jis Administration ane (a) Provident Fund (b) Pension (c)_ Deposit-linked insurance (a) Gratuity (c) Medical benefit. Types of Qualified Retirement Plans What Is a Qualified Retirement Plan? ployer that provides retirement income to employees lly to the end of Iris a Retirement Plan maintained by a andor results in the deferral of income by employees for periods extending, genera employment. ‘The employer i x treatment (ie, a deduction) for contributions made to the plan assuming they fall within the preseribed IRS limits and the Plan meets all of the “qualification requirements” under the Internal Revenue Code. Why Should a Company Adopt a Qualified Retirement Plan? available. The company is allowed ays no tax on monies ‘A Qualified Retirement Plan is one of the best tax shelters onent tax deductions for it's contributions to the plan and the employee p: inibuted tothe Plan until a distribution is made. Also, earnings from investments made with the Plan finds accumulate tax free. Thus, long term employees (i.e. usually key employees) can accumulate large sums of money through the tax free build up of capital. ‘There are also non-tax reasons for adopting a qualified Plan. ‘They attract good employees, reduce employee tumover; increase employee incentive and accumulate funds for retirement. What are the Basic Types of Qualified Retirement Plans? Categories: Defined Contribution Plans and Defined Qualified Retirement Plan Fall into Two Benefit Plans. Defined Contribution Plans (DC Plans): DC Plans are retirement Plans that provide for an individual account for each participant. The ultimate retirement benefit that each participant receives dependent largely on two variables; the amount of employer contributions or forfeitures allocated to = account and the investment experience of the fund (earnings, gains/losses, expenses, etc.) There is Buaranteed retirement benefit (i.e. no “De fined Benefit"), DC Plans include the following: ag, .hiefined contribution Plan specifies what contribution the employee and employer will make to » ployees” retirement or savings fund. It will provide a payout at retirement that is dependent upon mimount of money contributed and the performance of the investment vehicles utilized, There are "y kinds of defined contribution plan. They are: Q Se er ina become owners of stock in tis a defined contribution employee benefit that allows employces to Phere are several features 18 ¢4 th Pilaul they work for. It is equity based deferred compensation plan. ake ESOPs unique as compared to other employee benefit plans. In an ESOP, the organization's Scanned with CamScannerComp 136 nsation Manacerens distributes shares of stock to its employees by placing the stock into a trust managed on the emplo, behalf. Employees receive regular reports onthe value oftheir stock and when they leave the organizing they may sell the stock to the organization or (if it is a publicly traded company) on the open market 1 is required by law to invest primarily in the securities of the sponsoring employer. " How does ESOP works? (i) The ESOP operates through a trust, set up by the company that accepts tax deductibs contributions from the company to purchase company stock. (ii) The contributions made by the company are distributed to individual employee's accounts within the trust. (iii) The amount of stock each individual received may vary according to pre-established formulas based on salary, service, or position. (iv) The employees may cash out after vesting in the program or when they leave the company The amount they may cash out may depend on the vesting requirements. (v) When an ESOP employee who has at least ten years of participation in the ESOP réaches the age 55, he or she must be given the option of diversifying his/her ESOP account up to 25% of the value. This option continues until the age of sixty, at which time the employee has 2 one time option to diversify upto 50% of his/her account. This requirement is applicable to ESOP shares allocated to employees’ accounts after December 31st, 1986. (vi) Employees receive the vested portion of their accounts at termination, disability, death, or retirement. These distributions may be made in a lumpsum or in installments over aperiodof years. If employees become disabled or die, they or their beneficiaries receive the vested portion of their ESOP right away. Advantages (Capital Appreciation: Companies sell some or all of their equity to employees and by doing so, converts corporate and personal taxes into tax-free capital appreciation. This allows the owner to sell 100% of his or her company to get money out tax-free and still maintain control of the company. (ii) Incentive Based Retirement: It provides a cost-effective plan to motivate employees: (iii) Tax Advantage: It enables tax advantage purchasing of stock of a retiring company o¥n# With this purpose, a company owner may sell their shares to the ESOP and incur no x20 gain on the sale. A company owner can sell all or some of the company to the employees free. It has been found that owners who sell 30% or more of their company to an ESOP #* allowed to “roll-over” and proceeds into their securities and defer taxation on the £2!"