CE 02 INFRE International Foundation for Retirement Education
Retirement Plan Design INFRE CONTINUING EDUCATION Retirement Plan Design
2009 International Foundation for Retirement Education P.O. Box 1860 Lubbock, TX 79408-1860 847.756.7350 fax 806.742.6102 www.infre.org
CE02 2009 International Foundation for Retirement Education RETIREMENT PLAN DESIGN
Introduction
etirement professionals should know everything about pensions, contribution payouts, integration with other retirement plans, health care and estate planning right? We all are retirement professionals but we all may work for R different types of plans or associations. We all are knowledgeable about our specific plan, but our participants do not live in a vacuum.
True retirement professionals realize the need for the participant to utilize all of their benefits when planning for retirement. They will have their own pension and they may have a spouse who will also have a pension. They may each have Social Security benefits on top of that, not to mention their 401(k), 403(b), 457 plans and even IRAs.
Retirement professionals realize that a participant won’t always know which plan you are discussing or which one you work with.
Retirement professionals and Congress realize that portability is an increasingly interesting subject to many young professionals.
Retirement professionals realize that they do not know it all; especially in an industry that is trying to make the company pension plan more universal to associates.
Retirement professionals realize that the plan structure within your organization may evolve and you will be a player in the changing environment.
Retirement issues have become increasingly important in American life. Baby boomers are reaching retirement age in larger numbers than any generation that has come before. Because of this, media attention has made retirement education a sought after benefit. Many baby boomers realize they are reaching retirement age and haven’t saved much for the lifestyle they are planning on living. This so-called “crisis” in Americans’ retirement savings has spawned a Presidential Summit and a Commission to study the situation. National debates have been held to discuss Social Security and its solvency, as well as its ability to protect those currently enjoying benefits and those who would like to enjoy its benefits in the future.
Retirement plan models have been developed to better enable retirement plan sponsors to select the best program or combination of programs for its plan members. As with many issues, history plays a large role in shaping our view. The next section will look at the history of retirement plans and bring us up-to-date so we can examine the models available today.
CE02 2009 International Foundation for Retirement Education 1 RETIREMENT PLAN DESIGN
History
Retirement plans are a twentieth century development in the United States. Their development directly coincides with the Industrial Revolution. Before the industrial revolution people were cared for in old age by their family, church and community. There was no need for pension subsidies because old age transfers were voluntary and the majority of intergenerational transfers were agricultural in nature.
The industrial revolution brought about change. People moved from villages and farms into the cities, leaving behind their support systems. This move of the early 1800’s was a move to industrial jobs. People moved for the attractive wages but soon found that with greater wages and year round income security came greater risks than they had found in agriculture. They found they were without any support system in the city and therefore began to see the need for pensions and insurance. Individuals who lived long enough were eventually forced to public charities, often with the loss of civil rights that we enjoy today. But the fact was, old age was not a problem of importance to lawmakers. First of all, most people did not live that long, as life expectancy was only 41 years of age! Second, leaders saw these plans as socialist in nature (a term we have heard with the advocacy of national healthcare over the past decade). Finally, the issue was just politically and economically inefficient.
The Industrial Revolution had reached its peak years earlier overseas. For instance, the political clout of labor in Europe resulted in the public support of insurance and retirement. In places like England, private insurance “schemes” were becoming common to all classes of people.
The movement evolved from private “schemes” to public pension plans, initially aimed at assisting widows and the disabled.
In 1871, Chancellor Bismarck of the German Reich considered the working class a danger to the State. If left unchecked, the working class would create social unrest. Bismarck was the father of the modern pension plan. Instead of clamping down on the labor movement, Bismarck took a different approach, which included arranging social insurance to subdue the unrest. Bismarck’s scheme was the first defined benefit pension plan. The plan was mandatory and required that premium contributions be made by workers. Transfers were made to those who were sick, old, or needy. By 1890, health and pension laws spread across Germany and other parts of Europe. People were usually eligible at 70 years of age, if their working capacity was reduced to one third of normal capacity. The age 70 came from the biblical reference to “3 score and 10”. Some of these plans were the first to combine pension and disability. These plans were financially feasible since the chance of people living to age 70 collect was highly unlikely since the life expectancy was age 41! Payments were based on the time worked and wages earned and pensions were not indexed for inflation. Although some changes were made, these existed in this form until WWII.
CE02 2009 International Foundation for Retirement Education 2 RETIREMENT PLAN DESIGN
The United States lagged Europe in industrializing by some 25 years. Including in this lag was any debate on social insurance and pensions. American Express in 1875 and the Baltimore & Ohio Railroad Company in 1880 offered the first American plans. Proctor and Gamble offered the first profit sharing plan in 1887. By the early 1900’s there were 400 U.S. pension plans being offered. Most were for employees of railroad, banking and utility companies. Even then, manufacturing had no pension concerns. Metropolitan Life and the Equitable Life Assurance society offered the first group annuity contracts in 1921 and 1924 respectively. But during the Roaring Twenties Americans had little concern for the future, so there was little interest in pension plans.
The Great Depression brought the Roaring Twenties to a halt. People had no savings and no employment so many sank into poverty. America had lagged behind Europe mostly due to the individualistic culture we had. Americans tended to be migrant and until the great depression there was no need for savings.
The first government enacted plan was Social Security in 1935. As was done in Europe, the normal retirement age was set at a prohibitive level, although life expectancy had jumped to age 60 by now. It was immediately reworked from a system based on actuarial assumptions (defined benefit plan) to a “pay as you go” system.
Private pensions became widely accepted in the mid-1930 and early 1940’s. During the 1920’s there were only 200 such plans. By 1930, 15% of the entire population was covered by a plan. In 1934, Congress established a pension system for railroad workers. Finally, in 1949 there was a major US steel industry labor dispute. The dispute centered on the belief that American business had a moral obligation to provide for the elderly.
As a result of labor disputes, consultants made a case for the increased productivity possible with pension plans. Congress then developed tax incentives for businesses with retirement plans. The social pressure was great under the “New Deal” politics.
CE02 2009 International Foundation for Retirement Education 3 RETIREMENT PLAN DESIGN
Current Statistics
86% of all state & local government employees participate in some type of pension plan.
Approximately 51% of private employees participate in some plan.
67% of employees of medium and large private establishments participate in a plan.
37% of employees of smaller private establishments participate in a plan (with less than 100 employees).
61% of non-government workers have access to a plan.1
There are other factors worth noting:
Employees who earn less money are often excluded.
Employees with part-time jobs are often excluded.
Participation is lower among women.
