Guidance for Special Types of Businesses

A Guide to Common Qualified Plan Requirements

A qualified plan must satisfy the Internal Revenue Code in both form and operation. That means that the provisions in the plan document must satisfy the requirements of the Code and that those plan provisions must be followed. The IRS administers a determination letter program that enables plan sponsors to get advance assurance as to the form of their retirement plan document.

Employers should establish practices and procedures to ensure that the plan is operated in accordance with the plan document so that participants and beneficiaries receive their proper retirement benefits. Be aware that the law and regulations in the retirement plans area frequently changes. Make sure that your plan document and determination letter, if applicable, are up to date.

What follows is a list of some of the more important retirement plan requirements to help employers in implementing practices, procedures and internal controls to monitor plan operations. Your plan may have other operational requirements that need to be monitored.

Note that problems often arise from changes in personnel, procedures, payroll system, or new service providers such as accountants, attorneys, actuaries or third-party plan administrators. Employers that have experienced any of these changes should give special scrutiny to operational requirements affected by the change.

1. Minimum Participation Requirements
2. Operate in Accordance with Plan
3. No Cutback by Plan Amendment
4. 401(k) ADP and Distribution Requirements
5. Matching/Employee Contribution ACP Test
6. Elective Deferral Limit
7. 415 Maximum Contribution/Benefit Limit
8. 401(a)(17) Maximum Compensation Limit
9. Top-Heavy Requirements
10. Minimum Vesting Requirements
11. Minimum Distribution Requirements
12. Consent for Distribution Requirement
13. Joint and Survivor Annuity Requirements
14. Direct Rollover Requirements
15. Assignment or Alienation Prohibition
16. Nondiscrimination Requirements
17. Coverage Requirements
18. 401(a)(26) Participation Requirement
19. Funding Requirements
20. Exclusive Benefit Requirement
21. Reporting and Disclosure

1. Does your plan document satisfy the minimum participation requirements of section 410(a)? Check that all appropriate employees began participation on the correct date in accordance with section 410(a) and the plan document.
   
   Section 410(a)(1) of the Internal Revenue Code (Code) sets forth the minimum age and service requirements for a qualified retirement plan. In general, a plan cannot require, as a condition of participation, that an employee complete a period of service with the employer extending beyond the later of:
   
   a. the date on which the employee attains age 21; or
   b. the date on which the employee completes one year of service.
   
   Section 410(a)(4) sets forth the rules for plan entry dates (the dates when an eligible employee must begin participation). Under Code section 410(a)(4), a plan is not qualified unless it provides that an employee who is otherwise eligible to participate under the terms of the plan commences participation no later than the earlier of:
   
   a. the first day of the first plan year beginning after the date on which the employee satisfied the Code section 410(a)(1) minimum age and service requirements; or
   b. the date 6 months after the date on which the employee satisfied the minimum age and service requirements.
   
2. In operation, did you include in the plan all the employees described in the plan document? Did you give them the benefits described in the plan?
   
   Your plan document describes who is covered under your plan, i.e., who benefits under your plan, and what contributions or benefits will be provided to those covered employees. Your employees’ rights to contributions and benefits are derived from the plan document. You must operate your plan strictly in accordance with the terms of your plan document; that is, you must cover the employees that your plan document describes as being covered and when the plan document says they should be covered, and you must provide them the contributions or benefits set out in the plan document. Even if the terms of your plan do not reflect your intent, you must follow the terms of your plan. Of course, the terms of your plan may be amended by a plan amendment. But see item 3. below with respect to the prohibition against cutting back benefits that your employees have already accrued (or to which they are already entitled) under the plan.
   
3. If the plan has been amended, did the amendment result in a cutback of accrued benefits prohibited by section 411(d)(6)? Make sure that no plan amendment reduced any participants benefit accrued before the amendment.
   
