Dollars and Sense

Chapter 7

Employer Sponsored Pension Plans

  There was a time when employee benefits plans were growing at a rapid rate. They were considered a vital part of labor contract negotiations. Today that is less likely to be true as companies try to cut costs, staying competitive, and survive in an economically uncertain world.

  Traditionally there were three primary reasons for using employee benefits plans:

1. To improve industrial relations,

2. To meet union demands, and

3. To allow key employees the ability to provide their own insurance and retirement needs at a reasonable cost.

  Many feel employee benefit plans enable employers to attract better and more qualified employees, reduce costly employee turnover and improve employee morale and, therefore, also improve employee efficiency. 

  Since 1948, when the National Labor Relations Board ruled that insurance and pensions were subject to collective bargaining, these benefits were important union demands. It was due to union demands that so many employers felt forced to initiate pension and medical plans. Today many people take jobs not for the satisfaction the job will provide but rather for the medical coverage provided. If there is a pension paid for as well, that is just a bonus.

  Today’s employers may offer pensions, but they are increasingly funded by the employees with the employer acting more as a manager than a pension contributor. Many employee-funded pension plans do, however, receive matching funds in part or whole from the employer.

Private Pension Plans

  There was a time when Americans expected their employers to fund their pension plans.  As the cost became increasingly expensive, however, employers began moving from an employer-sponsored pension to an employee-sponsored format, meaning that the employees became increasingly responsible for creating their own pension funds (although there were employer incentives, such as matching or partially matching employer funds).

  In 1974, ERISA (Employee Retirement Income Security Act) set standards for private pension funds that included funding, participation, vesting, termination, insurance, disclosure, fiduciary responsibility, and tax treatment. Prior to ERISA, assets to fund private pensions were the largest private fund accumulation not subject to strict federal regulations.

  To provide employees with maximum security, private pension plans require realistic actuarial estimates of future benefit costs and provisions for accumulating funds for the benefits as they are due. Funded pension plans are those for which an excess amount of that needed to pay current benefits to retired employees is accumulated by the employer with a trustee or an insurer. The trustee is usually a bank, though not necessarily. Other institutions may also be used. The funding method used will determine how much is accumulated in excess of the current disbursements. A sound funding method is very important to adequately protect the employee pension expectations (to make sure the employee receives in retirement approximately what he or she expected to receive). The funding provisions of ERISA require full funding of current service costs and amortization over minimum periods for funding accrued under past service liabilities.

  Group retirement plans are more complex than are group life and health plans. There are tax considerations, questions of finance and employee relations involved, as well as other possibilities. ERISA, IRC, and the IRS rulings set forth broad requirements for a qualified pension plan. Basic decisions relating to pension plans must be made as to employee qualifications, conditions under which benefits are payable, benefit levels and types of benefits available. Cost, competitive conditions in the labor market, and the desire for an effective personnel and employee relations policy are important considerations in designing retirement benefit plans.

  For a benefit plan to be qualified, certain requirements must be met:

1. It must be established by the employer.

2. It must be for the exclusive benefit of the employees and their beneficiaries.

3. It must be in existence and in effect.

4. It must be in writing.

5. It must be permanent.

6. It must be communicated to the employees.

7. It must be financed by contributions made by either the employer, the employee, or both.

8. It must be nondiscriminatory with respect to coverage and/or benefits.

9. It must be based on a defined contribution or benefit formula.

10. There must be no possibility of permitting a reversion of contributions to the employer prior to the satisfaction of all liabilities to the employees or any other fund diversion for the benefit of other than employees.

  Under the IRC (Internal Revenue Code) provisions, a qualified plan must be for the benefit of employees in general. They cannot be for specific persons alone. Therefore, the plan must meet one of the following criteria tests:

1. At least 70 percent of all employees must be covered.

2. If only specific classes of employees are covered, such classifications must not discriminate in favor of officers, stockholders, supervisors, or high-salaried employees.

  Plans meeting the percentage test automatically satisfy the coverage requirements of the IRS (Internal Revenue Service). For the classification test, nearly any classification is acceptable if it does not violate the nondiscriminatory requirement. One classification not permitted is that of union employees only or nonunion employees only. That would clearly discriminate against one group or the other.

  ERISA requires that employees who are 25 years old with one year of service be covered. However, three years of service can be required if employer contributions are immediately 100 percent vested. 

  Among the common eligibility standards in pension plans is that employees be actively employed on a full-time basis. ERISA has eliminated many of the former restrictive participation requirements. ERISA has also improved the status of part-time and seasonal employees, as well as re-employed participants. Some plans require no probation period for eligibility. This is especially true for collectively bargained plans.

  Pension plans may specify a “normal” retirement age, at which an employee is eligible for full benefits. A compulsory retirement age may also be stipulated. If one were to follow the example of social security, for instance, age 65 would be the so-called “normal” retirement age, with 68 perhaps being the compulsory retirement age. Workers would, if these happened to be the designated ages, be encouraged to retire at the age of 65, and required to retire no later than the age of 68.

  There are some industries where age 65 is considered inappropriate for the occupation, so the retirement age is lower. If an earlier age (earlier than 65) for retirement is required by the occupation, then there is no loss in benefits, because the designated age is considered to be the “normal” retirement age. However, if the worker wishes to retire prior to the stated normal retirement age, then usually that worker would have to take a reduced retirement benefit amount by retiring earlier than what is considered to be the normal retirement age for his or her particular occupation. Where delayed retirement is permitted, employees may be entitled to an increased pension, but usually no additional pension credits accumulate beyond what is considered to be the normal age of retirement.

  Pension benefits usually are of the conventional type providing fixed dollar payments as scheduled, but there can be other types, as well. Some plans take advantage of the variable annuity principle, under which each periodic payment is a function of the investment performance of the pension fund.

  Under the flat amount formula all participants are given the same benefit regardless of their earnings, age, or years of service with the company. This type of pension plan is often used in negotiated plans, such as union contracts.

  The flat percentage formula relates benefits to earnings, but not to the years of service with the company. Under the flat percentage formula, a pension equal to a percentage of an employee's average annual wage is paid to all employees completing a minimum number of years of credited service to the employer. This formula gives no added benefit for time worked beyond the number of years required. Those employees who fail to meet the minimum requirement for time employed are given a proportionately reduced pension amount. The actual percentage will vary from plan to plan.

  The flat amount unit benefit formula relates pension benefits to years of service (number of years worked for the employer or industry), but not to the actual earnings. Generally, the employee is given one unit of benefit per month for each year of credited service. The flat amount unit benefit formula is often used in negotiated plans.

  Under the percentage unit benefit plan, the employee is given a percentage of earnings for each year of service.

  What happens when a pension plan is brought into a company where employees have already accumulated several years of work history with the company? This will, of course, vary but generally those employees are given credit for their previous years with the company, but typically at a reduced rate. Those years with the company from that point on will naturally be given full credit with the pension plan. This differential is justified. The cost is greater because interest plays a significant role in pension financing. There were no pension dollars earning interest prior to the pension plan's birth. Also, benefits earned prior to the plan's inception will be fully funded by the employer, since there was no employee contribution on previous years’ service. Due to these reasons, some plans will not recognize prior service to the company at all.

  One very important aspect of ERISA is the plan termination insurance (called PTI). PTI guarantees the pension up to a specified amount despite inadequate funding. The Pension Benefit Guaranty Corporation (called PBGC), operating within the U.S. Labor Department, administers PTI, collects the premiums from employers, and guarantees payment of covered non-forfeitable benefits. All benefits under a plan, or plan amendment, in effect for five years at termination are covered. If the plan has fewer than five years of operation, the benefits are covered on a percentage basis. 

  ERISA requires that a plan designate a fiduciary to administer its operation. A person exercising discretionary authority or management control over the plan and/or the plan's assets, are fiduciaries, regardless of their formal titles. Fiduciaries are responsible for compliance with the laws and must use the "care, skill, prudence and diligence of a prudent person acting in a like capacity for the purpose of providing benefits to participants and beneficiaries and defraying reasonable plan administrative expenses." The U.S. Department of Labor has charge of interpreting regulations and fiduciaries are held personally liable in the event that these regulations are violated. It is wise for a fiduciary to carry fiduciary liability insurance, as a result.

Plan administrators must file annual reports with the Department of Labor and also with the plans participants if the plan is terminated. There must also be an annual report filed with the Internal Revenue Service (IRS). Also, the plan administrators must furnish participants with a plan description so that they are aware of the benefits when the participants first join the pension plan, and then at least every five years thereafter.  Plan amendments, annual financial reports, any plans for termination, a statement of active participants' rights and inspections of the complete annual report must also be available upon request by participants.

Changing Plan Designs

  Companies often find themselves in a situation of rising costs under an existing plan. What insurance agent has not had the experience of having a client request something less expensive? Therefore, the business may feel it necessary to initiate changes in their current health plan. This will normally begin with a company committee who will be responsible for making decisions regarding changes. It is almost certain to be a time-consuming process.

  Normally, an analysis of the previous three years will be the first step necessary.  The three-year report should contain a breakdown of the costs relating to claims that have been paid, as well as a basic report of the needs and desires of the employees.  It should contain such things as statistical data on the types of services most frequently used by the employees (such as chiropractors, radiology, or whatever seems to be routinely used), the medical claims paid, the percentage of increase in claim amounts over previous years, how this percentage matches trend, non-institutional services (outpatient services), institutional services (hospitals, etc.), and totals for all types of costs by year.

  After studying the available data, it may be deemed necessary to cut back benefits.  Obviously, employees do not like to see their benefits (of any type) reduced. Therefore, it is very necessary that the employees understand what the problems are and where they originated.  The employees must be made aware of the changes that must be made as a result. Often employees will be supportive if the proposed cost shifting prevents an increase in their premium payments. If the employees are able to understand the complexity of medical benefit costs and how abuse of the system often leads to the loss of certain benefits, future problems may be avoided. It needs to be understood that the dollars going into medical benefits cannot be used for wage increases and/or other benefits.

  During the redesign process, it is normal for outside consultants and insurance agents to be sought out.  Generally, the opinions of several different agents will be weighed by the committee, so it is the agent who can best present his or her ideas that may well end up with the business. As is so often the case, verbal skills can be very important in several areas such as explaining the insurance plan well enough to be a part of the final decision.

  The data will need to be weighed and alternative suggestions brought out to the committee for review.

  Most committees end up suggesting stronger case management on the part of whichever carrier is selected, whether that is their current carrier or a new one.  Many insurance companies do not want to be involved in reviewing the necessity of claims and, as a result, possibly being put in the position of having to deny claims.  It is often felt that this will generate ill will between the carrier and the policyholder (which might result in lost business).  However, this attitude is changing as employers begin to want this type of cost management.

  Often, businesses re-bid their programs every three to four years as a routine procedure.  This is to ensure that they are getting a good value for their premium dollar. While getting bids can assist an employer in finding out whether the company is, indeed, getting a good value, the process can also be expensive. Often, consultants will advise employers to re-bid their current health plans. Of course, it is possible such consultants might be in a position to gain financially from the process. Therefore, the employer also needs to use his or her own good judgment. If the employer does feel that re-bidding is advisable, then funds must be set aside for the costs that will be incurred. A company with around 3,200 employees should plan on spending between $4,000 and $7,000 to cover the costs associated with preparing the request for proposals and analysis of bids if an outside constant is used. The larger the company and/or the more complex the plan and its options, the higher the cost will be to re-bid the plan. Smaller companies that cannot get experience-rated plans will not have to budget any funds, because the cost is figured into the commissions that the independent agents earn.

  There are alternatives to re-bidding health care plans. For example, comparable organizations and plans within the same area could simply be reviewed by a consultant.  That would be far less expensive than actually re-bidding the current plan.

  How would a company know whether they should seek re-bidding? There are no absolute answers, but there are some guidelines that can be followed. An individual may wish to re-bid when:

1. An extremely high loss ratio is being experienced on claims (90 percent or more of the total premium paid on an annualized basis).

2. The premiums are rising more than the national trend. A national trend is something that appears to be happening across a country and can be said to be representative of the population as a whole.

3. A move from a fully self-insured plan with internal administration to a self-insured plan with a Third-Party Administrator (TPA) is being considered.

4. A move is being considered from a fully insured plan to a partially self-insured plan.

5. State and/or federal regulations have mandated plan design changes, which are not included in the current health plan.

6. Employees and management personnel are unhappy with the present carrier, for whatever valid reason.

  If any of these conditions exist, it is possible that a change needs to be made. However, major changes need to be made using much thought and common sense. Generally, it is recommended that either the plan design or the carrier be changed, but usually not both items at the same time.