With all this history we can now study the types of plan you may be confronted with, either as an employee or counselor to others.
1 Bureau of Labor Statistics, “Employee Benefits in the United States,” 2008.
CE02 2009 International Foundation for Retirement Education 4 RETIREMENT PLAN DESIGN
Retirement Plan Types
DEFINED BENEFIT PLANS
ERISA and the IRS define this type of plan as “any plan that is NOT an individual account plan.” Defined benefit (DB) plans are subject to regulation by the Pension Benefit Guaranty Corporation (PBGC).
DB Plan Facts: Provides benefits after retirement from a trust of separately maintained funds, by the purchase of insurance, or from general assets.
Amount of benefit is either specifically stated or can be calculated in accordance with a set formula based on factors such as age, length of service, and earnings, but not profits.
Annual contributions needed to produce a specific benefit are calculated actuarially.
The amount of annual benefit that may be paid to a participant is $195,000 (2009, indexed for inflation).
Promises a specific benefit based on a calculated formula at retirement.
Flat dollar benefit formula
Flat benefit formula
Flat percentage of earnings formula
Percentage of earnings per year of service formula
CE02 2009 International Foundation for Retirement Education 5 RETIREMENT PLAN DESIGN
Types of Defined Benefit Formulas
Flat dollar benefit formula: A retirement benefit that calls for a specific pension amount without regard to income or service.
Flat benefit formula: A fixed amount per year of service, such as $20 of monthly retirement income for each year of credited service.
Flat percentage of earnings formula: A percent of earnings is selected as the measure of the benefit, for example 30 – 40%. This formula takes into account a worker’s career average earnings, final average earnings or final earnings.
Percentage of earnings per year of service formula: Specific recognition for service as well as earnings. Other ways you may hear this described would be past and future service formula or utilizing “unit credit.” Many people feel this is the most equitable defined benefit type because it relates more to employees’ value and contributions to the paying entity.
Defined benefit plans have formulas for vested workers who become disabled and for their spouses and/or other dependents in the event of an early death.
Defined benefit plans allow participants to plan their retirement with a guaranteed amount of money. ADVANTAGES
OF DEFINED Plans can provide a payout to a participant as well as to her spouse or other named
BENEFIT beneficiary. PLANS Defined benefit plans tend to lower employee turnover because they typically reward those who remain longer with a greater benefit.
Many plans have additional benefits such as disability and survivor protection.
The Pension Benefit Guaranty Corporation insures these plans, up to certain limits.
CE02 2009 International Foundation for Retirement Education 6 RETIREMENT PLAN DESIGN
There are relatively high costs associated with a DB plan due to the complexities of DISADVANTAGES actuarial calculations necessary to maintain the plan.
OF DEFINED DB plans can be difficult to maintain due to regulations, funding requirements and BENEFIT PLANS increasing complexities.
DB plans are often difficult to explain to participants.
These plans require that the plan sponsor fund the plan each year irrespective of profits or availability of resources – with only limited exceptions.
Pension funds are usually managed by professional fund or investment advisors. The plan sponsor bears all of the risk of the investment performance because there has to be enough assets available to pay benefits. If investments perform poorly, the plan sponsor may need to contribute more to shore up the reserves. There is no control over the funds by employees. (This could be seen as an advantage or disadvantage.)
DEFINED CONTRIBUTION PLANS
Defined contribution (DC) plans provide an individual account for each participant and a benefit based solely upon the amount contributed to the participant’s account plus income or loss from investments and forfeitures.
DC Plan Facts:
Annual addition amount per participant is lesser of $49,000 or 100% of pay (2009, indexed). Annual addition is the total of employer contributions, employee contributions, and forfeitures.
There is NO specific guaranteed payout.
It is an employer sponsored plan.
Employee contributions, where allowed, can be pre-tax or after-tax.
There is immediate vesting for elective deferrals – such as in 401(k) and 403(b) plans.
Accounts are portable with some limitations.
CE02 2009 International Foundation for Retirement Education 7 RETIREMENT PLAN DESIGN
The ending value depends upon:
How much is deferred by the participant
Any contributions made by the employer
Performance of the chosen investments
Types of Defined Contribution Plans
457(b) Plan: A plan for state, county and local governments. The employee may elect to begin drawing their pension before age 59½. The employee salary deferral limit is $16,500 or 100% of compensation (2009 indexed), whichever is less. This plan allows an additional catch-up contribution for participants age 50 or over. In addition, 457(b) plans are allowed their own special catch-up provision in the three years before normal retirement age. Rollovers to other plan types and IRAs are allowed.
403(b) Plan: A qualified plan, also known as a tax sheltered annuity, utilized by nonprofit organizations. The employee salary deferral limit is $16,500 or 100% of compensation (2009 indexed), whichever is less. (See table below.) This plan also allows an additional catch-up contribution for participants age 50 or over. As with governmental 457 plans, a 403(b) also provides its own unique catch-up provision for individuals with 15 years of service. This type of plan has loan privileges at the discretion of the provider. Rollovers to other plan types and IRAs are allowed.
401(k) Plan: This is a private industry plan. A 401(k) plan is generally part of a qualified profit sharing plan. As in all qualified DC plans, an individual 401(k) participant may receive total contributions to their accounts (both employer and employee) of up to $49,000 or 100% of compensation (2009, indexed). However, no more than $16,500 (2009, indexed) may come from elective deferrals. Employers may deduct contributions up to 25% of total eligible participants’ taxable compensation. A rollover to another plan type or IRA is allowed as long as IRS guidelines for reporting are followed. The provider may stipulate loan options. There is a 10% penalty for early withdrawal of a 401(k) before age 59½ unless the participant terminates employment after having reached age 55.
CE02 2009 International Foundation for Retirement Education 8 RETIREMENT PLAN DESIGN
Changes after EGTRRA: The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 had a major impact on the contributions that can be made to 401(k), 403(b) and 457 plans.
Deferral Limits: There have been significant efforts over the past few years to standardize many aspects of major employer sponsored deferred compensation plans. Specifically, 401(k), 403(b) and governmental 457(b) plans will have identical employee deferral limits. The deferral limits are indexed annually in $1,000 increments, as follows:
Year 401(k), 403(b) and 457(b) deferral limits
2008 $15,500
2009 $16,500
50-and-Over Catch-up Provision: Effective January 1, 2002, 401(k), 403(b) and 457(b) plans are allowed to provide a catch-up provision for participants age 50 or over. Prior to January 1, 2002, 401(k) plans did not have a catch-up provision available to them. (Note, however, that both 403(b) and 457 plans each have a separate catch-up unique to those plans, and these catch-ups remain in effect. The catch-up discussed here is a new provision common to all three plan types.) Again, the catch-up numbers below apply to 401(k), 403(b) AND 457(b) plans. To qualify for the catch-up provision, a participant must be 50 years old and must have contributed the maximum permitted, as it applies to the participant given all facts and circumstances.
