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Chapter 52: Profit sharing/401(k)/pension plan.


A profit sharing plan, as its name implies, is a retirement plan for sharing employer profits with employees. A profit sharing plan need not provide a definite, predetermined formula for determining the amount of profits to be shared. However, there must be a definite formula for allocating these profits to each participant. But absent a definite contribution formula, an employer must make recurring and substantial contributions to a profit sharing plan. (1)

A pension plan is a retirement plan established and maintained by an employer to provide a definitely determinable benefit for the employer's employees and their beneficiaries. The primary purpose of a pension plan must be to provide benefits for the employees upon their retirement because of age or disability.

A 401(k) plan, also known as a cash or deferred arrangement (CODA), is actually a feature that is part of a profit sharing plan, stock bonus plan, and, in some cases which are beyond the scope of this book, a money purchase pension plan. CODAs provide an employee an option to choose whether his employer should pay a certain amount to him in cash or contribute that amount to a qualified profit sharing or stock bonus plan on his behalf. A plan that contains a 401(k) feature generally must include the customary provisions required of all defined contribution plans. For additional information on 401(k) plans, see the questions and answers at the end of this chapter.


1. When your client would like to be sure of a steady, adequate, and secure personal retirement income.

2. When your client would like to set aside money for retirement on a tax deductible basis.

3. When your client wants to reward long-service employees and provide for their economic welfare after retirement.

4. When your client would like to put his or her business in a better competitive position for attracting, retaining, and eventually retiring personnel.

5. When your client's corporation is about to run into an accumulated earnings tax problem. The corporation may need to "siphon off" some of its earnings and profits and reduce or eliminate the threat of a penalty tax on unreasonably accumulated earnings.

6. When your client has employees who would like to defer compensation on an elective, pre-tax basis to a qualified retirement plan.


1. The plan must be for the exclusive benefit of employees or their beneficiaries. (2)

2. The primary purpose of the plan must be to offer employees a retirement benefit (or, in the case of a profit sharing plan, provide employees with a share in the company's profits).

3. The plan provisions must set forth, in writing, a description of the plan and details of the plan. (3) Furthermore, details of the plan must be communicated to employees.

4. The plan must be permanent. This means the plan must contain no set termination date.

5. The plan must not discriminate in favor of highly-compensated employees. Plans that are "top heavy," that is, plans that provide more than 60% of aggregate accumulated benefits or account balances for current key employees, must meet more stringent vesting, minimum benefit, and other rules.

6. The plan must meet minimum age and service standards, minimum coverage requirements and, in the case of defined benefit plans, a minimum participation test.

7. The plan must meet minimum vesting standards and provide for benefits or contributions that do not exceed the Section 415 limits.

8. Distributions generally must begin to all participants by the April 1 following the year of attaining age 701/2; however, (1) employees who are not more-than-5% owners and (2) participants in governmental or church plans, generally need not begin distributions until April 1 of the year following the year they retire, if that is later. (4)

9. Although traditional 401(k) plans are entitled to favorable tax treatment, they must meet certain special qualification requirements in addition to the regular plan qualification requirements. These special qualification requirements are as follows:

(a) The plan must permit the employees to elect either to have the employer make a contribution on his behalf or to receive an equivalent amount in cash.

(b) Unlike a typical profit sharing or stock bonus plan, a 401(k) plan cannot allow employees to receive a distribution of funds held in the plan which are attributable to elective deferrals merely because of the lapse of a fixed number of years or the completion of a specified period of participation. (5)

(c) The employee's rights to benefits derived from elective contributions, as well as from qualified matching and qualified nonelective contributions used to satisfy the ADP (actual deferral percentage) test, are nonforfeitable. (6)

(d) The employer cannot condition the availability of any other benefit (except employer matching contributions) on whether an employee elects to make elective contributions under the CODA or to receive cash in lieu thereof. (7)

(e) The plan must meet special nondiscrimination tests with respect to the amount of elective contributions made to the plan each year. See QUESTIONS AND ANSWERS for more details.

(f) Unlike a typical profit sharing or stock bonus plan, the CODA cannot require, as a condition of participation, that an employee complete more than one year of service for the employer maintaining the plan.

(g) The amount of the elective contributions made to the plan on behalf of a participant cannot exceed $15,000 in 2006. (8) Thereafter, the limit will be indexed for inflation.