- (iv) Reduction of Tax Liability: A company can reduce to corporate income taxe ae its cash flow and networth by simply issuing treasury stock or newly issued stock '° ESOP. Scanned with CamScannerBenefits & 4 Administration Pr Disadvantages (i) Defection: If the ESOP is used to finance the companies’ growth, the cash flow benefits must be weighed against the rate of dilution. (ii) Fiduciary liability: The committee members of the plan are deemed to be fiduciaries and can be held liable if they knowingly participate in improper transactions. (iii) Liquidity: Ifthe value of the stock appreciates substantially, the ESOP and/or the company may not have sufficient funds to repurchase stock, upon employees’ retirement. (iv) Stock Performance: Ifthe value of the company does not increase, the employees may feel that the ESOP is less attractive than a Profit sharing plan. In an extreme case, if the company fails, the employees will lose their benefits to the extent that the ESOP is not diversified in other investments. (a) Money Purchase Plan: The employer specifies a level of annual contributions that are invested and when the employee retires, he or she is entitled to receive the amount of the contributions plus the investment earning. (b) 401 (K) Plan: Itis a defined contribution plan in which employees may defer income upto a maximum amount allowed. Employees contribute a percentage of their earnings ‘and employers may make matching contributions. The amount employees contribute is not taxed as part of their income until they receive it from the plan. Its matching feature makes it attractive to both employers and employees. Employees’ benefit by accumulating tax-deferred retirement funds, employers benefit by reducing their risk, since there is no ‘ payment required when the employee leaves or retires. Usually, employees are free to decide individually how they wish to invest their funds. (©) Hybrid Plan: It is a desired approach to retirement plan. It is a cash balance plan, with elements of both defined benefit and defined contribution plan that have notional balances in hypothetical accounts where, typically, each year the plan administrator will contribute an amount equal to a certain percentage of each participant's salary. There is a switch from traditional benefit plans to cash balance plan, as it is more generous to young employees who will have many years ahead to earn interest. Defined Benefit Plans (DB Plans): DB Plans are retirement Plans other than “individual account Plans”. In other words.....any Plan that is not a Defined Contribution Plan usually is a Defined Benefit Plan. Ina Defined Benefit Plan the ultimate retirement benefit is stated (ic.: “definitely determinable”). The benefit is based on the Plan formula, your salary, and , in most cases, the number of years of service you work for your the employer. The ultimate benefit is called the “retirement benefit” and the amountportion of that benefit that you have earned at any point in time is called your “accrued benefit” In most cases...you will only eam your full retirement benefit (i.e: “fully accrue your benefit) if you continue your employment until the “normal retirement age” stated in Plan document, Ifa Plan is classified as a Defined Benefit Plan the following is true (a) retirement benefits are geared to the Plan Formulas not to contribs (b) itis not an individual account plan. Scanned with CamScanneron Compensation Manay, iwement (c) the annual employer contribution is actuarially determined (d) some benefits may be insured by the PBC A primary difference between the “Defined Contribution Plans” like the 401(k) Plan oF Prof Sharing Plan and a “Defined Benefit Plan” is that the investment risk under a “Defined Contribution” Plan lies with the employee participant and the investment risk, under the “Defined Benefit Plan’ fies with the employer sponsor. The “Defined Benefit” Plan defines and promises a specific benefit at some point in the future This defined benefit is provided typically atthe retirement of the employee participant. For example, a ‘ypical benefit may be a monthly income starting at age 65 equal to 50% of the employee's a salary over the last three years of work. The employer is required to contribute, and may deduct, whatever amount is actually ne assure the benefit is funded, which places the investment risk with the employer, not the participant, If the investments do not perform as projected, the employer may have more to contribute in the future Benefit accrual tends to reward long-term service, and because with older employees there is less time for assets to accumulate to fund the benefit, contributions for older employees generally are much higher than younger employees. Thus, older business owners, seeking large contributions often favour defined benefit plans. For aging