Common Terms in Defined Contribution Plans

Defined Contribution Plans

• 401(k) Deferral

  A contribution that is deducted from an employee’s paycheck at his/her election and deposited into the plan, usually on a pre-tax basis, meaning the employee’s taxable income is reduced by the amount contributed.

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• Actual Contribution Percentage Test ("ACP Test")

  The test to demonstrate that a matching contribution program is not discriminatory in favor of Highly Compensated Employees in practice. A plan may provide certain levels of employer contributions, known as safe harbor contributions, that exempts it from testing.

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• Average Deferral Percentage Test ("ADP Test")

  The test to demonstrate that a 401(k) deferral program is not discriminatory in favor of Highly Compensated Employees in practice. A plan may provide certain levels of employer contributions, known as safe harbor contributions, that exempts it from testing.

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• Catch-Up Contribution

  Catch-Up Contributions are available only to participants who are 50 or older. Either a 401(k) Deferral or Roth 401(k) Deferral that exceeds a plan or statutory limit may be categorized as a Catch-Up Contribution, up to $6,500 per year in 2020.

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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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• Defined Contribution Plan ("DC Plan")

  The category of retirement plans in which the amount a participant receives at retirement age depends on what has been contributed to the participant’s account and what the investment earnings on those contributions have been. The final account balance is not described or defined by the terms of the plan. A Defined Contribution Plan may be designed such that all contributions are made only at the employer’s discretion (often referred to as “profit sharing” contributions), but often permit an employee to elect 401(k) deferrals too.

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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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• Forfeitures

  A plan may provide that a participant must work a certain amount of time before becoming vested, or owning, any employer contributions made on his/her behalf. If the participant terminates service before earning full vesting, the unvested portion of the account is forfeited. Forfeitures may be used for other participant benefits or to pay plan expenses, or for certain other purposes.

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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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• Individually-Directed Accounts (or Self-Directed Accounts)

  A Defined Contribution Plan may allow participants to invest their funds in an Individually-Directed Account – a brokerage account managed by the participant or the participant’s advisor that is nevertheless still held as a plan asset and subject to all plan provisions.

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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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• 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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• Participant-Directed Accounts

  A Defined Contribution Plan that offers a pre-selected menu of investment options for participants to choose among is described as having Participant-Directed Accounts. It is possible for a plan to have one source of money, for example 401(k) Deferrals, that is participant-directed, but another source, such as employer profit sharing contributions, in a Pooled Account where the participant does not exercise control over the investments.

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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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• Pooled Account

  In a Pooled Account, the investments of participant accounts in a Defined Contribution Plan are managed by the Plan Trustee and not subject to individual participant discretion. All participants would generally experience the same rate of return on their share of funds in the Pooled Account.

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• Qualified Automatic Contribution Arrangement ("QACA")

  A Qualified Automatic Contribution Arrangement (“QACA”) features automatic enrollment for new participants at a predetermined level of contribution. A participant must opt out in writing if they do not wish to contribute. If the plan meets certain rules, a QACA is exempt from ADP Testing.

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• Qualified Default Investment Alternative ("QDIA")

  A Qualified Default Investment Alternative is an investment option for contributions made to a Participant-Directed Account in the event a participant has not made elections of their own. If the investment meets certain criteria, it will relieve potential liability of the plan’s fiduciaries related to the performance of that investment.

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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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• 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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• Roth 401(k) Deferral

  A contribution that is deducted from an employee’s pay check at his/her election and deposited into the plan on an after-tax basis. While there are no immediate tax benefits to the employee, if certain criteria are met the funds may be withdrawn tax-free later.

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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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• 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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• 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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