(h) Participants who have reached age 50 by the end of the plan year may make catch-up elective deferrals. (However, the total amount of a participant's elective deferrals may not exceed 100% of compensation for the year.) The catch-up amount is $5,000 in 2006. Thereafter, the limit will be indexed for inflation. (9)

The requirements for pension and profit sharing plans listed above are not exhaustive. For example, other requirements may include meeting minimum standards on participation, coverage, and funding. (10)

There are two basic types of qualified retirement plans. The first is known as a fixed or defined benefit plan. Here, definitely determinable retirement benefits are computed using a pre-determined benefit formula established when the plan is created. Each employee is promised a specific amount of retirement benefits. The amount of the employer's contribution to fund that benefit is based on an actuarial determination of the cost of benefits promised. In other words, contributions are based on benefits and the limits on contributions are based on the benefit they will produce.

A money purchase pension plan, which is a type of defined contribution plan, bases the retirement benefit upon an employer's commitment to make an annual contribution. Benefits are directly dependent upon the length of time an employee participates in the plan and the amount of money contributed on his behalf each year (plus interest and appreciation on such funds). In a money purchase pension plan, therefore, the employer is not obligated to provide a specific amount of retirement benefits, but is required to make the specified amount of contributions.

A profit sharing plan is an arrangement by which an employer shares a portion of corporate profits with employees. Contributions can be made even if there are no profits. It is a type of defined contribution plan. For all defined contribution plans, the limits on annual additions to the plans are based on the lesser of the employee's salary or a set limit ($44,000 in 2006) that is indexed for inflation. (11) There is no limit to the benefits produced by the plan.

The corporation can distribute these payments currently in the form of cash bonuses, or profits can be shared on a deferred basis through contributions to a profit sharing plan.

In deferred profit sharing, contributions are made into an irrevocable trust. Funds then accumulate and are distributed to participants, usually as a retirement benefit, at some later date. Under a profit sharing plan, participants can also receive benefits in the event of a termination other than retirement, such as death, layoff, or disability.

One important advantage of a profit sharing plan is that the employer need not make a contribution in years in which no profits are earned. (However, a substantial amount of contribution flexibility can also be made possible in a well-designed pension plan.)

A traditional 401(k) plan may stand on its own (e.g., permit only elective contributions) or it may permit other types of employer contributions and/or employee contributions. The key feature of a cash or deferred arrangement is that an employee can elect to have the employer make an elective contribution on his behalf in the form of a compensation reduction agreement under which the employee elects to reduce cash compensation and to have the employer contribute such amount to the plan on the employee's behalf. In some cases, the employer may agree to make a matching contribution based on the employee's contribution (e.g. 50 cents from the employer for every dollar put in by the employee from his or her compensation).

The comments that follow explain the basic principles of eligibility, vesting, contributions, actuarial assumptions, death benefits, retirement age, and Social Security integration for qualified plans in general. There are also special rules for "top heavy" plans; see below.


A qualified corporate retirement plan may not impose an age or service requirement that would exclude any full-time employee who has attained age 21, or who has completed one year of service, whichever is later. (12) If there is 100% immediate vesting, a two-year waiting period is permitted. (13)

A plan must be nondiscriminatory in its coverage of employees. (It is permissible to favor rank and file employees.) A plan will qualify if it benefits at least 70% of the nonhighly compensated employees, or benefits a percentage of nonhighly compensated employees which is at least 70% of the percentage of highly compensated employees benefiting under the plan. (14) Alternatively, a plan will qualify if it does not discriminate in favor of highly compensated employees and the average benefit percentage for the nonhighly compensated employees is at least 70% of the average benefit percentage for the highly compensated employees. (15) Additionally, a defined benefit plan must cover, on each day of the plan year, the lesser of 50 employees or 40% or more of all employees of the employer. (16)

A plan may exclude part-time and seasonal employees (those employees who work less than 1,000 hours in a 12-month period). (17) Also, a collective bargaining unit may be excluded if the union prefers not to be covered under a plan and the decision is made as the result of good-faith bargaining. (18)


Minimum vesting standards must be met by all plans. Vesting refers to nonforfeitability of benefits by covered employees. The general rule is that the benefits attributable to employee contributions must always be 100% vested. (19) Likewise, with respect to a 401(k) plan, an employee's rights to benefits derived from elective contributions, as well as from qualified matching and qualified nonelective contributions used to satisfy the actual deferral percentage (ADP) test, must be 100% vested at all times. (20)

