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Deferred Compensation Plan
A deferred compensation plan is a program maintained by an employer
to defer the receipt of compensation by its employees for more
than a few months, usually until retirement or other termination
of employment. A deferred compensation plan may be either qualified
or nonqualified.
Qualified Plan
A qualified plan is a deferred compensation plan that meets
a set of requirements outlined in the Internal Revenue Code
primarily structured to make such plan nondiscriminatory with
respect to highly compensated employees. A qualified plan provides
several favorable tax attributes including:
- amounts contributed for an employee are not subject to current
taxation
- amounts contributed are currently deductible by the employer
- investment earnings are not subject to taxation when earned
- taxation of distributions may be further deferred by rollover
to an individual retirement account or other qualified plan.
Nonqualified Plan
A nonqualified plan is a deferred compensation plan which does
not meet the requirements to be qualified. Consequently, the
plan may discriminate in favor of highly compensated employees
both as to eligibility to participate and benefit levels. Often
a nonqualified plan is merely an unfunded promise to pay future
benefits. An employer receives a deduction for contributions
to a nonqualified plan only at such time as the employee includes
the contribution in his income.
Defined Contribution Plan
A defined contribution plan is a deferred compensation plan in
which a participant's benefit is expressed as the value of a separate
bookkeeping account maintained on his behalf. This account is
credited with contributions as outlined in the plan and then adjusted
for gains and losses arising from plan investments. No specific
level of benefits are promised. There are several types of defined
contribution plans including:
Profit Sharing Plan
Historically, contributions could be made only from the employer's
profits, either current or accumulated. While the contribution
formula could be fixed, most were subject to employer discretion.
Since profits are no longer required, these plans might now
more accurately be called discretionary contribution plans.
Money Purchase Pension
Plan
A money purchase pension plan specifies a fixed rate of contribution
for each participant usually expressed as a percentage of compensation.
The contribution is required even if the employer is unprofitable
in a given year.
401(k)
Plan
A 401(k) plan is a type of profit sharing plan which allows
employees to voluntarily contribute to the plan via payroll
deduction. These contributions are free from current federal
or state income taxation. Often the employer will match all
or part of the employee's contribution.
Employee Stock Ownership Plan
An employee stock ownership plan is a defined contribution plan
designed to invest primarily in employer securities. There are
a number of tax incentives designed to encourage employee ownership
through this type of plan.
Cross-tested
Defined Contribution Plan
A cross-tested defined contribution plan is a plan which satisfies
the required nondiscrimination rules by comparing anticipated
benefits at retirement rather than the current rate of contributions
as specified in the plan. In estimating the benefits at retirement,
actuarial principles are employed.
Defined
Benefit Pension Plan
A defined benefit pension plan is a deferred compensation plan
in which a participant's benefit is stated in the plan document
as a stream of income commencing at retirement based on such factors
as average compensation and length of service. The employer's
contributions to fund the stated benefits are determined by an
enrolled actuary. Investment gains and losses do not directly
affect a participant's level of benefits, but do impact the employer's
required contributions.
SEP IRA
SEP
is an acronym for Simplified Employee Pension. It is a plan designed
for small businesses with attributes similar to a profit sharing
plan, although with less flexibility in design. Contributions
are deposited into an individual retirement account for each participant
rather than through a trust fund. In exchange for lack of flexibility,
these plans have less complexity and fewer reporting requirements.
SIMPLE IRA
SIMPLE is an acronym for Savings Incentive Match Plan for Employees.
It is a plan designed for small businesses with attributes similar
to a 401(k) plan, although with less flexibility in design. Contributions
are deposited into an individual retirement account for each participant
rather than through a trust fund. In exchange for lack of flexibility,
these plans have less complexity and fewer reporting requirements.
Cafeteria Plan
A cafeteria plan is a program which permits employees to choose
between two or more benefits consisting of cash and certain qualified
fringe benefits. Examples of such fringe benefits include health
insurance coverage (including dental, vision, and self-insured
plans), medical reimbursement, dependent care assistance, group
term life insurance coverage, and disability insurance coverage.
The cost of benefits may be provided by the employer, by employee
salary reduction, or a combination of each. Most of the qualified
fringe benefits are not subject to current federal or state income
and employment taxation.
Prototype Plan
A prototype plan is a type of plan document which has been preapproved
by the Internal Revenue Service as to form. It consists of two
parts - an adoption agreement and a basic plan document. The adoption
agreement contains options that are available to the employer
to tailor its design. The basic plan document contains definitions
and operational rules which apply to the options contained in
the adoption agreement.
Under a standardized adoption agreement, any available option
is acceptable to an adopting employer. A nonstandardized adoption
agreement provides more options, and hence more flexibility, but
some of these options may not be acceptable to an adopting employer
based on its demographics. The adopting employer should therefore
generally submit these prototypes for approval.
Volume Submitter Plan
A volume submitter plan is a type of document that has been prepared
by a practitioner (e.g., law firm, accounting firm, third party
administrator) who submits a large number of plans on behalf of
employers to the Internal Revenue Service. As such, the basic
language in the document has been preapproved as to form. Certain
sections of the document are variable, however, by an adopting
employer. The IRS will limit its review during the approval process
to these sections.
Individually Designed Plan
A document that does not fit the profile of a prototype plan or
a volume submitter plan is considered an individually designed
plan. Any design feature allowed by law may be incorporated in
an individually designed plan. The IRS will review all aspects
of such a plan when it is submitted for approval. Consequently,
the approval process is more costly.
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