DEFINITION of Determination Letter
A determination letter is a formal document that the Internal Revenue Service or IRS issues. It decrees whether or not the retirement plan of the addressee is within the Employee Retirement Income Security Act (ERISA) guidelines. If the plan is determined to be lacking in some respect, the determination letter will list these shortcomings, along with the necessary action steps to take to comply. If the plan meets all of the requirements that ERISA sets forth, then the plan becomes certified as a qualified plan and is eligible for all resulting tax benefits.
BREAKING DOWN Determination Letter
Determination letters must be requested from the local IRS district office of the employer. If a plan is found to be deficient, then after corrections are made, the IRS will issue a second letter. This process can repeat itself until the IRS finds the plan compliant with ERISA guidelines. Determination letters can also be issued pursuant to proposed changes in an existing plan if needed.
Plans that qualify with ERISA guidelines are called qualified retirement plans or QRPs. Two main categories of QRPs exist: defined benefit (DB) and defined contribution (DC) plans. In addition there is also a hybrid of the two called a cash balance plan.
Defined benefit plans give employees a guaranteed payout and place the risk on the employer to save and invest properly to meet plan liabilities. A traditional annuity-type pension is an example of a defined benefit plan. Under defined contribution plans, the amount employees receive in retirement depends on how well they save and invest on their own behalf during their working years. A 401(k) is the most popular example of a defined contribution plan. Other examples of qualified plans include:
- Profit-sharing plans
- 403(b) plans
- 457 plans
- Money purchase plans
- Target benefit plans
- Employee stock ownership (ESOP) plans
- Keogh (HR-10)
- Simplified Employee Pension (SEP)
- Savings Incentive Match Plan for Employees (SIMPLE)
The Internal Revenue Service (IRS) provides a comprehensive guide to common qualified plan requirements.
Determination Letter and ERISA
ERISA, the Employee Retirement Income Security Act of 1974, was designed to protects Americans' retirement assets. It implements rules that qualified plans must follow to ensure plan fiduciaries do not misuse plan assets. Under ERISA, plans must provide participants with thorough information about plan features and funding, and regularly furnish information free of charge.
ERISA also sets minimum standards for participation, vesting, benefit accrual and funding. While ERISA covers many major retirement plans, it does not cover those set up and maintained by government entities, churches, or plans outside of the United States for its nonresident alien employees.