Full vesting is required under one of the following schedules: for 401(k) matching contributions and for top heavy plans, after (a) three years, or (b) six years under a graduated vesting schedule. For all other plans, vesting must take place no later than (c) after five years or (d) after seven years under a graduated vesting schedule. (21) The following chart shows the required vesting percentages under each method at various years of service:
Years of Service     (a)     (b)     (c)     (d)

1                     0%      0%      0%      0%
2                      0      20       0       0
3                    100      40       0      20
4                             60       0      40
5                             80     100      60
6                            100              80
7                                            100

A plan must take into account all years of service (generally 1,000 hours in a plan year) completed after the employee attains age 18 for vesting purposes.

Contributions and Benefits

The law imposes certain limitations on contributions and benefits.

Defined Contribution Plans

Defined contribution type plans include money purchase pension plans, profit sharing plans, stock bonus plans, 401(k) plans, ESOPs, thrift plans, and target or assumed benefit plans.

Defined contribution plans are subject to an annual additions limit equal to the lesser of (a) 100% of compensation or (b) $44,000 (in 2006, as indexed). (22)

An employer who sponsors a profit sharing plan is permitted a maximum deduction of up to 25% of the total compensation of plan participants. (23) Furthermore, elective deferrals are not counted toward the maximum deduction limit. In addition, total compensation in a 401(k) plan is determined before subtracting any elective deferrals. (24)

Employees are typically not required to contribute their own funds as a condition of plan participation but plans can provide for voluntary contributions. Thrift plans commonly do require employees to contribute and require the employer to make matching contributions.

Defined contribution plans may be integrated with Social Security based on the Social Security tax (excluding hospital premium) for the current year.

Disabled plan participants (other than a disabled employee who is highly compensated) can receive the benefit of an employer contribution to a defined contribution plan based on the annualized compensation of the employee during his last year of employment. All such contributions must be immediately 100% vested. (25)

Defined Benefit Plans

A defined benefit plan is a plan which provides a fixed or determinable benefit such as 40% of an employee's final three years average salary or 1% times final three years average salary times number of years of plan participation or service with the employer.

The maximum normal retirement benefit for a defined benefit plan, based on retirement no earlier than age 62, is the lesser of (a) 100% of the highest three consecutive years of average compensation while actively participating in the plan, or (b) $175,000 (in 2006, as indexed). (26) The limitation is increased for retirement after age 65 and decreased for retirement before age 62. (27) These limits are based on the annual payment which, with interest compounded until the retirement date of the employee, will create a fund sufficient to provide the described benefit to the employee for his actuarial life expectancy. The benefit must be reduced pro-rata if the employee has fewer than 10 years of plan participation with the employer. (28)

A $10,000 minimum annual benefit may always be provided for an employee who has never been covered by a defined contribution plan maintained by the employer regardless of the rules mentioned above. (29) But this amount must be reduced pro-rata if the employee has served the employer for less than 10 years at retirement. (30)

All the limits above must be actuarially reduced to reflect any post retirement death benefits except in the case of a qualified joint and survivor annuity. (31)

Further reductions must be made in the limits described above if an employee retires before age 62. (32) If retirement benefits are to commence prior to age 62, the limit is reduced to the actuarial equivalent of a $175,000 benefit at age 62. If retirement benefits commence after age 65, the limit is increased to the actuarial equivalent of a $175,000 benefit at age 65. For this purpose, the interest rate assumption must be not greater than the lesser of 5% or the rate specified in the plan. (33)

Furthermore, the limit must be reduced if the normal form of retirement is something other than a nonrefund life annuity. (34) All of the dollar limits described above are subject to the annual cost-of-living changes.

Target or Assumed Benefit Plan

A target or assumed benefit plan is a hybrid between a defined contribution and defined benefit plan in which a "target benefit" is established under the plan for each participant, such as 50% of an employee's five highest years average salary.

Once the "target benefit" is found, contributions necessary to attain that goal are then actuarially determined based on a conservative interest assumption, such as 5% or 6%, and the age of the participant. The plan then becomes a money purchase plan.

The maximum annual addition to the account of a participant in a target benefit plan cannot exceed the lesser of (a) 100% of salary or (b) $44,000 (in 2006, as indexed). (35)

Each participant's account is credited with any investment earnings or gains and losses. This means the actual retirement benefit of a participant under a target benefit plan can be more or less than the actual target itself.