   Section 411(d)(6) prohibits the reduction of any participant’s accrued benefit by an amendment of the plan. In a defined contribution plan (a 401(k), profit-sharing, money purchase plan, etc.), this means that no employee’s account can be reduced because of a plan amendment. A plan amendment that has the effect of eliminating or reducing an early retirement benefit or a retirement-type subsidy, or eliminating an optional form of benefit, with respect to benefits attributable to service before the amendment will be treated as reducing accrued benefits.
   
4. If your plan is a 401(k) plan or contains a 401(k) cash or deferred arrangement (CODA), does it comply with the requirements of 401(k)? Check that your 401(k) plan complies with section 401(k), including the Actual Deferral Percentage test and the distribution requirements.
   
   Under a CODA, participants may elect to have their employer contribute a specific amount to the plan in lieu of receiving it in cash as wages. In order to satisfy the requirements of section 401(k), the plan must satisfy the Average Deferral Percentage (ADP) test. The ADP test requires that the deferral of income into the CODA by highly compensated employees be proportional to that for nonhighly compensated employees. Generally, amounts that the participant elects to defer may only be distributed upon specific events including death, disability, termination of employment, hardship and attainment of age 59 ½. The plan document must state that the Actual Deferral Percentage (ADP) test of Code section 401(k)(2) will be satisfied and must actually satisfy the test in operation.
   
5. If your plan permits employee and/or matching contributions, does it satisfy the nondiscrimination test for matching and employee contributions under Code section 401(m)? Determine that your plan satisfied the Actual Contribution Percentage test each year.
   
   If a retirement plan permits employee and/or matching contributions, the plan must satisfy the requirements of Code section 401(m). The plan document must state that the Actual Contribution Percentage (ACP) test of Code section 401(m)(2) will be satisfied and must actually satisfy the test in operation. The ACP test requires that the employee and matching contributions provided for highly compensated employees be proportional to those for non-highly compensated employees. Code section 401(m) does not apply to a defined benefit plan unless employee contributions to the plan are allocated to a separate account.
   
6. If your plan provides for elective deferrals, does it limit those deferrals to the section 402(g) limit? Check that in operation elective deferrals made for each employee are limited to the section 402(g) limit.
   
   Elective deferrals are amounts that employees elect to contribute to a retirement plan out of their compensation. A plan that provides for elective deferrals, for example a 401(k) plan, must provide that for each participant the amount of elective deferrals under the plan and all other plans, contracts, or arrangements of an employer maintaining the plan may not exceed the amount of the limitation in effect under Code section 402(g)(1). (Code section 401(a)(30))
   
   In addition to the plan terms providing that elective deferrals must satisfy the requirements of Code section 402(g), elective deferrals must satisfy these requirements in operation. For 2003, this limit is $12,000. This limit is adjusted for changes in the cost of living.
   
7. Did your plan limit contributions or benefits so they do not exceed the limitation set forth in section 415? Check to make sure that contributions made to any of your employees (or benefits accrued by your employees, if your plan is a defined benefit plan) were appropriately limited by the 415 limitations in accordance with the plan document.
   
   The limitations on benefits and contributions for retirement plans are set forth in Code section 415. For 2003, the annual benefit limitation for a defined benefit plan is $160,000 for each employee. The limitation on annual contributions to a defined contribution plan is $40,000 for each employee. These limitations are adjusted for changes in the cost of living.
   
8. Was the compensation of each employee taken into account under the plan limited to the section 401(a)(17) limitation? Check that for any employee with compensation in excess of $200,000, no more than $200,000 was taken into account under the plan for purposes of computing the employees contributions and benefits.
   
   The maximum annual compensation of each employee that can be taken into account under a plan for any year must not exceed $200,000 (for 2003). This limit is adjusted for changes in the cost of living.
   
9. Does the plan comply with the top-heavy requirements of section 416? Check that your plan’s top-heavy status is being determined and that if the plan is top-heavy, appropriate minimum vesting and contributions or benefits are being provided.
   
   A plan must satisfy certain vesting and minimum benefit requirements if the plan is top-heavy. In general, a plan is top heavy if 60 percent of the aggregate accrued benefits or account balances under plan are for the benefit of certain "key employees." Generally, a key employee is:
   • a 5 percent owner of the employer,
   • a 1 percent owner of the employer with over $150,000 in compensation from the employer, or
   • an officer of the employer with over $130,000 in compensation from the employer.
   
