GLOSSARY OF TERMS

401(k) Plan

An employer-sponsored defined contribution plan that allows participants to defer part of their compensation on a pretax basis to save for retirement. 401(k) refers to the section of the Internal Revenue Code (IRC) that describes this arrangement. 401(k) plans are often referred to as “cash or deferred arrangements” (CODA)

402(g) limits (employee elective deferral limits)

The maximum amount of elective deferral contributions a participant may make to any employer-sponsored, tax-qualified retirement plan(s). The 402(g) limit is an annual individual limit covering all deferral contributions regardless of plan(s). All elective deferral contributions to any tax-qualified retirement plan are subject to 402(g) limits, which are adjusted annually to reflect increases in the cost of living (COLA).

403(b) arrangement

An annuity contract or custodial account that meets the requirements of Section 403(b) of the IRC. Only employees of certain public schools, universities and tax-exempt organizations described in section 501(c) (3) of the IRC are eligible to establish 403(b) arrangements. The Treasury Department issued final 403(b) regulations that will cause administrative changes in the way current 501(c)(3) organizations, churches, schools and hospitals do business.

404 limit — employer deductible contribution limit

The maximum annual deduction permitted by an employer for federal income tax purposes with respect to tax-qualified, retirement plan contributions (employer contributions). 404 refers to the section of the IRC that sets the limit. Separate limits apply to defined contribution plans and defined benefit plans. The defined contribution limit is an aggregate limit covering all contributions by an employer to any defined contribution plan(s). In most cases, the annual defined contribution plan deduction limit is 25% of eligible compensation earned by all plan participants for that year.

415 limit — annual additions limit

For defined contribution plans, the annual contribution limit to a participant account. This limit includes all contributions except rollover and loan repayment. 415 refers to the section of the IRC that sets the limit. Separate limits apply to defined contribution plans and defined benefit plans. The defined contribution limit is an aggregate limit. All annual additions to the account of a participant − under all tax-qualified defined contribution retirement plan(s) maintained by the employer − are counted against the limit. The annual defined contribution plan 415 limit for a year is generally the lesser of 100% of the participant’s eligible compensation for a year or a specified dollar limit, which is adjusted annually to reflect changes in the cost of living.

The 415 limit for a defined benefit plan limits the amount of benefit the participant is allowed to receive at retirement. This limit is generally the lessor of 100% of compensation (3 year average) and a stated dollar amount that is indexed for cost of living.

457 plan

A deferred compensation arrangement sponsored by a federal, state or local government / municipality or a tax-exempt organization. Most 457 plans are funded by elective deferrals and are similar to 401(k) plans (but significantly different tax rules apply). 457 refers to the section of the IRC that describes the tax treatment of 457 plans.

ADP/ACP nondiscrimination tests

Nondiscrimination tests that apply to 401(k) plans. The ADP test prohibits highly compensated employees (HCE) from making disproportionately greater elective deferral contributions to a 401(k) plan than non-highly compensated employees (NHCE). The ACP test prohibits HCEs from making employee after-tax contributions and receiving employer matching contributions in disproportionately greater amounts.

Automatic deferral default percentage

The percentage of pay that is automatically deferred when an employee is enrolled in a plan through automatic enrollment. A typical automatic deferral default percentage is 3% of pay. Generally, participants can choose to defer an amount other than the default percentage.

Automatic enrollment

A plan feature that allows an employer to enroll employees in a salary deferral plan without the employees’ initial consent, as long as employees have the right to “opt out” of contributing to the plan. Also known as “negative election”.

Cash Balance Plan

A type of defined benefit plan that includes some elements that are similar to a defined contribution plan. Typically, each employee has a “hypothetical account”. Each year the account is credited with some amount that is determined by formula, usually a percentage of pay. The account is also credited with interest at a stated rate. In a cash balance plan the employees’ pension benefit payable at retirement is based on the projection of his hypothetical account. The employee has the choice of receiving this pension or a lump sum distribution equal to the hypothetical account.