  If it looks like both the plan design and the carrier are in need of change at the same time, it must be realized that the employees may be adversely affected (either in actuality or in the way the plan is perceived by the employees). Therefore, great care must be taken to educate the employees as to what changes are taking place and why.  Even so, during the first six months, a company may expect to spend a great deal of time with their employees to clarify misconceptions and to put concerns at rest.

  Before changing a current carrier, a business should first provide a list of the plan design changes being considered to its current carrier.  If the current carrier is able to handle the changes, at a cost that is competitive, it is often easiest to continue working with the same carrier.  Because plan design changes are based on utilization review data and are aimed at correcting existing problems of either misuse or perhaps overuse, the current carrier should be willing to work with the employer (the business). If, however, the current carrier seems reluctant, unwilling, or unable to work with the employer, then there is probably no point in wasting time with that carrier. The employer may as well just put the medical plan up for bidding.

  When designing group medical coverage, there are several factors that must be considered. First the goals of the plan must be established. As with anything, it is impossible to have effective planning if no clear goal is established.

  Also, decisions must be made regarding such things as deductibles and co-payments that employees must make. Other provisions, such as stop-loss amounts and additional benefits, must also be discussed and set down on paper. All of this allows potential providers of medical benefits to have a clear idea of what they are bidding on.

  Sometimes a flexible spending account (called FSA) is established that allows individual staff members to pay pretax dollars for otherwise uncovered medical, dental, vision, or childcare benefits. FSA may also be used for additional medical or life insurance premiums.

  Some carriers do use cost-management practices and these companies generally do a better job as far as premium costs are concerned.  The types of procedures used will vary from company to company.  They may include, but are not limited to:

1. Audits of hospital and doctor bills;

2. Concurrent review and discharge planning;

3. Home health care benefits to reduce the length of hospital stays;

4. Hospice benefits to reduce the length of hospital stays for the terminally ill;

5. Hospital length-of-stay assignments (similar to Medicare's system);

6. Incentives for outpatient surgery rather than inpatient surgery;

7. Incentives for outpatient diagnostic and pre-admission tests;

8. Individual case management;

9. Weekend admission limitations.  This limits such things as being admitted on a Sunday afternoon for a Monday surgery, which is often unnecessary, since a Monday morning admission would work just as well.

10. Long-term custodial care;

11. Pre-certification and pre-admission review programs;

12. Required second opinions prior to surgery. Many feel this is more than simply cost containment; it is good sense as well.

13. Wellness benefits.

 These thirteen items have sub-categories which may include such things as well-baby care for prevention of future medical problems (costs), preferred pharmacy options with participating pharmacies and on-site case management of all hospital admissions. As medical costs soar, cost management procedures will become increasingly important to employers who want to keep premium costs under control.  Sometimes, however, a side effect turns up.  That side effect is the cost incurred in managing the medical program.  A company can spend as much on the management as was saved on the medical costs.

Flexible Spending Accounts

Flexible spending accounts, called FSA, have often been used, since the accounts offer tax savings for both employees and employers.  FSAs are accounts which employees make deposits into. Their deposits pay for such benefits as childcare, extended medical coverage, life insurance, and other special benefits. These plans must have administrators who handle the funds.

  As of 01/01/90, employers must carry some of the risks associated with Flexible Spending Accounts. Health care expenses under FSAs' must be treated like life insurance.  In other words, if the employee has only accrued $500 in their account and then has claims amounting to $2,500, the complete $2,500 must be reimbursed, even though that employee does not have that much money in their FSA account. As a result of this requirement, many employers stopped offering FSAs.

  Some of the FSAs use the employee's pretax dollar contributions, while others are funded by the employer to some degree. If the employer funds the account, it is usually in the form of a "credit" for having taken a less expensive medical plan, which the company would have paid for. In some instances, it may also be due to taking either a reduced life insurance benefit or eliminating the life insurance benefit altogether. The savings to the employer is then "credited" to the Flexible Spending Account for the employee to use as he or she chooses, as long as it is within the IRS guidelines for such accounts.

  As of 1984, the IRS stipulated that such money can be spent in only three areas:

1. For medical expenses that are not covered by the company's medical plan. This might include such things as plan deductibles or dental care.

2. For the care of a dependent person, whether that be a spouse, child, parent, or sibling.

3. For a group legal plan.

  In a way, there was previously a fourth option. If the money were not spent on any of the three listed items, the employee could withdraw the money (take the cash). That is no longer allowable.

  It is easy to see why flexible spending accounts caught on so well. As we stated, however, employers are becoming more reluctant to use them. Employers now have a financial stake in these accounts that they did not previously have.

  There was one other point that was too good to last.  In the beginning, the employees did not have to decide in advance what benefits they wanted funded by the FSA. Now, the Internal Revenue Service has mandated that employees must decide at the beginning of each year exactly where their account is to be spent. If the employee guesses wrong regarding which benefits he or she will need, it does not matter. The theme has now become one of "use it or lose it."  That is because it is no longer possible, as we stated, to cash out the plan at the end of the year. In fact, any unused cash cannot even be left in the account for use in the following year. Between this change and the possibility of financial cost to the employer (for medical benefits), there is certainly the chance that the flexible spending accounts may be used much less as an employee benefit.

Benefit Plans for Retirement

Defined Benefit Plans

  Today’s employees feel very lucky if they have an employer-sponsored retirement plan.  One type of employer-sponsored plan is called a defined benefit plan. Although it is much less likely to be offered by today’s businesses, they were the cornerstone of the retiree income system in the past. These plans began in the forties and fifties, but on a very small level. However, they rapidly expanded and evolved into some of the most efficient pensions employees had the pleasure of participating in. They were “defined” benefit plans because the monthly income employees received in retirement were “defined;” the employee knew exactly what he or she would receive each month. Many also had cost-of-living raises built into them.

  Life insurance companies were often used to design and manage the programs. These programs included such incentives as salary continuation after retirement, medical benefits after retirement, and deferred compensation. As time went by, many companies began creating and administering the programs themselves as a way of containing costs.

  Retirement benefit plans for the general workers became increasingly expensive. Critics have argued that the defined benefit plans:

1. Became too costly to administer.

2. Had unpredictable funding.

3. Did not provide adequately for workers who were constantly changing jobs.

4. Did not allow employees to manage their own retirement funds.

  Whatever problems existed in defined benefit plans, their strength was their flexibility of design and the security they provided for workers who often did no personal planning for themselves.  These retirement plans benefited thousands of retired people who would otherwise have experienced poverty in their last years.

  The strength of the plans may not have been fully recognized by those that received them.  There was the assumption that companies would continue to offer defined benefit plans, making personal retirement savings unnecessary. At specified ages, a specific benefit was available.  For example, a worker could elect to retire at the age of 62 rather than the normal retirement age of 65.  In many plans, there was no reduced benefit due to early retirement if other criteria were met.  Some plans simply stated that benefits would not be reduced after 30 years of service, regardless of retirement age.  Some employers wishing to reduce the work-force offered full retirement benefits at an earlier age.

Defined Contribution Plans

  As defined benefit plans became increasingly expensive, many companies changed to defined contribution plans.  Defined contribution plans allow employees to manage their own money and forces employee participation.  Few people plan effectively for their own retirement; it just seems easier to let the employer plan and implement it for them.  The emergence of defined contribution plans required workers to plan for themselves.

  Defined contribution plans were initially used by executive benefit programs to attract and keep the professionals needed by any given company.  Many corporations now use life insurance contracts in some form to fund their executive benefit programs because of the safe and dependable rate of return.  In addition, any death proceeds the corporation may receive as the listed beneficiary are free from federal income tax.  In the fifties and sixties, corporate clients were basically sold in the same way individual clients were.  Consequently, these types of sales were slow to catch on.

401(k) Plans

  The 401(k) Plan has become a major source of retirement income.  These plans became a popular vehicle purely by accident; no particular entity or political force championed them, not even employees themselves.  Section 401(k) of the Internal Revenue Code was added to resolve a conflict between Congress and the Treasury Department over tax-deferred profit-sharing plans adopted by many banks to replace cash bonus plans.  It was this fluke that created one of the most widely used and appreciated retirement savings plan: the 401(k).

  At the time, higher-paid employees deferred as much of their earnings as possible to their retirement plans to avoid the up to 50% tax levied on their earnings.  Lower-paid employees generally took any elective amount as cash to supplement their lower incomes.

  As employees became aware of the possibilities of the 401(k) plans their popularity grew, especially among higher paid employees and those who took their retirement seriously.  Government eventually sought to restrict the growth of the plans, even though contributions were elective, since the effect was a tax advantage for higher-paid employees. Eventually Congress included a provision in ERISA that froze their tax status through 1976. When Congress passed the Revenue Act of 1978, Section 401(k) remained virtually unnoticed and passed into the Internal Revenue Code.  It provided a new avenue for saving on a tax-deferred basis, certainly an advantage for those saving for a number of years as is typically the case for retirement.

  Section 401(k) actually added just one paragraph to the Internal Revenue Code (probably why it received so little notice from lawmakers) requiring cash-deferred vehicles to meet a special non-discrimination test.  Employee benefit specialists knew Section 401(k) made it possible for them to establish new cash-deferred profit sharing plans for their employees, especially higher paid employees who previously received company bonuses. 

  The non-discrimination test meant that lower paid employees must use 401(k) plans as well as higher-paid employees.  That meant companies needed to find a way to encourage lower paid employees to participate. Therefore, employers offered a matching or partially matching contribution for every dollar the employee saved (for example, if Emily Employee contributed $10, her company might contribute $5 to her retirement account or half of her contribution).  Generally, companies designated a maximum per year per employee they would contribute to prevent having to commit more money than they wished to. For example, if Emily Employee works for a company that matches her contributions dollar-for-dollar it is likely that her employer will specify an upper maximum, such as $5,000 (the employer will contribute no more than this maximum amount per year).  The dollar amount contributed by the employer translated into “free” money in the employee’s retirement fund, as long as employee’s met their own contribution plan requirements.  Generally employee contributions were made through automatic salary reductions so that employees did not see, so did not miss, the contributed dollars.

  Ironically, the inventors of the 401(k) plans (R. Theodore Benna and his company) initially offered the idea to two of the largest insurers at that time; both turned him down.  Eventually, they marketed the idea themselves, using their own company.  On January 1, 1981 Johnson Companies converted their after-tax savings plan to the first 401(k) savings plan in the United States.[1] Eventually the Treasury Department issued regulations supporting the 401(k) concept, but initially most companies were skeptical that use of such plans were legal and were concerned that they might attract unwanted IRS attention.

  Many politicians wanted to eliminate 401(k) plans entirely due to massive loss of tax revenues.  The government eventually modified the Tax Reform Act of 1986 (TRA), reducing the maximum amount employees could contribute each year from $30,000 to $7,000 and imposing more restrictive and complex non-discrimination tests.

  No plan is perfect and it is possible to make investing mistakes using 401(k) Plans as well as any other type of financial vehicle. However, anyone who is saving money versus spending it is doing something right. Certainly no worker would object to their company contributing retirement funds on their behalf.

  Many 401(k) plans allow plan participants to invest in risky vehicles so investors should not automatically assume that all available options are safe ones.  Each investor has what is referred to as “risk tolerance.”  While professionals generally believe younger investors can absorb loss (so investing in riskier investments may be advised) if the investor is not risk tolerant even younger investors may then need to avoid some types of investments that would cause them mental anguish. 

  Older investors must look at how much time they have to make up potential losses.  It would be foolish, for example, for someone nearing retirement to invest in volatile securities, and then sell in a panic if values fell dramatically.  A novice investor will not have the same knowledge as a seasoned investor; an older investor will not have the same risk tolerance as a younger worker, and so forth.  Each investor must choose according to his or her own personal circumstances and risk tolerance.

  Perhaps the biggest mistake people make is failing to take full advantage of their employer’s 401(k) plan, especially when the employer matches funds to some degree.  Not utilizing the availability of a 401(k) plan is the same as passing by free money.  How is it free money?  In two ways: first the 401(k) funds grow tax-deferred, allowing interest to earn additional interest; secondly, if the employer even partially matches the employee contributions it is money the investor would not have otherwise had.  Typically, the only criterion is that employees must deposit a portion of their own earnings (often stated as a percentage, such as 3 to 5% of gross earnings).  According to Keys to Investing in Your 401(k) Plan by Warren Boroson, about 30 percent of those who are eligible to participate in 401(k) plans fail to do so.

