Common Terms in Defined Benefit Plans

Defined Benefit Plans

• 10-Year Certain and Life Annuity ("10 C&L")

  A Life Annuity (i.e. a series of payments that continues until death) with the added guarantee that it will be paid for at least 10 years whether or not the participant lives that long. Certain and Life Annuities are also commonly seen with a 5-year or 15-year guarantee period.

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• Accrued Benefit

  All Defined Benefit Plans have a formula to determine what annuity amount will be paid, usually monthly, starting at retirement age and continuing until death. Participants not yet at retirement age may have earned, or “accrued”, an annuity benefit based on compensation and service to-date, even though the annuity is not scheduled to begin until later.

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• Actuarial Valuation

  A valuation, usually performed annually, to determine how well-funded a plan is and the amount the employer must contribute to the plan for the year. A valuation may also develop a maximum deductible contribution or other measurements that are required or desired.

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• Actuary

  “The typical actuary is a man past middle age, spare, wrinkled, intelligent, passive, non-committal, with eyes like codfish…Happily they never reproduce …” (Saturday Evening Post, 1940).

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• Adjusted Funding Target Attainment Percentage ("AFTAP")

  A specific measurement of the plan’s assets as compared to its liabilities (in other words, its Funded Status), created by the Pension Protection Act of 2006. It is the benchmark for determining whether a plan is adequately funded or is subject to one or more of several restrictions that are imposed on an Underfunded plan.

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• Annuity

  A sum of money payable over time at regular intervals.

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• Average Monthly Compensation ("AMC")

  An average monthly rate of compensation or income earned by a participant over a given time period that is commonly used to determine his or her benefit.

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• Benefit Restrictions

  Plans with an Adjusted Funding Target Attainment Percentage under 80% may be restricted from activities such as allowing Lump Sum payments to participants, being amended to increase benefits, or even in some cases accruing any new benefits at all. These restrictions are designed to protect Underfunded plans and may be lifted when the plan’s funding improves.

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• Cash Balance Plan ("CB Plan")

  A Defined Benefit Plan that has the look and feel of a Defined Contribution Plan. Some key differences between a Cash Balance Plan and a Defined Contribution Plan are that a Cash Balance Plan (1) provides stated rates of contributions and investment return, (2) often has higher tax-deductible contribution limits, and (3) may have required minimum contributions if it is not well-funded.

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• Cross-Test

  Cross-Testing refers to the way in which a plan demonstrates it meets nondiscrimination requirements. The need for Cross-Testing usually indicates a plan that offers different contribution or benefit rates for Owners and employees.

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• Deferred Annuity

  Any type of annuity, such as a Life Annuity or Joint and Survivor Annuity, that is not scheduled to begin until a date in the future, usually at a participant’s retirement age.

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• Defined Benefit Plan ("DB Plan")

  The category of retirement plans in which the amount a participant receives at retirement age is specifically defined in the plan document’s benefit formula. That amount is due to the participant regardless of what was contributed to the plan in the past. Defined Benefit Plans are also required to offer the option for participants to receive benefits in an annuity form and do not maintain individual participant accounts. Defined Benefit Plans often feature higher tax-deductible contribution limits; minimum contributions may be required if the plan is not well-funded.

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• Effective Rate

  The single rate of interest that would yield the same Funding Target, or liability, as a set of rates that vary based on the length of time from the Valuation Date until a payment is due. The Effective Rate is used to add interest to the required contribution from the Valuation Date to the date it is actually deposited to the plan.

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• Fidelity Bond

  The law generally requires that every person who handles plan assets be bonded. The requirement for a Fidelity Bond is designed to help protect plan assets in the event of fraud or dishonesty. Unlike a Fiduciary Bond (or Fiduciary Insurance), the plan is named as the loss payee under a Fidelity Bond. Also referred to as an ERISA bond.

