Rules

Workplace retirement plans can either be qualified or non-qualified. To be considered qualified, a plan must be governed by the Employee Retirement Income Security Act (ERISA) - a retirement plan law discussed below. In particular, ERISA generally governs qualified plans of non-governmental (private) organizations. Qualified plans are eligible for substantial tax benefits for both the employer and employee.

Most qualified retirement plans offer pre-tax contribution ability. Typically, every dollar a person makes at work is taxable. The more one makes, the more taxes due. However, taxation is reduced with pre-tax contributions. Assume you make $100,000 at your job, which is subject to income taxes. If you were to contribute $5,000 to your company’s qualified retirement plan, you’d only be taxed on $95,000 of income for the year. Additionally, most qualified retirement plans allow payroll deductions of work earnings to be directly deposited into a retirement account without being taxed*. The more money placed in a qualified retirement plan, the less taxable income to report. However, retirement plan assets are taxable when distributed later in retirement.

*Not all qualified plans offer pre-tax contributions. Roth 401(k)s are a good example. We will learn more about these accounts later in this unit.

Qualified plans are in high demand due to their tax benefits. Organizations offer access to these plans to stay competitive when attracting potential employees. Certain specifications and requirements must be followed to provide qualified plans to employees. In particular, compliance with the ERISA is required. This legislation protects employee retirement assets from employer misconduct or mismanagement. Qualified plans must meet ERISA standards to be offered, which include the following:

Minimum participation/non-discrimination

• Must offer the plan to all full-time employees
  • Cannot offer the plan to executives only (this would be discrimination)
• To be considered full-time, an employee must be:
  • Age 21 or older
  • Working 1,000 hours+ annually

Reporting and disclosure

• Details of retirement plan available in writing
• Employees provided annual updates

Funding

• Defined benefit plans (discussed below) must be funded appropriately

Vesting

• Employees must earn employer-provided benefits in a reasonable amount of time (five years or less)
  • For example, employer-matched contributions*
• Employee contributions are always 100% vested

*Some employers match employee contributions as a workplace benefit. For example, a company offers to match 100% of employee contributions, up to 5% of their salary. If an employee saves 5% of their salary, the employer matches the contribution (allowing the employee to effectively save 10% of their salary). Employers usually apply vesting periods of five years or less, which means an employee quitting their position within the vesting period loses part or all of the employer match.

Every qualified plan is governed by a plan document that must be created before it is offered to employees. This document identifies the rules of the plan, including:

• Who can contribute to the plan
• Employer-provided benefits (e.g., matching contributions)
• Vesting schedules
• Investment options
• Beneficiary designation rules
• Distribution guidelines

If you’re interested, here’s a link to a boilerplate plan document. Knowing the minor details of a plan document is unnecessary, but viewing an example may help build real world context.

A fiduciary administers the qualified plan according to the rules in the plan document. The Internal Revenue Service (IRS) defines a fiduciary as:

“A person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity.”

The fiduciary’s job is to ensure the qualified plan functions as intended according to the plan document. Their ultimate responsibility is representing the plan participants (employees with plan access) and placing their interests above those of the employing organization. Several entities could fill the fiduciary role, including organization employees (usually an executive or board member) or unaffiliated third parties.

After the plan document is created and a fiduciary is appointed, the organization must submit the plan documents in writing to the IRS for approval. Once approved, the qualified plan may be offered to employees.