  Wealthier individuals are more likely to participate in 401(k) plans and this is not surprising.  Lower paid employees often have trouble making it from check to check and they are less likely to save for retirement as a result (although they still should).  In fact, many economists have noted that it is the lower-earning employees that would benefit the most from participating in their company’s 401(k) plans since the matching employer funds often amount to an immediate 50 percent return on their savings.  Since lower-paid employees are less likely to be able to save sufficiently for retirement, such returns are especially needed to provide security later on in life.

  By now it is well known that Americans save too little for their retirement; we are a nation of spenders.  The frugal era of our grandparents is gone.  Those now entering retirement generally do so with a mortgage, credit card debt, and little intention of cutting back on their spending.  As a result, they often go through their retirement savings in the first ten years of retirement, leaving them in poverty for their remaining years.  Women fare the worse since they tend to outlive their older male partners.  Once the male partner dies any income that was exclusively his goes with him; the remaining female faces a double whammy: too little saved and diminished income.

  Besides saving too little, many people also fail to properly diversify.  While the employer’s stock may seem impressive, it would be a mistake to only save through that avenue, for example.  A 401(k) plan should always be maxed out if there are matching funds available before using other financial vehicles, but other financial vehicles should be used at some point in addition to the 401(k) plan.  Retirement planning should start early enough to be a long-term investing project.  That allows employees time to weather bear markets (when prices go down) as well as enjoy bull markets (when prices go up).  If a lump sum distribution is received from a pension plan due to retirement or a job loss, the entire sum should be rolled immediately into another retirement plan or long-term investment, such as an annuity.  The employee should never, ever spend it in part or whole because his or her retirement years will require the entire amount to survive comfortably.  Unfortunately, the statistics tell us that less than 15 percent of those who receive lump sum distributions roll the entire amount into another financial vehicle.  Most either spend part of it before re-investing the remainder or they spend all of it, reinvesting nothing for their retirement.

  Although the 401(k) plan seems to have originated more by accident than design, the IRS is very aware of their existence.  On the subject of 401(k) plans, the IRS States:

“Topic 424 - 401(k) Plans

  A section 401(k) plan is a type of tax-qualified deferred compensation plan in which an employee can elect to have the employer contribute a portion of his or her cash wages to the plan on a pretax basis. These deferred wages (commonly referred to as elective deferrals) are not subject to income tax withholding at the time of deferral, and they are not reflected on the employee’s Form 1040 since they were not included in the taxable wages on the employee’s Form W-2.  However, the funds are included as wages subject to social security, Medicare, and federal unemployment taxes.

  The amount that an employee may elect to defer to a 401(k) plan is limited. Therefore, your elective contributions may be limited based on the terms of your 401(k) plan. Refer to Publication 525, Taxable and Nontaxable Income, for more information about elective deferrals. Employers should refer to Publication 560, Retirement Plans for Small Business, for information about setting up and maintaining retirement plans for employees, including 401(k) plans.

  Distributions from a 401(k) plan may qualify for optional lump–sum distribution treatment or rollover treatment as long as they meet the respective requirements. For more information, refer to Topic 412 (see below), Lump-Sum Distributions, and Topic 413 (see below), Rollovers from Retirement Plans.

  Many 401(k) plans allow employees to make a hardship withdrawal because of immediate and heavy financial needs. Generally, hardship distributions from a 401(k) plan are limited to the amount of the employees' elective deferrals only, and do not include any income earned on the deferred amounts. Hardship distributions are not treated as eligible rollover distributions.

  Distributions received before age 59 1/2 are subject to an early distribution penalty of 10% additional tax unless an exception applies. For more information about the treatment of retirement plan distributions, refer to Publication 575, Pension and Annuity Income.

Topic 412 - Lump–Sum Distributions

  If you receive a lump–sum distribution from a qualified retirement plan or a qualified retirement annuity and the plan participant was born before January 2, 1936, you may be able to elect optional methods of figuring the tax on the distribution. These optional methods can be elected only once after 1986 for any eligible plan participant.

  A lump–sum distribution is the distribution or payment, within a single tax year, of a plan participant's entire balance from all of the employer's qualified pension, profit-sharing, or stock bonus plans. All participant's accounts under the employer's qualified pension, profit-sharing, or stock bonus plans must be distributed in order to be a lump-sum distribution.

  If the lump-sum distribution qualifies, you can elect to treat the portion of the payment attributable to your active participation in the plan using one of five options. (1) Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and the part from participation after 1973 as ordinary income. (2) Report the part of the distribution from participation before 1974 as a capital gain (if you qualify) and use the 10-year tax option to figure the tax on the part from participation after 1973 (if you qualify). (3) Use the 10-year tax option to figure the tax on the total taxable amount (if you qualify). (4) Roll over all or part of the distribution. No tax is currently due on the part rolled over. Report any part not rolled over as ordinary income. (5) Report the entire taxable part as ordinary income.

  You should receive a Form 1099-R from the payer of the lump-sum distribution showing your taxable distribution and the amount eligible for capital gain treatment. If you do not receive Form 1099–R by January 31st you should contact the payer of your lump–sum distribution.

  You may defer tax on all or part of a lump–sum distribution by requesting that your employer directly roll over the taxable portion into an Individual Retirement Arrangement (IRA) or to an eligible retirement plan. You can also defer tax on a distribution paid to you by rolling over the taxable amount to an IRA within 60 days after receipt of the distribution. A rollover, however, eliminates the possibility of any future special tax treatment of the distribution. Refer to Topic 413 for more information on rollovers. Mandatory income tax withholding of 20% applies to most taxable distributions paid directly to you in a lump-sum from employer retirement plans regardless of whether you plan to roll over the taxable amount within 60 days.

  For more information on the rules for lump–sum distributions, including information on distributions that do not qualify for the 20% capital gain election or the 10-year tax option, refer to Publication 575, Pension and Annuity Income, and to Form 4972, Instructions, Tax on Lump–Sum Distributions.  Information is also available in Publication 17, Your Federal Income Tax.

Topic 413 - Rollovers from Retirement Plans

A rollover occurs when you withdraw cash or other assets from one eligible retirement plan and contribute all or part of it within 60 days to another eligible retirement plan. This transaction is not taxable but it is reportable on your Federal Tax Return. You can roll over most distributions except for:

1. The nontaxable part of a distribution, such as your after-tax contributions to a retirement plan (in certain situations after-tax contributions can be rolled over),

2. A distribution that is one of a series of payments based on your life expectancy or the joint life expectancy of you and your beneficiary or paid over a period of ten years or more,

3. A required minimum distribution,

4. A hardship distribution,

5. Dividends on employer securities, or

6. The cost of life insurance coverage.

  Further exclusions exist for certain loans and corrective distributions.

  Any taxable amount that is not rolled over must be included as income in the year of the distribution.

  If a distribution is paid to you, you have 60 days from the date you receive it to roll it over. Any taxable distribution paid to you is subject to a mandatory withholding of 20%, even if you intend to roll it over later. If you do roll it over, and want to defer tax on the entire taxable portion, you will have to add funds from other sources equal to the amount withheld. You can choose to have your employer transfer a distribution directly to another eligible plan or to an IRA. Under this option, the 20% mandatory withholding does not apply.

  If you are under age 59½ at the time of the distribution, any taxable portion not rolled over may be subject to a 10% additional tax on early distributions. Certain distributions from a SIMPLE IRA will be subject to a 25% additional tax. For more information on SIMPLE IRAs, refer to Publication 590, Individual Retirement Accounts.”

Funding

  As we know, a 401(k) plan is a retirement savings vehicle that is funded by employee contributions and may receive matching or partially matching contributions from the employer. The major attraction of these plans is that the contributions are taken from pre-tax salary, and the funds grow tax-free until withdrawn. To some extent the 401(k) plans are self-directed and portable. Both for-profit and many types of tax-exempt organizations can establish these plans for their employees.

  It is the tax code that created 401(k) plans and it is the tax code that determines the rules and regulations for them.  Its name is derived from the section of the Internal Revenue Code of 1978 that created them. Although the IRS determines the rules and regulations governing 401(k) plans, the operation of them are regulated by the Employee Benefits Security Administration of the U.S. Department of Labor.  The 401(k) plan is actually a plan qualified under Section 401(a) of the Internal Revenue Code.  Section 401(a) is the section that defines qualified plan trusts in general, including the various rules required for qualifications.  Section 401(k) provides for an optional "cash or deferred" method of getting contributions from employees; therefore, every 401(k) plan already is a 401(a) plan.

  Although the average person might assume that matching employer 401(k) contributions will be in the form of cash that is not always the case.  Some company plans pay in company stock rather than cash.  This is not necessarily a bad thing since the stock has the potential of growing greater than might be the case with interest earnings, but as is always the case with stocks, they could also lose value.

  Although companies initially were wary of 401(k) plans when they were first created (companies were concerned with their tax treatment and there was initially no track record to consult) as these issues became clearer, people quickly recognized the advantages of the tax-deferred vehicle.  A primary advantage was the employees’ ability to contribute to his or her 401(k) plan with pre-tax money, which reduced taxes paid out of each paycheck. Additionally, the accumulating funds grow tax-free until withdrawn.  The compounding effect of consistent periodic contributions over 20 or 30 years without taxation allows for maximum growth.  The investor can decide where to direct future contributions and/or current savings, giving much control over the investments to the employee; some argue that this lends to investing errors, but many workers are savvy investors and do an adequate job.  Also many companies have an individual available to lend investing advice and product information. 

  If the company matches the investor’s contributions, as we have previously stated, it amounts to getting free money on top of the worker’s salary.  This alone makes it worthwhile to invest in the company’s 401(k) plan, with the goal of contributing the maximum amount allowed. Unlike traditional pension plans, all 401(k) plan contributions may be moved from one company's plan to another (or to an IRA) if an investor loses his job or changes jobs. Since the plan is a personal investment program designed for retirement, it is protected by pension (ERISA) laws. This includes the additional protection provided to pensions from garnishment or attachment by creditors or assigned to anyone else, except in the case of domestic relations court cases dealing with divorce decree or child support orders (QDROs; i.e., qualified domestic relations orders). 

  Although the 401(k) plan is similar in nature to an IRA, the Individual Retirement Account will not receive matching company contributions, and personal IRA contributions are subject to much lower limits. The IRA limits have been raised from the original amount allowed, but the 401(k) is still likely to have higher limits.

  As with all financial vehicles, there are some disadvantages with 401(k) plans:

First, it is difficult and potentially expensive to access the 401(k) funds prior to age 59½.  This is not surprising since the goal is retirement funding; if it were easy to withdraw funds investors would likely do so, defeating the very purpose of the account. 

Second, 401(k) plans don't have the luxury of being insured by the Pension Benefit Guaranty Corporation (PBGC).  It should be noted, however, that not all pension plans are protected by the PBGC either. 

Third, employer matching contributions are usually not immediately vested. 

  Why are the employer’s contributions not immediately vested?  The money the company contributes does not belong to that employee until a specified number of years have passed.  The rules say that employer matching contributions must vest according to one of two schedules: either a three-year "cliff" plan (100 percent after three years) or a six-year "graded" plan (twenty percent per year in years two through six). Despite these disadvantages, however, 401(k) plans have generally performed well for investors.

  Investors usually get to choose how their 401(k) money is invested, within the options offered by their employer. Typically the options offered are a menu of mutual funds, such as money market funds, bond funds of varying maturities (short, intermediate, long-term), and various stock funds.  Some plans may allow investments in company stock, US Series EE Savings Bonds, or other types of financial vehicles.  The employee chooses how to invest the savings and is typically allowed to change where current savings are invested and/or where future contributions will go a specific number of times a year, such as monthly or quarterly.  Generally, the employee may stop contributions at any time.

  With respect to participant's choice of investments, professionals often say the average 401(k) participant is not aggressive enough with their investment options.  Historically, stocks have outperformed all other forms of investment and will probably continue to do so.  Since the investment period of 401(k) plans is relatively long (if the worker began as soon as the 401(k) plan was available) the length of the investment time (twenty to forty years) would minimize the risks associated with the stock market and allow a "buy and hold" strategy to pay off.  As the investor nears retirement, he or she might want to switch to more conservative funds to preserve the plan’s value.

  Puzzling out the rules and regulations for 401(k) plans is difficult simply because every company's plan is different. The law requires lower paid employees to participate in sufficient numbers when compared to higher paid employees.  If lower paid employees do not contribute enough by the end of the plan year, then the limit is changed for highly compensated employees.  The employer sets a maximum percentage of gross salary in order to prevent highly compensated employees from reaching the limits.  The employer chooses how much to match, how much employees may contribute, and so forth.  Obviously the IRS has the final say, so there are certain regulations that apply to all 401(k) plans equally.

