With certain exceptions, all employees with 1 year of
service who are at least 21 years of age must be included in the plan.
A year of service is a calendar year, plan year, or any other consecutive
12-month period defined in the plan in which the employee has at least
1,000 hours of service. As an exception to the one-year participation
rule, plans may require 2 years of service for participation, but
if they do, they must provide 100 percent vesting immediately.
Nonvested participants may have breaks of service away
from their employer of up to 5 years without losing any prior service
as credit toward both participation and vesting.
General rule. Vesting refers to
the percentage of an employee's benefit account that he or she is
entitled to retain after leaving the organization. Employees immediately
vest in their own contributions and the earnings on them. However,
employees do not necessarily have an immediate right to any contributions
made by an employer. Federal law provides a maximum number of years
a company may require employees to work to earn the vested right to
all or some of these benefits.
In a defined benefit plan, there may be:
• 100 percent vesting after five years; or
• 20 percent vesting after three years, plus 20 percent
per year thereafter.
Employers have a choice of two different vesting schedules
for employer-matching 401(k) contributions:
• An employer may use a schedule in which employees are
100 percent vested in employer contributions after 3 years of service
(cliff vesting); or
• Under graduated vesting, an employee must be at least
20 percent vested after 2 years, 40 percent after three years, 60
percent after 4 years, 80 percent after 5 years, and 100 percent after
If an automatic enrollment 401(k) plan requires employer
contributions, employees vest in those contributions after 2 years.
Automatic enrollment 401(k) plans with optional matching contributions
follow one of the vesting schedules above.
The contributions or benefits provided under a retirement
plan must not discriminate in favor of highly compensated employees.
IRC Section 401(a)(4) contains the test for nondiscrimination that
a qualified plan must satisfy. The purpose of this test is to ensure
that the benefits provided to highly compensated employees are proportional
to those provided to nonhighly compensated employees.
In order to protect surviving spouses, defined benefit
plans, money purchase pension plans, and target benefit plans must
pay benefits in the form of a qualified joint and survivor annuity
(QJSA) or qualified preretirement survivor annuity (QPSA) if the participant
dies before annuity payments may begin. A QJSA or QPSA is required
unless the participant, with the consent of the spouse, elects another
form of benefit.
QJSA requirements. A QJSA is an
annuity for the life of the participant, with a survivor annuity for
the life of the participant's spouse. The amount paid to the surviving
spouse must be no less than 50 percent and no greater than 100 percent
of the amount of the annuity paid during the participant’s life.
QOSAs. A participant who waives
a QJSA may elect to have a qualified optional survivor annuity (QOSA).
The amount paid to the surviving spouse under a QOSA is equal to the
certain percentage (as chosen) of the amount of the annuity payable
during the participant’s life.
QPSA requirements. A QPSA is a form
of a death benefit paid as a life annuity to the surviving spouse
of a participant who was vested in his or her retirement plan benefits,
died before retirement, and was married to the surviving spouse (for
at least one year if the plan so provides).
Notice requirements. A QJSA notice
generally must be given to plan participants in certain retirement
plans that contain a QJSA feature. Such notice must be given between
30 and 180 days before the date benefits are paid.
A QOSA notice must be given to plan participants in certain
retirement plans that contain a QOSA feature. It is given between
30 and 180 days before the date benefits are paid.
A QPSA notice must be given to a participant during the
time beginning when he or she is age 32 and ending with the close
of the plan year before the participant is age 35 or within 1 year
from when an employee becomes a plan participant if he or she is hired
after the age of 35. It is given in certain retirement plans that
contain a QPSA feature.
What happens to employees' retirement benefits when they
leave a job before they retire?
Employees in defined benefit plans (other than cash balance
plans) will most likely be required to leave the benefits with the
retirement plan until they become eligible to receive them.
Employees in cash balance plans will probably have the
option of transferring at least a portion of the account balance to
an IRA or to a new employer’s plan.
In most cases, employees in defined contribution plans
(e.g., 401(k)s) who leave an employer before retirement age will be
able to transfer their account balance out of their employer’s plan.
Generally they can choose:
• A lump sum;
• A rollover to another retirement plan; or
• A rollover to an IRA.
If an employee’s account balance is less than $5,000
when he or she leaves an employer, the plan can make an immediate
distribution without the employee’s consent. If this distribution
is more than $1,000, the plan must automatically roll the funds into
an IRA it selects, unless the employee elects to receive a lump-sum
payment or to roll it over into an IRA of his or her choice. The plan
must first send the employee a notice allowing him or her to make
other arrangements, and it must follow rules regarding what type of
IRA can be used.
ERISA generally bars retirement plans from paying benefits
to a third party, even under court order. This means that a creditor
cannot attach an employee's pension and get a court order requiring
it to be paid to the creditor. There is, however, an exception for
A QDRO is a judgment, decree, or order for a retirement
plan to pay child support, alimony, or marital property rights to
a spouse, former spouse, child, or other dependent of a participant.
The QDRO must contain certain specific information, such as:
• The participant and each alternate payee’s name and last
known mailing address; and
• The amount or percentage of the participant's benefits
to be paid to each alternate payee.
A QDRO may not award an amount or form of benefit that
is not available under the plan.
A spouse or former spouse who receives QDRO benefits
from a retirement plan reports the payments received as if he or she
were a plan participant. The spouse or former spouse is allocated
a share of the participant's cost (investment in the contract) equal
to the cost times a fraction. The numerator of the fraction is the
present value of the benefits payable to the spouse or former spouse.
The denominator is the present value of all benefits payable to the
A QDRO distribution that is paid to a child or other
dependent is taxed to the plan participant.
There is a dollar limit on the amount that may be contributed
each year to an individual employee's account in a tax-qualified defined
contribution plan. This amount is indexed for inflation.
Warning: The contribution and benefit
limits and the nondiscrimination rules are very complex. It is easy
for a plan to inadvertently run afoul of the rules with dire tax consequences
for both the employer and the employees. Employers should have a benefits
expert evaluate the design and operation of their qualified retirement
plans in light of the new limits. This advice is particularly relevant
to 401(k) plans because of the special nondiscrimination rules and
contribution limits that apply to these plans.
on February 22, 2017.