Steps to get a plan qualified under Sec 401.

Qualified plans are employer sponsored plans that helps the employee save money on a pre tax basis towards retirement. Since qualified plans are the most important plans included in a compensation package employers tend to want to have these plans to offer as an incentive to recruit, reward, and retain employees. There are many tax advantages to the employer and employee under a qualified plan. In order for an employer to take advantage of the tax benefits and get a plan qualified under Sec 401 it must satisfy several requirements of the tax laws. Below I will discuss a few. Qualified plans must comply with requirements such as the minimum participation standards, non discrimination standards, minimum vesting rules, minimum funding standards, specific limitations on contributions and benefits and minimum survivor annuity requirements.

Participation requirements state that an individual must be at least 21 years of age and have provided a minimum of one-year service with the employer to be eligible to participate in the plan. There are no maximum ages or service restrictions.

Contributions or benefits must not discriminate in favor of highly compensated employees. All employees should be treated equal in regards to contribution to highly compensated and non-highly compensated employees.

Minimum vesting standards must be met. Vesting is the individual’s right to a percentage of benefits that they would be entitled to if they were to leave the employer before normal retirement age. All plans must satisfy at least one of two vesting schedules (Sec 411 a 2). Under a defined benefit plan employer contributions must vest under a 5-year cliff-vesting schedule or a 3-7 year graded vesting schedule. A 5 year cliff is when an employee has completed 5 years of service with the employer and a 3-7 year schedule is when the employee becomes vested after 3 years of service at a 20 percent rate per year. Defined contribution plans must vest the non-elective contributions faster than defined benefit plans. Employers must comply with either a 3-year vesting schedule or a 2-6 year graded vesting schedule.

Contributions and benefits to the qualified plan must not exceed the specified limitations (as of 2014). These limits set maximum amounts that an employer may contribute to participants. Defined benefits plan contribution limit is the lesser of $210k (annual) or 100% of the average compensation for high 3 years. Defined contribution plan limit is the lesser of $52k or 100% of the compensation.

Employer must provide automatic survivor benefits in two forms. A qualified joint and survivor annuity which is payments for a vested participant that does not die before annuity start date and a qualified pre retirement survivor annuity which is payments to the surviving spouse of the vested participant.

Question: All requirements must be satisfied (at minimum) in order for the plan to be qualified under Section 401. Choosing any requirement mentioned above (or from IRC Sec 401) what is the significance of that requirement and why do you think it was mandated? Are there any other requirements other than those mentioned above or discussed in class?