401(k) Plan Contributions

  Employees have the option of making all or part of their 401(k) plan contributions from gross income (prior to taxation).  This has the added benefit of reducing the amount of tax paid by the employee from each check now and deferring it until the person takes the pre-tax money out of their plan.  Employer contributions (if applicable) and accumulated interest earnings continue to compound tax-deferred, meaning no taxes will be due until the funds are withdrawn. According to the Department of Labor regulations, these contributions must be deposited rapidly, within a few business days after the end of the month in which they were made.  This protects the investors, preventing companies from delaying deposits in order to gain interest earnings for the company, for example.

  The rules govern what happens regarding before-tax and after-tax contributions. The IRS limits pre-tax deductions to a fixed dollar figure that changes annually.  This means a 401(k) investor can only reduce his or her gross pay up to a specified fixed dollar maximum via contributions to his or her 401(k) plan. An employer's plan may place restrictions on the employees that are stricter than the IRS limit.

After-tax contributions are different than pre-tax contributions.  If an employee elects to make after-tax contributions, the money comes out of net pay, meaning after taxes have been deducted. While it does not help the employee's current tax situation, funds that were contributed on an after-tax basis may be easier to withdraw since they are not subject to the strict IRS rules that apply to pre-tax contributions. When distributions begin the employee pays no tax on the portion of the distribution attributed to after-tax contributions but does have to pay tax on any gains realized.

  The IRS limits the amount of pay that may be contributed to a 401(k) plan.  These limits change from year to year so we will not list them in this course.  Individuals should consult a financial planner or tax specialist for exact details. It is always important to know the current 401(k) plan contribution limits to prevent excessive contributions.  This figure indicates only the maximum amount that the employee can contribute from his or her pre-tax earnings to all of his or her 401(k) accounts combined.  It does not include any matching funds that the employer might contribute. The maximum figure is not reduced by monies contributed towards many other plans, such as an IRA. If the individual works for two or more employers during the year, it is his or her responsibility to make sure contributions do not exceed the maximum amount allowed.  If the employee inadvertently contributes more than the pre-tax limit into his or her 401(k) account, the employee must contact the employer. The excess might be refunded or might be reclassified as an after-tax contribution.

  The maximum before-tax contribution limit is subject to the catch-up provision, which is available to employees who are over 50 years old. This provision allows older employees to contribute extra amounts over and above the limit currently in effect for that year.  The amount of “catch up” contribution changes, so once again, it is necessary to consult with a professional for the current amounts allowed.  Older Americans should pay the maximum contribution allowed by law if at all possible.

  Highly compensated employees also face 401(k) contribution regulations.  Initially the government was concerned that executives would make their company’s 401(k) plans advantageous to themselves without allowing lower paid employees to receive the same benefits. The definition of “highly compensated” is determined by Internal Revenue Code (IRC), which specifies specific dollar amount compensation requirements, preventing companies from including those with lower pay within the definition.

  Lawmakers decided executives needed an incentive to make 401(k) plans something lower compensated employees would want to participate in. Highly compensated employees are not allowed to save at the maximum rates. The company will still determine who is classified as “highly compensated” (within IRS guidelines) so there will be variations from company to company.

  IRS regulations include what is referred to as "415 limits." Contributions can only be made on wages up to specified amounts, which change annually.  The IRS further limits the total amount for defined contribution plans, such as 401(k) plans, 401(a) plans, and pension plans each year to the lesser of 100 percent of annual compensation, or a predetermined dollar amount. The specified dollar amount changes periodically so it is necessary to consult a specialist for the current figure. Annual compensation is defined as gross compensation for the purpose of computing the limitation.  This is a change from an earlier law; a person's annual compensation for the purpose of this computation is no longer reduced by 401(k) contributions and salary redirected to cafeteria benefit plans.

  Unlike IRA or other retirement-saving accounts, 401(k) plans allow limited, penalty-free access to savings prior to age 59½. In effect, the investor is taking a loan from him or herself since it is legal to take a loan from his or her 401(k) plan prior to age 59½. The tax code is not specific as to what loans are permitted, just that loans must be made reasonably available to all participants. However, the employer can restrict loans to specific needs, such as covering un-reimbursed medical expenses, buying a home, or paying for education. Once the loan is obtained the individual must repay the loan through regular payments, which can be set up as payroll deductions. The investor, as with any loan, must repay both principal and interest but in this case he or she is repaying the loan to him or herself.  If the investor withdraws money that is not a loan from their 401(k) plan (they do not intend to repay it, in other words), not only must he or she pay tax on any pre-tax contributions and the growth, he or she must also pay an additional 10 percent penalty to the government. There are special conditions that permit withdrawals at various ages without penalty; an expert should be consulted for exact details.

  There are varying opinions as to whether or not an investor should use their 401(k) plan monies for any purpose other than retirement.  Does it make sense for an investor to ever take a loan from his or her 401(k) plan? As with most things, there are both advantages and disadvantages to doing so.  The individual investor will need to assess their personal situation and hopefully make an informed decision. Certainly it is convenient to withdraw from one’s 401(k) plan since there is no credit check or approval process, but that should never be the primary reason funds are withdrawn from the plan. The interest rate is usually just a few points over the prime rate, although the investor is repaying the rate of interest to him or herself anyway.

  Disadvantages include the loss of interest earnings on any money withdrawn from the 401(k) plan and there may also be fees involved. Additionally, the loan must be repaid immediately if the investor changes jobs. A loan default (failing to repay the loan) is treated as an early withdrawal with all applicable taxes and penalties due. Since few people have absolute job security, there are considerable risks involved with loans taken against 401(k) plans.

  Once vesting in the 401(k) plan has occurred, investors can begin to withdraw their savings without withdrawal penalties at various ages, depending on the plan and personal circumstances.  An investor who leaves his or her job at age 55 or more during the year of separation may withdraw any amount from his or her 401(k) plan without any calculated minimums and without any 5-year rules. Depending on the plan, a participant may be able to withdraw funds without penalty at or after age 59½, regardless of whether he or she is still employed. It is important to check with the plan administrator to be certain of such rules or requirements. The minimum withdrawal rules for participants who are no longer employed begin at age 73 (previously 70½ and with The SECURE Act of 2019 it was changed to 72 and will again change in 2033 to age 75). If the investor is age 55 or more, being able to draw any amount of money and for any length of time without penalty after leaving the job is one of the least understood differences between 401(k) plans and IRAs. Whether the investor is officially “retired” is not relative to 401(k) plans. 

  Individuals who no longer work for the company offering the 401(k) plan, and who is entitled to withdraw funds without penalty, may take a lump sum withdrawal. Until 1999, the tax laws allowed people to use an income averaging method to spread that lump sum over five years for tax purposes, but that option is no longer available. The entire withdrawal must be reported to the IRS as income in the year the withdrawal was taken.  It is not necessary to make a full withdrawal since the entire 401(k) account can be transferred directly to an IRA custodian, allowing the account to continue to grow tax deferred.

  Like IRA’s, participants in 401(k) plans must start taking distributions by the minimum distribution age. The Internal Revenue Service imposes a minimum annual distribution on 401(k) plans at a minimum distribution age as well; taxes will be due on amounts withdrawn. There is an exception, however, to the minimum and required distribution rules: if the individual continues to work for the same company that sponsors the 401(k) plan, he or she does not have to start withdrawing from their 401(k) plan.

  Since 401(k) plans are company-administered (and every plan is different) changing jobs could significantly affect the 401(k) plan. Each company will handle this situation according to their personal guidelines; some companies will allow the investor to keep his or her savings in the program until age 59½. If this is available, it may be the easiest way to handle the 401(k) plan. Some companies will require the investor to withdraw their money when they leave employment, which will then be more complicated. The new company may allow a "rollover" contribution to its 401(k) plan, which would allow the investor to take all his or her 401(k) savings from his or her old job and put them into the new company's plan. If this is not a possibility, the investor could elect to roll over his or her funds into an IRA instead of another 401(k) plan. However, as we noted, a 401(k) plan has several advantages over an IRA, so most professionals would prefer to roll the money into another 401(k) plan if possible.

  Anytime money is rolled from one plan to another it is very important to do it properly to avoid errors that may result in withdrawal penalties. It is best to make a direct rollover, meaning the money goes from one plan to another without every resting in the investor’s hands. Because the investor never touches the money, no tax is withheld or owed on the direct rollover amount.

  If the direct rollover option is not chosen, meaning the money rests in the investor’s hands, the withdrawal is immediately subject to a mandatory tax withholding of the taxable portion, which the old company must send to the IRS. The remaining amount must be rolled over within 60 days to a new retirement account; otherwise it is subject to a 10 percent tax. The mandatory withholding at the time of withdrawal is designed to cover any possible taxes due, but it can be recovered using a special form filed with the investor’s next tax return to the IRS. If the investor fails to file that form, however, the mandatory tax withholding is lost. 

Important notice: the mandatory tax withholding that was withheld when the 401(k) funds were withdrawn from the first plan must also be rolled into a new retirement account within 60 days, out of the investor’s own pocket, or it will be considered withdrawn and subject to the 10 percent tax. The investor should check with his or her benefits department prior to performing any type of rollover of 401(k) funds.

  To demonstrate the rollover that did not utilize a direct rollover, consider the following example:

  Ernest Employee changed jobs. He had $10,000 in his company’s 401(k) plan when his job ended with ABC Corporation. Because he did not utilize a direct rollover, the 401(k) money will temporarily rest in his hands.  Ernest receives $8,000 of the $10,000 he had in his 401(k) plan at ABC Corporation. The IRS will received $2,000 from his employer against possible taxes on his withdrawal. To maintain tax-exempt status on the entire amount, Ernest must deposit $10,000 into XYZ Corporation’s retirement plan within 60 days of the withdrawal date, even though he only received $8,000 of the $10,000 he had in the original 401(k) plan. As we know, Ernest Employee only has $8,000 in hand; if he is not able to obtain the remaining $2,000 until he files his taxes at the end of the year, what can he do?  Ernest can:

1. Borrow $2,000 from a bank or friend so he can deposit the entire $10,000, or
2. Roll over just the $8,000 he has in his hands. The remaining $2,000 then loses its tax status and will incur income tax and a 10 percent penalty tax.

  Obviously a direct rollover would have been advantageous for Ernest Employee. It should be noted that if Ernest had been in an employee contribution retirement plan prior to 1986, some of the rules may be different on those funds invested before1986. He should consult with his benefits department for exact details.

  The rules changed at the end of 1999 to disallow income averaging of lump-sum withdrawals over five years. Ten-year income averaging is available only to those born before January 2, 1936.  Any amount withdrawn will be taxed along with other existing income. If the investor could withdraw funds over several years it might reduce the total tax by keeping him or her out of a higher tax bracket. As always, it is wise to consult with a tax specialist if a lump sum distribution is being considered.

401(k) Tax Consequences

  Most 401(k) contributions are made on a pre-tax basis. Starting in the 2006 tax year, employees can either contribute on a pre-tax basis or opt to utilize the Roth 401(k) provisions to contribute on an after-tax basis and have similar tax effects of the Roth IRA. In order to do that, however, the plan sponsor must amend the plan to make those options available. Whether pre-tax or after-tax contributions are chosen, earnings from investments in a 401(k) account (in the form of interest, dividends, or capital gains) are not taxable events. The resulting compound interest without taxation can be a major benefit of the 401(k) plan.

  For pre-tax contributions, the employee does not pay federal income tax on the amount of current income that he or she defers to a 401(k) account. For example, a worker who earns $50,000 that year but defers $3,000 into a 401(k) account only pays taxes on $47,000 for the year's tax return. The employee will eventually pay taxes on the diverted money but not until he or she withdraws the funds, generally during retirement. The gains (including tax favored capital gains) are transformed into "ordinary income" at the time the money is withdrawn.

  For after-tax contributions to a Roth 401(k), qualified distributions can be made tax free.  To qualify, distributions must be made more than 5 years after the first designated Roth contributions and not before the year in which the account owner turns age 59½, unless an exception applies as detailed in IRS code section 72(t). In the case of designated Roth contributions, the contributions being made on an after tax basis means that the taxable income in the year of contribution is not decreased as it is with pre-tax contributions. Roth contributions are irrevocable and cannot be converted to pre-tax contributions at a later date. Administratively Roth contributions must be made to a separate account, and records must be kept that distinguish the amount of contribution that are to receive Roth treatment.

