Employer retirement plans overview

Caveat: This overview is intended to introduce basic concepts, not provide guidance. Retirement plans are complex and contain many subtleties not described here. There can be penalties if plan withdrawal or contribution limitations are not followed correctly. Please don't hesitate to ask questions in the Bogleheads' forum.

This page describes retirement plans offered by employers. For individual retirement plans, see Retirement Planning in the wiki.

=Employer Retirement Plan Defined= A pension plan is an employee benefit plan established or maintained by an employer or by an employee organization (such as a union), or both, that provides retirement income or defers income until termination of covered employment or beyond. There are a number of types of retirement plans, including the 401(k) plan and the traditional pension plan, known as a  defined benefit plan.

Most private sector pension plans are covered by the Employee Retirement Income Security Act (ERISA). Among other things, ERISA provides protections for participants and beneficiaries in employee benefit plans, including providing access to plan information. Also, those individuals who manage plans (and other fiduciaries) must meet certain standards of conduct under the fiduciary responsibilities specified in the law.

=Types of Retirement Plans=

Qualified Retirement Plan
A qualified retirement plan meets the requirements of Internal Revenue Code Section 401(a) and the  Employee Retirement Income Security Act (ERISA) and therefore qualifies for favorable tax treatment. Contributions and earnings are tax-deferred until withdrawn.

The Employee Retirement Income Security Act (ERISA) covers two types of pension plans: defined benefit plans and defined contribution plans.

Defined Benefit Plan
A defined benefit pension plan promises a specified monthly benefit at retirement. The plan may state this promised benefit as an exact dollar amount, such as $100 per month at retirement. Or, more commonly, it may calculate a benefit through a plan formula that considers such factors as salary and service — for example, 1 percent of average salary for the last 5 years of employment for every year of service with an employer. The benefits in most traditional defined benefit plans are protected, within certain limitations, by federal insurance provided through the Pension Benefit Guaranty Corporation (PBGC).

Defined Contribution Plan
A defined contribution plan, on the other hand, does not promise a specific amount of benefits at retirement. In these plans, the employee or the employer (or both) contribute to the employee's individual account under the plan, sometimes at a set rate, such as 5 percent of earnings annually. These contributions generally are invested on the employee's behalf. The employee will ultimately receive the balance in their account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to the changes in the value of the investments. Examples of defined contribution plans include 401(k) plans,  403(b) plans, employee stock ownership plans, and profit-sharing plans.

Non-Qualified Retirement Plan
A non-qualified retirement plan does not meet the requirements of Internal Revenue Code Section 401(a) and the  Employee Retirement Income Security Act of 1974 (ERISA) and therefore does not qualify for favorable tax treatment.

In essence, a non-qualified retirement plan is a contract to provide pension benefits. Individuals can create one, but most are created by employers.

Contributors to non-qualified plans don't get the same tax benefits as contributors to qualified plans, such as 401(k)s, do. However, non-qualified plans can be much more flexible in setting benefit amounts and timing payouts.

The contributions made to these plans are usually nondeductible to the employer and are usually taxable to the employee. However, they allow employees to defer taxes until retirement. Non-qualified plans are often used to created to attract and retain highly paid employees.

Deferred Compensation Plan
Deferred compensation is the term used for future income that would have otherwise been realized in the present.

But when used in context by employers, the name denotes a non-qualified "promise to pay" on the part of the employ er. There are many forms, which often include the increased valuation of the company's stock, measures of executive performance, cash value built in life insurance, salary increases/bonuses for the next year not paid by the employer but kept in a company trust, and so on.

Each participating employee needs to understand that the assets set aside in a Deferred Compensation plan are nothing more than the employer's promise to pay them at a future date. This promise is only as good as the employer's ability to keep it, i.e. assets are at risk if the employer fails. This is a different situation than qualified plans, where vested vested account balances are 100% owned by the employee regardless of employer status.

Deferred Compensation plans are very hard to describe, as it is at the employer's discretion. It is really about contract law: A written agreement between an employee and employer, and is not subject to the statutory law administered by the DOL and IRS that governs qualified plans.

=Employer Retirement Plans=

Implementing an employer retirement plan requires consideration of many factors that affect both the employer and employee, as shown in the IRS table below. Refer to the Retirement Plans Navigator web site for further information. The table is an example - not all plans are shown or described.

