The Employee Retirement Income Security Act of 1974 (ERISA) established standards that corporate retirement plans must adhere to in order to receive favorable tax considerations. If a corporate retirement plan meets the criteria set forth by ERISA, the plan is a qualified plan and the employer may deduct contributions to the plan as a business expense. Vesting, eligibility and discrimination are the core issues addressed by ERISA. Vesting refers to the amount of time required to pass before the plan participant achieves a non-forfeitable right to benefits under the plan.

Employees are always 100% vested in their own contributions to the plan. Under ERISA rules, the most restrictive vesting schedules are graded and cliff vesting. Graded vesting requires a portion of the company contribution vest annually, with the employee being fully vested no later than the end of the sixth year. If the employer chooses to restrict vesting of company contributions to 0% for the first two years, the company contribution must be 100% vested at the end of year three, known as cliff vesting.

Eligibility Under ERISA rules, all employees who meet the following criteria are eligible to participate in a corporate sponsored retirement plan: • At least 21 years of age • Employed by the organization for at least one year • Work at least 1,000 hours per year Discrimination It is common for an employer to match employee contributions up to a certain percentage of salary.

ERISA requires the percentage be the same for all employees regardless of salary, job level, tenure, etc. If a plan favors certain highly compensated employees (i.e. an executive has the ability to take personal loans from the plan) it will lose its qualified status, this is a violation of exclusive benefit rules. Also known as a “top heavy plan.” ERISA also requires a qualified plan document be in writing. The plan must be funded, with assets in the plan segregated from other corporate assets.

Corporate retirement plans can be structured as either defined benefit or defined contribution plans. A defined benefit plan will provide a specific benefit at retirement. The benefit is determined using a formula typically involving age at retirement, compensation level, and years of service. A defined benefit plan tends to favor older employees because a larger amount may be contributed for those nearing retirement.

Defined contribution plans are more prevalent and easier to administer. The benefit that will ultimately be received by the plan participant is unknown; it depends on the investment return of the funds in the plan. With a defined contribution plan, the allowable contribution is restricted to certain amounts by the IRS. While there is a “catch-up” provision that allows people over 50 to contribute more to a qualified plan, if a person exceeds the maximum allowable contribution, a 6% per year penalty will be assessed on the excess contribution.

A 401(k) is the most common type of qualified defined contribution plan. Employees may allocate a portion of their salaries to this plan, and contributions are excluded from their income for Federal income tax purposes (Contributions to qualified plans have no effect on the employees' Social Security tax liability). Contributions and earnings grow tax deferred until withdrawn. Withdrawals from a 401(k) plan are taxed as ordinary income and may be subject to an additional 10% federal tax penalty if withdrawn prior to age 59 ½.

Roth 401(k) plans became available January 1, 2006. Roth 401(k) plans must be funded with after tax contributions but allow tax-free withdrawals, provided that the account owner is at least age 59½. A SEP (Simplified Employee Pension Plan) is also an IRA established and maintained by the employee, but to which the employer may contribute. With high contribution limits and immediate vesting, SEPs are generally appropriate for small family owned businesses looking to fund a retirement plan with company profits, lowering the tax liability of the company.

SIMPLE (Savings Incentive Match Plan for Employees) A SIMPLE Plan is an IRA established and maintained by the employee, but to which the employer may contribute. SIMPLEs are only available to small employers (100 or fewer employees). A SIMPLE eliminates the administrative work and costs associated with other plans. A participant in a SIMPLE plan will “simply” open an IRA account at the brokerage firm of their choice; the employer will make appropriate salary deductions and deposit them, along with

any match the company may make, into the employees IRA. Keogh (HR-10) Keoghs are intended for self employed persons and owners of unincorporated businesses, such as lawyers or doctors. If the owner of a Keogh has any employees, the plan then is subject to ERISA eligibility rules.

Profit Sharing/Money Purchase Plans Profit sharing plans are popular with companies in cyclical industries because they do not require a fixed contribution. The company can increase, decrease, or even skip a contribution as long as the contributions are “substantial and recurring." With a Money Purchase Plan, the employer contributes a fixed percentage of the employee’s salary regardless of the company’s profitability. The company must make contributions or pay a penalty.

Distributions taken from a qualified retirement plan are taxed as ordinary income. If taken prior to age 59 ½, the distribution is also subject to a 10% penalty. While it is not possible to avoid taxation, the 10% penalty will not be imposed if the distribution is due to: •Death, Disability or Divorce •Financial Hardship •Qualified Higher Education Expenses •Medical Expense Insurance Premiums for Unemployed Individuals •Medical Expenses over 7.5% of AGI •1st Time Home Buyer, up to $10,000 •Rollover to Another Qualified Plan •Substantially Equal Payments (55+)

If the reason for the distribution is death of the account owner and the beneficiary is the spouse of the deceased, the assets of a qualified plan may be rolled into the beneficiary’s qualified plan, further deferring taxes until retirement of the beneficiary. The IRS also requires distributions from a qualified plan to begin no later than April 1st of the year following the year the owner of the account attains age 70 ½. The penalty for failing to take the required minimum distribution (RMD) is 50%.

The assets in a qualified retirement plan can be transferred to another qualified plan with few restrictions. If the owner of the account takes possession of the funds, the transfer must be completed within 60 calendar days. This action is commonly referred to as a 60 day rollover. An individual is only allowed one 60 day rollover per year (12 rolling months, not calendar year). Further, if the funds are being “rolled” from a company-sponsored retirement plan, the corporation is required to withhold 20% of the distribution to be sent directly to the IRS.

403(b) TSA and 457 Plans A 403(b) is a defined contribution plan that may be established by a public school, state university, or nonprofit service organization. 457 plans are available to state and local government employees. Other than who is eligible to establish the plan, 403(b) plans and 457 plans work the same as a 401(k) plan. Also, 403(B) plans and 457 plans are not corporate retirement plans, therefore not regulated by ERISA rules. While they play by the same rules, these plans are not technically qualified plans.

A deferred compensation plan is a nonqualified retirement plan where an employee or business owner defers current compensation in exchange for a larger payout at retirement. Because the plan is nonqualified, it can discriminate, and commonly does. Deferred compensation plans are typically established by business owners for themselves and are not made available to the employees of the business. (Discriminatory--Nonqualified)

IRAs (Individual Retirement Accounts) While not technically qualified plans, many of the same rules apply here. IRAs provide an opportunity to save for retirement on a tax-deferred basis and may provide an immediate tax benefit through deductible contributions. A Traditional IRA may be funded by anybody with earned income. If the individual making the contribution is not covered by a qualified retirement plan, the contribution to a traditional IRA is tax deductible. If the individual making the contribution is covered by a qualified plan, but has income below certain levels, the contribution is deductible in the year it is made.

the year it is made. A Spousal IRA may be funded for the benefit of the nonworking spouse who has no earned income. Traditional and spousal IRAs must be funded no later than April 15 of the year following the year for which the contribution is intended. Withdrawals are taxed as ordinary income and there is a 10% penalty for premature distributions prior to age 59½. Required minimum distributions begin no later than April 1 of the year following a year the account owner attains age 70 ½ and rollover/transfer rules are the same as qualified plans.