Glossary
Average Contribution Percentage Test (“ACP” Test)
Average Deferral Percentage Test (“ADP” Test)
The Employee Retirement Income Security Act of 1974 (“ERISA”)
Genetic Information Nondiscrimination Act of 2008 (“GINA”)
Health Insurance Portability and Accountability Act of 1996 (“HIPAA”)
Internal Revenue Service (“IRS”)
Non-Highly Compensated Employee (“NHCE”)
Pension Benefit Guaranty Corporation
Third Party Administrator (“TPA”)
§ 162(m) – Provision of the IRC that allows a company to deduct up to $1 million of performance-based compensation paid out to its covered employees. See IRC § 162(m). IRS Notice 2007-49 provides guidance on identifying covered employees for purposes of this section. In general, the IRS treats the (a) the principal executive officer of the taxpayer or the individual acting in such a capacity, and (b) the three highest compensated officers (excluding the principal executive officer or principal financial officer) as "covered employees."
§ 401(k) Plan – A type of employer-sponsored retirement plan that allows employees to choose to have a percentage of their salary contributed to the plan and invested, thereby postponing current income tax on the deferred portion of income. Additionally, the employer can choose to match an amount of the employee’s contribution by depositing additional sums into the employee’s account. See ERISA § 401(k).
§ 403(b) Plan – A type of retirement plan a tax-exempt entity might establish for its employees. Like the 401(k) plan, it allows employees to choose to have a percentage of their salary contributed to the plan and invested, thereby postponing current income tax on the deferred portion of income. It differs from a 401(k) plan in that only non-profits (such as school, hospitals, universities, charities, and research institutes) can maintain 403(b) plans. See ERISA § 403(b).
§ 410(b) Minimum Coverage Test – The minimum coverage test analyzes the percentage of NHCEs compared to the percentage of HCEs covered under the plan. A plan satisfies the minimum coverage test of IRC § 410(b) if it passes the Ratio Percentage Test or the Average Benefit Test. In order to pass the Ratio Percentage Test, the percentage of NHCEs eligible to participate under the plan must be at least 70% of the percentage of HCEs eligible to participate. If a plan fails to meet the requirements of the Ratio Percentage Test, it can instead attempt to meet the requirements of the Average Benefit Test. The Average Benefit Test requires a plan to benefit a nondiscriminatory classification of employees, as well as to have an average benefit percentage for non-highly compensated employees that is at least 70% of the average benefit percentage for highly compensated employees. See IRC § 410(b).
§ 412(i) Plan –(which is now section 412(e) of the Internal Revenue Code): A defined benefit pension plan that is fully funded using annuity or insurance contracts. The only difference from a traditional defined benefit pension plan is the method of funding. The plan must still meet all of the coverage, non-discrimination and benefit requirements under ERISA. The plan is designed for small businesses; however, due to the large premiums that employers must pay each year, this plan may not be ideal for all small businesses. See IRC § 412.
§ 501(c)(3) Organization – An organization that is tax exempt; it must be organized and operated exclusively for the exempt purposes set forth under the section, and none of its earnings can inure in favor of any private shareholder or individual. Organizations within this category are typically referred to as charitable organizations. Furthermore, such organizations are restricted in their political and legislative activities. See IRC § 501(c)(3).
Average Contribution Percentage Test (“ACP” Test) –This is a non-discrimination test that measures employer matching contributions and/or employee after-tax contributions into a 401(k) plan. The ACP test is almost identical to the ADP test, except that it compares the ACP for the group of eligible HCEs to the ACP for the group of eligible NHCEs. See 26 CFR 1.401(m)-2.
Average Deferral Percentage Test (“ADP” Test) – This is a non-discrimination test that measures how much an employee has contributed into a 401(k) plan. For example, a person making $40,000 contributes $4,000, thus the calculation would be 4/40,000 = 10%. The test requires an employer to classify each employee into a class (HCE/NHCE). The employer must then compare the average rates of the two classes. To pass the test, the ADP of the HCE group must not exceed the ADP of the NHCE group by 1.25% or 2 percentage points, as a general rule. See 26 CFR 1.401(k)-2.