1. Only required if plan has employer contributions but never for government plans. 2. Other - Generally, the plan's assets are held in a tax-exempt trust, though they can also be held in custodial accounts and annuity contracts. 3. All Dollar limits are for 2009 and subject to cost-of-living adjustments in future years (except the age 50+ catch-up contributions for Payroll Deduction IRAs). 4. Employer may contribute to an employee's retirement account but the total employer and employee contributions may not for 2009 exceed 100% of the employee's compensation, or $49,000 or more if additional contributions permitted by plan (age 50+ catch-up contributions, 15 or more years of service or 3 years prior to normal retirement age). In a 403(b) plan, compensation means the employee's includible compensation. 5. Required - The amount an employer must deposit into the plan on behalf of an employee must either be a matching contribution that equals a certain portion or percentage of the employee's contributions or a minimum nonelective contibution to all plan participants. The amount of the required employer contributions vary depending on the plan. 6. The amount of an employer's annual contributions are determined by an actuary. 7. The maximum combined employer and employee contributions are for 2009 the lesser of 100% of an employee's includible compensation, or $16,500 or more if additional contributions permitted by plan (age 50+ catch-up contributions or 3 years prior to normal retirement age). 8. Only applies to government plans. 9. Withdrawals may be made at any time, subject to tax

Payroll Deduction IRA
(Employer perspective) This is probably the simplest retirement arrangement that a business can have. It is so easy that, in fact, no plan document is needed under this arrangement.

Under a Payroll Deduction IRA, an employee establishes an IRA (either a Traditional IRA or a Roth IRA) with a financial institution. The employee then authorizes a payroll deduction amount for the IRA.
 * Payroll Deduction IRA, from the IRS

SARSEP
(Employer perspective) A Salary Reduction Simplified Employee Pension plan (SARSEP) is a  Simplified Employee Pension (SEP) plan set up before 1997 that permits contributions to be made through employee salary reductions, referred to as “employee elective deferrals.” Under a SARSEP, employees and employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for the employees, subject to certain percentage-of-pay and dollar limits.

Employees can play an active role in funding for their retirement by choosing to have the employer contribute part of their pay to their separate IRAs, referred to as SEP-IRAs. SEP-IRAs need to be established for each participant, even those becoming eligible after December 31, 1996, with a bank, insurance company or other qualified financial institution.

No new SARSEPs can be established after December 31, 1996. However, employers who established SARSEPs prior to January 1, 1997, can continue to maintain them and new employees of the employers hired after December 31, 1996, can participate in the existing SARSEP.
 * SARSEP, from the IRS
 * Retirement Plans FAQs regarding SARSEPs, from the IRS
 * SARSEP, in the wiki

SEP
(Employer perspective) A SEP is a Simplified Employee Pension plan. Because this is a simplified plan, the administrative costs should be lower than for other, more complex plans. Under a SEP, employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for employees (including self –employed individuals), subject to certain limits.
 * SEP, from the IRS
 * Retirement Plans FAQs regarding SEPs, from the IRS
 * SEP, in the wiki

SIMPLE IRA
(Employer perspective) A SIMPLE IRA plan is a S avings I ncentive M atch PL an for E mployees. Because this is a simplified plan, the administrative costs should be lower than for other, more complex plans. Under a SIMPLE IRA plan, employees and employers make contributions to traditional Individual Retirement Arrangements (IRAs) set up for employees (including self-employed individuals), subject to certain limits. It is ideally suited as a start-up retirement savings plan for small employers who do not currently sponsor a retirement plan.
 * SIMPLE IRA, from the IRS
 * Retirement Plans FAQs regarding SIMPLE IRA Plans, from the IRS
 * SIMPLE IRA, in the wiki

401(k) Plans
Plan Type: Qualified Defined Contribution

A 401(k) plan is a qualified (i.e., meets the standards set forth in the Internal Revenue Code (IRC) for tax-favored status) profit-sharing, stock bonus, pre-ERISA money purchase pension, or a rural cooperative plan under which an employee can elect to have the employer contribute a portion of the employee’s cash wages to the plan on a pre-tax basis. These deferred wages (elective deferrals) are not subject to federal income tax withholding at the time of deferral, and they are not reflected as taxable income on the employee’s Form 1040, U.S. Individual Income Tax Return.
 * 401(k) Resource Guide - Plan Sponsors - 401(k) Plan Overview, from the IRS

For those employees who would like to make changes to their employer's 401(k), please refer to "How to Campaign for a Better 401(k) Plan" in this wiki.