10. Did your plan satisfy the minimum vesting requirements? Check that any distributions from your plan were computed by applying the vesting schedule in the plan document.
    
    Code section 411 provides the minimum vesting requirements. This requires that each employee vest or own, at a minimum, a stated percentage of their interest in the plan each year. Your plan’s vesting schedule will be set out in your plan document. Many plans provide for 100% vesting for all employees immediately upon their commencement of participation. All employees must be 100% vested by the time that they attain Normal Retirement Age under the plan and when the plan is terminated. Amounts that are not vested may be “forfeited” by the employees when they separate from service with the employer. Your plan will describe how these forfeitures will be used: either to increase benefits or to fund future benefits for other plan participants. In a defined benefit plan, forfeitures must not be applied to increase the benefits any employee would otherwise receive under the plan. (Code section 401(a)(8))
    
11. Did your plan make required minimum distributions in accordance with section 401(a)(9)? Check to make sure that all distributions were made to employees at the correct time and in the correct amounts as described under the plan document.
    
    An employee’s assets may not remain in the retirement plan indefinitely. Section 401(a)(9) sets out the latest date by which distributions must begin and the minimum amount of the distribution. A plan must provide that the interest of each employee will begin to be distributed to the employee not later than the required beginning date which means, in general, April 1 of the calendar year following the later of:
    
    a. the calendar year in which the employee attains age 70 ½, or
    b. the calendar year in which the employee retires. (This does not apply to an employee who is a 5-percent owner.)
    
    At a minimum, the distributions must be evenly spread over the life of the employee or over the lives of the employee and a designated beneficiary (or over a period not extending beyond the life expectancy of the employee and a designated beneficiary). (Code section 401(a)(9))
    
12. Did the plan comply with the consent requirements of section 411(a)(11)? Check that distributions prior to normal retirement age or age 62 were made with the consent of the participant.
    
    Section 411(a)(11) prevents a plan from forcing a distribution on a plan participant prior to the time the participant attains normal retirement age or age 62. In general, if the present value of any nonforfeitable accrued benefit exceeds $5,000, a plan must provide that such benefit may not be distributed without the consent of the participant.
    
13. If applicable, are distributions from the plan made in accordance with the joint and survivor annuity requirements? Check to make sure that your plan made all distributions in the form of a joint and survivor annuity unless the spouse waives the right to a joint and survivor or your plan is a profit-sharing plan that is exempt from the joint and survivor annuity requirements.
    
    The joint and survivor requirements are designed to protect the employee’s spouse. In general, they require that distributions from the plan be made in the form of a joint and survivor annuity unless the spouse waives the right to a qualified joint and survivor annuity. The term “joint and survivor annuity” means an annuity for the life of the participant with a survivor annuity for the life of the spouse which is not less than 50 percent of (and is not greater than 100 percent of) the amount of the annuity which is payable during the joint lives of the participant and the spouse.
    
    The joint and survivor requirements do not apply to certain profit-sharing plans that do not provide distributions in the form of an annuity and that provide that the employee’s spouse receives the employee’s account upon death of the employee. (Code sections 401(a)(11) and 417)
    
14. If there were any distributions made, were participants given the right to a direct rollover? Check that for distributions from your plan eligible to be rolled over to another plan, the distributee was given the option to have the distribution transferred directly to the other plan.
    
    Your plan must provide that if the distributee of any eligible rollover distribution (a) elects to have such distribution paid directly to an eligible retirement plan, and (b) specifies the eligible retirement plan to which such distribution is to be paid, such distribution shall be made in the form of a direct trustee-to-trustee transfer to the eligible retirement plan. Your plan must comply with this provision in operation. (Code section 401(a)(31))
    
15. Check that, other than for participant loans permitted under the terms of your plan, no benefits under the plan were used as collateral for a loan or otherwise assigned or alienated.
    
