Question

In order for a pension plan to qualify for special tax treatment, what requirements must be met?

Answer 1

Pension plans are arrangements designed to provide income to individuals during their retirement years. Funds are set aside during an employee's working years so that the accumulated funds plus earnings from investing those funds are available to replace wages at retirements. An individual has a pension fund when she or he periodically invests in stocks, bonds, CDs, or other securities for the purpose of saving for retirement. When an employer establishes a pension plan, the employer provides some or all of the periodic contributions to the retirement fund.

In order for a qualified retirement plan (e.g., a 401(k) Plan, Profit Sharing Plan, or Defined Benefit Pension Plan) to qualify for special tax treatment*, the plan must conform to certain requirements.

In order to complete the takeover of an existing plan, and to assist our new clients in verifying that some of these basic requirements are being met, requires the following information for the plan:

Defined Benefit Plans

Defined Benefit Plans are traditional pension plans, where benefits are based on a specific formula. Most formulas use the number of years of service times a salary factor (often an average of the highest three, or highest five, years of salary history). An age factor is used as well, so a worker retiring at 65 receives a higher monthly benefit than one retiring at 62.

Defined benefit plans have these characteristics:

• Employer makes all contributions
• Employer makes all investment decisions and bears the risk if investments perform poorly
• Less popular since the rise of defined contribution plans.

Participant valuation reports

(as of date of asset transfer)

For plans that allow participant direction, the new recordkeeper must load participant account values as of the date of the asset transfer. These values must be in a data file or report provided by the prior recordkeeper.

For each participant, the data file must list the participant’s account value and activity by each type of contribution allowed under the plan. For example, a participant in a 401(k) Plan may have contributions to his/her account of salary deferrals, employer match, employer profit sharing and, if a participant loan is outstanding, the loan balance (for each loan, the amortization schedule and promissory note should be provided as well). For an accurate beginning balance on the new recordkeeping system, each of these values must be loaded separately for each participant.

Defined Contribution Plans
Rather than basing plan benefits on a specific formulaas defined benefit plans do, defined contribution plans allocate money to plan participants based on a percentage of each employee's earnings. The longer the employee participates in the plan, the higher the account balance grows, based on the amounts contributed and the investment earnings. Most defined contribution plans allow employees to choose their own investment mix from the specific funds made available through the employer.

Defined contribution plans include the following:

• Profit-sharing plan- This allows the employer to contribute a percentage of salary each year, but the percentage can vary each year based on corporate profits. However, contributions can be made even when there are no profits, at the employer's discretion.
  
• 401(k) plan - This form of profit-sharing plan allows employees to reduce their taxable income by deferring a percentage of their salary into the plan.
  
• 403(b) plan - These plans are also known as tax-sheltered annuities.
  
• Money purchase pension plan - This requires the employer to contribute a set percentage of salary each year regardless of corporate profits.