Employee Benefits – Spring 2015 – Prof. Anderson
I. Introduction
a. Employee benefit plans include healthcare plans, disability plans, life insurance, retirement plans, severance
II. Time Value of Money
a. Present value
i. Also known as present discounted value, is a future amount of money that has been discounted to reflect its current value, as if it existed today.
ii. If interest rate is low, need more money up front to reach a certain number later
iii. Higher the discount rate, the lower the present value of the future cash flows
1. When the interest rate goes up, the present value of the given future value drops. Reduce the interest rate, and the present value increases
iv. Formula for the future value of a given present value after n years, earning interest at the annual rate as: Present value x (1+i)^n = future value
v. If we know the future value: Future value/(1+i)^n = present value
III. Tax Deferral
a. Employer deduction
i. EE may want to defer his income to a time when his tax bracket is lower
1. Generally has no effect on the employer whether you take it now or later
ii. Whatever employee counts as income employer can count as deduction
iii. But employer cannot count it as his deduction until the time employee counts it as income == matching principle
b. Constructive receipt
i. Income is deemed received as soon as it is “made available” to the recipient
1. Once made available, the recipient will not be permitted for tax purposes to turn his or her back on the income and defer it to a future year
c. For qualified retirement plans, both matching and constructive receipt do NOT apply
i. Do not have to pay taxes on qualified retirement until you take it out, but ER can take his deduction as soon as he makes it
d. Rabbi trust
i. This is a limited exception to the general tax rules
ii. Employer irrevocably transfers assets to a trust on the employee’s behalf with on critical caveat written into the trust agreement:
1. In the event of the employer’s insolvency, the assets of a rabbi trust are available to satisfy the claims of the employer’s general creditors
iii. This allows employers to get around ERISA rules if they don’t wanna set up qualified benefit plan
IV. Introduction to Qualified Retirement Plans (21-40)
a. ER who adopts a retirement plan for EEs and meets specific requirements may secure payments under the plan by means of an irrevocable trust w/o taxes until benefits paid
i. EE isn’t taxed now but employer takes deduction now
ii. Not available to creditors
iii. EE doesn’t pay taxes on contributions or gains until he takes the money out
b. Types of qualified plans
i. Defined Benefit Plans
1. The plan document specifies the amount of the benefit to be paid out at time of retirement (usually using a formula)
a. Retirement benefit = 1% x years of service x final salary (but not greater than 30% of final salary)
2. Investment risk and underestimation of contribution is on the ER/sponsor
ii. Defined Contribution Plans
1. Specifies how much ER will contribute to the plan on the EE’s behalf
2. Investment risk and underestimation of contribution on EE/participant
3. 401k Plan
a. Most prominent kind of defined contribution plan
b. EEs can direct ER to defer some of their pay into this plan
c. Employers might contribute in some way as well
4. Most retirement plans are defined contribution
5. Commonly paid as lump sum but can be paid as annuities as well
c. Vesting
i. Usually an employee must work a certain amount of time with the employer to be guaranteed any benefit under the plan
1. If not vested, no benefit under the plan
ii. Graded vesting
1. Vesting according to a schedule
a. Ex: Leave 60% vested, accrued is 10% of final salary = get 6%
2. Cliff vesting
a. After a certain amount of years you’re 100% vested, no grading
V. Anti-discrimination Rules (Code §§ 410(b)(1)-(4), (6)(A), 414(q)(1)- (3), § 416(a)-(g)(1), (i)(1)
a. Must comply with the anti-discrimination rules for plan to be qualified
i. Still allow a lot of discrimination, just not too much to the highest paid EEs
b. Minimum Coverage Rules
i. Plan must cover a specified percentage of employer’s employees; or alternatively, a group of employees identified under a classification set up by the employer which did not discriminate in favor of officers, shareholders, supervisors, or highly compensated employees
ii. Separate Line of Business (SLOB rules) (414r)
1. Employer who has 2 completely separate businesses (well-digging and computer software design) can maintain a qualified plan for one of those groups of employees but not for the other
iii. Highly Compensated Employees (HCEs)
1. Anyone who is 5% owner of the employer during the year we’re talking about or during the preceding year
a. Count ownership by person’s spouse, children, parents
b. So if spouse owns 5%, I do too
2. OR anyone with compensation in excess of 120k (adjusted for inflation)
3. If not in either of those 2 categories è non-highly compensated employee (NHCEs)
4. Certain employees do not get counted
a. Employees counted under collective bargaining if they bargained over retirement plans)
b. Exclude non-resident aliens with no U.S. income
