Types of Retirement Plans - Qualified Plan Rules and Options

Publication 560: Retirement Plans for Small Business, Internal Revenue Service
401(k) and Qualified Plans, Investopedia.com, /university/retirement plans/qualified plan/
Leimberg & McFadden, The Tools & Techniques of Employee Benefit and Retirement Planning, 8th Edition
Fundamentals of Employee Benefits Programs, 5th Edition, Employee Benefit Research Institute

Nondiscrimination and eligibility requirements
Under a qualified plan, neither contributions nor benefits may discriminate in favor of highly compensated employees and must cover a minimum number of employees.

  1. Age and service requirements - In general, an employee must be allowed to participate if he or she meets the following requirements:
    • Has reached age 21.
    • Has at least one year of service (two years if the plan is not a 401(k) plan, provided after not more than two years of service the employee has a nonforfeitable right to all his or her accrued benefit).
    • A plan cannot exclude an employee who has reached a specified age.
  2. Coverage requirements - A qualified plan must cover at least the lesser of the following:
    • 50 employees.
    • The greater of:
      • 40% of all employees, or;
      • Two employees.
      • If there is just one employee, the plan must benefit that employee.
  3. Minimum participation
  4. Highly compensated employee - A qualified plan may not discriminate in favor of a highly compensated employee (HCE) in contributions or benefits. The definition of a highly compensated employee:
    • An individual who owned more than a 5% interest in a business at any time during the year or preceding year, or
    • For the preceding year, received compensation of more than $115,000 and was in the top 20% of employees as ranked by compensation.
  5. Permitted vesting schedules
    • Vesting - The process by which an employee earns a non-forfeitable right to benefits funded by employer contributions. Qualified plans must ensure that employees are vested in employer contributions according to vesting schedules that meet regulatory requirements. Employees are always 100% vested in their own contributions.
      An employer may choose one of two types of vesting schedules:
      • Cliff vesting - All contributions become fully vested at once after a specified period.
        • For regular employer contributions, such as profit-sharing contributions, the employee must be fully vested within five years.
        • For employer-matching contributions, the employee must be fully vested within three years.
      • Graded vesting - Contributions are vested over a period of time.
        • Regular employer contributions - 20% of contributions vested after three years of service with an additional 20% vested each subsequent year until 100% vested, which occurs after seven years of service.
        • Employer matching contributions - 20% of contributions vested after two years of service with an additional 20% vested each subsequent year until 100% vested, which occurs after six years of service.
      • Forfeiture of contributions - Employee who leaves employer before becoming 100% vested forfeits unvested portion of employer contributions.
      • Vesting eligibility - Employee who performs at least 1,000 hours of service within one-year period must be credited with a year of service for vesting purposes.
      • Automatic vesting - An employer may elect to allow immediate, 100% vesting.
  6. ADP/ACP testing - Actual Deferral Percentage (ADP) and Actual Contribution Percentage (ACP) are special tests 401(k) plans must undergo to ensure the plans do not discriminate in favor of highly compensated employees.
    • Actual Deferral Percentage testing - Designed to limit extent to which employee contributions by Highly Compensated Employees exceed contributions by Non-highly Compensated Employees.
      • Highly Compensated Employee - An individual who:
        • Owned more than 5% of a business at any time during the year or the preceding year, or
        • For the preceding year, received compensation of more than $115,000 in 2014 and was in the top 20% of employees when ranked by compensation.
    • o A 401(k) plan must satisfy one of two ADP tests.
      • ADP of all HCEs for plan year may not exceed ADP of all other employees for the preceding plan year multiplied by 1.25, OR
      • ADP of all HCEs for plan year does not exceed ADP of all other employees by more than 2% and the ADP of eligible HCEs for plan year is not more than ADP all other eligible employees for preceding year multiplied by 2.
    • Actual Contribution Percentage - A test to ensure employer contributions and employee after-tax contributions to plan do not discriminate in favor of Highly Compensated Employees.
      • A plan meets the ACP test if:
        • ACP for HCE is not more than 1.25 times the ACP for non-HCE.
        • Average ACP for HCE is not more than twice the ACP for other employees and does not exceed the ACP for other employees by 2%.
  7. Controlled group - A group of two or more employers with sufficient common ownership under Internal Revenue Code Section 1563.
    • For purposes of qualified plan requirements and testing, the IRS treats a controlled group as a single employer.
Integration with Social Security/disparity limits
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