Catch-up contributions

Contributions that permit individuals 50 or older to make additional elective deferral contributions in excess of the 402(g) limit, the 415 limit or any other limit imposed by the terms of a tax-qualified retirement plan. Catch-up contributions were established by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The maximum amount of annual catch-up contributions is adjusted annually to reflect increases in the cost of living.

Cliff vesting

A vesting schedule in which the participant’s accumulation is not vested during the initial years of service but becomes fully vested upon completing the number of years required by the plan. While traditional vesting schedules are graduated (20%, 40%, 60%, etc.), cliff vesting is not (0%, 0% and 100%).

COLA

Acronym for Cost-Of-Living Adjustment, which refers to periodic (generally annual) changes in wages, benefits or contribution levels. The IRS issues COLAs, which are designed to compensate for the effects of inflation.

Compliance Testing

Testing required by the IRS to ensure that non-highly compensated employees (NHCEs) do not benefit disproportionately relative to the benefit received by the highly compensated employees (HCEs). There are many tests of this type that must be passed, and most are quite complicated.

Cross-testing

Generally, refers to nondiscrimination testing performed on a defined contribution plan by projecting the contributions to retirement age, converting the projected account balances to monthly benefits and comparing the benefits. Examples of cross-tested plans include age-weighted or new comparability plans.

Defined benefit plan

An employer-sponsored retirement plan that pays a specific amount to a retired employee. The amount to be paid to the retired employee is usually based on a formula that takes salary history and years of service into account. The employer bears the investment risk because the plan promises a specific benefit. If plan assets (including employer contributions and investment earnings) are insufficient to fund benefit payments to plan participants, the employer must generally contribute the difference.

Defined contribution plan

An employer-sponsored retirement plan, such as a 401(k) or profit-sharing plan, that is funded by employer contributions, employee elective deferrals or both. Unlike defined benefit plans, the participants bear the investment risk because the plan does not promise a specific benefit. Instead, it promises to pay the employee the amount in his or her account, which is the sum of contributions and investment earnings.

Discretionary contributions

Amounts an employer may – but is not obligated to – contribute to a plan. Discretionary contributions can be profit sharing or matching contributions.

EGTRRA

Acronym for the Economic Growth and Tax Relief Reconciliation Act of 2001, which made significant changes in several areas, including income tax rates, estate and gift tax exclusions and qualified and retirement plan rules. In general, the act simplified retirement and qualified plan rules for individual retirement accounts (IRAs), 401(k) plans, 403(b) and pension plans.

Elective deferral

Payroll reduction contributions made by an employer on behalf of an employee pursuant to an election by the employee to have such a contribution made in lieu of cash compensation, which is otherwise payable to the employee.

Eligible employee

An employee who meets a plan’s age and service requirement provisions for participation.

Employee Benefit Security Administration (EBSA)

An agency of the Department of Labor responsible for protecting the integrity of retirement plans, health plans and other employee benefits.

ERISA

Acronym for the Employee Retirement Income Security Act of 1974, a federal law that imposes various requirements on voluntarily established pension, health and other welfare benefit plans in private industry, and establishes standards applicable to certain service providers of such plans in order to provide protection for plan participants.

Fidelity bond

A bond designed to protect a retirement plan’s participants in the event a fiduciary or other responsible person steals or mishandles plan assets.

Fiduciary (under ERISA)

Any person or party who:

• Exercises any discretionary authority or discretionary control with respect to management of the plan or exercises any authority or control with respect to management or disposition of assets.

• Renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of the plan or has any authority or responsibility to do so.

• Has any discretionary authority or discretionary responsibility in the administration of the plan.

ERISA section 3(21)(A)(ii) sets out a simple two-part test for determining fiduciary status: A person or party who (1) renders investment advice with respect to any moneys or other property of the plan or has any authority or responsibility to do so; and (2) receives a fee or other compensation, direct or indirect, for doing so.

Forfeiture

The portion of a participant’s account balance that is relinquished (the non-vested portion) upon termination of employment.

Form 1099R

A form sent to the recipient of a plan distribution and filed with the IRS to document the distribution amount.