Fund Withdrawals

  Virtually all employers impose severe restrictions on withdrawals while a person remains in service with the company and is under age of 59½. Any withdrawal that is permitted before the age of 59½ is subject to an excise tax equal to ten percent of the amount distributed, including withdrawals to pay expenses due to a hardship, except to the extent the distribution does not exceed the amount allowable as a deduction under Internal Revenue Code section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

  In any event any amounts are subject to normal taxation as ordinary income. Some employers may disallow one, several, or all the previous hardship causes. Someone wishing to withdraw from a 401(k) plan would have to resign from their employer. To maintain the tax advantage for income deferred into a 401(k), the law stipulates the restriction that unless an exception applies, money must be kept in the plan or an equivalent tax deferred plan until the employee reaches age 59½. Money that is withdrawn prior to age 59½ typically incurs a 10 percent penalty tax unless a further exception applies. This penalty is on top of the ordinary income tax that must be paid on the withdrawal. Exceptions to the 10 percent penalty include the employee's death, the employee's total and permanent disability, separation from service in or after the year the employee reached age 55, substantially equal periodic payments under section 72(t), a qualified domestic relations order, and for deductible medical expenses (exceeding the 7.5% floor). This does not apply to the similar 457 plan.

  Many plans also allow employees to take loans from their 401(k) to be repaid with after-tax funds at pre-defined interest rates. The interest proceeds then become part of the 401(k) balance. The loan itself is not taxable income nor subject to the 10 percent penalty as long as it is paid back in accordance with section 72(p) of the Internal Revenue Code. This section requires, among other things, that the loan be for a term no longer than 5 years (except for the purchase of a primary residence), that a "reasonable" rate of interest be charged, and that substantially equal payments (with payments made at least every calendar quarter) be made over the life of the loan. Employers, of course, have the option to make their plan's loan provisions more restrictive. When an employee does not make repayments in accordance with the plan or IRS regulations, the outstanding loan balance will be declared in “default.”  A defaulted loan, and possibly accrued interest on the loan balance, becomes a taxable distribution to the employee in the year of default with all the same tax penalties and implications of a withdrawal.

  These loans have been described as tax-disadvantaged, on the theory that the 401(k) contains before-tax dollars, but the loan is repaid with after-tax dollars. This is not correct. The loan is repaid with after-tax dollars, but the loan itself is not a taxable event, so the "income" from the loan is tax-free. This treatment is identical to that of any other loan, as long as the balance is repaid on schedule. (A residential mortgage or home equity line of credit may have tax advantages over the 401(k) loan; but that is because the interest on home mortgages is deductible, and unrelated to the tax-deferred features of the 401(k).)

Minimum Distributions Required

  An account owner must begin taking distributions from their accounts at least by age 73 (75 in 2033) unless the account owner is still employed at the company sponsoring the 401(k) plan. The amount of distributions is based on life expectancy according to the relevant factors from the appropriate IRS tables. The only exception to minimum distribution is for people still working once they reach that age, and the exception only applies to the current plan they are participating in. Required minimum distributions apply to both pre-tax and after-tax Roth contributions. Only a Roth IRA is not subject to minimum distribution rules. Other than the exception for continuing to work after age 73, 401(k) plans differ from the rules for IRA minimum distributions. The same penalty applies to the failure to make the minimum distribution. The penalty is 50% of the amount that should have been distributed, one of the most severe penalties the IRS applies.

  There is a maximum limit on the total yearly employee pre-tax salary deferral. The limit, known as the “401(k) limit,” may change from year to year; it is always important to know the current limit. The limit may be indexed for inflation, increasing in increments of $500. Employees who are 50 years old or more at any time during the year are allowed additional pre-tax "catch up" contributions. The limit for future "catch up" contributions may also be adjusted for inflation in increments of $500. In eligible plans, employees can elect to have their contribution allocated as either pre-tax contributions or as after-tax Roth 401(k) contributions, or a combination of the two. The total of all 401(k) contributions must not exceed the maximum contribution amount.

  If the employee contributes more than the maximum pre-tax limit to 401(k) accounts in a given year, the excess must be withdrawn by April 15 of the following year. This violation most commonly occurs when a person changes employment mid-year and the latest employer does not know to enforce the contribution limits on behalf of their employee. If this violation is noticed too late, the employee may have to pay taxes and penalties on the excess. The excess contribution, as well as the earnings on the excess, is considered "non-qualified" and cannot remain in a qualified retirement plan such as a 401(k).

  Plans that are set up under section 401(k) can also have employer contributions that (when added to the employee contributions) cannot exceed other regulatory limits. The total amount that can be contributed between employee and employer contributions is the section 415 limit, which is the lesser of 100 percent of the employee's compensation or a specified amount. Since the dollar amount changes, a tax attorney should be consulted.  Employer matching contributions can be made on behalf of designated Roth contributions, but the employer match must be made on a pre-tax basis.

  Governmental employers in the US (that is, federal, state, county, and city governments) are currently barred from offering 401(k) plans unless they were established before May 1986. Governmental organizations instead can set up a section 457(g).

Highly Compensated Employees (HCE)

  To help ensure that companies extend their 401(k) plans to low-paid employees, an IRS rule limits the maximum deferral by the company's “highly compensated” employees, based on the average deferral by the company's non-highly compensated employees. If the rank and file saves more for retirement, then the executives are allowed to save more for retirement. This provision is enforced through what is called “non-discrimination testing.” Non-discrimination testing takes the deferral rates of highly compensated employees (HCE) and compares them to non-highly compensated employees (NHCE).

401(k) Plans for Small Businesses or Sole Proprietorships

  Many financial advisors self-employed individuals felt that 401(k) plans did not meet the needs of small business owners. The high costs, difficult administration, and low contribution limits were difficult for the self-employed and sole proprietorships. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made 401(k) plans more beneficial for the self-employed. The two key changes enacted related to the allowable “Employer” deductible contribution, and the “Individual” IRC-415 contribution limit.

  401(k) plans can be a powerful tool in promoting financial security in retirement. They are a valuable option for businesses considering a retirement plan, providing benefits to employees and their employers. Employers start a 401(k) plan for a many reasons. A well-designed 401(k) plan attracts talented employees so offering such a plan becomes an incentive to key personnel. It allows participants to decide how much to contribute to their accounts on a before-tax basis. Employers are entitled to a tax deduction for their contributions to employees’ accounts, but it also benefits the rank-and-file employees.

  The money contributed may grow through investments in stocks, mutual funds, money market funds, savings accounts, and other investment vehicles. Contributions and earnings generally are not taxed by the Federal government or by most State governments until they are distributed. A 401(k) plan may allow participants to take their benefits with them when they leave the company, easing administrative burdens.

As of 2006, 401(k) plans can be established or amended to permit employees to designate some or all their contributions (employee deferrals) as Roth contributions. These contributions are made on an after-tax basis, but distributions (including earnings) are tax-free (if certain conditions are met).

Initial Actions

  There are four basic steps to set up a 401(k) plan:

(1)  Adopt a written plan

  Plans begin with a written document that serves as the foundation for day-to-day plan operations.  If the plan provider has hired someone to help with the plan, that person will probably provide the written document.  If not, assistance may often be obtained from a financial institution or retirement plan professional. Since the business is bound by the terms of the plan document it is very important to set it up correctly and appropriately.

  Before beginning the plan document, however, the business owner will need to decide on the type of 401(k) plan that is best for the situation: a traditional 401(k), a safe harbor 401(k), or a SIMPLE 401(k) plan.

  A traditional 401(k) plan offers the maximum flexibility of the three types of plans. Employers have discretion to make contributions on behalf of all participants, to match employees’ deferrals, or do both. These contributions can be subject to a vesting schedule (which provides that an employee’s right to employer contributions becomes non-forfeitable only after a period of time). In addition, a traditional 401(k) allows participants to make pre-tax contributions through payroll deductions. Annual testing ensures that benefits for rank and file employees are proportional to benefits for owners/managers.

A safe harbor 401(k) plan is similar to a traditional 401(k) plan, but, among other things, must provide for employer contributions that are fully vested when made.  However, the safe harbor 401(k) is not subject to many of the complex tax rules that are associated with a traditional 401(k) plan, including annual nondiscrimination testing.  Both the traditional and safe harbor plans are for employers of any size and can be combined with other retirement plans.

A SIMPLE 401(k) plan was created so that small businesses could have an effective cost-efficient way to offer retirement benefits to their employees.  A SIMPLE 401(k) plan is not subject to the annual nondiscrimination tests that apply to the traditional plans. Similar to a safe harbor 401(k) plan, the employer is required to make employer contributions that are fully vested. This type of 401(k) plan is available to employers with 100 or fewer employees who received at least $5,000 in compensation from the employer for the preceding calendar year. In addition, employees that are covered by a SIMPLE 401(k) plan may not receive any contributions or benefit accruals under any other plans of the employer.

  Once the business has decided on the type of plan for their company, they will have flexibility in choosing some of the plan’s features, such as which employees can contribute to the plan and how much.  Other features written into the plan are required by law.  For example, the plan document must describe how certain key functions are carried out, such as how contributions are deposited in the plan.

(2)  Arrange a trust fund for the plan’s assets

  A plan’s assets must be held in trust to assure that assets are used solely to benefit the participants and their beneficiaries. The trust must have at least one trustee to handle contributions, plan investments, and distributions to and from the 401(k) plan.  Since the financial integrity of the plan depends on the trustee, this is one of the most important decisions made in establishing the 401(k) plan. If the plan is set up through insurance contracts, the contracts do not need to be held in trust.

(3)  Develop a recordkeeping system

  An accurate record keeping system helps track and properly attribute contributions, earnings and losses, plan investments, expenses, and benefit distributions in participants' accounts.  If there is a contract administrator or financial institution assisting in managing the plan, that entity typically will help in keeping the required records. In addition, a record keeping system will help the employer, the plan administrator, or financial provider prepare the plan’s annual return/report that must be filed with the Federal government.

(4)  Provide plan information to eligible employees

  As the 401(k) plan is put in place, the employer must notify employees who are eligible to participate in the plan about the plan’s benefits and requirements. A summary plan description or SPD is the primary vehicle to inform participants and beneficiaries about the plan and how it operates. The SPD typically is created with the plan document. The employer will need to send it to all plan participants. In addition, the employer may want to provide their employees with information that discusses the advantages of joining the company’s 401(k) plan. Employee perks, such as pre-tax contributions to a 401(k) plan (or tax-free distributions in the case of Roth 401(k)s), employer contributions if available, and compounded tax-deferred earnings help highlight the advantages of participating in the plan.

  Once the business has established a 401(k) plan, it assumes certain responsibilities in operating the plan. If someone was hired to help set up the company plan, that arrangement may have included help in operating the plan. If not, another important decision will be whether to manage the plan or hire a professional or financial institution such as a bank, mutual fund provider, or insurance company to take care of some or most aspects of operating the plan. Elements of a plan that need to be handled include:

· Participation

· Contributions

· Vesting

· Nondiscrimination

· Investing 401(k) Monies

· Fiduciary Responsibilities

· Disclosing Plan Information To Participants

· Reporting To Government Agencies

· Distributing Plan Benefits

Participation

Typically, a plan includes a mix of rank-and-file employees and owner/managers. However, some employees may be excluded from a 401(k) plan if they:

· Have not attained age 21;  

· Have not completed a year of service; or

· Are covered by a collective bargaining agreement that does not provide for participation in the plan, if retirement benefits were the subject of good faith bargaining.

  Employees cannot be excluded from a plan merely because they are older workers.

Contributions

  Another design option when establishing and operating a 401(k) plan is deciding on whether or not the business will make a contribution to participants’ accounts (matching funds). The company could match in part or whole the amount contributed by the employees.  If a match is made, the company will likely want to state a maximum amount it will match per employee per year.

Traditional 401(k) Plan

  If the company decides to contribute to their employee’s 401(k) plans, there are further options.  The employer can contribute a percentage of each employee’s compensation for allocation to the employee’s account (called a non-elective contribution), or the company can match the amount the employees decide to contribute (within the limits of current law) or you can do both.

  If the company decides to add a percentage, such as 50 percent, to each employee’s contribution that results in a 50-cent increase for every dollar the employee sets aside. Using a matching contribution formula will provide additional employer contributions only to employees who make deferrals to the 401(k) plan. If the employer decides to make non-elective contributions, the employer makes a contribution for each eligible participant, whether the participant decides to make a salary deferral to his or her 401(k) account or not.

  Under a traditional 401(k) plan, there is usually the flexibility of changing the amount of non-elective contributions each year, according to business conditions.