    The plan must provide that benefits provided under the plan may not be assigned or alienated. In practice, the plan must not allow the assignment or alienation of any employee’s interest in the plan, other than for certain participant loans if they are provided for under the plan terms, and for certain qualified domestic relations orders. (Code section 401(a)(13))
    
16. Did the contributions or benefits provided under the plan comply with the nondiscrimination requirements of section 401(a)(4)? Determine that the plan satisfies the nondiscrimination test of section 401(a)(4).
    
    The contributions or benefits provided under a plan must not discriminate in favor of highly compensated employees. Section 401(a)(4) contains the test for nondiscrimination that a qualified plan must satisfy. The purpose of this test is to assure that the benefits provided to highly compensated employees are proportional to those provided to non-highly compensated employees.
    
17. Does the group of employees covered by the plan satisfy section 410(b)? Check to make sure that contributions are being made (or benefits are accruing) for each employee entitled to contributions (or benefits) under the plan document, and determine that this group of employees satisfies one of the tests below.
    
    In general, 410(b) sets out rules on who the plan must cover. In order to satisfy this Code section, a plan must meet one of the following tests.
        (1) The plan benefits at least 70 percent of employees who are not highly compensated employees. (percentage test)
        (2) The plan benefits:
            (i) a percentage of non-highly compensated employees which is at least 70 percent of
            (ii) the percentage of highly compensated employees benefiting under the plan. (ratio test)
        (3) The plan must benefit a classification of employees that does not discriminate in favor of highly compensated employees (nondiscriminatory classification test) and the average benefit percentage of the non-highly compensated employees must be at least 70 percent of the average benefit percentage of the highly compensated employees (average benefit percentage test).
    
    For purposes of Code section 410(b), employees who are included in a unit of employees covered by a collective bargaining agreement and employees who are nonresident aliens receiving no U.S. source earned income from the employer can be excluded from consideration.
    
    Note that changes in employee demographics may affect the way that the plan satisfies the coverage tests. In addition, if the employer has been involved in a merger, acquisition or divestiture of a business unit, the plan should be reviewed to assure that it passes one of the section 410(b) coverage tests.
    
18. If your plan is a defined benefit plan, does it comply with the minimum participation requirements of 401(a)(26)? Check that your defined benefit plan benefits at least the number of employees set out below.
    
    On each day of the plan year, a defined benefit plan must benefit the lesser of:
        (1) 50 employees of the employer, or
        (2) the greater of:
            (i) 40 percent of all employees of the employer, or
            (ii) 2 employees (or if there is only 1 employee, such employee).
    
19. If your plan is a money purchase pension plan or a defined benefit plan, has it complied with the minimum funding requirements of section 412? Check that appropriate contributions were made to the plan.
    
    If your plan is a defined benefit plan, an enrolled actuary will have to compute the funding required for the plan and sign Schedule B of Form 5500 setting out the plans funding status. If your plan is a money purchase pension plan, the contributions required by the plan document must be made in order to satisfy the minimum funding requirements of section 412.
    
20. Did your plan comply with the requirement that all plan assets are used for the exclusive benefit of employees and their beneficiaries? Check that none of your plan’s assets were diverted for other purposes.
    
    A trust is a medium under which the retirement plan assets are accumulated. The employer or employees, or both, contribute to the trust, which forms part of the retirement plan. The assets are held in the trust until distributed to the employees or their beneficiaries according to the plan’s provisions. The trust must be maintained for the exclusive benefit of the employees and their beneficiaries. Section 401(a) of the Code sets out the requirements that a trust must satisfy in order to “qualify” for favorable tax treatment. When a trust is “qualified” under section 401(a), it obtains its exemption from income tax under Code section 501(a).
    
21. Did your plan comply with the reporting and disclosure requirements?
    
    Make sure that your plan complies with the applicable reporting and disclosure requirements, including:
        a. retirement plans must file Form 5500 or 5500-EZ annually unless they are covered under one of the exceptions in the instructions to the forms.
        b. distributions from the plan must be reported to the IRS on Form 1099-R.
        c. participants must receive periodic statements of their account balance/benefits.