Deduction of Contributions

In a defined benefit pension plan, an employer can contribute and deduct the amount necessary to pay for the benefits promised. Technically stated, the employer may pay and deduct the plan's "normal cost" plus any amount necessary to amortize liability for benefits earned through the past service of employees. Past service (simplified, past service is the cost of financing benefits credited for past services) liability can be amortized over as few as 10 years (but no more than 30 years). (36)

An employer sponsoring a profit sharing plan may contribute and deduct a maximum of 25% of the total compensation of plan participants (without carry-forwards). A $100,000 covered payroll would therefore yield the right to a $25,000 deductible contribution. (37)

Where the employee is utilizing both a pension and profit sharing plan, the maximum deductible contribution for both plans is the greater of 25% of the compensation of covered employees or the contribution required to fund the minimum funding standard. This deduction limitation also applies to combinations of defined benefit and money purchase plans. (38)

Prior to 1987, employees could deduct "qualified voluntary employee contributions" made to the plan up to a maximum of $2,000 per taxable year or, if less, 100% of compensation. The plan had to contain special provisions allowing these contributions. (39) Qualified voluntary employee contributions (made prior to 1987) must be accounted for separately, although separate investment will not be required. No loans to participants or investments in life insurance contracts should be made with plan assets attributable to deductible employee contributions or such action will be considered a distribution. (40)

Since a CODA must be part of a profit sharing or stock bonus plan, the limitation on the employer's tax-deductible contributions to such a plan is 25% of the participants' total compensation. (41) Furthermore, for purposes of the limitation on annual additions, elective contributions made under a qualified CODA are not considered employer contributions. (42)

Employers may also permit employees to make voluntary contributions to a separate account or annuity, referred to as a "deemed IRA." If certain requirements for a traditional or Roth IRA are met, then the account or annuity will be treated as a traditional or Roth IRA, not as a qualified plan. (43)

Actuarial Assumptions

In a defined or fixed benefit pension plan, a conservative estimate should be made as to the rate of return of funds invested in assets other than life insurance. Interest rate assumptions of 5% to 7% are typical. Any actual return in excess of the amount assumed must be used to reduce the employer's future contributions.

After challenging the use of rates as low as 5% or 6% for a number of years, the IRS backed down on its position that such rates were too conservative. The Tax Court and several circuit courts had sided with the employers in several such cases, noting that Congress intended actuaries to be "afforded a range of latitude in establishing a mix of reasonable assumptions, and that only if such assumptions are 'substantially unreasonable' should they be challenged and changed retroactively." (44)

In a money purchase plan, the investment experience directly affects the amount a participant will have at retirement. Normally, earnings are allocated to the participant's account in proportion to his or her account balance.

In a profit sharing plan, the investment experience directly affects the amount in a participant's account. Gains and losses must be allocated proportionately to each individual. Typically, such allocations are made in proportion to the account balances of each participant. At retirement a participant may have more or less than was contributed, depending on the investment experience of the plan.

In the event an employee terminates, under a defined benefit plan the portion of a terminated participant's nonvested account is used to reduce future employer contributions. (45) However, in a profit sharing plan, the funds in a terminated participant's nonvested account (forfeitures) can be allocated among the accounts of remaining participants on the same basis as the following year's contribution, or can be used to reduce future employer contributions, depending upon what provisions have been made in the plan. (46) Generally, forfeitures under all defined contribution plans, including money purchase plans, may also be used to increase participants' account balances. (47)

Mortality is an important actuarial assumption. In a fixed benefit pension plan, if life insurance is included in the plan, the investment account is generally not used to provide the death benefit. Instead, the investment account that would have gone to the deceased employee had he or she lived is used to reduce future employer contributions to the plan. If life insurance is included in the plan, death proceeds generally go to the employee's beneficiary.

In either a money purchase pension plan or a profit sharing plan, the total funds in a participant's account are paid to a beneficiary as a death benefit. This includes the life insurance proceeds as well as any other investments.

Retirement Age

Generally, plans will make provision for normal, early, and late retirement age. Usually, normal retirement age will be age 65.

Mandatory retirement is generally prohibited. Exceptions exist for certain top executives and for good faith occupational requirements.

