Employee benefit plans can be complicated. Offering a retirement plan to your employees creates huge benefit for your organization, but it also means that your business:
- Undertakes the cost of administering a retirement plan;
- Accepts responsibilities associated with the plan; and
- Assumes the task of adding some new words and acronyms to your everyday vocabulary (that may previously have been unknown to you and your team).
If your business is just beginning to consider offering a retirement plan to your employees, the last of those three duties can be just as daunting as the first two.
Here, we’ve outlined the definitions of the most commonly used terms in the employee benefit plan realm so that you can start speaking the retirement language like a pro and begin setting your business’s retirement plan up for success.
Types of Retirement Plans
- Defined Contribution Plan – A qualified retirement plan that defines the contribution made to a participant’s account (i.e. 401(k) plan, profit sharing plan, etc.)
- Defined Benefit Plan (pension plan) – A company pension plan in which an employee’s pension payments are calculated according to length of service and the salary they earned at the time of retirement
- Cash Balance Plan – A type of defined benefit plan often referred to as “hybrid plan” that offers the high contribution limits of defined benefit plans and the ease of understanding a defined contribution plan
- 401(k) Plan – a type of defined contribution company sponsored retirement plan that allows employees to contribute a portion of their compensation, up to an annual limit. The employer may or may not match part of the employee contribution. The contributions are pre-tax (or after tax if a Roth 401(k) is elected).
- Profit Sharing Plan – a type of defined contribution plan that allows employers to make a discretionary contribution for all eligible employees
- Safe Harbor Plan – A common defined contribution plan. In exchange for making a required employer contribution, the plan avoids many of the nondiscrimination tests that can often limit the ability of highly-compensated employees to contribute to the plan. This allows highly-compensated employees the ability to maximize deferrals to a traditional 401(k) plan. There are two types of Safe Harbor plans:
- Non-Elective Safe Harbor Plan – A required employer contribution into a Safe Harbor plan that is contributed to all eligible employees, regardless of if or how much they defer from their wages. A minimum contribution of 3% of compensation is required.
- Matching Safe Harbor Plan – A required employer contribution into a Safe Harbor plan that is contributed to all eligible employees who elect to defer from their wages. A match of 100% on the first 3% contributed and 50% on the next 2% contributed is the basic formula (an employee who contributes 5% of their compensation receives a match of 4%).
- SIMPLE IRA – an employer-sponsored retirement plan offered within small businesses that have 100 or fewer employees. SIMPLE is an acronym for savings incentive match for employees. Small businesses may favor SIMPLE IRAs because they are a less expensive and less complicated alternative to a 401(k) plan. SIMPLE IRAs require a match up to 3% or a contribution of 2% to all eligible employees.
- Traditional IRA – a retirement account (not sponsored by an employer) that allows an individual with earned income to make contributions and potentially receive an income tax deduction. There are certain limitations that determine if a contribution is tax deductible.
- SEP IRA – a type of traditional IRA for self-employed individuals or small business owners. The business makes the contribution, not the employees. The business makes a contribution equal to a percentage of each employee’s compensation, subject to annual contribution limits.
- 403(b) Plan – a retirement savings plan available to employees of certain public education, non-profit, or hospital service organizations
- SOLO 401(k) – a 401(k) plan for employers with no full-time employees other than the business owner(s)
Retirement Plan Forms
- Form 5500 – The Form 5500 Series is part of Employee Retirement Income Security Act’s (ERISA) reporting and disclosure framework intended to ensure that employee benefits plans are operated and managed in accordance with prescribed standards. In addition, it ensures that participants and beneficiaries, as well as regulators, are provided or have access to sufficient information to protect the rights and benefits of participants and beneficiaries under the covered employee benefits plans. All qualified retirement plans, 403(b) plans subject to ERISA, and health and welfare plans covering more than 100 participants are subject to filing the Form 5500.
Retirement Plan Laws and Regulations
- The Employee Retirement Income Security Act of 1974 (ERISA) – a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans.
- The Setting Every Community Up for Retirement Enhancement (SECURE) Act – law enacted in December of 2019 that is widely considered to be the most impactful retirement legislation in almost 20 years. It contains several provisions to advance the access to and facilitate ease of the administration of qualified retirement plans.
Retirement Plan Authorities and Organizations
- Department of Labor – A government agency responsible for administering and enforcing the provisions of ERISA. PBGC’s insurance program is designed to pay the benefit provided by a pension plan (up to the limits set by law) if your plan ends without the ability to pay the benefits.
- IRS – The Internal Revenue Service oversees federal tax laws associated with retirement plans.
- Pension Benefit Guaranty Corporation (PBGC) – A government agency created by ERISA to protect pension benefits in private-sector defined benefit plans.
Other Retirement Plan Terms
- Automatic Enrollment Provision – Allows a plan sponsor to automatically deduct deferrals from an employee’s wages unless the employee makes an election to opt out
- Fiduciary – a person or entity responsible for many of the actions and decisions related to administering a retirement plan. Fiduciaries must follow the plan document and act solely in the interest of the participants.
- Highly-Compensated Employee (HCE) – An employee who either:
- Owns more than a 5% interest in the plan sponsor at any time during the year or preceding year; OR
- Earns greater than the Indexed Compensation limit in the preceding year. The indexed amount for 2020 is $125,000 earned during the 2019 year. The indexed amount for 2021 is $130,000 earned during the 2020 plan year.
- Nondiscrimination testing – A series of both numerical and facts and circumstance tests that are prescribed by regulations to verify that a plan does not discriminate in favor of highly-compensated employees or key employees (owners)
- Plan Document – A legal document that dictates the details and operations of the plan
- Plan Sponsor – A designated party, usually a company or employer, that sets up a retirement plan for the benefit of the organization’s employees
- Required Minimum Distribution – The minimum amount that must be withdrawn after reaching a certain age or event
- Trustee of a Qualified Retirement Plan – The entity or group of individuals who hold the assets of the plan in trust. Trustees are either designated in the plan document or appointed by another fiduciary, typically the employer who sponsors the plan.
- Vesting – “Vesting” in a retirement plan means ownership. This means that each employee will vest, or own, a certain percentage of their account in the plan each year. An employee who is 100% vested in his or her account balance owns 100% of it and the employer cannot forfeit, or take it back, for any reason.
Learn More about Retirement Plan Terms and Best Practices for Your Business
For more information about what businesses should know about the retirement plans they offer to their employees, ask a Warren Averett employee benefit plan advisor to reach out to you.