CE02 2009 International Foundation for Retirement Education 9 RETIREMENT PLAN DESIGN
Catch-up Year Amount
2008 $5,000
2009 $5,500
Annual Addition Limits: Plans that are subject to IRC Section 415 – which would include all 401(a) plans (DB, Profit Sharing, 401(k), 403(b) etc.) – must limit the total amounts contributed for an individual participant. For DC plans, the limit is the lesser of $49,000 or 100% of compensation per participant (2009, indexed). For DB plans, the benefit limit is the lesser of $195,000 or 100% of high 3-year average of compensation. Note: There are a few exceptions to the 3-year average compensation rule.
Federal Thrift Savings Plan: This is a defined contribution component of the Federal Employee Retirement System (FERS), a qualified plan designed for federal employees established in 1986. For those hired after 1983, FERS allows employee contributions to the Federal Thrift Savings Plan of up to $16,500 (2009, indexed). The agency may match up to 4% of base pay. In addition, the agency automatically invests 1% of the employees’ compensation. These plans also allow the 50-and-over catch-up provision. Under this plan participants pay into and are covered by Social Security. Prior to the establishment of FERS, all federal employees were covered by the Civil Service Retirement System (CSRS). In 1983, the Civil Service Retirement System (CSRS) voluntarily transferred to the FERS. CSRS covers employees hired before 1983. CSRS-covered employees may also voluntarily contribute to the Federal Thrift Savings Plan, however employee contributions are limited to up to $16,500 (2009, indexed). This plan provides a government contribution as well as the 50-and-over catch-up provision. Under this plan, participants do not pay into Social Security and therefore are not covered by Social Security.
CE02 2009 International Foundation for Retirement Education 10 RETIREMENT PLAN DESIGN
Profit Sharing Plan: These plans are found in private industry. Prior to 1986, the employer contribution was a percentage of profits, however profits are no longer required for an employer to make and deduct contributions to a profit sharing plan. It is a qualified plan; therefore, if you leave the company you may roll your money into an IRA. The employer may deduct contributions of up to 25% of compensation.
SIMPLE Plan: The Savings Incentive Match Plan for Employees (SIMPLE) plan was established in 1996 with the passage of the Small Business Jobs Protection Act. With a SIMPLE plan, small employers can easily establish a retirement plan for their employees without many of the burdens often associated with other types of Plans. An employer may not simultaneously sponsor a SIMPLE Plan and a Qualified Plan.
There are two types of SIMPLE Plans: the SIMPLE IRA and SIMPLE 401(k).
SIMPLE IRA: An employer with 100 or fewer employees may establish a SIMPLE IRA. Employees must have earned at least $5,000 in the prior year to be eligible to participate. Participants may contribute up to $11,500 (2009, indexed). The employer is required to contribute to each participant’s account. Employer contributions may be in the form of matching or non-elective (profit sharing) contributions. The normal match is dollar for dollar up to 3% of compensation. The normal non- elective contribution is 2% of compensation. With appropriate notice (60 days) to participants, the normal employer contribution rate may be reduced to 1% of compensation for a given year. However, an employer may not elect to reduce the normal contribution rate more than twice in a five year period. All contributions (employer and employee) are 100% vested. There is a 25% early withdrawal penalty if contributions are withdrawn prior to age 59½ in the first two years of participation. The normal 10% early withdrawal penalty applies for amounts withdrawn after two years. It is not necessary to file form 5500 with SIMPLE IRAs.
SIMPLE 401(k): A SIMPLE 401(k) is very similar to a SIMPLE IRA, with a few exceptions. First, the normal employer contribution is the match. With notice to participants, an employer may make a 2% nonelective contribution instead of match. Unlike the SIMPLE IRA, no reduction to 1% of compensation is available. Second, regular distribution restrictions apply to SIMPLE 401(k) plans, meaning
CE02 2009 International Foundation for Retirement Education 11 RETIREMENT PLAN DESIGN
distributions are allowed for death, disability, retirement or other termination of employment. Hardship withdrawals and loans may be available. Third, a SIMPLE 401(k) may require that employees satisfy regular 401(k) eligibility rules, such as having worked for one year and attained at least 21 years of age. Last, a SIMPLE 401(k) must file Form 5500 and associated schedules. Before adopting a SIMPLE 401(k) it might be prudent to compare it to a regular safe harbor 401(k). As with a SIMPLE IRA, employee salary deferrals are limited to $11,500/year (2009, indexed), and both employer and employee contributions are immediately vested.
SEP-IRA Plan: Another plan utilized by smaller organizations and the self-employed is the Simplified Employee Pension (SEP) Plan. Only the employer may contribute to this plan. Pre-tax contributions are limited to 25% of earned income. No set contribution is required. No IRS reporting is involved. All employees over age 21 and who have worked three out of the last five consecutive years must be included. All contributions to the plan are deductible and, as with most plans, a 10% penalty exists for early withdrawal. Participant accounts are always 100% vested. Loans are not permitted.
Keogh Plan: This plan is named for the New York state senator who sponsored the legislation. Also known as HR-10 plans, Keogh plans were established for self-employed owners of unincorporated businesses. The business may be a sole proprietorship, partnership, or limited liability company. A Keogh is a qualified plan and can be any type of 401(a) plan, either defined benefit or defined contribution. The type of plan that is established is up to the sponsor/owner. All ERISA and IRC compliance rules for participation, coverage, vesting, contribution limits, etc., apply to Keogh plans. If the business has employees, they must also be covered by the plan. The main difference between Keoghs and plans for incorporated businesses is in the way compensation is determined for the self-employed owner.
NOTE: ERISA allows qualified defined contribution plans to have loans and hardship withdrawals and most do, but not all of them. Loan regulations state the minimum loan to be $1,000 and the maximum $50,000, or the greater of half the vested amount or $10,000. The loan must be paid back in 5 years, unless it is used for the purchase of a primary residence. It is also within guidelines for an individual plan to put constraints on the number of loans, minimum loan amounts, etc. Loans are offered because they help attract participants, but participants need to understand that the money
CE02 2009 International Foundation for Retirement Education 12 RETIREMENT PLAN DESIGN represented by that loan has a loss of opportunity for the highest potential gain. It is paid back with after tax dollars and if an employee leaves the company with a loan outstanding, most plans require immediate payback. If it is not paid back, the loan will be considered a distribution, with taxes due plus a 10% early distribution penalty. Plan loans should always be a last resort. Self-employed individuals– including shareholders of S-corporations – may take loans from their qualified plans.