Traditional 401(k)
A traditional 401(k) plan allows eligible employees (i.e., employees eligible to participate in the plan) to make pre-tax elective deferrals through payroll deductions. In addition, in a traditional 401(k) plan, employers have the option of making contributions on behalf of all participants, making matching contributions based on employees’ elective deferrals, or both. These employer contributions can be subject to a vesting schedule which provides that an employee’s right to employer contributions becomes nonforfeitable only after a period of time, or be immediately vested.
 * 401(k), in the wiki

Designated Roth Accounts in 401(k) Plans: Beginning in 2006, a 401(k) plan (but not a SARSEP or SIMPLE IRA plan) may permit an employee to irrevocably designate some or all of his or her elective contributions under the plan as designated Roth contributions. The plan must contain language that allows for these Roth contributions.

A designated Roth account is a separate account under a 401(k)plan to which designated Roth contributions are made, and for which separate accounting of contributions, gains, and losses is maintained.
 * Designated Roth Accounts in 401(k) or 403(b) Plans, from the IRS

Safe harbor 401(k)s
A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, it must provide for employer contributions that are fully vested when made. These contributions may be employer matching contributions, limited to employees who defer, or employer contributions made on behalf of all eligible employees, regardless of whether they make elective deferrals. The safe harbor 401(k) plan is not subject to the complex annual nondiscrimination tests that apply to traditional 401(k) plans.

SIMPLE 401(k)
The SIMPLE 401(k) ( S avings I ncentive M atch PL an for E mployees) plan was created so that small businesses could have an effective, cost-efficient way to offer retirement benefits to their employees. A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to traditional 401(k) plans. As with a safe harbor 401(k) plan, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. Employees who are eligible to participate in a SIMPLE 401(k) plan may not receive any contributions or benefit accruals under any other plans of the employer.

Defined Benefit
A defined benefit pension plan is the most administratively complex type of retirement plan. It may be used by businesses of any size. Employers can generally contribute more to a defined benefit plan than to other types of retirement plans.

This fund is different from many pension funds where payouts are somewhat dependent on the return of the invested funds. Therefore, employers will need to dip into the companies earnings in the event that the returns from the investments devoted to funding the employee's retirement result in a funding shortfall. The payouts made to retiring employees participating in defined-benefit plans are determined by more personalized factors, like length of employment.

The most common type of monthly benefit is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending on investment returns. It is 'defined' in the sense that the formula for computing the employer's contribution is known in advance.


 * Choosing a Retirement Plan: Defined Benefit Plan, from the IRS
 * Defined Benefit Pension Plan, in the wiki

403(b) Tax Sheltered Annuity
A 403(b) tax-sheltered annuity (TSA) plan is a retirement plan offered by public schools and certain tax-exempt organizations. An individual’s 403(b) annuity can be obtained only under an employer’s TSA plan. Generally, these annuities are funded by elective deferrals made under salary reduction agreements and nonelective employer contributions.
 * IRC 403(b) Tax-Sheltered Annuity Plans, from the IRS
 * 403(b) Retirement Plan Mini-Course for Employees, from the IRS - a short flash-based presentation (for your browser)
 * 403(b), in the wiki

Designated Roth Accounts in 403(b) Plans: Beginning in 2006, 403(b) plan (but not a SARSEP or SIMPLE IRA plan) may permit an employee to irrevocably designate some or all of his or her elective contributions under the plan as designated Roth contributions. The plan must contain language that allows for these Roth contributions.

A designated Roth account is a separate account under a 403(b) plan to which designated Roth contributions are made, and for which separate accounting of contributions, gains, and losses is maintained.
 * Designated Roth Accounts in 401(k) or 403(b) Plans, from the IRS

457(b) Deferred Compensation
Plan type: Non-qualified tax-deferred compensation

Plans of deferred compensation described in IRC (Internal Revenue Code) section 457 are available for certain state and local governments and non-governmental entities tax exempt under IRC 501. They can be either eligible plans under IRC 457(b) or ineligible plans under IRC 457(f). Plans eligible under 457(b) allow employees of sponsoring organizations to defer income taxation on retirement savings into future years. Ineligible plans may trigger different tax treatment under IRC 457(f).
 * 457-b, in the wiki

=Notes=

=See Also= Types of Retirement Plans, from the IRS Retirement Plans FAQs regarding IRAs, from the IRS Retirement Plans and tax deferred investing, the Bogleheads' forum Reference Library