

 

Permanency Requirements

Employers must establish the Defined Benefit Plan with the intent of it being a permanent, rather than a temporary, program.

 

If an employer terminates the Plan within a few years of when it was set up, there must be a valid business reason. Examples of valid business reasons include change in ownership, liquidation or bankruptcy of the employer, adverse business conditions, affordability of the Plan, the adoption of a new Plan or employee dissatisfaction with the Plan.

 

 

Defined Benefit Rules Regarding Beneficiaries

Whether a Defined Benefit Plan provides payments to beneficiaries will depend.

 

For example, if the participant has not yet commenced payments from the Plan, then Defined Benefit Plan rules require the Plan to provide a minimum survivor benefit. However, this benefit only is required to a surviving spouse if the participant has been married for at least one year.

 

This minimum benefit is equal to the monthly payment had the participant terminated employment, survived to the Plan's retirement age, elected a joint & 50% survivor annuity, then deceased. Depending on the relative ages of the participant and spouse, as well as the Plan assumptions for converting benefits to an optional payment form, this amount would be roughly equal to 45% of the original lifetime payment to the participant. If the survivor elects it and the Plan permits it, the surviving benefit may be paid before the date the participant would have reached the Plan's retirement age, but the amount likely would be reduced for early payment (i.e., more payments received). Because this type of death benefit is only available to a surviving spouse, no beneficiary election is necessary.

 

Note, that often small Plans provide the full value of the benefit to the beneficiary, whether or not the beneficiary is a spouse, when the participant deceases. In this case, a beneficiary election is required, because the beneficiary may be someone other than the spouse (with spousal permission). If a positive election is not made, the Plan document typically will provide default elections for the primary and successor beneficiary.

 

On the other hand, if the participant already has commenced payment of benefits, then the surviving beneficiary only receives payment if the form of payment provides for it. For example, no death benefit is due if the participant elected a single life annuity or a single sum payment. However, a joint & survivor option would provide a (reduced) lifetime benefit to the beneficiary, if he or she is still alive. A certain & life annuity would provide a stream of payments for the rest of the guarantee period if it had not already elapsed. For death benefits paid after the participant commences payments, the beneficiary is elected as a part of the benefit commencement paperwork.

 

 

How Do I Terminate a Plan?

The employer may decide to terminate the Plan if it no longer makes sense for the business (assuming permanency rules are satisfied).

 

The process for termination requires several steps, including filing a final Form 5500. If the Defined Benefit Plan is covered by the PBGC, the process for Plan termination takes longer and is more complicated.

 

At a high level, Plan termination involves:

 

• Amending the Plan document to establish the termination date, making required legislative updates, and fully vesting all benefits

 

• Notifying participants of the termination and providing required disclosures

 

• Filing the applicable forms

 

• Distributing all assets based on the participant's benefit elections; additional funding may be required for underfunded Plans; excess assets, for overfunded Plans, may be subject to excise tax

 

• Filing a final Form 5500

This Retirement Plan Disclosure is a summary of frequently encountered retirement plan rules. It is not a complete statement of all requirements under the Internal Revenue Code, ERISA, or related regulations, notices, and other government guidance. Laws and regulations change over time. The PLAN SPONSOR/TRUSTEE is responsible for monitoring applicable IRS, DOL, and PBGC guidance, consulting with its own legal, tax, and other professional advisors, and ensuring that the PLAN is operated in compliance with all current requirements. The fact that a particular rule, deadline, or requirement is not described in this Disclosure does not shift responsibility for that rule from the PLAN SPONSOR/TRUSTEE to TPA.​

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New “Automatic Enrollment and SECURE 2.0” subsection

Insert under your existing automatic enrollment / contributions area:

Automatic enrollment and SECURE 2.0 requirements
Recent legislation (often referred to as “SECURE 2.0”) requires most new 401(k) (and certain 403(b)) plans established after 2022 to include an automatic enrollment feature beginning with plan years starting after December 31, 2024, unless a statutory exception applies (for example, certain small employers, new businesses, governmental and church plans). The PLAN SPONSOR/TRUSTEE is responsible for determining whether the PLAN is subject to these mandatory automatic enrollment rules and for adopting and administering any required automatic enrollment provisions.​
When automatic enrollment and auto‑escalation features are used, the law generally requires that default deferral percentages fall within stated ranges and increase over time, subject to statutory minimums and maximums. The PLAN SPONSOR/TRUSTEE is responsible for selecting compliant default and escalation rates, for ensuring that payroll systems correctly apply those rates, and for providing required automatic enrollment notices describing default contribution rates, investment of default contributions, and participants’ rights to opt out or change deferral rates.​

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New “Long‑Term Part‑Time (LTPT) Employees” subsection