Safe Harbor 401(k) Plan

  Under a safe-harbor plan, the business can match each eligible employee’s contribution, dollar for dollar, up to 3 percent of the employee’s compensation, and 50 cents on the dollar for the employee’s contribution that exceeds 3 percent, but not 5 percent, of the employee’s compensation. Alternatively, the company can make a non-elective contribution equal to 3 percent of compensation to each eligible employee’s account. Each year the company must make either the matching contributions or the non-elective contributions.

SIMPLE 401(k) Plan

  Employer contributions to a SIMPLE 401(k) plan are limited to either:

· A dollar-for-dollar matching contribution, up to 3 percent of pay; or

· A non-elective contribution of 2 percent of pay for each eligible employee.

  No other employer contributions can be made to a SIMPLE 401(k) plan, and employees cannot participate in any other retirement plan of the employer. There are maximums that cannot be exceeded.

  An additional catch-up contribution is allowed for employees aged 50 and over. The company should consult their tax advisor for the amounts allowed.

Vesting

  Employee salary deferrals are immediately 100 percent vested. The money that an employee has put aside through salary deferrals cannot be forfeited. When an employee leaves employment, he or she is entitled to those deferrals, plus any investment gains (or minus losses) on their deferrals.

  In SIMPLE 401(k) plans and safe harbor 401(k) plans, all required employer contributions are always 100 percent vested. In traditional 401(k) plans, the employer can design their plan so that employer contributions become vested over time, according to a vesting schedule.

Nondiscrimination

  Realizing 401(k) plan tax benefits requires that plans provide substantive benefits for rank-and-file employees, not just for business owners and managers.  These requirements are referred to as non-discrimination rules and cover the level of plan benefits for rank-and-file employees compared to owners/managers.

  Traditional 401(k) plans are subject to annual testing to assure that the amount of contributions made on behalf of rank-and-file employees is proportional to contributions made on behalf of owners and managers. Safe harbor 401(k) plans and SIMPLE 401(k) plans are not subject to annual non-discrimination testing.

Investing 401(k) Monies

  After deciding on the type of 401(k) plan, the company can consider the variety of investment options. One decision to make when designing a plan is whether to permit employees to direct the investment of their accounts or to manage the monies on their behalf. If the former is chosen, the company also needs to decide what investment options to make available to the participants. Depending on the plan design chosen, the company may want to hire someone either to determine the investment options to make available or to manage the plan’s investments. Continually monitoring the investment options ensures that selections remain in the best interests of the plan and its participants.

Fiduciary Responsibilities

Many of the decisions regarding 401(k) plans involve fiduciary duties. For example, should the company hire someone to manage the plan for the company or should it self-manage. Controlling the assets of the plan or using discretion in administering and managing the plan makes the company or the entity hired a plan fiduciary to the extent of plan discretion or control. As a result, fiduciary status is based on the functions performed for the plan, not a title. This is important, so to repeat: fiduciary status is based on the functions performed – not the person’s title. Be aware that hiring someone to perform fiduciary functions is itself a fiduciary act.

  Some decisions with respect to a plan are business decisions rather than fiduciary decisions. For instance, the decision to establish the plan, to include certain features in a plan, to amend a plan and to terminate a plan is business decisions. When making these decisions, individuals are acting on behalf of the business rather than the plan, and therefore, is not a fiduciary function. However, when the company takes steps to implement these decisions, the company or those they hire are acting on behalf of the plan and therefore are acting as fiduciaries.

  Individuals or entities that are fiduciaries are in a position of trust with respect to the participants and beneficiaries in the plan. The fiduciary’s responsibilities include:

· Acting solely in the interest of the participants and their beneficiaries;

· Acting for the exclusive purpose of providing benefits to workers participating in the plan and their beneficiaries, and defraying reasonable expenses of the plan.

· Carrying out duties with the care, skill, prudence, and diligence of a prudent person familiar with such matters.

· Following plan documents;

· Diversifying plan investments.

  These are the responsibilities that fiduciaries need to keep in mind as they carry out their duties.  The responsibility to be prudent covers a wide range of functions and it is probably best to use persons or entities with past fiduciary responsibilities.  Since all these functions must be carried out in the same manner as a prudent person would carry them out, it may be in your best interest to consult experts in the various fields, such as investments and accounting.

  There are specific rules for some fiduciary duties that help guide the person or entity performing that job. For example, if the plan provides for salary reductions from employees’ paychecks for plan contribution, then these contributions must be timely deposited. The law states that this must be accomplished as soon as it is reasonably possible to do so, but no later than the 15th business day of the month following the payday. If the deposits could reasonably be made in a shorter time frame, that should be done.

Limiting Fiduciary Liability

  With fiduciary responsibilities, there also comes some potential liability. However, there are actions a business can take to demonstrate that they carried out their responsibilities properly and also ways to limit liability.

  The fiduciary responsibilities cover the process used to carry out the plan functions rather than simply the end results. For example, investments made by the employer or someone they hired would not mean investments must always be “winners” as long as those decisions were part of a prudent overall diversified investment portfolio for the plan. Since a fiduciary must carry out activities through a prudent process, he or she should document the decision-making process to demonstrate the rationale behind the decisions at the time they were made.

  In addition to the steps above, there are other ways to limit potential liability. The plan can be set up to give participant’s control of the investments in their accounts. For participants to have control, they must have sufficient information on the specifics of their investment options. If properly executed, this type of plan limits the company’s liability for the investment decisions made by participants. The employer can also hire a service provider or providers to handle some or most of the fiduciary functions, setting up the agreement so that the person or entity then assumes liability.

Hiring a Service Provider

  Even if the employer hires a financial institution or retirement plan professional to manage the whole plan, it still retains some fiduciary responsibility for the decision to select and keep that person or entity as the plan’s service provider. Obviously, this potential liability is a major reason companies use fiduciaries with past experience and training in retirement plans. The employer should document the selection process and monitor the services provided to determine if a change needs to be made, however.

  Some items to consider in selecting a plan service provider:

· Information about the firm itself: affiliations, financial condition, experience with 401(k) plans, and assets currently under their control;

· A description of business practices: how plan assets will be invested if the firm will manage plan investments or how participant investment directions will be handled, and proposed fee structure;

· Information about the quality of prospective providers: the identity, experience, and qualifications of the professionals who will be handling the plan’s account; any recent litigation or enforcement action that has been taken against the firm; the firm’s experience or performance record; if the firm plans to work with any of its affiliates in handling the plan’s account; and whether the firm has fiduciary liability insurance.

· Once hired, these are additional actions to take when monitoring a service provider, including:

o Review the service provider’s performance;

o Read any reports they provide;

o Check actual fees charged;

o Ask about policies and practices (such as trading, investment turnover, and proxy voting); and

o Follow up on participant complaints.

Prohibited Transactions and Exemptions

  There are certain transactions that are prohibited under the law to prevent dealings with parties that have certain connections to the plan, self-dealing, or conflicts of interest that could harm the plan. However, there are a number of exceptions under the law, and additional exemptions may be granted by the U.S. Department of Labor, where protections for the plan are in place in conducting the transactions.

  For example, there is an exemption that permits the employer to offer loans to participants through the plan. If the 401(k) plan does offer loans, the loan program must be carried out in such a way that the plan and all other participants are protected.  So, the decision with respect to each loan request is treated as a plan investment and considered accordingly.

Bonding

  Individuals handling plan funds or other plan property generally must be covered by a fidelity bond to protect the plan against fraud and dishonesty.

Disclosing Plan Information to Participants

  Plan disclosure documents keep participants informed about the basics of plan operation, alert them to changes in the plan’s structure and operations, and provide them a chance to make decisions and take timely action with respect to their accounts.

Summary Plan Description (SPD)

  The summary plan description is a basic descriptive document. It should be a simply stated explanation of the plan and must be comprehensive enough to apprise participants of their rights and responsibilities under the plan. It also informs participants about the features and what to expect. Among other things, the SPD must include information about:

· When and how employees become eligible to participate in the 401(k) plan;

· The contributions to the plan;

· How long it takes to become vested;

· When employees are eligible to receive their benefits;

· How to file a claim for those benefits; and

· Basic rights and responsibilities participants have under the federal retirement law, the Employee Retirement Income Security Act (ERISA).

  The SPD should include an explanation about the administrative expenses that will be paid by the plan. This document must be given to participants when they join the plan and to beneficiaries when they first receive benefits. SPDs must also be redistributed periodically during the life of the plan.

Summary of Material Modification (SMM)

  This summary apprises participants of changes made to the plan or to the information required to be in the SPD. The SMM or an updated SPD must be automatically furnished to participants within a specified number of days after the change.

Individual Benefit Statement (IBS)

  The Individual Benefit Statement shows the total plan benefits earned by a participant and information on their vested benefits. The IBS must be provided when a participant submits a written request, but no more than once in a 12-month period, and automatically to certain participants who have terminated service with the employer.  In addition, many plans choose to provide on a quarterly basis individual account statements that show the assets in a participant’s account, how it is invested, and any increases or decreases in investments during the period covered by the statement.

Summary annual report (SAR)

  The SAR is a narrative of the plan’s annual return/report, and the Form 5500, filed with the Federal government.  It must be furnished annually to participants.

Blackout period notice

  This notice gives employees advance notice when a blackout period occurs, typically when plans change record keepers or investment options, or when plans add participants due to corporate mergers or acquisitions.  During a blackout period, participants’ rights to direct investments, take loans, or obtain distributions are suspended.

Reporting to Government Agencies

  In addition to the disclosure documents that provide information to participants, plans must also report certain information to government entities.

Form 5500 Series

Plans are required to file an annual return or report with the Federal government. Depending on the number and type of participants covered, most 401(k) plans must file one of the two following forms:

· Form 5500, Annual Return/Report of Employee Benefit Plan, or

· Form 5500-EZ, Annual Return of One-Participant (Owners and Spouses) Retirement Plan

  For 401(k) plans, the Form 5500 is designed to disclose information about the plan and its operation to the IRS, the U.S. Department of Labor, plan participants, and the public.

  Most one-participant plans (sole proprietor and partnership plans) with total assets of $100,000 or less are exempt from the annual filing requirement. A final return or report must be filed when a plan is terminated regardless of the value of the plan’s assets.

Form 1099-R

  Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. is given to both the IRS and recipients of distributions from the plan during the year. It is used to report distributions (including rollovers) from a retirement plan. See Form 1099-R and the Form 1099-R and 5498 Instructions for additional information.

Distributing Plan Benefits

  Benefits in a 401(k) plan are dependent on a participant’s account balance at the time of distribution.

When participants are eligible to receive a distribution, they typically can elect to:

· Take a lump sum distribution of their account,

· Roll over their account to an IRA or another employer’s retirement plan, or

· Purchase an annuity.

Terminating a 401(k) Plan

  Although 401(k) plans must be established with the intention of being continued indefinitely, the employer may terminate the plan when it no longer suits the business needs.  For example, the employer may want to establish another type of retirement plan in lieu of the 401(k) plan, so the 401(k) plan would be terminated.

  Typically, the process of terminating a 401(k) plan includes amending the plan document, distributing all assets, and filing a final Form 5500.  The company must also notify their employees that the 401(k) plan will be discontinued.  

Compliance

  Even with the best intentions, mistakes in plan operation can still happen. The U.S. Department of Labor and IRS have correction programs to help 401(k) plan sponsors correct plan errors, protect participants and keep the plan’s tax benefits.  These programs are structured to encourage the employer to correct the errors early.  Having an ongoing review program makes it easier to spot and correct mistakes in plan operations.

Simplified Employee Pension Plans (SEP)

Definition:

A SEP is a retirement plan that allows an individual to contribute and deduct up to 20 percent of self-employment income (25 percent of salary if the individual is an employee of your own corporation).

  As its name implies, the Simplified Employee Pension Plan (SEP) is the simplest type of retirement plan available. Essentially, this is a glorified IRA that allows individuals to contribute a set percentage up to a maximum amount each year. The percentage can be varied each year, so lower amounts (or nothing at all) can be contributed when income is down. If cash is not available, nothing need be deposited to the SEP at all, even for the entire year.

  Paperwork is minimal which is favored by many small companies. It is the employer that makes the contributions on the employee’s behalf.  Unlike 401(k) plans, employees don't make any contributions to SEPs. Employers must pay the full cost of the plan, and whatever percentage is contributed for the business owner must also be contributed to all eligible employees. The maximum contribution is 15 percent of an employee's salary or the currently specified dollar amount, whichever is less.

  SEPs are easy to establish and administer. They may be established with a bank, brokerage firm, or insurance company. No annual government reports are required, and there are no ongoing administrative expenses. SEPs are just as easy as deductible IRAs, but they allow much bigger contributions.