Form 5500

A form that all qualified retirement plans – excluding Simplified Employee Pension (SEP) plans and Savings Incentive Match Plan for Employees (SIMPLE) IRAs – must file annually with the IRS. Fees to prepare Form 5500 are usually included in recordkeeping and administration charges.

Hardship Distribution

A participant’s withdrawal of plan contributions prior to retirement due to hardship. Financial hardship may be a condition for eligibility for this type of withdrawal, which may or may not be permitted under the terms of the plan. Reasons for hardship withdrawals can include uninsured medical expenses for the participant, a spouse or eligible dependents; purchase of a primary residence (excluding mortgage payments); payment of post-secondary tuition costs for the participant, a spouse or eligible dependents; payments necessary to avoid foreclosure or eviction from the participant’s principal residence; funeral expenses for the employee, a spouse, dependents, or beneficiary of the employee; or certain damage repair expenses for the employee’s principal residence. These distributions are taxable as early distributions and are generally subject to a 10% penalty tax if the participant is under 59 1/2.

HCE

An acronym for Highly Compensated Employee, who meets one of the following conditions:

• Owned more than 5% of the employer business at any time during the year or preceding year. Ownership may be direct or through attribution.

• For the preceding year, received compensation of more than a specified dollar amount that is adjusted annually to reflect increases in the cost of living, and if elected by the employer, was in the top 20% of employees when ranked by compensation.

Key Employee

An individual who:

• Is an officer of the company that sponsors the plan and earns income in excess of a specified dollar amount that is adjusted annually to reflect increases in the cost of living.

• Owns more than 5% of the company that sponsors the plan.

• Is a 1% owner of the company that sponsors the plan, with income of more than $150,000.

Matching Contribution

An employer contribution to a participant’s employer-sponsored retirement plan. The amount of the contribution is based on the amount of the participant’s elective deferral contributions. For example, the plan might specify that it will contribute 50 cents for each dollar of elective deferral contributions under its 401(k) plan. Matching contributions are subject to ACP testing.

Money Purchase Plan

A defined contribution plan that requires the plan sponsor to make contributions on behalf of each participant based on the plan’s formula, which is specified in the plan’s document. Contributions must be made to a money purchase pension plan regardless of the profitability of the sponsor.

NHCE

Acronym for Non-Highly Compensated Employee, which includes employees who do not meet the criteria for an HCE.

Nondiscrimination testing

Various types of nondiscrimination tests applicable to employer-sponsored, tax-qualified retirement plans under the IRC. The tests are generally designed to prevent HCEs from receiving disproportionately greater benefits than NCHEs. The ADP/APC nondiscrimination tests are two examples.

Non-elective Contribution

An employer contribution other than a matching contribution. One example of a non-elective contribution would be a profit-sharing contribution that is allocated among employees on the basis of pay. The term non-elective comes from the fact that a participant’s right to share in this contribution is determined without regard to any election made by the participant. 

Participant

An employee who is eligible to participate in an employer-sponsored retirement plan and has passed an entry date. An employee who is eligible to elect to have his or her employer make elective deferral contributions to a 401(k) plan — but chooses not to — is still considered a participant. Also, a terminated employee that still has benefits in the plan is considered a participant.

PBGC

Acronym for Pension Benefit Guaranty Corp., which was established by ERISA to ensure that benefits will be payable to participants when due if the sponsor of a defined benefit pension plan is unable to make payments. Companies that sponsor defined benefit plans pay premiums to PBGC based on the number of employees in the plan and the current ratio of assets to liabilities in the plan.

PPA

Acronym for the Pension Protection Act of 2006, legislation that affects qualified retirement plans, plan sponsors and plan participants. It contains extensive new rules governing the implementation of automatic enrollment plans, cash balance and other hybrid plans and combined defined benefit pension/401(k) plans for small employers. The act also includes changes affecting retirement plan contributions and distributions, including liberalization of plan rollover rules and new disclosure and reporting rules for ERISA-covered plans, including fiduciary protection for providing certain investment advisory services to participants.