c. Exclude employees who have not yet satisfied minimum age and service requirements
c. Minimum Coverage Testing
i. Code provides tests to determine whether plan is in accordance with the nondiscrimination rules
ii. TEST: find % HCE benefitting, multiply by 70%, find % NHCE and compare the 2 numbers – if the % NHCE is at least as high then the plan passes, if not = fails
iii. For purposes of this test, doesn’t matter how much the person benefits
1. Under 401k you benefit even if you just have the opportunity to contribute money – even if you don’t actually contribute
d. Average Benefits test
i. Looks at how much employees benefit
ii. Complex – won’t need to know it
e. Cross testing
i. Testing defined benefit plans under defined contributions rules, and vice versa, by actuarially equating accrued benefits with equivalent contribution levels
f. Top Paid Group Election
i. Will help plan pass the test in a company that has a lot of top earners (law firm)
ii. Can change the definition of HCE so that 5% owners and people who make more than 115K are in the top 20%
1. Need to make more than 115k AND are in the top 20%
g. Controlled Group Rules
i. Keeping employer from creating 2 corporations and putting all the HCEs in one and all the NHCEs in the other
ii. If there is more than 80% ownership then we treat them as if they’re the same employer
h. Safe Harbors
i. The provision in law or agreement that will protect from any liability or penalty as long as set conditions have been met – basically a set formula
ii. If plan follows these requirements then it will be deemed to satisfy 401a4 non-discrimination rules without having to go through the testing each year
iii. Pro Rata Compensation safe harbor (if non-401k plan)
1. Same percentage of compensation for all participants
2. Plan compensation is a term of art. It means actual compensation, but only up to a limit, which is $260,000 for 2014
3. See illustration on course page
i. Top Heavy Rules (416) (p. 48) (flowchart on CP)
i. Entirely additional set of non-discrimination rules that plan needs to pass in addition to non-discrimination
ii. Plan will fail if key employees account for more than 60% of all the accrued benefits under the plan, unless the plan provides special minimum benefits and vesting for NON-key employees
iii. Officers: number of officers cannot exceed 50
1. Fewer than 50 employees, it’s the greater of 3% or 10%
iv. If the plan is top heavy: if DCP, must make annual contributions to the account of every non-key ee of at least 3% of planned contribution until its not top heavy anymore
v. Takeaways:
1. Fo
i. They then use this information to come up with the contribution amount for the employer
ii. ERISA has rules to govern what methods actuaries use to come up with these amounts
c. Want to limit issues with underfunding
i. Employer will need to put more money in later years
d. Past Service Liability
i. Employer runs a company for 20 years and then decides to institute a plan – what happens to employees who have worked there all that time?
1. Employer will most likely give them their credit (20%)
2. Problem then that on 1st day of plan employer needs to put a massive amount of benefits into the plan
3. To solve this, company is allowed to spread the cost of the past service liability over a long period of time, so essentially the plan will be underfunded during this period – so what if employer goes out of business??
a. ERISA holds employer responsible for the full amount under the plan
i. Spread the liability to the controlled groups (affiliates, companies with common ownership, etc)
ii. Liability does not go away in bankruptcy
b. ERISA also created PBGC
i. Basically a federal insurance agency that collects premiums and insures benefits
ii. Plan sponsor pays premiums, if they go under PBGC will pay plan participants and go after the employer and controlled group
iii. Chronically underfunded
iv. Covers only DBPs not DCPs
VIII. Portability (67)
a. Ability of an individual employee to change jobs without adversely affecting his or her retirement benefits
b. Several ways employee may lose value when changing employers
i. may not be totally vested and forfeit some or all of the benefit
ii. may not be able to participate in the new employer’s plan for while
iii. employer 2 plan may be less generous
iv. employer 2 may have a more stringent vesting schedule
c. Defined Benefit Plans
i. U.S. law really does nothing for portability so you will just get retirement checks from multiple plans
d. Defined Contribution Plans
i. Law provides a limited portability tool: rollovers
ii. Can rollover the old plan into a new plan or an IRA
iii. Continue the same treatment as under the qualified plan
iv. Rollovers do not count against the 52k cap on annual additions
IX. IRAs (70)
a. Savings accounts established by individuals not by employers
b. Meant for low to mid level workers without qualified plans
c. Have same tax advantages as qualified plans
d. Subject to less regulation
e. Lower limits on how much you can put in
i. If income is above a certain level and you’re part of a qualified plan then you can’t contribute to the plan at all
