Resources: Employee Benefit Plans
Employee benefit plans are a vital part of today’s economic environment and provide many benefits to employers and their employees. Plans that meet numerous and complex tax qualification requirements do not pay federal income taxes on the income their investments generate; neither do the plan participants pay taxes until they receive income in the form of distributions from the plan.
In 1974, the Employee Retirement Income Security Act of 1974 (ERISA) was passed to provide minimum standards of vesting, funding, and fiduciary behavior for pension and welfare benefit plans. The passing of ERISA was a result of (1) many participants losing their benefits due to large unfunded pension plans and (2) participants unable to receive their accumulated benefits because of their plans’ strict vesting schedules. ERISA also established the Pension Benefit Guaranty Corporation, which insures benefits in case certain types of pension plans were unable to meet benefit obligations.
Furthermore, ERISA established record keeping and financial reporting responsibilities for plans, which included an annual audit of their financial statements. ERISA gave the Department of Labor and the Internal Revenue Service authority to issue regulations specifying requirements for the financial records, tax return, annual report and audit. Those requirements include financial statement requirements and audits in accordance with generally accepted auditing standards.
In 2006, the Pension Protection Act was passed to improve the pension system and expand opportunities to build retirement savings by overhauling the funding and disclosure rules for defined benefit plans, addressing cash balance plans, and looking at payout and rollover rules, among other changes.
Employee benefit plans are segregated into two types of plans: defined benefit or defined contribution.
- A defined benefit plan, often referred to as a pension plan, is defined as a promise to pay a participant’s specified benefits (i.e. retirement income) that are determinable (typically by a pre-determined formula as defined in the plan) and are based on such factors as age, years of service, and compensation. FASB ASC 960-10-05-4
- A defined contribution plan, such as a 401(k) or 403 (b) plan, provides an individual account for each participant and provides benefits that are based on all of the following: (a) amounts contributed to the participant’s account by the employer and employee, (b) investment experience, and (c) any forfeitures allocated to the account, less any administrative expenses charged to the plan. FASB ASC 962-10-20
The employee benefit plan document defines the plan type, the formula for determining the rate at which participants accrue benefits (defined benefit) or the sponsor’s contribution rate (defined contribution).
The most common employee benefit plan in today’s economy is the defined contribution plan, which includes, but not limited to the following:
- 401(k) Plan
- Provides participants the option of having a portion of their compensation received currently or contributed to the plan instead. The employer receives a tax deduction for the participant amount contributed, and the participant is not currently taxed on that amount. An account for each participant records the contributions, any forfeitures allocated to the account, and investment income, gains and losses. Taxes on participants’ benefits (contributions plus/minus investment income, gains and losses) are deferred until distributed from the plan.
- 403(b) Plan
- Similar to a 401(k) plan, but is available to tax-exempt organizations (hospitals, churches and educational institutions). It allows participants to make salary reduction contributions to the plan. Taxes on participants’ benefits are deferred until distributed from the plan.
- Roth
- A plan allows participants to elect to be taxed currently on part or all of their contributions made to the plan (i.e. participant contributions are made on an after-tax basis). As a result, there are no taxes on participants’ benefits distributed from the plan if certain requirements are met.
- Roth retirement plans are available in both the 401(k) and 403(b) plans.
- A plan allows participants to elect to be taxed currently on part or all of their contributions made to the plan (i.e. participant contributions are made on an after-tax basis). As a result, there are no taxes on participants’ benefits distributed from the plan if certain requirements are met.
Find out more:
- Department of Labor
- Form 5500: The Department of Labor, Internal Revenue Service, and the Pension Benefit Guaranty Corporation jointly developed the Form 5500 Series so employee benefit plans could utilize the Form 5500 Series forms to satisfy annual reporting requirements under Title I and Title IV of ERISA and under the Internal Revenue Code.
- Pension Plan Protection Act: In 2006, the Pension Protection Act was passed to improve the pension system and expand opportunities to build retirement savings by overhauling the funding and disclosure rules for defined benefit plans, addressing cash balance plans, and looking at payout and rollover rules, among other changes.
- Pension Benefit Guaranty Corporation: Pension Benefit Guaranty Corporation was created by the Employee Retirement Income Security Act of 1974 to encourage the continuation and maintenance of private-sector defined benefit pension plans, provide timely and uninterrupted payment of pension benefits, and keep pension insurance premiums at a minimum. Defined benefit pension plans promise to pay a specified monthly benefit at retirement, commonly based on salary and years on the job.