Cafeteria Plan –An employee benefit plan maintained by an employer and funded with nontaxable employer dollars, which allows an employee the flexibility to choose among different types of levels of benefits to suit their particular needs. Employers must permit participants in a cafeteria plan to choose among at least one taxable benefit (e.g. cash) and one qualified benefit (e.g. dependent care assistance). See IRC § 125.
Covered Employees – IRC § 162(m)(3) defines a “covered employee” as any employee of the taxpayer during a taxable year who: (1) is the chief executive officer of the taxpayer or is an individual acting in such a capacity; or (2) is among the four (4) highest compensated officers (other than the chief executive officer). This classification is necessary for purposes of compliance with IRC § 162(m). See IRC § 162(m).
Defined Benefit Plan – A pension plan under which an employee receives a set monthly amount upon retirement, which the employer guarantees for the employee’s lifetime. The amount of the benefit is based upon a formula that takes into account the participant’s wages, length of service, and benefit accrual rate.
Defined Contribution Plan – A retirement savings program, such as a 401(k) plan, under which employees make certain specified contributions to an account during employment. A defined contribution plan differs from a defined benefit plan because at retirement, there is no guarantee of a specified benefit. The benefit is based upon the contributions by the employee, which the employer may match, and investment earnings of the plan.
Department of Labor (“DOL”) – Government agency responsible for setting standards and enforcing compliance in areas such as fiduciary breach, occupational safety, wages, unemployment insurance benefits, and re-employment services. See http://www.dol.gov/dol/aboutdol/main.htm.
Employee Benefit – Various types of non-wage compensations provided to employees by their employer in addition to their normal wages. Generally, employees exchange wages for some other form of benefit. Some of these benefits include: group insurance, retirement benefits, sick leave, vacation, social security, profit sharing, and other specialized benefits.
The Employee Retirement Income Security Act of 1974 (“ERISA”) – A federal statute, which establishes rules and minimum standards for employee benefit plans. The purpose of ERISA is to protect the interests of employee benefit plan participants and beneficiaries through the lengthy requirements laid out under the provisions of the statute. Additionally, ERISA provides participants and beneficiaries access to the federal courts to dispute claims. The IRS, the DOL and the PBGC govern the interpretation and enforcement of the provisions of ERISA. See http://uscode.house.gov/download/pls/29C18.txt
Excess Contributions – The amount that equals the excess of (1) the elective contributions, including qualified nonelective contributions and qualified matching contributions that are treated as elective contributions, made on behalf of an eligible HCE for the plan year, divided by (2) the maximum amount of such contributions permitted under the ADP test for that plan year.
Fiduciary – One who has a duty, imposed by law, to act with loyalty and care towards another person or organization. ERISA’s definition of fiduciary duty, which establishes higher standards of care for individuals who have control over a plan’s assets, is binding upon employers who offer employee benefit plans. Under ERISA, each plan must have a named fiduciary who is liable to the plan for a duty of care, duty of loyalty, duty of prudence and duty to follow plan terms. For more information, see ERISA §§ 3(21), 404(a)(1).
Fiduciary/Fidelity Bond – Statutorily mandated insurance that a plan must carry. Plans are generally required to carry fiduciary bond insurance equal to at least 10% of the dollar value of their plan’s assets, but at no time less than $1,000. Additionally, the fiduciary bond limit cannot exceed $500,000, unless the plan holds employer securities, in which case the maximum insurance amount increases to $1,000,000. The purpose of the bond is to protect the plan from possible actions taken by a fiduciary. See ERISA § 412.
Fiduciary Liability Insurance – Insurance that insures the individual fiduciary’s personal assets. Employers must not confuse fiduciary bond coverage with fiduciary liability insurance. In assessing whether the policy is a bond or liability insurance policy, employers must look to who is ultimately benefiting. If the policy is protecting the plan, it is likely a bond, whereas if the policy is protecting the individual fiduciary, it is likely fiduciary liability insurance. While a fiduciary bond is a statutory requirement under ERISA, fiduciary liability insurance is not.