management groups who have little chance to save for retirement, a defined benefit plan is an excellent way to make up for lost time. A defined benefit plan provides the only way for companies to make annual tax-deductible contributions for their employees in excess of $41,000 or 100% of pay [the maximum for “defined contribution” plans). For example, the following are the maximum contributions for 2004 that are tax deductible for defined benefit plans and defined contribution plans COMPARATIVE ANALYSIS Defind Benefit Plan vs. Defined Contribution Plan SCENARIO#1 Company owner is aged $0 and eams more than $205,000, Two other employees aged 25 and 30 cara {$25,000 and $30,000 respectively, ‘Ages0 $65,000 Sapo ‘Age2s_, r 31,800 35,000 ‘Age 30 $3,000 36000 ‘SCENARIO #2 - Company executives are aged 55 and 50 and eam more than $205,000 each. Two other employees agel25 and 30 ear $25,000 and $30,000 respectively. Age 5S $117,000 ‘$41,000 —j ‘Age 50 $65,000 $41,000 Age2s $1,800 $5,000 Age30 $3,000 $6,000 Scanned with CamScannernenefits & Administration However, because of the required funding costs, and potential growing funding liability for older employees, the number of defined benefit plans has dropped over the past decade. As the baby boom of employees is growing older and becoming more transitory in employment, larger employers have away from defined benefit plans to employee participatory plans such as 401(k) plans. TYPES OF RETIREMENT PLAN This chart provides quick details for each of the main types of employee retirement plans from traditional 401(k) plans to various kinds of Individual Retirement Accounts (IRA). Table 9.1 Plan type ‘Summary “Annual plan Key feature Notes limits* ‘Traditional 401(4)| For any type or size | $15,000inemployee | Matching contri-| Requires yearly ‘company. Funded by | deferrals and up to | butions can be] discrimination employee elective | $29,000 in optional | vested overtime. | testing to prevent deferrals and op- | matching funds; investing primarily tional employer | catch-up limit: from —_highly- matching. $5,000. compensated staff| members. 403b For any non-profit | $15,000inemplayee | “15-Year Rule”: ] Typically features business, govern- | deferrals and up to | employees with 15 | fewer investment ment entity, or edu- | $29,000in optional | years service can | options than tradi- cational institution. | matching funds; | contribute an | tional 401(k) plans. Funded by employee | catch-up limit: | additional $15,000 elective deferrals and | $5,000. over five years. optional employer matching. Safe Harbor For any size com- | $44,000 (total em- | Employer contribu- | Employer must 401(k) pany. Funded by | ployee and em- | tions 100% vested | make contributions mandatory employer | ployer contribu- | from day one. No | even when business and optional em- | tions); catch-up | discrimination test- | is not doing well. ployee contributions. | limit: $5,000, ing required. Simple 401(K) | For businesses with | $10,000 (total em- | Employer contribu- | Considerably lower 100 employees or | ployee and em- | tions 100% vested | annual limits than less and no other re- | ployer contribu- | from day one. No | traditional 401(k) tirement plan, tions); catch-up | discrimination test- | plans. limit: $5,000. ing Solo 401(k) For self-employed, | $44,000; catch-up | Features high con- | Must convert to sole proprietors, part- | limit: $5,000. tribution limits. | traditional 401(k) or nerships, corpora- SIMPLE 401(4)} tions, S-corpora- once you add any| tions. Covers owner : non-spousal em- and spouse only. Funded by salary and profit share con- tributions, Scanned with CamScannerCompensation M 7 INA neny $44,000 (based on | Employer contribu-] Can supreme tions 100% vested | with another from day one. ment plan, SEP-IRA For self-employed and small busi- | years of service, nesses under 25 em- | performance, and ployees. Funded by | employee salary) employer contribu- tions only. ‘SIMPLEIRA | Forsmall businesses | $10,000 (matched or | Employer contribu- | Considerably loge, with 100 employees | fixed contribu- | tions 100% vested | annual limits th, or fewer. Funded by | tions); catch-up | from day one. Can | traditional 49), mandatory employer | limit: $2,500. reduce contribu- | plans, and optional em- tions when busi- ployee contribu- ness is not doing tions, well, KEOGH For law partner- | $44,000 (defined | Definedcontribution: | Defined benefits ships, medical prac- | contribution); | Amountemployces | very complex; tices, and family busi- } $175,000 (defined | receiveatretirement }e m ployer nesses with 10 or | benefit). varies based on} responsible for fewer highly paid years of service, | administration and employees. Funded camings, expenses, Jin vestment by employee and gains, and losses | choices. Defined employer contribu- Defined benefit: | contributions tions. Formula provides | allow emplayeesto fixed monthly income | make their own upon retirement —_| investment decisions. FLEXIBLE COMPENSATION OR CAFETERIA STYLE OF