Legal Definitions - employee benefit plan

An employee benefit plan is a formal program or arrangement established by an employer to provide various forms of compensation or benefits to its employees, officers, and advisors, beyond their regular wages. These plans are typically documented and can encompass a wide range of offerings, from retirement savings and health insurance to stock options and paid time off.

• Example 1: A large technology company offers its workforce a comprehensive package that includes group health, dental, and vision insurance, a 401(k) retirement savings plan with employer matching contributions, and a program allowing employees to purchase company stock at a discounted rate.

  Explanation: This scenario illustrates an employee benefit plan because it involves multiple structured programs (insurance, retirement, stock purchase) provided by the employer to its employees, offering benefits beyond their standard salary.

• Example 2: A local manufacturing plant provides its unionized workers with a traditional pension plan that guarantees a specific income in retirement, along with life insurance coverage and a generous paid vacation and sick leave policy.

  Explanation: Here, the pension, life insurance, and paid leave are all components of an employee benefit plan, as they are formal benefits offered by the employer to its staff.

• Example 3: A small consulting firm sets up a Simplified Employee Pension (SEP) plan for its consultants and administrative staff, alongside a group long-term disability insurance policy to protect against loss of income due to illness or injury.

  Explanation: The SEP plan (for retirement savings) and the disability insurance (for income protection) collectively form an employee benefit plan, demonstrating how even smaller businesses can offer structured benefits.

A defined-benefit plan is a type of retirement plan where employees are promised a specific, predetermined payout amount upon retirement. This amount is typically calculated using a formula that considers factors such as the employee's salary history, years of service, and age. The employer bears the investment risk and is responsible for ensuring the plan has sufficient funds to pay the promised benefits.

• Example 1: A state government offers its public school teachers a pension plan that guarantees 65% of their average final salary after 30 years of service, payable monthly for the rest of their lives.

  Explanation: This is a defined-benefit plan because the teachers are promised a specific, calculable benefit (65% of final salary) upon meeting certain criteria, and the state government is responsible for funding that promise.

• Example 2: A large utility company provides a retirement plan where employees receive a fixed monthly payment for life, calculated based on a formula involving their highest five years of salary and their total years of employment with the company.

  Explanation: The plan's formula ensures a "definitely determinable benefit" for retirees, making it a defined-benefit plan where the company must ensure the funds are available to meet these obligations.

• Example 3: A union contract for factory workers specifies that retired members will receive a set monthly benefit, adjusted annually for inflation, based on their contribution years and job classification throughout their career.

  Explanation: The promise of a specific, inflation-adjusted monthly benefit, determined by a clear formula, characterizes this as a defined-benefit plan, with the employer responsible for managing the assets to fulfill these payments.

A defined-contribution plan is a retirement plan where both the employer and/or employee contribute money into individual accounts for each participant. The final retirement benefit depends entirely on the investment performance of the money in that specific account. The employee typically bears the investment risk, as the employer's contribution is usually a set amount or percentage, not a guaranteed future payout.

• Example 1: An architecture firm offers a 401(k) plan where employees can contribute a portion of their salary, and the firm matches 50% of those contributions up to 6% of the employee's pay. The retirement income an employee receives will depend on how well their chosen investments perform over time.

  Explanation: This is a defined-contribution plan because contributions are made to individual accounts, and the ultimate benefit is not guaranteed but depends on investment growth, with the employee bearing the investment risk.

• Example 2: A non-profit organization sets up a 403(b) plan, allowing employees to contribute pre-tax dollars to an investment account, with the organization making a small, fixed percentage contribution each year. The amount available at retirement varies based on market fluctuations.

  Explanation: The plan defines the contributions (employee pre-tax, employer fixed percentage) to individual accounts, and the final benefit is variable, making it a defined-contribution plan.

• Example 3: A small business establishes a Simplified Employee Pension (SEP) plan, where the owner makes annual contributions directly into individual retirement accounts for each eligible employee. The employees' retirement savings grow based on the performance of their chosen investments within their SEP-IRA.

  Explanation: The employer's contribution is defined, and these funds go into individual accounts whose value fluctuates with investments, fitting the definition of a defined-contribution plan.

A disability retirement plan is a plan that provides income or benefits to an employee who becomes unable to work due to a disability before reaching their normal retirement age. It can either allow for early retirement with benefits or provide enhanced benefits specifically because of the disability, offering financial support when an employee can no longer perform their job duties.

• Example 1: A police department has a disability retirement plan where an officer injured in the line of duty and permanently unable to return to active service can retire early and receive a portion of their salary as a disability pension, even if they are decades away from standard retirement age.

  Explanation: This plan provides a specific benefit (disability pension) triggered by an inability to work due to injury, allowing for early retirement outside of normal age requirements, thus qualifying as a disability retirement plan.