Profit sharing plan

A defined contribution plan that permits the employer to make discretionary contributions. A participant’s retirement benefits are based on his or her account balance, which consists of profit-sharing contributions, investment earnings and forfeitures. A single plan can contain both a profit sharing and an elective deferral feature.

QACA

Acronym for Qualified Automatic Contribution Arrangement, a type of automatic enrollment resulting from PPA that qualifies for safe harbor and automatically complies with nondiscrimination testing. A QACA arrangement under PPA regulations:

• Does not automatically enroll current employees who:

• Were eligible to participate in the plan before the automatic enrollment arrangement became qualified.

• Had deferral elections (or elections not to defer) in place when the automatic enrollment arrangement became qualified.

• Requires that employees who are eligible to participate in the qualified arrangement receive written notice of their legal rights and obligations within a reasonable time prior to the start of the plan year.

• Provides that employer contributions become 100% vested after an employee has completed no more than two years of service.

• Requires that the plan sponsor make either matching contributions (100% of the first 1% of compensation deferred, plus 50% of the next 5% deferred) or non-elective contributions (at least 3% of compensation to all eligible non highly compensated employees, whether they make deferrals or not).

• Provides for an automatic contribution percentage of at least a minimum specified percentage that ranges from 3% to 6% (depending on how long contributions have been made for the employee), but not more than 10%. This provision offers guidelines for the step-up feature which increases the automatic deferral by 1% per year.

QDIA

Acronym for Qualified Default Investment Alternative. This is the default investment option that is used when a participant does not elect an investment. If the default meets certain criteria, it qualifies as a QDIA.  QDIA qualification provides relief from some fiduciary liability. The DOL has approved these four types of investments as QDIAs:

• A product with a mix of investments that takes into account the individual’s age or retirement date (e.g., a lifecycle or target-retirement-date fund)

• An investment service that allocates contributions among existing plan options to provide an asset mix that takes into account the individual’s age or retirement date (e.g., a professionally managed account)

• A product with a mix of investments that takes into account the characteristics of the group of employees as a whole, rather than each individual (e.g., a balanced fund)

• A capital preservation product for only the first 120 days of participation (e.g., a stable value fund)

QDRO

Acronym for Qualified Domestic Relations Order which is a judgement, decree or order that creates or recognizes an alternate payee’s (such as a child or former spouse) right to receive all or a portion of a participant’s retirement plan benefits.

QMAC

Acronym for Qualified Matching Contribution. Employers can make a QMAC to 401(k) plans to correct failed ACP nondiscrimination tests. Qualified matching contributions must satisfy the vesting and distribution requirements specific to QMAC’s..

QNEC

Acronym for Qualified Non-Elective Contribution. Employers can make a QNEC to 401(k) plans to correct failed ADP/ACP nondiscrimination tests.

Rollover

A qualifying distribution from a tax-favored retirement arrangement – a 401(k) plan, 403(b) arrangement, SEP plan, SIMPLE IRA, 457 plan or IRA – that is transferred to another qualified plan. There are two types of rollovers from a qualified plan: direct and indirect.

• With a direct rollover the distribution is paid directly to the trustee or custodian of the receiving arrangement.

• With an indirect rollover, an individual takes a cash distribution from a qualified plan (less 20% withholding) and contributes it (rolls it over) within 60 days of receiving the distribution.

Safe harbor 401(k) plan

A plan that provides many of the features and flexibility of a traditional 401(k) without the administrative concerns of ADP/ACP nondiscrimination testing. However, employers must either make a specified matching contribution or mate a specified non-elective contribution and meet other requirements to satisfy the safe harbor requirements.

Summary plan description (SPD)

A document containing a comprehensive description of a retirement plan, including the terms and conditions of participation. 

Top-heavy test

A nondiscrimination test that generally requires a qualified retirement plan sponsor to possibly make minimum contributions and to establish an accelerated minimum vesting schedule. A plan is generally top heavy when account balances of key employees are greater than 60% of the total of all account balances.

Vesting schedule

The schedule that determines the portion of a participant’s accrued benefit or account balance to which the participant has a nonforfeitable right after completing a specified number of years of service.