Insert in the eligibility/coverage section:

Long‑Term Part‑Time (LTPT) employees
Law changes now require many 401(k) plans to allow certain long‑term part‑time employees to make elective deferrals once they satisfy minimum service conditions defined by statute and the PLAN (for example, working a sufficient number of years with at least a minimum number of hours of service per year). The PLAN SPONSOR/TRUSTEE is responsible for tracking hours or other required service data, identifying LTPT employees who become eligible, updating the PLAN document and payroll systems when required, and offering deferral opportunities to eligible LTPT employees in accordance with current law.​

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Amended “Catch‑Up Contributions” subsection (additions only)

Add the following paragraphs to your existing catch‑up section:

Mandatory Roth catch‑up contributions for higher‑paid employees
Beginning with plan years starting in 2026, certain higher‑paid employees who are age 50 or older will be permitted to make catch‑up contributions only on a Roth (after‑tax) basis. In general, if an employee had more than a specified amount of wages subject to Social Security (FICA) tax from the PLAN SPONSOR in the prior calendar year (for example, $150,000 of prior‑year FICA wages for the 2026 plan year, subject to future IRS adjustments), then any catch‑up contributions that employee makes for the current year must be made as Roth contributions rather than pre‑tax contributions.​
The PLAN SPONSOR/TRUSTEE is responsible for: (i) tracking prior‑year FICA wages from the PLAN‑sponsoring employer to determine which employees are subject to the Roth catch‑up requirement; (ii) ensuring that the PLAN document and payroll/recordkeeping systems either allow Roth deferrals and treat affected employees’ catch‑up contributions as Roth, or, if Roth deferrals are not allowed, prevent affected employees from making catch‑up contributions as required by law; and (iii) coordinating with its payroll provider, recordkeeper, and TPA to implement these rules and correct any failures in accordance with IRS guidance. TPA does not determine which employees are subject to these rules and does not provide tax advice regarding Roth versus pre‑tax contributions.​
Enhanced “super catch‑up” window (if adopted)
Certain participants in a limited age band (for example, ages 60 through 63) may be permitted under current law to make higher “super catch‑up” contributions above the standard catch‑up limit, subject to annually updated IRS limits and other conditions. The PLAN SPONSOR/TRUSTEE is responsible for determining whether to include any such enhanced catch‑up feature in the PLAN, ensuring that the PLAN and administrative systems are updated if such a feature is adopted, and coordinating with its tax advisor regarding any implications.​

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New “Required Minimum Distributions (RMD) – Changing Rules” paragraph

Insert into your RMD/distribution section:

Required minimum distributions (RMD) – changing ages and rules
Congress has changed, and may change again, the ages at which participants must begin required minimum distributions and the rules that apply to beneficiaries. These requirements may differ for IRAs versus qualified plans and for different categories of beneficiaries. The PLAN SPONSOR/TRUSTEE is responsible for monitoring current RMD ages and rules, working with its recordkeeper, TPA, and other vendors to identify participants and beneficiaries subject to RMDs, and causing the PLAN to make timely distributions in accordance with current law and the PLAN document.​

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New “Tax Credits and Incentives” paragraph

Insert in your employer‑level “miscellaneous” or “plan adoption” section:

Employer tax credits and incentives
Recent law provides tax credits and other incentives for eligible employers that establish new retirement plans, add automatic enrollment, or expand coverage for certain employees, subject to limitations based on employer size, years in business, and other factors. The availability, amount, and duration of any such tax benefits depend on the PLAN SPONSOR/TRUSTEE’s particular facts and circumstances. The PLAN SPONSOR/TRUSTEE is responsible for determining its eligibility for any tax credits or incentives and for claiming any such benefits with the assistance of its own tax advisor. TPA does not provide tax advice and is not responsible for identifying or securing tax credits or incentives for the PLAN SPONSOR/TRUSTEE.​

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New closing “Law Changes and Continuing Responsibility” paragraph

Add near the end of the RPD:

Law changes and continuing sponsor responsibility
Retirement plan laws, regulations, and agency guidance are subject to frequent change. This Disclosure summarizes certain current and commonly encountered rules to assist PLAN SPONSORS/TRUSTEES in understanding general concepts, but it does not describe all requirements or all recent or future law changes. The PLAN SPONSOR/TRUSTEE remains at all times responsible for monitoring applicable IRS, DOL, PBGC, and other government guidance, consulting with its own legal, tax, and other professional advisors, adopting timely PLAN amendments, and operating the PLAN in accordance with the PLAN document and applicable law. TPA’s role is limited to the non‑fiduciary, administrative services set forth in the applicable Service Agreement and does not include PLAN design decisions, fiduciary decisions, legal interpretation, or overall compliance responsibility.​