Form 5500 – Information filing with the federal government relating to an employer’s employee benefit plan. Under ERISA and the IRC, employers that sponsor employee benefit plans are required to file a Form 5500 annually with the Employee Benefits Security Administration (“EBSA”). The EBSA then reports the information contained within the form to the DOL, the IRS and the PBGC. The DOL and IRS use the information contained within the Form 5500 as the basis for DOL and IRS benefit plan audits. Therefore, accurate reporting and timely submission are critical for continued compliance. For instructions on completing the Form 5500, see http://www.irs.gov/instructions/i5500/index.html.
Genetic Information Nondiscrimination Act of 2008 (“GINA”) – An Act of Congress designed to prohibit the improper use of genetic information in employment. The Act expands upon the genetic information protections delineated under HIPAA. It forbids health insurers and group health plans from denying coverage to an individual based solely on a genetic predisposition. Furthermore, it disallows the use of an individual’s genetic information when making employment decisions, such as decisions relating to hiring, firing, job placement or promotion. Other provisions of the Act prohibit employers from requiring genetic testing and restrict the collection of genetic information. For more details on the coverage of GINA, see http://www.eeoc.gov/laws/statutes/gina.cfm.
Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) – An Act passed by Congress to reform health care. Title I of HIPAA protects health insurance coverage for workers and their families when they change or lose their jobs. Title II of HIPAA requires the establishment of national standards of electronic health care transmissions. It also mandates national identifiers for providers, health insurance plans, and employers. Congress enacted the provisions of Title II to help keep employees’ personal health information private. For more details on the coverage of HIPAA, see http://www.cms.hhs.gov/HIPAAGenInfo/Downloads/HIPAALaw.pdf.
Highly Compensated Employee (“HCE”) – Classification of employees which is necessary for nondiscrimination testing purposes. Individuals classified as HCEs fall into one of two categories: (1) An owner of more than 5% of the employer in the previous year; or (2) An employee who received compensation in excess of a specified limit from the employer in the previous year ($110,000 for 2010, indexed annually). See IRC § 414(q)(1)(B)
Internal Revenue Code (“IRC”) – The main body of statutory text relating to tax law. For instance, the IRC includes provisions concerning income taxes, payroll taxes, gift taxes and excise taxes. The Internal Revenue Service governs the enforcement and interpretation of its provisions. The IRC is contained in Title 26 of the United States Code. See http://www4.law.cornell.edu/uscode/26/ .
Internal Revenue Service (“IRS”) – Division of the U.S. Treasury Department that is responsible for the collection of most federal taxes, including corporate and income taxes. See http://www.irs.gov/ .
Key Employee – Employees who, at any time during the plan year, are: (1) A more than 5% owner of the employer; (2) A more than 1% owner of the employer with annual compensation greater than $150,000; or (3) An officer with annual compensation greater than $160,000 (for 2010 – indexed annually for cost-of-living adjustments). This classification is necessary for top-heavy testing purposes. See IRC § 416.
Non-Highly Compensated Employee (“NHCE”) – An employee who does not meet the definition of an HCE. This characterization is necessary for nondiscrimination testing purposes.
Pension Benefit Guaranty Corporation – A federal corporation created by ERISA to protect the pensions of American workers and retirees in defined benefit pension plans. See http://www.pbgc.gov/.
Third Party Administrator (“TPA”) – A service provider who assumes responsibility for administering employee benefit plans without assuming financial risk.
Top-Heavy Test –Test that ensures that lower paid employees receive a minimum benefit under the plan comparative to the key employees. To determine whether a defined contribution plan is top-heavy, one must look to the last day of the preceding plan year. Thus, an employer runs a top-heavy test for 2010, using plan assets valued as of December 31, 2009. In examining the previous year, one must assess whether the aggregate value of the plan accounts of key employees exceeds 60% of the aggregate value of the plan accounts of all employees under the plan. See IRC § 416