Hardship withdrawals are specified under ERISA and if a withdrawal of this kind is requested, it usually goes before a board. Once a participant takes a hardship withdrawal, he or she cannot make any pre-tax or after-tax contributions to the plan for six months.
Individual Retirement Accounts
Individual Retirement Accounts (IRAs) provide yet another retirement savings vehicle. They can be very effective for the self-employed, however IRAs are not exclusively for the self-employed. Several different types of IRAs exist.
Traditional IRA: Under the traditional IRA an owner can contribute up to $5,000 of earned income annually (in year 2009, indexed). Contributions may be tax deductible with limited eligibility. If you are covered by an employer-sponsored plan, the amount of contribution you can deduct on your tax return will be reduced according to adjusted gross income (AGI). No deduction can be taken for AGIs above the following amounts:
Single: AGI over $65,000 (2009, indexed for inflation)
Married: AGI over $109,000 (2009, indexed for inflation)
Traditional IRAs do not allow contributions after age 70½. There is an early withdrawal penalty of 10% if you make a withdrawal before age 59 ½. Early withdrawals are taxed as ordinary income upon disbursement. Mandatory withdrawals begin at age 70½. If not begun at that time, you will incur a 50% penalty. The penalty for early withdrawal is waived for hardship such as disability or health insurance premium payments if unemployed. The penalty may also be waived for post-secondary education and first time home ownership (lifetime limit of $10,000). Finally, you may convert a traditional IRA to a Roth IRA without a 10% penalty, but you will have to pay the taxes due. A catch-up provision is available to individuals who have attained age 50 and have contributed the maximum allowed to the IRA. (See table below for contribution and catch-up limits.)
CE02 2009 International Foundation for Retirement Education 13 RETIREMENT PLAN DESIGN
Roth IRA: Roth IRAs have the same limit on maximum contributions as the traditional IRA (see table below). However, the actual contribution amount is limited by AGI:
Single: AGI less than $120,000
Married: AGI less than $176,000
If your AGI is above these levels, you cannot make a contribution to a Roth IRA. This also must be earned income, but a major difference between a Roth IRA and the traditional IRA is that contributions to a Roth IRA are NOT tax deductible. You contribute to the Roth IRA with after-tax dollars. Therefore, withdrawals are not taxed federally if held for at least 5 years and withdrawn after age 59½. A 10% penalty will be assigned for a withdrawal before age 59½, unless you are disabled or using the funds for the first time purchase of a home. Unlike traditional IRAs, an owner of a Roth IRA may contribute after age 70½; the owner is not required to take distributions after age 70½.
Spousal IRA: This is set up for a nonworking spouse with the same maximum annual contribution as the traditional or Roth IRA. Owners must file a joint tax return.
Nondeductible IRA. You may have one of these IRAs if you do not qualify for either a Traditional IRA or Roth IRA. The withdrawals are handled the same as with the Traditional IRA; you are only taxed on the earnings you make.
CE02 2009 International Foundation for Retirement Education 14 RETIREMENT PLAN DESIGN
Contribution and catch-up limits for Traditional and Roth IRAS:
Maximum Traditional Year and Roth IRA Over 50 Catch-up Contribution
2006 $4,000 1,000 2007 $4,000 $1,000 2008 $5,000 $1,000 2009 $5,000 $1,000
CE02 2009 International Foundation for Retirement Education 15 RETIREMENT PLAN DESIGN
DC plans encourage employee self-responsibility. ADVANTAGES
OF DEFINED No mandatory employer contributions (strictly an advantage to the employer.)
CONTRIBUTION DC plans encourage employee participation, often through matching funds. PLANS DC plans shift investment responsibility to the employee (participant-directed accounts).
DC plans may promote worker participation by allowing for participation in profits.
The perception by the employees is that they are in control of their money.
DC plans can be designed for maximum portability.
NO specific guaranteed payout. DISADVANTAGES
OF DEFINED Educational seminars are not always available to employees to help them
CONTRIBUTION make
PLANS informed investment decisions. Ending value depends on:
How much is contributed
Whether there are employer contributions
Performance of chosen investments.
CE02 2009 International Foundation for Retirement Education 16 RETIREMENT PLAN DESIGN
THE CHANGING LANDSCAPE
Up until the 1980’s, the majority of all plans were defined benefit. Since the mid 1980’s the majority of new plans implemented have been defined contribution (DC) plans. In less than two decades, the assets held in DC plans have approached 50% of the assets held in DB plans.
FORM 5500 DATA SUMMARY
YEAR NO. OF DB PLANS %ACTIVE WORKFORCE
1975 103,346 40
1980 148,096 38
1985 170,172 33
1990 113,062 28
1995 69,492 23
1996 63,657 22
2000 48,773 14
2005 47,000 (est.) 10
Source: DOL Form 5500 Abstracts.
The advent of the DC plan together with changing demographics may contribute to what some refer to as the “retirement crisis.” Unlike government, where many systems with DB plans have supplemental DC plans, in corporate America the DC plan is the sole retirement vehicle for many private employees. According to some, corporate America is abdicating its responsibility to the employee with the decline of the DB plan. One brilliant light on the horizon of this defined benefit decline may be the interest in what is becoming known as “hybrid plans.”
CE02 2009 International Foundation for Retirement Education 17 RETIREMENT PLAN DESIGN
HYBRID PLANS
A hybrid plan combines features of both DB and DC plans and may be a viable option for some employers. There are a number of hybrid plans available today. Here, we present a few of the more widely used ones.
Pension Equity Plan: Future benefits are based on a company formula based on a percentage of final average earnings where the percentage increases with years of service. While not all of these plans are portable (a benefit of the pure defined contribution plan), you do have IRA rollover eligibility with this type of plan.
Cash Balance Plan: This type of plan defines future benefits based on percentage of pay or a flat dollar amount. A hypothetical “side” account is established where interest and contributions are credited. Over time the “side” account grows as though it consisted of actual assets. The participant will receive the greater of the cash balance of the hypothetical account or the value of the accrued pension. The individual “side” account is portable and provides IRA rollover eligibility. ERISA vesting rules apply to these plans. An employer can convert a defined benefit plan to a cash balance plan by providing transitional benefits.