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• Fiduciary Bond (or Fiduciary Insurance)

  Unlike a Fidelity Bond, a Fiduciary Bond or Fiduciary Insurance that protects individuals who manage or administer the plan, is not required by law. One way to tell the difference between Fidelity Bond coverage and fiduciary coverage is to look at the party that is reimbursed in the event of a loss; a Fidelity Bond reimburses the plan, and a Fiduciary Bond reimburses named individuals who are fiduciaries of the plan.

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• Floor Offset Arrangement

  A Defined Benefit Plan and Defined Contribution Plan that together provide a total benefit. The Defined Benefit Plan provides a minimum, or “floor”, benefit that is reduced (or offset) by a benefit equivalent to the Defined Contribution Plan account balance.

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• Funded Status (or Funded Percentage)

  The ratio of the plan’s assets to its liabilities.

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• Funding Target ("FT")

  The Present Value of all Accrued Benefits determined using assumptions prescribed by law.

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• Highly Compensated Employee ("HCE")

  The IRS categorizes employees as either highly compensated or nonhighly compensated. The benefits for the two groups are compared to ensure they do not discriminate in favor of the highly compensated. Generally, employees who are more than 5% Owners or earned more than $125,000 in 2019 may be considered highly compensated.

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• Hybrid Plan

  A Defined Benefit Plan with characteristics of a Defined Contribution Plan (or vice-versa). Cash Balance Plans and pension equity plans are the most common Hybrid Plans.

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• Immediate Annuity

  Any type of annuity, such as a Life Annuity or Joint and Survivor Annuity, that is scheduled to begin immediately or has already begun being paid.

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• Installment Annuity

  Often considered a misnomer, an Installment Annuity is NOT paid for life and is instead paid for a predetermined number of regular, level installments whether the participant is living or deceased.

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• Joint & Survivor Annuity ("J&S")

  A Life Annuity (i.e. a series of payments that continue until death) with the added benefit of payments that continue after death to a selected beneficiary (if living) for the remainder of their life. The amount of each payment to the beneficiary is specified as a percent of the payment amount prior to death. For example, the beneficiary of a 50% Joint & Survivor Annuity would receive payments equal to half of the pre-death payment amount.

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• Key Employee

  An officer of the plan sponsor earning over $180,000 in 2019, or a 5% Owner, or a 1% Owner earning over $150,000.

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• Life Annuity

  A benefit that continues to be paid, usually monthly, for as long as the annuitant lives. Payments stop upon death.

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• Lump Sum (or Present Value)

  The single payment today that is considered equal in value to a payment or stream of payments in the future. If the plan provides a Lump Sum payment option, a plan may settle all of a participant’s benefits promised to be paid in the future by paying the Lump Sum, or Present Value now.

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• Maximum Deductible Contribution

  The maximum amount a plan sponsor may contribute to a plan and fully deduct from taxable income.

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• Minimum Required Contribution ("MRC")

  The amount a plan sponsor must contribute to a Defined Benefit Plan for a plan year in order to satisfy its statutory funding requirements for that year.

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• Overfunded

  A plan is generally considered Overfunded when the plan assets exceed the sum of the Lump Sum / Present Value of all participants’ benefits.

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• Owner

  A person owning interest in the Plan Sponsor. A person may be considered to own any interest that is owned by his/her spouse, parents, children or grandchildren under family attribution rules.

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• Partial Plan Termination

  In general, a 20% or more reduction in an employer’s workforce due to involuntary lay-offs is deemed a Partial Plan Termination. The consequence of a Partial Plan Termination is immediate 100% vesting for the affected participants.

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• Pension Benefit Guaranty Corporation ("PBGC")

  A federal agency that insures benefits earned under a Defined Benefit Plan. Employers pay an annual premium for this insurance. Not all Defined Benefit Plans are covered or required to pay premiums.

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• Plan Administrator

  A representative of the plan’s sponsoring employer who is responsible for managing the plan. Note that the Plan Administrator is a position defined by law to be a fiduciary, however parties engaged to assist with some administrative duties such as a third-party administrator, recordkeeper, or actuary may or may not be a fiduciary. If a Plan Administrator is not specifically designated, the Plan Sponsor is deemed to be the Plan Administrator.