• Example 2: A manufacturing company's benefits package includes a provision that if an employee becomes permanently disabled and cannot continue their job, they can access their retirement savings sooner or receive an increased monthly payout compared to what they would get from standard early retirement.

  Explanation: The plan offers enhanced benefits or earlier access to retirement funds specifically because of a qualifying disability, aligning with the purpose of a disability retirement plan.

• Example 3: A university offers a long-term disability plan that transitions into a disability retirement benefit if a faculty member's medical condition prevents them from ever returning to their academic duties, ensuring continued income support.

  Explanation: This plan provides a pathway to retirement benefits specifically due to a long-term disability, demonstrating its function as a disability retirement plan.

An ESOP (Employee Stock Ownership Plan) is a type of retirement plan that primarily invests in the stock of the employer company. It allows employees to own a stake in the company they work for, often receiving shares as a benefit, which can grow in value as the company succeeds. ESOPs are designed to provide employees with an ownership interest and a retirement savings vehicle.

• Example 1: A successful software startup establishes an ESOP, granting shares to its employees annually as part of their compensation package. This allows employees to benefit directly from the company's growth and potential future valuation.

  Explanation: This is an ESOP because it's a retirement plan that primarily invests in the employer's stock, giving employees a direct ownership stake in the company.

• Example 2: A long-standing construction company transitions its ownership to its employees through an ESOP. Over time, employees gradually acquire company stock, fostering a sense of shared ownership and responsibility for the company's performance.

  Explanation: The company uses an ESOP to transfer ownership to its employees through stock, serving as both a benefit and a mechanism for employee ownership.

• Example 3: A regional grocery chain uses an ESOP to provide retirement benefits, with employees accumulating company stock over their careers. Upon retirement, they can sell their shares back to the company, providing a payout based on the stock's value.

  Explanation: This plan functions as a retirement vehicle where the primary asset is the employer's stock, illustrating the core concept of an ESOP.

An excess-benefit plan is an employee benefit plan maintained by an employer solely for the purpose of providing benefits for certain employees, typically highly compensated executives, that exceed the limitations on contributions and benefits imposed by federal tax law for standard "qualified" plans. It allows employers to offer more generous benefits to key personnel without violating regulations for broader employee plans.

• Example 1: A multinational corporation offers its top executives an excess-benefit plan to supplement their 401(k) contributions, as their high salaries mean they quickly reach the federal contribution limits in the standard plan.

  Explanation: This plan provides additional benefits beyond the legal limits of a regular 401(k), specifically for high-earning executives, making it an excess-benefit plan.

• Example 2: The CEO of a financial services firm receives an additional retirement benefit through an excess-benefit plan, ensuring their total retirement income aligns with their executive compensation, even though their standard pension is capped by IRS rules.

  Explanation: The plan is designed to provide benefits that would otherwise exceed the maximum allowed for a qualified pension, targeting a specific executive and thus fitting the definition of an excess-benefit plan.

• Example 3: A pharmaceutical company provides its senior research scientists with an unfunded excess-benefit plan, promising them additional deferred compensation that goes beyond the maximum allowed in their regular qualified retirement plan, as an incentive for retention.

  Explanation: This plan offers deferred compensation that surpasses the limits of a standard qualified plan, exclusively for a select group of employees, which is the hallmark of an excess-benefit plan.

A 401(k) plan is a popular type of retirement and savings plan that allows employees to contribute a portion of their pre-tax salary directly into an investment account. These contributions and their earnings grow tax-deferred until retirement. Employers often match a percentage of these contributions, and employees typically choose investments from a list of options provided by the plan administrator.

• Example 1: Sarah, an engineer at a manufacturing company, elects to contribute 10% of her paycheck to her 401(k) plan. Her employer matches 50% of her contributions up to 6% of her salary, and she chooses to invest her funds in a diversified stock mutual fund.

  Explanation: This illustrates a 401(k) plan through employee pre-tax contributions, employer matching, and employee choice of investments for retirement savings.

• Example 2: A small marketing agency offers a 401(k) plan to its employees, allowing them to defer a portion of their income and choose from a diversified portfolio of mutual funds for their retirement savings, with all earnings growing tax-deferred.

  Explanation: The plan allows employees to save pre-tax income for retirement and select investments, which are key features of a 401(k).

• Example 3: John, a project manager, rolls over his previous employer's 401(k) into his new company's plan, continuing to make pre-tax contributions and benefiting from the new employer's matching program, all while his investments grow without immediate taxation.

  Explanation: This demonstrates the portability and ongoing nature of a 401(k) plan, including pre-tax contributions and employer matching.

A 403(b) plan is a retirement plan specifically designed for employees of public schools, colleges, universities, and certain tax-exempt organizations (such as hospitals, charities, or religious organizations). Similar to a 401(k), it allows employees to contribute pre-tax income, and employers may also contribute. Funds grow tax-deferred until withdrawal in retirement.