Deferred Retirement Option Plan (DROP): This plan for public employees pays retirement benefits while the employee is still working. The plan sponsor invests the benefit, which may be commingled with the main pension fund. The benefit is paid in a lump sum to employees when the participant ceases employment and can be rolled into an IRA. DROP plans are usually found among the public service professions (police, fire, etc.) where normal retirement age is much younger than 65. It provides an additional nest egg builder for employees and encourages key employees to continue working. There are no specific IRS guidelines for DROP plans.
There are a number of reasons to consider hybrid accounts. For example, cash balance plans clearly provide an added benefit and feel of a DC plan (the side account looks and acts like a DC account) to younger workers while still providing a pension to older workers. Some hybrid plans are so new that it will take time to see how they ultimately perform when it matters most. At a minimum, hybrid plans are intended to offer a win-win situation for companies and their employees. Plans that can maintain the goals of business and still offer employees a defined benefit plan may be the plan of the
CE02 2009 International Foundation for Retirement Education 18 RETIREMENT PLAN DESIGN future. Recently, some hybrid plans have caused great concern among employees who are nearing retirement and had counted on a particular benefit. In many cases, it is merely the idea of change that results in fear and confusion. Watson Wyatt, in the June 2000 Insider, states “to make the retirement strategy work, employers must explain why the change is being made and what it means for employees.” SOCIAL SECURITY
The big question today is “will Social Security be around for me?” The answer is probably, but it will doubtless be different! The problem with “pay as you go” plans is that there is a significant risk of more people drawing on the benefit than paying into it. According to the Social Security Administration the ratio of “covered workers” (those paying into the system) to each beneficiary (those drawing out of the system) will drop from 3.2 in 1995 to 2.0 in 2030.
Example: In 1995, for every 3.2 persons employed and paying into Social Security (FICA), there is one person who is drawing on a benefit, so in essence 3.2 people are supporting 1. In 2030, for every 2 persons employed and paying into Social Security there is one person who is drawing on a benefit, so in essence 2 people are supporting 1.
To keep the system solvent, one of three options will have to be chosen. Payroll taxes will need to be increased, cash benefits will have to decrease, or eligibility age will increase. What is most likely to happen is a combination (which actually makes a fourth option). If you are from one of the few public retirement systems that do not pay into Social Security or you are new to the pension industry, you may be surprised to note all the benefits Americans derive from Social Security.
Social Security can be divided into the following categories:
Individual and family benefits
Retirement
Disability
Survivor benefits Medicare
To be eligible for Social Security benefits you must have 40 quarters of work. In 2009, $1,090 of earnings (indexed) equals 1 quarter and you can accumulate 4 quarters in a year. The contribution comes out of your paycheck, with your employer matching the
CE02 2009 International Foundation for Retirement Education 19 RETIREMENT PLAN DESIGN
contribution. If you are self-employed you are required to pay both parts. Starting in the year 2000, Social Security began mailing annual benefit statements to everyone over age 25.
You will know what you are paying by looking at the paycheck or pay stub you receive from your employer. Social Security is covered by the Federal Insurance Contributions Act (FICA). The FICA tax is distributed into two taxes. One is the OASDI (or Old Age, Survivors & Disability Insurance). You pay 6.2% of your gross salary for this. The other tax is the Medicare tax. You pay 1.45% of your gross salary to Medicare. (Remember, the employer also pays the same amount on your behalf. If you are self- employed you pay twice these percentages.) This is a tax, not an individual account. You cannot take your money out because, remember, you are paying tax for someone else to receive their current Social Security benefit. If you work in a State where public employees do not pay into FICA, you will see employees paying the 1.45% Medicare tax. This was a result of the 1986 Tax Reform Act. INDIVIDUAL AND FAMILY BENEFITS
RETIREMENT BENEFITS After you have paid into Social Security, you may (depending on your year of birth) draw your full benefits at age 65. If you were born after 1937 you have a new schedule and may be required to work to age 67, depending on the year of your birth, in order to claim full benefits. This change is being phased in from age 65 to 67. Currently, everyone still has the option of taking their Social Security retirement benefit early, at age 62 if they wish, however, the benefit is reduced. If you are married, your spouse may be eligible for half your benefit. The spouse is eligible for his or her own Social Security benefit or half the spouse’s, whichever is larger. If you’re divorced and your marriage lasted 10 years, you would also be eligible for half the amount of your former spouse’s benefit.
DISABILITY BENEFITS If you become unable to engage in any substantial gainful work you may quality for disability benefits. You must not be able to perform any work, anywhere. The inability to perform work would result from a medically determinable physical or mental impairment that is expected to result in death or is expected to last at least 12 months. The applicant must be under 65 and fulfill a five- month waiting period. Upon the disability recipient’s death, the family would receive survivor benefits if there were qualifying survivors.
SURVIVOR BENEFITS Survivor benefits are paid to qualifying dependents upon the worker’s death. Qualifying dependents are:
CE02 2009 International Foundation for Retirement Education 20 RETIREMENT PLAN DESIGN
Widow or widower age 60 or older
Any age, if caring for a child under age 16
Children under age 18 MEDICARE
You are eligible for Medicare if you are 65 years of age or older, are disabled, or have permanent kidney failure. Medicare is divided into two major parts. Part A is coverage for hospitalization and Part B is for other medical services. Part A pays for room and board after a deductible and pays for associated services required for an inpatient stay. Part B is related more to physician’s care, which would include lab tests and other procedures normally done in a doctor’s office. States that are purely public retirement systems will usually have Medicare as part of their health care program. This can be done because every U.S. Citizen is eligible for Medicare Part B. The premium (which everyone pays) is billed quarterly to those not receiving a Social Security check. For those that do get a Social Security check, their premium is deducted each month. Only people not getting a Social Security check or not eligible for half of their spouse’s benefit are billed for Medicare Part A, and this is only if they elect to purchase the coverage.
Medicare also offers Part C coverage plans, which are offered by private insurance companies that agree to follow the rules set by Medicare. Plan choices include managed care plans, fee-for-service plans, preferred provider organizations and specialty plans. These plans may provide extra benefits for an additional cost.
Medicare also began offering prescription drug coverage (Part D) in 2006. This coverage typically covers about 50% of the average participant’s drug costs annually. Costs for the various plans vary according to the particular plan chosen, as well as premiums, co-payments and/or deductibles. Each state offers its own unique set of resident-specific coverage plans.