Employers are required to accrue additional benefits or pay the actuarial equivalent of normal retirement benefits to employees who choose to work beyond normal retirement age. It is unlawful to eliminate the accrual of further benefit credits to an employee's retirement account after the employee attains normal retirement age. (48)

It is also unlawful to exclude an employee from participation in a pension plan even though his age is within five years of the age set for normal retirement. Allowance is made, however, for the extension of the normal retirement date for any such late-age-hired person. (49) Most pension plans state that the normal retirement age of participants who are over age 55 at the time they enter the plan is five years from the date of entering the plan.

Early retirement benefits are generally available under a defined benefit plan at an actuarially reduced amount. In a money purchase plan, the amount of a pension that can be provided with the participant's vested share is what he or she will receive at early retirement. Under a profit sharing plan, in the case of early retirement, the amount accumulated in a participant's account will be paid generally as a lump sum or as monthly income.

The IRS has challenged the use of retirement ages under age 65 in small defined benefit plans; however, it backed down on this issue. The Tax Court and several circuit courts had sided with the employers in litigation of some of these cases. (See the discussion above, under "Actuarial Assumptions" with regard to IRS challenges to the use of low interest rates.)

Social Security Integration

Generally speaking, the benefit structure of Social Security can be viewed as discriminating against the higher-paid employee, which usually includes the key shareholders and highly-paid management. Social Security benefits replace, relatively speaking, a higher percentage of the lower-paid employee's pre-retirement income. In essence, the business owner is already providing a base pension through contributions to the Social Security system.

Integration of a retirement plan with Social Security allows an employer to coordinate the benefits provided by Social Security with those provided by the employer's retirement plan. Through integration, the two benefits combined produce roughly the same proportionate benefit for higher-paid employees as for lower-paid employees. (The Internal Revenue Code and the IRS refer to integration as "permitted disparity.")

Example: In the case of a money purchase or profit sharing plan, the contribution rate (%) that applies to compensation above the taxable wage base may not exceed the contribution rate (%) that applies to compensation below the taxable wage base by more than the lesser of (1) the rate applied to compensation below the wage base or (2) 5.7% points (or, if greater, the rate of Social Security tax attributable to old-age insurance). (50) Thus, if the plan provides for contributions of 10% of pay in excess of the wage base, it would be properly integrated if it provided for contributions of at least 5% on pay below the wage base.

It is also possible to integrate a defined benefit pension plan. But here integration is on the basis of benefits rather than contributions.

Top Heavy Plans

Plans that are considered "top heavy" must meet the basic qualification requirements of other qualified plans and, in addition, meet the following requirements: (1) implement one of two alternative rapid vesting schedules; (2) provide minimum nonintegrated contributions or benefits for plan participants who are non-key employees; and (3) reduce the aggregate limit on contributions and benefits for some key employees. (51)

A plan is considered "top heavy" when more than 60% of its aggregate accumulated benefits or account balances is provided to key employees. An employee's status and whether or not a plan is top heavy is determined on a year by year basis. The determination is made on the last day of the preceding plan year for existing plans and on the last day of the first plan year for new plans. (52)

A key employee is any employee-participant who, at any time during the plan year is an officer earning more than $140,000 (in 2006, as indexed), a 5% (or more) owner, or a 1% (or more) owner earning more than $150,000 a year. (53)

Special rules apply for smaller employers: If the business (or aggregated group of businesses) has fewer than 500 employees, only 10% will be considered officers, but if the business has fewer than 30 employees, at least three officers must be counted.

Each additional qualification requirement will be discussed below.


A top heavy plan must meet one of two special vesting rules. The first is a three-year 100% vesting rule. Under this rule an employee who is at least 21 years old and who has completed at least three years of service with the employer (or employers) maintaining the plan must be given a nonforfeitable right to 100% of his accrued benefit derived from employer contributions. The second is a 6-year graded vesting rule. This provides 20% vesting at the end of the second year of service and 20% in each succeeding year. Full vesting must be attained by the end of the 6-year period. (54)
Years of service       percentage

2                            20
3                            40
4                            60
5                            80
6 or more                   100

Contributions and Benefits

Special limitations on contributions and benefits are imposed if the plan is considered top heavy. (55) Minimum benefits under defined benefit plans must be provided to non-key employees. The benefit accrued during a top heavy year must be at least 2% of average pay for the highest five years for each year of service in which a top heavy plan year ends, up to a total of 20% of average pay.

