Simply put, a pension plan document is like the Constitution of a country. It outlines all the rules and regulations governing the pension plan. Note that the IRS makes certain things mandatory and the plan document cannot overrule those. For a few other things, the plan document can be a little more liberal within IRS limits.
For example, for the purpose of calculation, a pension plan needs to assume a retirement age. The pension plan document can assume the retirement age to be 62 or 65. Similarly, a profit sharing 401(k) plan can provide for immediate entry into the plan upon hire or can prescribe a one/two year waiting period. However, if a two year wait period is selected, the plan needs to provide 100% vesting upon participation for the profit sharing contributions. The selection of the waiting period is the discretion of the plan sponsor, but the vesting schedule up on selecting a two year waiting period is a rule of the IRS and cannot be over-ruled via the plan document.
There are several small technicalities that need to be taken into consideration while drafting the plan document. As such, it is always better to hire the services of a pension firm to draft the document. A specialist firm can help you design the pension plan and the document to reduce the overall cost of funding the pension plan or maximize the contributions from a specified group.
A pension plan document will consist of the following sub parts
- Basic Plan Document
- Trust Document
- Summary Plan Description
- Adoption Agreement
Basic Plan Document: This section will define all keywords related to the pension plan. What is the definition of an eligible employee, or what is the meaning of accrued benefit can be found in this section.
Trust Document: A qualified trust needs to be created to manage the money in the pension plan. Depending on the size of the plan, appointing a third party trustee may be an option. For smaller defined benefit plans with only a single participant, the plan sponsor can himself act as the trustee. For profit sharing plans with participant money, it is advisable to appoint a financial advisor to ensure all processes are followed.
Summary Plan Description: A Summary Plan Description provides a basic description of the plan in layman terms. A copy of the SPD is generally given to the plan participants for their understanding.
Adoption Agreement: The adoption agreement will look more like a checklist and the provisions of the plan will be checked on the adoption agreement. The adoption agreement itself is of several parts. Each part will seek to address a specific set of rules:
- General Section: The General Section will list out basic information about the plan sponsor like the address, date of business commencement, type of entity, the tax identification number (TIN) etc.
- Eligibility Requirements: This section pertains to all the rules regarding eligibility requirements. For example: the number of hours an employee needs to work each year to be a part of the pension plan is defined in this section. It could be 500 or 1000, but it is the choice of the plan sponsor and is enlisted in this section.
- Contribution: This section lists the types of contributions that are available in the plan. A profit sharing plan can have a 401(k) contribution, a safe harbor contribution, or several other contributions. A defined benefit plan will have this same section titled as Benefits, and the defined benefit formula will be listed in this section.
- Vesting and Forfeitures: Vesting basically means ownership. Not all money contributed to the employees becomes 100% vested immediately. i.e. Even though money may be contributed towards an employee, they will not be owners of it. This section will define the vesting rules, and outline other rules regarding the unvested portion. The most common is the 2-20 vesting table, which means an employee will be 20% vested each year after completing two years of service.
- Distributions: A contribution made to a pension plan can be withdrawn only after the specified retirement age, and this section will outline the rules regarding this. The plan can, however, permit some type of distributions categorized as loans or hardship withdrawals.
This is a basic idea of a pension plan document. Some companies like Data Air draft standard documents and get it approved by the IRS. Your actuary or TPA can use these pre-approved plan documents to customize the pension plan according to your needs. The IRS issues an opinion letter for a pre-approved plan document. Make sure you receive a copy of this letter when you get a document designed.
Pension Plan documents need to be updated regularly and comply with all pension laws. A profit sharing plan document has to comply with the Pension Protection Act (PPA) of 2006, and the defined benefit plan has to comply with The Economic Growth and Tax Relief Reconciliation Act (EGTRAA) of 2001.
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