CE02 2009 International Foundation for Retirement Education 21 RETIREMENT PLAN DESIGN
Retirement Plan Distributions
As baby boomers enter their retirement years, the percentage of non-active participants will grow dramatically. It is essential that participants have a good understanding of their distribution options where each type of investment is concerned. You cannot put enough emphasis on specialized communications to this population sector.
There are several types of distributions your participants should be aware of:
Distribution at retirement
Pre-retirement, or in-service distributions, and
Distribution upon termination of employment
Participants’ questions about distributions will vary depending on what type of plan you are representing. Although IRAs are not set up through the employer, you still may be asked questions.
Individual Retirement Accounts (IRAs) Are there mandatory distribution rules?
What are the tax ramifications of my distribution?
What types of plans can I transfer or rollover my funds to?
Social Security When is it best to take the benefit?
What about working after retirement?
Pension Questions When do I elect to take my pension?
Which pension annuity to elect?
What is the taxation of the pension?
Are there any left-over taxable contributions (from years prior)?
CE02 2009 International Foundation for Retirement Education 22 RETIREMENT PLAN DESIGN
Defined Contribution Plans Do I leave the account balance where it is or roll it over?
What are the tax implications of my distribution?
Where should I invest my funds after retirement?
DEFINITIONS FOR A DEFINING TIME
PENSION VS. PENSION PLAN A pension is a series of periodic payments, for life or some specified time period, payable monthly or another specified time frame. The term is often used to describe the part of a retirement allowance financed by employer contributions. It is usually stated in referring to a defined benefit payout. It can be as a result of advanced age or disability.
ANNUITY In a broad term, it is any contract that provides an income for a specified period of time such as a number of years or for life. You will see the terminology in language such as “the periodic payments provided” under an annuity contract. This term usually specifies whether a monthly or annual payment to a pensioner is being paid. Often used synonymously with pension. DEFINED BENEFIT PLAN DISTRIBUTION OPTIONS
Upon making the decision to retire, the participant must decide how to take his money out of the account. Under a defined benefit plan, there are a number of possible distribution options, but we describe the three most common ones here. Which option the participant selects depends upon whether there is a spouse or other dependent.
Single Life Option: This option pays a monthly payout for the life of the retiree. It does not provide a monthly payout to a survivor. This selection maximizes the monthly retirement payout. This may be a good option if the retiree is single, in good health, or has decided there is no reason to leave continuing monthly benefits to a spouse. The retiree may have chosen to carry life insurance (pension maximization plan) that will provide the necessary income or the spouse may have earned a nearly equal benefit.
CE02 2009 International Foundation for Retirement Education 23 RETIREMENT PLAN DESIGN
Joint Survivor Option: This payout option provides a specified percentage or dollar amount to be paid out for the lifetime of a spouse, or other beneficiary, upon the death of the retiree. This selection reduces the monthly benefit of the retiree.
Period Certain This plan allows the retiree to provide a monthly benefit to a spouse or other named beneficiary for a guaranteed number of years. The retiree is paid for life, and the beneficiary receives the payout for the years remaining in the guarantee period, if any.
Taxation of Defined Benefit Distributions
Defined benefit plans are federally taxed. Whether the retiree pays state tax depends on his state of residency. A retiree can elect to have taxes withheld from his pension check.
CE02 2009 International Foundation for Retirement Education 24 RETIREMENT PLAN DESIGN
DEFINED CONTRIBUTION DISTRIBUTION OPTIONS
S P E C I A L N O T E R E G A R D I N G P O R T A B I L I T Y –
Prior to 2002 there were many restrictions on the ability to rollover or transfer funds from one type of plan to another. For example, a 457 account balance could not be rolled over into a 401(k) plan. A 401(k) could not be rolled over into a 403(b), and so on. However, that has now been changed. Since January 2002, any tax deferred account may be transferred to another tax deferred account without restriction. (These portability rules will not apply to Roth IRAs, Roth 401(k)s and Roth 403(b)s because Roth contributions are made with after-tax dollars, thereby setting them apart from other IRAs or tax qualified accounts.)
401(K)
You can usually leave your money in a defined contribution plan until age 70½ or the company retirement age. There is a 50% penalty if you do not take the mandatory withdrawal. You can roll over funds to an Individual Retirement Account (IRA). You can also get to your defined contribution account at age 59½ if you are no longer an active employee. At retirement you can either take the money on a regular payment schedule or make withdrawals as needed. Your money is still invested and you are still in control of where that money is invested. Since all of the contributions were tax deferred, they are all taxed at both the federal and state level. NOTE: if the retiree made after-tax deferrals, those funds will NOT be taxed again but will be pro-rated using an exclusion ratio.
If you are terminating employment with the 401(k) sponsor, you can usually leave the money with the plan. This is an important issue to find out before a surprise distribution and tax bill is presented. If a participant elects to take money out of a 401(k), she may roll it over to a new employer plan or IRA. Rollovers must follow specific steps to prevent taxation. If a participant has less than $5,000 in an account, the company can automatically distribute without any warning – however, the IRS has now stated that such involuntary rollovers will go to an IRA if the participant does not direct otherwise. If you terminate employment after age 55, you may access funds without the 10% penalty.
CE02 2009 International Foundation for Retirement Education 25 RETIREMENT PLAN DESIGN
457(b) PLANS
Distributions from a governmental 457(b) plan can begin:
Upon retirement or termination of employment
At death
In the event of an unforeseeable emergency (hardship)
By April 1st following the year the participant reaches age 70½.
Most 457 plans offer a variety of distribution options, including single or joint and survivor annuity, and lump sum. After December 31, 2001, 457 plans can make rollovers to, and accept rollovers from other types of plans, including 401(k), 403(b) and IRAs. Unlike other plans, early distributions from 457 plans are not subject to the 10% early distribution penalty. Distributions are taxable when paid. As of January 1, 2002, 457 plans are subject to the same minimum distribution rules under IRC Section 401(a)(9) as qualified plans and 403(b) tax sheltered annuities.
Although easy on the eyes to watch grow, this program’s distribution options can be tricky to explain to participants. The reason for this is that some 457 plans are held by an insurance company whose contract may state in what forms distributions can occur, i.e., what types of annuity are possible. Participants need to read the fine print. Mandatory distribution age is 70½ unless that participant is still employed and desires to delay distributions. If the participant waits to withdraw until 70½, the withdrawal amount is based on the value of the account and the participant’s life expectancy. As with the 401(k), the penalty for not taking required minimum distributions is a 50% excise tax on the amount that should have been distributed. Also, early distributions (before age 59½) are subject to the 10% early distribution penalty, with some exceptions. If the distribution is made on account of death or disability, there is no penalty.