  A simplified employee pension is an excellent option for employers who want an easy way to provide retirement savings for their employees. A SEP is basically just an individual retirement account, similar to the traditional IRA, and is often referred to as a SEP-IRA. The employer sets it up on behalf of each employee and pays into it for the employee.  From the perspective of the SEP participant, a SEP-IRA is not much different from a traditional IRA, except that a SEP-IRA allows the participant to put away more money each year for retirement income.

  Employers like SEP plans because they are easy to establish and inexpensive to administer. Under a SEP plan, the employer sets up a traditional IRA for each qualifying employee. Although an employer may adopt less restrictive participation requirements, an employer adopting a SEP plan must allow participation if an employee meets all the following conditions:

• The employee is at least 21 years old.
• The employee has worked for the employer during at least three of the five years immediately preceding the current year.
• The employee has received at least minimum requirements for compensation from the employer.

  An employer with leased employees may have to provide them with SEP-IRAs as well. A leased employee is generally a person who works for the employer, but was hired by a leasing organization.  To qualify for SEP benefits, a leased employee must do all of the following:

• Provide services under an agreement between the employer and the leasing organization;
• Perform services for the employer, or for the employer and related persons, on a substantially full-time basis for at least one year;
• Perform services under the primary direction and control of the recipient;

· Although an employer adopting a SEP plan must include all eligible employees in the plan, the employer may exclude the following two types of employees:

• Employees covered by a union agreement if their retirement benefits were a result of good faith bargaining between their union and the employer;
• Nonresident alien employees who have no U.S. source earned income from their employer.

  An employer may offer a SEP plan in conjunction with another defined contribution plan.  Employees may also make additional contributions to their SEP-IRAs independent of the employer, but they are subject to the same restrictions imposed on traditional IRAs when contributions are simultaneously being made to a retirement plan.  Plan distribution is the same for SEP plans as for IRAs because they are essentially the same thing.

  Simplified employee pension (SEP) plans, also known as SEP/IRAs since they make use of individual retirement accounts, are pension plans intended specifically for self-employed persons and small businesses. Created by Congress and monitored by the Internal Revenue Service, Simplified Employee Pension plans are designed to give small business owners and their employees the same ability to set aside money for retirement as traditional large corporate pension funds.  SEP plans are available to all types of business entities, including proprietorships, partnerships, and corporations.

  As employer-funded retirement plans, SEPs allow small businesses to direct at least 3 percent and up to 15 percent of each employee's annual salary into tax-deferred IRAs on a discretionary basis up to a specified dollar amount, whichever is less.  SEP plans are easy to set up and inexpensive to administer, as the employer simply makes contributions to IRAs that are established by or on behalf of employees. The employees then take responsibility for making investment decisions regarding their own IRAs. Employers are able to avoid the risk and cost involved in accounting for employee retirement funds. In addition, employers have the flexibility to make large percentage contributions during good financial years, and to reduce contributions during hard times. Like other tax-deferred retirement plans, SEPs provide a tax break for employers and a valuable benefit for employees.

  In many ways, SEPs can be more flexible and attractive than corporate pensions. They can even be used to supplement corporate pensions and 401(k) plans. Many people who are employed full-time use SEPs as a way to save and invest more money for retirement than they might normally be able to put away under IRS rules. In fact, an article in Forbes magazine called SEPs a "moonlighter's delight," in that they enable full-time employees to contribute a portion of their self-employment income from consulting or free-lancing outside of their regular jobs.

Rules Governing SEPs

  The rules governing SEPs are fairly simple but are subject to frequent changes, so annual reviews of IRS publications 560 (retirement plans for the self-employed) and 590 (IRAs) are recommended.  The SEP plans are easy to set up and do not require a separate trustee.  The maximum allowable tax-deductible SEP contribution per employee is 15 percent of net compensation or a specified dollar amount, whichever is lower.  Since the specified dollar amount is open to change, we have not listed it here.  Our intent is for the agent to keep up with the changes, meaning he or she must yearly check to see what the dollar amount is.  In general, eligibility is limited to employees 21 or more years old with at least three years of service with the company and a minimum level of compensation.

  A similar program is the Savings Incentive Match Plan for Employees (SIMPLE) IRA. SIMPLE plans became available in January 1997 to businesses with less than 100 employees, replacing the discontinued Salary Reduction Simplified Employee Pension (SARSEP) plans.  They are intended to provide an easy, low-cost way for small businesses and their employees to contribute jointly to tax-deferred retirement accounts. An IRA set up as a SIMPLE account requires the employer to match up to 3 percent of an employee's annual salary, with an upper dollar limit per year.  Employees are also allowed to contribute to their own accounts, again subject to a maximum limit.  In this way, a SIMPLE IRA is similar to a 401(k), but it is generally less complex and has fewer administrative requirements.

Companies that establish SIMPLEs are not allowed to offer any other type of retirement plan. The main problem with the plans, according to Stephen Blakely in Nation's Business, is that legislation changes from time to time. It is possible, even if currently in favor, that changes could happen in the future. What started out “simple” may not remain simple in the future.

SEP Advantages

· Contributions to a SEP are tax deductible and your business pays no taxes on the earnings on the investments.

· You are not locked into making contributions every year. In fact, you decide each year whether, and how much, to contribute to your employees’ SEP-IRAs.

· Generally, you do not have to file any documents with the government.

· Sole proprietors, partnerships, and corporations, including S corporations, can set up SEPs.

· You may be eligible for a tax credit of up to $500 per year for each of the first 3 years for the cost of starting the plan.

· Administrative costs are low.

SEP Terms

Employee: An “employee” is not only an employee, but can also be a self-employed person as well as an owner-employee who has earned income. In other words, an individual can contribute to a SEP-IRA on his or her own behalf. The term also includes employees of certain other businesses owned and certain leased employees.

Eligible Employee: An eligible employee is an employee who:

1. Is at least 21 years of age, and

2. Has performed service for the company in at least 3 of the last 5 years.

  All eligible employees must participate in the plan, including part-time employees, seasonal employees, and employees who die or terminate employment during the year.  The SEP may also cover the following employees, but there is no requirement to cover them:

1. Employees covered by a union contract;

2. Nonresident alien employees who did not earn income from you;

3. Employees who received less than a specified amount in compensation during the year (subject to cost-of-living adjustments).

Compensation: The term generally includes the pay an employee received from their employer for a year’s work. As either the owner or employee, compensation is the pay received from the company. Employers must follow the definition of compensation included in the plan document.

Establishing the Plan

  There are just a few simple steps to establish a SEP.

Step 1:

  Contact a retirement plan professional or a representative of a financial institution that offers retirement plans and choose the IRS model SEP, Form 5305-SEP, Simplified Employee Pension – Individual Retirement Accounts Contribution Agreement, or another plan document offered by the financial institution. Regardless of the SEP document chosen, when filled in, it will include the name of the employer, the requirements for employee participation, the signature of a responsible official, and a written allocation formula for the employer’s contribution.

  A SEP may be established as late as the due date (including extensions) of the company’s income tax return for the year they want to establish the plan.  For example, if the business’s fiscal year (a corporate entity) ends on December 31 and it filed for the automatic 6-month extension, the company’s tax return for the year ending December 31 of that tax year would be due on September 15 of the following year, allowing the employer to make the initial SEP contribution no later than September 15 of that same year.

For Example: If a business’s fiscal year ends on December 31st and it files for the

6-month extension, the company would have until September 15th

of the following year to pay taxes and initiate their SEP plan.

  Choosing a financial institution for the SEP is one of the most important decisions made, since that entity becomes a trustee to the plan. Trustees work closely with employers and agree to:

1. Receive and invest contributions, and

2. Provide each participant with a notice of employer contributions made each year and the value of his or her SEP-IRA at the end of the year.

  Trustees of SEP-IRAs are generally banks, mutual funds, or insurance companies that issue annuity contracts, and certain other financial institutions that have been approved by the IRS.

Step 2:

  Complete and sign Form 5305-SEP (or other plan document, if not using the IRS model form). When it is completed and signed, this form becomes the plan’s basic legal document, describing the employees’ rights and benefits. Do not send it to the IRS; instead, use it as a reference since it sets out the plan’s terms (e.g., eligible employees, compensation, and employer contributions).

Step 3:

Give the employees a copy of the Form 5305-SEP (or other plan document, if not using the IRS model form) and its instructions, along with certain information about SEP-IRAs (described in Employee Communications below). The model SEP is not considered adopted until each employee is provided with a written statement explaining that:

1. A SEP-IRA may provide different rates of return and contain different terms than other IRAs the employee may have;

2. The administrator of the SEP will provide a copy of any amendment within 30 days of the effective date, along with a written explanation of its effects; and

3. Participating employees will receive a written report of employer contributions made to SEP-IRAs by January 31 of the following year.

Operating the SEP Plan

  Once in place, a SEP is simple to operate. The trustee will take care of depositing the contributions, investments, annual statements, and any required filings with the IRS.

SEP Contributions

  The employer’s obligation is to forward contributions to the financial institution or trustee for participating employees. Employers must keep their financial institution aware of any changes in the status of participating employees. As new employees are hired, if they satisfy the eligibility criteria described in the plan, then the employer would notify their financial institution of the addition to participating employee rolls.

  Contributions to each employee’s SEP-IRA account cannot exceed the lesser of that year’s specified dollar amount or a percentage of the employee’s compensation. These limits apply to the total contributions to the plan and any other defined contribution plans (other SEPs, 401(k), 403(b), profit-sharing, or money purchase plan) the company has.

  Employers are not required, as we previously said, to make contributions every year. When employees contribute, they must contribute to the SEP-IRAs of all participants who actually performed work for the business during the year for which the contributions are made, even employees who died or terminated employment before the contributions were made (as long as they met plan participation criteria). Contributions must be uniform for all eligible employees.

  Employee salary reduction contributions cannot be made under a SEP.

  There are special rules for those who are self-employed. For more information on the deduction limitations for self-employed individuals, see IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans).

Employee Communications

  When employees participate in a SEP, they must receive certain key disclosure documents from either their employer or the financial institution acting as trustee:

1. Employees must receive a copy of IRS Form 5305-SEP and its instructions (or other document used to establish the plan).  New employees who become eligible to participate in the plan must also receive a copy of the plan.

2. Provide employees a written statement containing information about the terms of the SEP, how changes are made to the plan, and when employees are to receive information about contributions to their accounts.

3. The financial institution must provide each employee participating in the plan with a plain, non-technical overview of how their SEP operates.

  In addition to the information above, the financial institution provides an annual statement for each participant’s SEP-IRA, reporting the fair market value of that account.

The financial institution also gives participating employees a copy of the annual statement filed with the IRS containing contribution and fair market value information.

  When employees participating in the plan receive distributions from his or her account, the financial institution sends them a copy of the form that is filed with the IRS for the individual’s distribution.  The financial institution will notify the participant by January 31 of each year when a minimum distribution is required.

Reporting to the Government

  SEPs are generally not required to file annual financial reports with the Federal government. SEP-IRA contributions are not included on the Form W-2, Wage and Tax Statement.  The financial institution or trustee handling employees’ SEP-IRAs provides the IRS and participating employees with an annual statement containing contribution and fair market value information on Form 5498, IRA Contribution Information.

  The financial institution will also report on Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., any distributions it makes from participating employees’ accounts.  The 1099-R is sent to those receiving distributions and to the IRS.

Distributions

  Participants cannot take loans from their SEP-IRA. However, participants can make withdrawals at any time. These monies can be rolled over tax free to another SEP-IRA, to another traditional IRA, or to another employer’s qualified retirement plan (provided the other plan allows rollovers).

  Money withdrawn from a SEP-IRA (and not rolled over to another plan) is subject to income tax for the year in which an employee receives a distribution.  If an employee withdraws money from a SEP-IRA before age 59½, a 10 percent additional tax generally applies.

  As with other traditional IRAs, participants in a SEP-IRA must begin withdrawing a specific minimum amount of money from their accounts at the required minimum distribution (RMD) age and annually thereafter. The financial institution/trustee will notify the participant by a specified date each year when a minimum distribution is required.

Monitoring the Trustee

  As the plan sponsor, the business should monitor the financial institution or trustee to be sure it is doing everything required. The business should also ensure that the trustee’s fees are reasonable for the services being provided. If the trustee is not doing its job properly, or if its fees are not reasonable, the business might want to consider replacing the trustee.

