Retirement plans in the United States
These plans may be set up by employers, insurance companies, trade unions, the government, or other institutions.
Federal tax aspects of retirement plans in the United States are based on provisions of the Internal Revenue Code and the plans are regulated by the Department of Labor under the provisions of the Employee Retirement Income Security Act (ERISA).
In a defined benefit (or pension) plan, benefits are calculated using a fixed formula that typically factors in final pay and service with an employer, and payments are made from a trust fund specifically dedicated to the plan.
The accrued benefit from such a plan is solely attributable to contributions made into an individual account and investment gains on those funds, less any losses and expense charges.
This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other investments (such as bonds).
The employee-only amount is $18,000 for 2015, but a plan can permit participants who are age 50 or older to make "catch-up" contributions of up to an additional $6,000.
The cash balance plan typically offers a lump sum at and often before normal retirement age.
A defined benefit plan is required to maintain adequate funding if it is to remain qualified.
In general, they are treated as defined benefit plans for tax, accounting, and regulatory purposes.
These features make them more portable than traditional defined benefit plans and perhaps more attractive to a highly mobile workforce.
Hybrid designs also typically eliminate the more generous early retirement provisions of traditional pensions.
Because younger workers have more years in which to accrue interest and pay credits than those approaching retirement age, critics of cash balance plans have called the new designs discriminatory.
Actuarial assumptions like 5% interest, 3% salary increases and the UP84 Life Table for mortality are used to calculate a level contribution rate that would create the needed lump sum at retirement age.
The IRS defines strict requirements a plan must meet in order to receive favorable tax treatment, including: Failure to meet IRS requirements can lead to plan disqualification, which carries with it enormous tax consequences.
They are typically used to provide additional benefits to key or highly paid employees, such as executives and officers.
However, others state that these apparent advantages could also hinder some workers who might not possess the financial savvy to choose the correct investment vehicles or have the discipline to voluntarily contribute money to retirement accounts.
Because the lump sum actuarial present value of a former worker's vested accrued benefit is uncertain, the IRS, under section 417(e) of the Internal Revenue Code, specifies the interest and mortality figures that must be used.
This has caused some employers as in the Berger versus Xerox case[citation needed] in the 7th Circuit (Richard A. Posner was the judge who wrote the opinion) with cash balance plans to have a higher liability for employers for a lump sum than was in the employee's "notional" or "hypothetical" account balance.
When the interest credit rate exceeds the mandated section 417(e) discounting rate, the legally mandated lump sum value payable to the employee [if the plan sponsor allows for pre-retirement lump sums] would exceed the notional balance in the employee's cash balance account.
The Pension Protection Act signed into law on August 17, 2006 contained added provisions for these types of plans allowing the distribution of the cash balance account as a lump sum.
However, because the lump sum actuarial present value of a former worker's vested accrued benefit is uncertain, the mandate under in section 417(e) of the Internal Revenue Code specifies the interest and mortality figures that must be used.
This is true for practically all cases, but pension law in the United States does not require that employees bear investment risk.
The law only provides a section 404(c) exemption under ERISA from fiduciary liability if the employer provides the mandated investment choices and gives employees sufficient control to customize his pension investment portfolio appropriate to his risk tolerance.
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) brought significant changes to retirement plans, generally easing restrictions on the ability of the taxpayer to roll money from one type of account to the other, and increasing contributions limits.