401(K), 457 AND 403(B) ROLLOVERS
It is possible to rollover a 401(k), 457 and some 403(b) accounts to an IRA. A rollover of this type is usually done trustee to trustee as opposed to the direct distribution to the employee route.
When qualified plan money passing through the hands of an employee is rolled over to an IRA, the employer automatically withholds a 20% tax. However, if the participant has the withheld amounts available and replaces it within 60 days, the participant can avoid the tax altogether.
CE02 2009 International Foundation for Retirement Education 26 RETIREMENT PLAN DESIGN
If the participant chooses to maintain the account with the plan rather than roll over the assets to an IRA, there are no transactions necessary. Usually, inactive employees cannot take out loans on their account. Any loans taken when they were actively employed are typically required by the company to be paid up upon termination or retirement. As you can see, a participant who chooses to roll over an account will potentially have more investment control and access to their money.
A large consideration in this decision is the early distribution regulations. Funds taken before age 59½ are typically subject to a 10% penalty (on top of ordinary income taxes) unless:
The funds are rolled into an IRA and then taken in equally substantial payments for 5 years or until age 59½, whichever is longer.
A scheduled series of payments based on the life of participant and beneficiary is taken.
The participant terminates employment at age 55 or later.
The funds are used to pay medical expenses in excess of 7.5% of AGI.
Distributions are made to an alternative payee as part of a Qualified Domestic Relations Order (QDRO).
For IRAs only:
First time home purchase of up to $10,000
Qualified education expense
Health insurance premiums if unemployed
CE02 2009 International Foundation for Retirement Education 27 RETIREMENT PLAN DESIGN
INDIVIDUAL RETIREMENT ACCOUNTS (IRAS)
A participant can access their IRA free of penalty after age 59½, though income taxes may still apply. The 401(k) plan and the IRA account have basically the same rules. It is important to note that a participant may be forced to roll a 401(k) into an IRA for recordkeeping simplification. This makes for some very large IRA accounts!
Be careful when it comes to working with participants on rollovers. There are some particularly confusing rules relative to survivor regulations. Not all plans follow the same rules. Make sure participants are seeking financial guidance.
Beneficiary selection for a Qualified Plan:
If the participant is married, the spouse must be the beneficiary unless the spouse signs a consent form to forego this right. (Government plans are exempt from this requirement, although many follow it.)
Beneficiary selection for an IRA
The beneficiary of an IRA may be anyone you choose. Remember that spouses enjoy favored estate planning in relation to IRAs.
Beneficiary selection and age
If a participant selects a joint survivor option, it is imperative they realize that the age of the beneficiary will affect the amount of their payment. A participant selecting a 25-year-old child could significantly affect the monthly pension income to be received.
CE02 2009 International Foundation for Retirement Education 28 RETIREMENT PLAN DESIGN
ERISA
Employee Retirement Income Security Act (1974)
ERISA has had a tremendous impact on the American retirement plan and its administration. It was passed in 1974 and covers most private sector employee plans. Although government plans are not covered by ERISA, many public sector plans use it as a guide to prudent policy. It created uniform minimum standards to assure that employee benefit plans are established and maintained in a fair and financially sound manner. ERISA rules cover vesting, communications and plan terminations, among other rules. Under ERISA, statutory and regulatory authority was given to the Department of Labor’s Pension & Welfare Benefits Administration, in addition to the IRS. Health care continuation and portability of benefits is also covered by ERISA.
According to ERISA, persons who manage and control funds must:
Manage plans for the exclusive benefit of participants and beneficiaries.
Carry out their duties in a prudent manner and refrain from conflict of interest transactions expressly prohibited by law.
Comply with limitations on certain plans’ investments in employer securities and properties.
The Pension Benefit Guaranty Corporation is a regulatory agency that assures that:
Defined benefit plans fund benefits in compliance with the law and with plan rules.
The government and participants receive reporting & disclosure information on the operations and financial condition of plans.
Plans receive the documents required to maintain compliance with the law.
Since ERISA’s enactment, a number of other key pieces of legislation have been passed. What follows are just a few of the many laws that affect the way ERISA interplays with the operation and design of retirement plans.
CE02 2009 International Foundation for Retirement Education 29 RETIREMENT PLAN DESIGN
REVENUE ACT OF 1978
The IRS officially sanctioned cash or deferred arrangements called CODAs.
Added Section 401(k) to the law.
TAX REFORM ACT OF 1982
Created Individual Retirement Accounts and clarified 401(k) rulings.
Widespread use of defined contribution plans was enhanced with clarifications to IRS sections 401(k), 403(b) and 457.
Allowed matching contributions for 401(k) plans.
Purpose was to make individuals at least partially responsible for their futures.
TAX REFORM ACT OF 1986
Created limitations on who could contribute on a tax deferred basis to IRAs.
Applied nondiscrimination requirements.
TAXPAYER RELIEF ACT OF 1997
Raised elective contributions on deferral plans.
Prohibits companies from requiring employees to invest more than 10% of their deferrals in company stock.
Relaxed retirement plan reporting.
Created SIMPLE IRA and SIMPLE 401(k) plans for smaller companies.
Introduced the Roth IRA.
Changed deductibility limits for other IRAs.
CE02 2009 International Foundation for Retirement Education 30 RETIREMENT PLAN DESIGN
ECONOMIC GROWTH ACT 2001
Increases compensation limits.
Increases benefit and annual addition limits.
Increases elective deferral limits and creates specific indexing.
Standardizes portability among deferred compensation plans.
Creates and standardizes catch-up provisions.
Accelerates vesting requirements on matching contributions.
Allows matching to count towards Top Heavy minimums.
Increases tax deduction limits for profit sharing plans to 25% of pay.
PENSION PROTECTION ACT 2006
Automatic enrollment for 401(k) plans.
Full funding for pension plans.
Participant education.
Nonspouse beneficiary rollover provisions.
Saver’s credit.
WORKER,RETIREE AND EMPLOYER RECOVERY ACT OF 2008
Required minimum distributions waived for 2009.
Nonspouse beneficiary rollover options for decedent accounts.
Automatic enrollment for SIMPLE plans.
CE02 2009 International Foundation for Retirement Education 31 RETIREMENT PLAN DESIGN
ERISA has strict rules on investing. ERISA states that persons engaged in the administration, supervision and management of pension monies have a fiduciary responsibility to ensure that all investment related decisions are made:
With the care, skill, prudence and diligence that a prudent expert familiar with such matters would use, and
By diversifying the investments so as to minimize risk.