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• Plan Document

  A written, legally-binding document that defines the terms of the plan, such as who is eligible to participate and how their benefit will be determined. Plan documents are also required to contain some statutory provisions that occasionally must be updated, or “restated”, for changes in the law.

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• Plan Sponsor

  The employer, or an individual representing the employer, who sets up the plan and is responsible for contributing to the plan.

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• Plan Termination

  The discontinuance of a retirement plan. In a Plan Termination, the account holding plan assets is completely discharged via either (1) distributions directly to participants (with the option to rollover into an IRA) or (2) the purchase of an annuity contract providing that another party, typically an insurance company, will be responsible for the payment of all future benefits when due.

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• Plan Trustee

  A party with discretionary authority over plan administration and plan assets. Trustees are fiduciaries. The custodian of plan assets may or may not be delegated trustee responsibilities.

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• Pre-Funding Balance ("PFB")

  The Prefunding Balance represents prior contributions in excess of required amounts that a plan sponsor can use to offset (reduce) current or future contribution requirements. It is a hypothetical balance for tracking purposes only and is not tied to any actual asset holdings.

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• Projected Benefit

  All Defined Benefit Plans have a formula to determine what annuity amount will be paid, usually monthly, starting at retirement age and continuing until death. This formula is often dependent upon a participant’s compensation and service. The projected benefit uses the participant’s expected service and compensation assuming he/she remained employed until retirement age, to estimate what the participant’s benefit would be at retirement age.

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• Qualified Domestic Relations Order ("QDRO")

  An order entered into a court of law and accepted by the plan to split benefits between a participant and an alternate payee. The alternate payee is frequently an ex-spouse.

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• Quarterly Installments

  If a Defined Benefit Plan is Underfunded, the plan sponsor must make accelerated quarterly contributions to the plan. Failure to do so will result in penalty interest added to the Minimum Required Contribution and may require the plan sponsor to notify plan participants and/or the Pension Benefit Guaranty Corporation.

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• Required Minimum Distribution ("RMD")

  The IRS generally requires that participants begin to receive taxable distributions from the plan after turning 70 1/2. In some cases, if the plan allows, these distributions may be deferred until termination of employment, if later.

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• Restatement

  A plan document must be amended as changes in the law require. The amendments are typically brief documents separate from the plan document. Every six or so years, the IRS requires those amended provisions be reflected within the main body of the document. The updated document renders the separate amendments obsolete and is referred to as the restated plan document, or a Restatement.

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• Shortfall

  The difference between the plan’s assets and Funding Target (liabilities). Assets are adjusted downward by the Pre-Funding Balance, if any, before taking the difference.

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• Shortfall Amortization Charge

  An amount equal to a seven-year amortization of the Shortfall. It is a component of the Minimum Required Contribution.

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• Summary Plan Description ("SPD")

  A document that must be provided to employees eligible for the plan. It summarizes in layman terms how the plan operates and what benefits or contributions it provides.

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• Target Normal Cost ("TNC")

  The Present Value of the benefits expected to be earned in the current plan year. It is a component of the Minimum Required Contribution.

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• Terminated Vested Participant

  A plan participant whose employment has terminated but who retains rights to a benefit or account balance and, in the case of an annuity, has not yet begun payments.

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• Top-Heavy

  If more than 60% of the accounts and/or benefits belong to Key Employees, a plan is considered Top-Heavy and special minimum contributions and vesting rules apply. The term Key Employee is defined by law and can include Owners, officers or highly-paid employees of the employer.

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• Underfunded

  A plan is generally considered Underfunded when its Funded Status (or Funded Percentage) is less than 100%. Plans that are less than 80% funded may face Benefit Restrictions.

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• Valuation Date

  Assets and liabilities are determined as of the Valuation Date, usually the first day or the last day of the plan year.

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• Volume Submitter or Nonstandardized Document

  A type of plan document that has been preapproved by the IRS. It generally has more flexibility to be customized than a prototype, or standardized, plan document, but less than a individually-designed plan document. However, if a desired plan feature isn’t included in the preapproved language, an individually-designed document may be necessary.

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