Terminating the Plan

  Although SEPs are established with the intention of continuing indefinitely, the time may come when a SEP no longer suits the purposes of the business.  To terminate a SEP, the financial institution must be notified that contributions will cease for the next year and that the business wants to terminate the contract or agreement. Although not mandatory, it is a good idea to notify the employees that the plan is being discontinued. It is not necessary to notify the IRS that the SEP plan has been terminated.

Correcting Errors

  Even with the best of intentions, mistakes in plan operations happen. The U.S. Department of Labor and the IRS have correction programs to help employers with SEPs correct plan errors, protect participants’ interests, and keep the plan’s tax benefits. These programs are structured to encourage early error correction. Ongoing review makes it easier to spot and fix mistakes in the plan’s operations.

Owners Benefit Less Than Non-Owner Employees

  A note of caution is in order. A small business owner who wants to establish a SEP or any other qualified retirement plan for him or herself must also include all other company employees who meet minimum participation standards. As an employer, the small business owner can establish retirement plans like any other business.  As an employee, the small business owner can then make contributions to the plan he or she has established in order to set aside tax-deferred funds for retirement, like any other employee. The difference is that a small business owner must include all non-owner employees in any company-sponsored retirement plans and make equivalent contributions to their accounts. Unfortunately, this requirement has the effect of reducing the allowable contributions that the owner of a proprietorship or partnership can make on his or her own behalf.

  For self-employed individuals, contributions to a retirement plan are based upon the net earnings of their business. The net earnings consist of the company's gross income less deductions for business expenses, salaries paid to non-owner employees, the employer's 50 percent of the Social Security tax, and the employer's contribution to retirement plans on behalf of the company’s employees. Therefore, rather than receiving pre-tax contributions to the retirement account as a percentage of gross salary, like non-owner employees, the small business owner receives contributions as a smaller percentage of net earnings. Employing other people thus detracts from the owner's ability to build up a sizeable before-tax retirement account of his or her own. In the case of a SEP plan, the business owner's maximum annual contribution is reduced to 13.04 percent of income (compared to the 15 percent maximum that applies to non-owner employees), to a specific dollar maximum.

  Even so, a SEP plan offers significant advantages for self-employed persons and small business owners. It allows a much greater annual pre-tax contribution than a standard IRA. In addition, individuals can contribute to their existing IRAs and 401(k)s, and still participate in their SEP plan.

Divorce and Retirement Accounts

  At one time the house was the biggest asset to split in most divorces. Today it may well be the retirement account. Whether it is a pension or profit-sharing arrangement, 401(k), IRA, stock bonus plan or Keogh, it will probably be split up as part of the divorce property settlement. While agents seldom want to find themselves in the middle of a divorce it may well happen if it happens to be an annuity or some other vehicle funded through an insurance company the agent represented.

Retirement Plans at Work

  Retirement accounts are often divided by using a qualified domestic relations order or QDRO. A QDRO is specific language that needs to be included in the divorce papers.

  The QDRO establishes the soon-to-be-ex-spouse's legal right to receive a designated percentage of the qualified plan account balance or benefit payments. Since the divorcing spouse may be entitled to this money, he or she will also be responsible for paying the related income taxes when that money is received in the form of a pension, annuity, or withdrawals. In effect, the ex-spouse becomes a co-beneficiary of the existing qualified plan account.

  Alternatively, the QDRO arrangement permits the ex-spouse to withdraw his or her share and roll the money over into his or her own IRA (to the extent current withdrawals are permitted by the terms of the qualified retirement plan). The IRA rollover procedure allows the ex-spouse to take over management of the money as well while continuing to postpone taxes until funds are withdrawn from the IRA. The important point from the earning spouse’s perspective is that his or her ex will be the one who owes any taxes due.

  While we often prefer to avoid legal documents out of fear or lack of understanding, it is not wise to split pensions without having a QDRO. Without such legal documents, the pension-earning spouse would have a taxable distribution and resulting taxes and penalties. In other words, he or she would owe the IRS for money that actually went to the ex-spouse. It would be a tax-free windfall for the ex-spouse at the expense of the earning spouse. It might also include a 10 percent premature withdrawal penalty if the accountholder is less than age 59½. Agents should never act as legal counsel, but the agent may well want to advise both clients (husband and wife) to seek legal help before splitting any account designed for retirement income.

  Understanding why a QDRO is advisable is the first step.  The next is to set one up. To do so, the language in the divorce papers must include the following:

• The name and mailing address of the "plan participant" and the "alternate payee";
• Each retirement qualified plan account to be split up under the divorce;
• The dollar amount or percentage of benefits to be paid from each account to the alternate payee; and
• The number of payments or benefits period covered by the QDRO.

  To be safe, the papers should also specify that a qualified domestic relations order is being established under their state's domestic relations laws and Section 414(p) of the Internal Revenue Code.

  There are a few other procedural details, so a tax professional with substantial divorce case experience should be consulted to make sure the process goes smoothly.  This must happen before the divorce papers are finalized. Do not assume the divorce attorney knows how to properly draft a QDRO. Many attorneys do not understand the tax implications of splitting a pension plan.  Again, we are not advising agents provide either tax or legal advice. Doing so is foolish, but it may be wise to suggest to the divorcing clients that each seek out a pension specialist regarding this prior to finalizing their divorce.

  If the qualified pension plan is with a major company, the plan administrator will usually make sure the divorce papers include proper QDRO language before allowing the divorcing individuals to withdraw any money but this cannot be taken for granted.

  The risk is highest that the pension administration will not require a proper QDRO when it is a small business or the earning spouse manages the qualified retirement plan personally, without the help of a qualified administration. This often happens when the pension earner is self-employed, such as agents tend to be. People in this position often hand over-qualified retirement account money without a QDRO because they do not understand the tax implications and the potential penalties involved.

IRAs and SEPs

  A QDRO is not required to split up an IRA account, but the pension earner still needs to be very careful. It is possible to roll over money tax-free from one IRA or SEP to another without it being considered a withdrawal under certain circumstances, but when an ownership change is involved taxation and penalty rules could apply. It should only be done if this division is called for in the divorce property settlement. Then the pension earner does not have some of the responsibility he or she might otherwise have.  

  At all times the focus should be on avoiding tax implications and penalties that could be involved in splitting a pension fund, regardless of the type it happens to be.  Usually the divorce papers need to include the following wordage: "Any division of property accomplished or facilitated by any transfer of IRA or SEP account funds from one spouse or ex-spouse to the other is deemed to be made pursuant to this divorce settlement and is intended to be tax-free under Section 408(d)(6) of the Internal Revenue Code." It may not say this word-for-word but some form of it should exist.

  If money from an IRA account set up in one person’s name and is transferred to the other spouse without proper documentation and use of correct legal avenues the earning spouse may find him or herself paying taxes and penalties that would not otherwise have been due. The same rules apply to simplified employee pension (SEP) accounts, because they are treated as IRAs for this purpose.

  How do people most commonly get into trouble?  Some try to make predivorce rollovers from one spouse's IRA to the other's thinking it is a tax-free transaction.  It often is not.  It could be treated as a taxable distribution to the IRA owner (the person in whose name the account is set up).  Others try to satisfy post-divorce financial obligations to their ex by taking IRA withdrawals.  Once again, this will always trigger an immediate tax bill for the IRA owner, even though the ex-spouse receives the money.

Women are Receiving More These Days

  There was a time when pension funds were not divorce issues. The person earning the pension kept it; this usually meant the husband had the pension and the wife did not. That is no longer true. Many divorces now involve pension divisions. The earning spouse is most likely to lose half, but sometimes he or she loses the entire account if other conditions warrant it. It is now common to hear: “She/He took my retirement. I didn't even think that was a possibility.”

  Men have always complained about their divorce settlements, but in reality, they've typically come out far ahead financially. Women often ended up living in poverty circumstances, even when alimony was granted.  No longer. Today’s divorcing women are closer than ever to achieving parity.  Due to many factors, courts are putting a higher price tag on what the nonworking or lower-earning spouse, usually the wife, contributes to the marriage. Judges are granting more alimony, putting more assets in play, and increasingly requiring husbands to pay their wives' legal fees. Of course, each case is individual, but primarily pensions are now on the divorcing tables.

Keep Premarital Assets Separate

  Although most people fail to do this, marrying couples should keep their premarital assets separate even during marriage. Any money one spouse brings into a marriage before the wedding is considered separate property should the couple get divorced. There is one important exception to the rule: commingling funds in a joint bank account or spending it on something for the couple changes it to joint property in most cases.

Protect Your Inheritance

  In most states an inheritance, regardless of when it was received, is also viewed as separate property, unless it is gifted to the spouse. Again, if the money is deposited into a joint account or spent on something for the couple, then the assets are converted into marital property.

After the Divorce

  Faced with the financial responsibilities of being single again, many recently divorced people put retirement savings on hold, but that is a big mistake. Instead, they should reorganize their financial priorities to find a way to continue saving for retirement. The time will still come, and retirement funding will still be a necessity. In fact, it may be even more important to save for retirement since the individual will be relying on one income rather than two.

  A divorce could also leave the person with investments that do not fit his or her investment goals. Perhaps they involve more risk than the individual is comfortable with or maybe they are too conservative for the time frame involved until retirement. The divorced individual may need to reassess what they already have for retirement as well as set future goals for acquiring more retirement assets. 

  A divorced individual may be able to collect Social Security based on their ex-spouse's entire earnings history, even earnings earned after the divorce. This is known as “derivative benefits.”  It is particularly attractive for stay-at-home parents who have had little earned income of their own.  There are, however, certain restrictions: the marriage must have lasted at least 10 years, and the individual cannot have remarried at the time he or she starts collecting benefits.

  Derivative benefits equal half of the ex-spouse's own benefit.  In other words, if the ex-spouse receives $1,000 per month, the ex-spouse would receive $500. Individuals need to choose between collecting their own Social Security or the derivative benefit, whichever is more. It is not possible to collect both the ex-spouse’s Social Security and their own simultaneously. Details are available at the Social Security Administration's website.

Dividing Other Investments

While attorneys may be very knowledgeable on the divorce laws of their state, they may not necessarily be as well versed on taxation, financial vehicles, pensions and other financial issues. The 50/50 split they proposed in court might actually be a 60/40 split after taxes are taken into account. Again, insurance agents should never offer legal advice, but they should suggest a tax accountant or financial expert be consulted. This would especially be true if their clients are asking questions about the vehicles they purchased from the agent in a divorce context.

  While still married, generally people can make unlimited tax-free transfers of investment assets held in taxable accounts or anywhere else. The same is true for later transfers between the divorcing couple if they are made per the divorce property settlement. This assumes both spouses are U.S. citizens. After such a tax-free transfer, the new owner's tax basis in the investment is the same as the old owner's, and the new owner's holding period includes that of the old owner. Nothing should ever be assumed, however. All transfers should be done after consulting with a tax and investment specialist since many taxation factors are affected by divorce.

  For example, if the property settlement calls for one party to give the other some long-held stock, there is no immediate tax impact. The ex-spouse steps into her husband’s shoes and keeps going under the same tax rules that would apply if he still owned the stock. If the stock was jointly owned or community property, nothing changes tax wise. When your ex-spouse sells, she will owe the federal capital gains tax plus any state and local taxes.

  Of course, that's the tax catch. When she ends up owning appreciated investments, they come with a tax liability attached. The bigger the gain, the bigger the built-in tax bill. So from a net-of-tax point of view, appreciated investments are worth less than an equal amount of cash or financial items that have not appreciated.

Good News for Attorneys

  According to the CDC, the divorce rate is 2.3 per 1,000 population (from 2000-2020)[2]. On average the divorce rate seems to be going down. On average cost of a divorce is between $15,000 and $20,000 while the median is $7,000 according to Forbes. Divorce is second only to death in “traumatic” experiences.

  Due to the high costs (often more than either party can afford) many are turning to mediators and this can prevent some financial mistakes with pensions as well.  Of course, the mediator must be versed in such issues, so both parties should ask for the individual’s qualifications prior to employing them.

  However the couple separates their financial vehicles, the separation can be financially painful since one party is giving up something of value to the other. Many financial planners, due to our high divorce rates, now recommend that even happily married couples have separate pensions from the start of their marriage. While one person’s pension may be tied to an employer it does not mean that both must be. Putting an equal amount into an annuity or some other format can provide equalization. Of course, we all want to believe that our marriages will last; if that proves true it just means there will be two accounts funding the couple’s retirement. It never hurts to have more money in retirement than might otherwise have existed.

End of Chapter 7

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[1] Helping Employees Achieve Retirement Security, Page 9

[2] https://www.cdc.gov/nchs/fastats/marriage-divorce.htm