ERISA also established an insurance program to guarantee workers’ receipt of pension benefits if their defined benefit plan should terminate. ERISA covers private defined benefit plans and profit sharing plans. ERISA does not cover government plans, IRAs or most 403(b) plans.
A qualified plan is one that meets the requirements of Section 401(a) of the 1954 Internal Revenue Code. These plans receive tax advantages.
Many defined contribution plans give participants the opportunity to choose how they want their contributions invested. If handled correctly, allowing participants to control their investments will protect plan fiduciaries from the liability associated with investment losses.
The idea of protecting fiduciaries from investment liability is not new; however it was not until 1992 that the Department of Labor issued an official regulation for ERISA § 404(c).
These regulations state two primary principles. First, just because a participant directs their own investments does not make them a plan fiduciary, and second, if minimum requirements are satisfied, plan fiduciaries cannot be held responsible for poor investment decisions the participant may make. In addition, the Plan Fiduciaries cannot be held responsible for the poor performance of an individual fund(s) so long as proper diligence has been taken to select and monitor the fund(s).
It is not a requirement to comply with ERISA § 404(c), however, once a decision is made to comply, the plan must comply in whole. Compliance in this matter is an “all or none” proposition, so being 99% in compliance will not protect a fiduciary any more than being 0% in compliance.
What it takes to fully comply with ERISA 404(c):
A participant directed plan must allow participants to choose from a broad range of investments, each with different risk and return characteristics. To truly provide a broad range of investments, a minimum of three funds must be offered. Generally, this would require a stock fund, a bond fund and a cash
CE02 2009 International Foundation for Retirement Education 32 RETIREMENT PLAN DESIGN
fund. Ultimately, the mix of funds should be designed to optimize the potential investment returns, and decrease the potential risks.
The plan must allow participants to transfer among the investment choices at least quarterly. However, it may be necessary and prudent to permit more frequent transfers if the volatility of each investment so dictates.
Participants must be educated and provided with sufficient information to enable them to make solid investment decisions.
Participants must be able to give their investment instructions to an identified fiduciary, who is obligated to carry out their instructions.
The above four requirements are a starting point. While it is true that fiduciaries can limit their liability by complying with the above four requirements, this should not be misunderstood as limiting their ongoing involvement or monitoring responsibilities. A fiduciary must continue to act with prudence and diligence. In short, the protection from liability is purchased through a higher level of participant communication, education, monitoring and follow-up. Fiduciaries who casually approach their responsibilities associated with operating a 404(c) plan may in the future find themselves in more trouble than they would have been had the plan not ever been intended to comply with 404(c).
DOL EDUCATIONAL INTERPRETATIVE BULLETIN
In June 1996, the DOL issued an educational interpretative bulletin, which attempted to settle the confusion about what plan sponsors can safely do when it comes to educating their employees. It states what can be delivered and cannot be considered investment advice under ERISA so as not to expand fiduciary responsibility.
The bulletin tried to bring a common sense approach to financial education in the workplace. General information about the plan, including the investment alternatives within the plan, as well as the importance of tax deferred savings, the impact of loans and withdrawals on total retirement income, and the effects of inflation are considered acceptable educational topics. Also included as acceptable was general financial and investment information such as risk & return, characteristics of various asset classes, diversification, dollar-cost-averaging, compounded return, investment time horizons, and assessing risk tolerance. It was determined that asset allocation models can be used as long as the educator is using generic asset classes which relate to hypothetical individuals with different goals, time horizons and risk profiles. Interactive materials such as worksheets, questionnaires, and software for participants to work up their own
CE02 2009 International Foundation for Retirement Education 33 RETIREMENT PLAN DESIGN numbers and different investment scenarios were deemed acceptable as education tools.
Advice is becoming more apparent…more so in the private arena but in the public sector as well. Look for more legislation to be introduced similar to H.R. 1000 from Rep. Boehner (R-Ohio), which limits fiduciary responsibility with regard to education and advice. Though it had not became law as of this writing, this particular piece of legislation would not have held the provider of a plan responsible for advice rendered by a financial advisory vendor as long as the provider of the plan used prudence in selecting the financial advisory vendor and maintained checks and balances on the vendor. Any incorrect advice would be the fiduciary responsibility of the financial advisory vendor. Retirement professionals should stay abreast of continuing developments.
CE02 2009 International Foundation for Retirement Education 34 RETIREMENT PLAN DESIGN
QUALIFIED DOMESTIC RELATIONS ORDERS
More than 48 million American workers presently are covered by employer-sponsored pension plans.2 Pensions represent a significant asset of marriage partners and, therefore, are an important consideration should a divorce, separation, or other domestic relations proceeding occur. While state domestic relations law generally governs the division of marital property, the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code dictate the provisions for dividing pension assets. A pension may only be divided through a qualified domestic relations order (QDRO) that meets federal pension law requirements.
Facts:
Individuals who may become entitled under a QDRO to receive all or part of a participant’s benefit in a pension plan are the spouse, former spouse, child, or other dependent of the participant. These individuals, when named in a QDRO, are called “alternate payees.”
While an order must meet federal requirements to be a QDRO, the order must be issued by a state court (or other appropriate state authority) with the jurisdiction to issue judgments, orders, or decrees, or to approve property settlement agreements, pursuant to state domestic relations law (including community property law).
Two aspects of a participant’s pension benefits should be considered when deciding how to divide those benefits: (1) the benefit payable under the plan directly to the participant for the retirement purposes; and (2) any benefit that is payable on behalf of the participant to someone else after the participant dies.
2 Department of Labor, Employee Benefits Security Administration, QDROs.
CE02 2009 International Foundation for Retirement Education 35 RETIREMENT PLAN DESIGN
Plan administrator’s responsibility:
Under federal law, the administrator of a pension plan providing the benefits affected by an order is the individual/entity responsible for determining whether an order is a QDRO. The state court cannot make this determination.
A plan administrator, as fiduciary, must ensure that QDRO determinations are made in a timely, efficient and cost-effective manner consistent with the plan administrator’s fiduciary duties.
Each pension plan must have written procedures for handling QDROs. These procedures should explain how the plan administrator will determine whether an order is a QDRO and how the plan administrator will administer QDROs.
While not required, plan administrators may develop and make available “model” QDROs to assist in the preparation of such documents. Using models may make it easier for the parties to prepare a QDRO and reduce the time and expense associated with a plan administrator’s determination of the “qualified” status of an order.
QDRO rules apply to 403(b), 457(b), 401(k) and other qualified plans.
CE02 2009 International Foundation for Retirement Education 36