• Example 1: A high school teacher contributes a portion of her salary each month to a 403(b) plan, investing in a mix of annuities and mutual funds offered by her school district for her retirement savings.

  Explanation: This is a 403(b) plan because it's a retirement savings vehicle for an employee of a public educational system, funded by pre-tax contributions.

• Example 2: An administrator at a non-profit hospital participates in the hospital's 403(b) plan, where both she and the hospital make contributions to her retirement account, which then grows tax-deferred.

  Explanation: The plan serves an employee of a tax-exempt organization, allowing for both employee and employer contributions, fitting the definition of a 403(b).

• Example 3: A professor at a state university has a 403(b) plan that allows him to defer income and choose from a range of investment options provided by the university's plan administrator, helping him save for his post-career years.

  Explanation: As an employee of a public educational institution, the professor's retirement savings through pre-tax deferrals into investment options exemplify a 403(b) plan.

A 457 plan is a type of deferred compensation plan primarily for employees of state and local governments, and some tax-exempt organizations. It functions similarly to a 401(k) or 403(b) plan, allowing employees to defer a portion of their income until retirement or separation from service, with taxes typically paid upon withdrawal.

• Example 1: A city government employee contributes to a 457 plan, allowing her to save for retirement with pre-tax dollars. She appreciates the flexibility of the plan's withdrawal rules compared to other retirement accounts.

  Explanation: This is a 457 plan because it's a deferred compensation plan offered by a local government entity, allowing employees to save pre-tax for retirement.

• Example 2: A librarian working for a county library system participates in a 457(b) plan, which offers a flexible way to save for retirement, often with different withdrawal rules and contribution limits than a 401(k) or 403(b).

  Explanation: As an employee of a governmental agency, the librarian's participation in a deferred compensation plan for retirement savings aligns with the characteristics of a 457 plan.

• Example 3: The director of a large public university's foundation, which is a tax-exempt organization, has a 457 plan that supplements her other retirement savings, allowing for additional pre-tax contributions beyond other plan limits.

  Explanation: The plan is offered by a tax-exempt organization to its employee, allowing for deferred compensation, which is a key feature of a 457 plan.

A governmental plan is an employee benefit plan established and maintained by a federal, state, or local government entity, or any of their agencies or instrumentalities, for their employees. These plans often have different regulatory requirements and oversight compared to private sector plans.

• Example 1: The pension fund for all employees of a state's Department of Transportation, including engineers, administrative staff, and road maintenance crews, is a governmental plan.

  Explanation: This plan is established and maintained by a state government agency for its employees, fitting the definition of a governmental plan.

• Example 2: A health insurance program offered to all city sanitation workers and their families by the municipal government is considered a governmental plan.

  Explanation: The health insurance program is provided by a local government entity (the city) for its employees, making it a governmental plan.

• Example 3: The retirement system for federal civil service employees, managed by the U.S. Office of Personnel Management, which covers a wide range of federal workers, is a prime example of a governmental plan.

  Explanation: This retirement system is established and maintained by the federal government for its employees, clearly demonstrating a governmental plan.

A money-purchase plan is a type of defined-contribution retirement plan where the employer is legally obligated to contribute a fixed percentage of each employee's salary to their retirement account every year, regardless of company profits. Employees' retirement benefits depend on the total contributions and the investment performance of their individual accounts.

• Example 1: A law firm establishes a money-purchase plan, committing to contribute 10% of each attorney's annual salary to their individual retirement accounts, even if the firm has a less profitable year. This contribution is mandatory.

  Explanation: This is a money-purchase plan because the employer is required to contribute a fixed percentage of salary (10%) to each employee's account, irrespective of the firm's financial performance.

• Example 2: A small engineering company sets up a money-purchase plan, ensuring that 7% of every employee's compensation is deposited into their retirement fund each year. This provides a predictable and guaranteed employer contribution.

  Explanation: The mandatory, fixed-percentage employer contribution to individual employee accounts defines this as a money-purchase plan.

• Example 3: A veterinary clinic implements a money-purchase plan, where the owner contributes 5% of each veterinary technician's gross pay to their retirement savings, regardless of the clinic's financial performance or the owner's discretion.

  Explanation: The employer's non-discretionary contribution of a set percentage of pay to employee retirement accounts is the core feature of a money-purchase plan.

A nonqualified deferred-compensation plan is a compensation arrangement, typically for executives or highly compensated employees, that allows them to defer receiving a portion of their income until a future date (e.g., retirement, termination, or a specific event). Unlike "qualified" plans, these do not receive special tax benefits and are not subject to the same strict rules regarding contributions, benefits, or non-discrimination. They are generally unfunded and carry more risk for the employee, as the deferred funds are typically subject to the employer's general creditors.

• Example 1: A technology company offers its CEO a nonqualified deferred-compensation plan, allowing them to defer a significant portion of their annual bonus until retirement, thereby delaying the tax liability on that income