COMPENSATION It is a type of compensation which refers to compensation program that allows employees # choose what type and how much of each reward is desired during the coming year. It is also known 3s smorgasbord which allows employees to choose from a selection of employer provided benefits sist as life insurance, health insurance, pension, unemployment compensation, and rest provided vacatiors etc. It was basically designed to enable senior executives, top professionals and managers to choo individually many of these benefits and services. The demands of services depend on their age, ti educational and income levels, their life style and other forms of preferences. Recent studies sve that flexible or cafeteria compensation programs are becoming increasingly popular among employe It provides an opportunity to contain the costs of the benefit package and provides benefits on # mort tax-effective basis. It also increases loyalty and motivation of employees, which in turn enhanc productivity. : Benefits provided in a cafeteria compensation approach are: © Accidental death, dismemberment insurance * Bonus eligi a Scanned with CamScannerBenefits & Administration Business and professional membership © Club membership © Cash profit sharing Automobile allowance * Medical assistance * Housing allowance * Deferred Bonus or Deferred Compensation Plan © Dental and eye care insurance * Education costs © Free or subsidized lunches © Group Life Insurance © Health maintenance fees * Interest-fee Loans © Long-term disability benefit © Recreational facilities © Saving Plans * Sabbatical leaves * Sickness and accident insurance * Stock bonus plan and stock purchase plan ‘Source: Robert M. Noe and R. Wayne Mondy, HRM. p.-346. Features of Cafeteria Style Compensation Under this programme, the employee is told that his total compensation mode is of, say Rs.2,000/- and than he can choose mix of salary life insurance, deferred compensation and other benefits that suit his particular needs. Each of the options carries a price and the employee can select up to Rs.2,000/- of salary — those items that he feels best suit his personal needs. While adopting the programme, the management should remember that the most of younger employees are more concemed with “take home pay” than with “retirement benefits”, On the other hand, older employees are more concerned about retirement and pension programmes. Types of Cafeteria Plans ‘The two most popular types of cafeteria plan are: (i) Pre-tax premium conversion plans (ii) Flexible spending arrangements (FSA's) Scanned with CamScannerMe Compensation Management (i) Premium Conversion: Its the simplest type of cafeteria plan which permits employees to pay their share of premiums for health coverage, life insurance and other qualified benefits such as disability insurance on a pre-tax basis. This plan converts what would otherwise be after-tax employee contributions to pre-tax contribution by means of an employee's election prior to the beginning of the year, to reduce pay and to have the company contribute the amount of the reduction to pay for the coverage selected by the employce. (ii) Flexible Spending Arrangements or flexible spending accounts: It lets employees pay for certain benefits expenses such as dental care, medical and dependent care expenses on a pre-tax basis periodically, employees can elect the amount of salary reduction dollars they wish to allocate to various elements in their plans. There are two types of FSA's — (a) Health and (b) Dependant care In Health FSA employees as well as other uninsured medical care exper may set aside money to pay for health plan deductibles and co-payments 8, Such as dental or vision expenses, on a pre-tax basis. In Dependent FSA, employees may be reimbursed for dependent care expenses that enable the cniployce and spouse to work. They are not subject to the uniform reimbursement requirement. (i) The information regarding employee satisfaction with flexible compensation plans is limited, However, the employers hope that it will improve the understanding of the benefits provided. (ii) These plans are very costly. The cost for development and administration exceeds those for traditional plans, Advantages (i) Employees can choose benefits that meet their individual needs and adjust those choices annually as needs change. (ii) _Ithelp employers control costs by ensuring that money is not spent on benefits, that employees neither want nor need, Gii)__By offering more flexible cafeteria type benefits, employers gain an edge in attracting and retaining valuable employees. Gv) _Ithetps in improving employer-employee relationships, as giving employees control over their benefits promotes goodwill and creates a partnership in the benefit programs between both the part (x) Cafeteria plans address the wide variation in benefit needs of di (i) Ithelps in developing better understanding of the benefit package, as employees are actively involved in the selection process. employees. Scanned with CamScanner