When I first entered this field, my immediate supervisor gave me a three step approach to learning what I needed to know to take care of qualified plans. First, she had me read relevant IRC Sections along with some of the regulations. (This proved to be very exciting! No, wait, the other thing...mind-numbingly boring.) Next, she handed me a client’s file and said, “Read the plan document.” (Not quite as boring. Far more exciting than watching paint dry.) Finally, she told me to look over what had been done for the client the year before.
All in all, this was an effective way to introduce someone to the world of pensions. It got me started on a rewarding career. But in my Spring / Summer Series, I’m going to do something a little bit different. As I said in my introduction earlier this month, I’m going to give some basic information about different types of qualified plans. (Qualified, meaning they meet the requirements of IRC 401(a).) If it inspires anyone to read the Internal Revenue Code, great! If it inspires anyone to become a pension actuary, even better! And if any of my readers come away with at least a basic understanding of qualified retirement plans, better still!
In my introduction, I said I would break down the series into five parts. I’ve added a sixth. (And who knows, I may add more later! We actuaries a wild and unpredictable bunch!) For this first entry, I’d like to lay out some basic information that’s not specific to any one type of plan, such as:
Eligibility and coverage. Congress recognizes the administrative burden of covering all employees in a plan, no matter how long they work for an employer. For instance, students working during college breaks may be unlikely to come back after graduation, so an employer can legitimately exclude anyone under age 21 from its plan. And employees sometimes don’t work out, either by their own choice or the employer’s. Employers can exclude short-term employees from their plans. Collective bargaining agreements often address retirement benefits for union members. An employer can exclude employees in that category.
Even after excluding employees by statute, an employer may have some category of employees who it does not want to cover. Whether it’s the commissioned sales force, the Third Street office, or Employees Who Never Have Change for the Vending Machine, an employer can choose not to cover some people. But only within reason. And reason, according to Congress and the Internal Revenue Code, means that the ratio of covered Non-Highly Compensated Employees (NHCE) to covered Highly Compensated Employees (HCE) must be at least 70% That is, if your plan covers 100% of the HCE, it must cover 70% of the NHCE. If your plan covers 50% of the HCE, it must cover 35% of the NHCE.
HCE/NHCE. I suppose this is a good time to define Highly Compensated and Non-Highly Compensated Employees. An HCE is an employee who owned 5% of the employer in the current or prior year, or anyone who made over a certain amount (currently $125,000) in the prior year. (The employer can elect to limit those in the second criteria to the top 20% of earners.) An NHCE is anyone who is not an HCE.
Vesting. When we say that a participant’s account balance is vested, we simply means it is non-forfeitable. If an employee leaves an employer for any reason, that employee is entitled to the vested portion of her benefit. When and to what extent an employee becomes vested must be included in the plan document. The three types of vesting are graded, immediate, and cliff. Immediate is exactly what the name implies: an employee is fully vested as soon as he enters the plan. Cliff is similar, in that an employee goes from 0% vested to 100% vested all at once, but not necessarily upon entering the plan. Graded is when an employee becomes fully vested over a period of years, such as 20% after two years of service, 40% after three, all the way up to 100% after six years of service. There are minimum vesting schedules described in the IRC, but any vesting schedule that is at least as good as those can be used in a qualified plan.
Top-Heavy. A Top-Heavy plan is one in which 60% or more of the benefits are for key employees (owners and certain officers). Many, if not most, small plans are Top-Heavy. Being Top-Heavy means that minimum contribution and vesting requirements must be met.
Of course you realize there is much more information I could give, but I don’t want to overload. As we go along, I’m happy to address any questions. Even more, I welcome any feedback. Especially, but not limited to, the good kind.
Next up: Profit sharing plans.
According to a recent poll by CivicScience, Inc, 56% of Americans think that Arabic numerals should not be taught in American schools. 56%. Another 15% polled had no opinion.
Now, I’m not the most mathy mathematician in the world, but I’m kind of a numbers guy. Some dinner table conversations I’ve started with my kids were about whether one infinite set of numbers can be bigger than another (it can) and whether .999... (repeating) is really equal to 1 (it is). Also, I’m part Syrian (my mother’s side), which I guess makes me Arabic myself. So maybe I’m a bit biased in this situation.
The survey of over 3200 Americans asked a simply worded question: Should schools in America teach Arabic numerals as part of their curriculum? It didn’t ask why the responders answered the way they did. Was it bigotry against anything Arabic? Was it because they felt “Hindu-Arabic numerals” is a more appropriate label than “Arabic numerals?” Are they against all concepts of enumeration? We may never know.
Personally, I think the 15% with no opinion simply didn’t remember what number system we use. Not knowing probably has little effect on their lives. The 56% who voted “no” may also not remember. But voting against teaching something when you don’t know what that something is does show some sort of prejudice. I’ll leave it to the experts to decide what that prejudice is.
Me, I would have voted “yes” if they asked me. Learning algebra and trigonometry was hard enough using Arabic numerals. I imagine it would be even harder with Roman numerals.
I had a lovely chat with a woman I connected with on LinkedIn a few days ago. She asked me a simple question: “Where can I find information about pensions so that I’ll know what type to suggest to my clients who need a retirement plan.” I jokingly suggested she could read Internal Revenue Code Section 401(a), adding that I’ll try to email her some good resources. She appreciated the joke and the offer, but also said that she just might read the code anyway.
Most of the professionals I meet have no interest in learning about pensions through the Internal Revenue Code or it’s regulations. I think what most professionals want is an actuary who can recommend and design a plan for their clients based on each particular client’s goals and objectives. But I think most professionals also want at least a basic knowledge of what’s available, and they want to have an idea of when to use each type of plan. Let’s face it, we can all speak intelligently about our own area of expertise. But as professionals, we also want to speak somewhat intelligently about peripheral fields. I can rely on the accountant to recommend forming a C Corp or S corp, the financial professional to advise whether to use a target date or index fund, and the life insurance expert to know the type and amount of insurance to recommend. But it’s still good for me to know the differences and advantages of each.
My next several blog entries (I’m informally calling them my Spring / Summer Series) will be about different types of plans. The purpose is to provide some basic information about each plan: how it works, what are the advantages, and in which situations the plan will work, may work, or won’t work at all. I’m plan to break it down into five sections (six if you count this as a Spring / Summer Series introduction), focusing on traditional profit sharing plans (plain and with Permitted Disparity), hybrid profit sharing plans (including age-based and new comparability), 401(k) plans (traditional and safe harbor, both with Roth options), defined benefit plans, and cash balance plans.
I won’t bombard you with a plan every week, and I may squeeze in some other topics along the way. I’ve got plenty of other things I’d love to discuss. Maybe you’d like to hear about my top ten favorite movies?