In the case of top heavy defined contribution plans, in each year the plan is top heavy, non-key employees must receive minimum contributions of at least 3% of compensation. But if the plan provides the contribution rate of less than 3% for all participants, then instead of the 3% contribution rate, the highest contribution rate percentage on behalf of any key employee can be used (counting only the first $220,000 of compensation for plan years beginning in 2006).

In determining benefits under a top heavy plan, only the first $220,000 of compensation (for plan years beginning in 2006) can be counted, as is the case in non-top heavy plans. (56) The $220,000 limit is indexed for inflation. Social Security benefits or contributions cannot be counted against the required minimum benefits or contributions.


There are basically three ways an employer places funds into a retirement plan. The first is known as a "fully-insured" plan. Here, the employer places contributions into a funding vehicle of an insurance company, such as a retirement income life insurance contract. The funds usually receive a guarantee as to principal, minimum rate of interest, and annuity purchase rate (the "rate of exchange" at which pension funds can be changed into lifetime payment guarantees). It is the simplest method of investing pension monies.

The second type of investment vehicle is known as the "split funded" plan. Here, the employer places contributions into a trust fund. The trust fund splits contributions into two parts: part of the funds are placed in fixed assets, annuities, and/or life insurance, while the remainder is invested in other investments for diversification. There are principal, interest, and annuity purchase rate guarantees for the funds invested with the insurance company. However, frequently funds invested otherwise have no guarantees of principal or interest, but they may have the advantage of appreciation if invested in equities.

The third type of funding vehicle is known as uninsured. This type of funding implies that the employer contributions are invested solely by investments including equities. Contributions are made by the employer to a trust fund. There are no guarantees as to principal or interest although funds may be applied to buy a guaranteed annuity at normal retirement age. This funding method involves the highest risk because there are no guarantees made by a third party, but in return for the extra risk, this method offers the greatest potential appreciation (or depending upon how the plan is arranged, the lowest possible employer cost).

All three arrangements have advantages and disadvantages. For example, the fully-insured plan guarantees the principal, interest, annuity purchase rates, and expenses. It is the easiest plan to install and administer. The cost and effort of compliance with the Employee Retirement Income Security Act (ERISA) is relatively minimal. A disadvantage is that the growth of dollars in the plan is fixed, and so there is no chance for an equity-type appreciation of funds.

The split funded plan combines guarantees with the possibility of appreciation. The funds invested in insurance contracts obtain guarantees on principal and interest earnings, expense costs, and annuity rates. The side fund is usually invested in growth-oriented securities. Of course, since the side fund is invested in equities, the possibility exists that depreciation in the value of the securities will result in lower benefits for employees (or higher costs for the employer).

The main advantage of a full equity funded approach is that all funds have the possibility of appreciation. If the investment manager is successful, the result will be either reduced cost for the employer or increased benefits for the employees, depending on the type of plan utilized. The disadvantage of this arrangement is that there are no guarantees applied to the funds. Also, if an insurance company is not used, the employer or the plan must pay directly for actuarial, administrative, and investment expenses. The cost of hiring private actuarial and administrative services will be higher for small employers in most cases than if an insurer's services were utilized.


1. Within the limits mentioned above, employer contributions to these plans are fully deductible for income tax purposes. (57)

2. Earnings on plan assets accumulate income tax free. (58)

3. Distributions made in the form of a lump sum distribution are included as ordinary income to the employee in the year paid. Certain amounts may be subject to 10-year averaging, in the case of a taxpayer who attained age 50 before January 1, 1986. In any event, special averaging cannot be used for the portion of a taxable distribution attributable to deductible employee contributions. Payment of such amounts can be distributed in a different tax year from the balance of the lump sum payment without jeopardizing any special averaging treatment that may still be available. See the table in Appendix D for the federal tax consequences of a lump-sum distribution based on the use of special averaging.

4. Before distribution is made, an employee generally does not have to include an employer's contribution in gross income, even if rights to the benefits in the plan are fully nonforfeitable. Benefits payable under a qualified retirement plan-including deductible employee contributions and earnings on those contributions-are taxed only when paid to a participant or beneficiary and are not taxed if merely "made available." (59)

However, if life insurance protection is provided under the plan, an employee is considered to have received a distribution each year (a current economic benefit) equal to the portion of the employer's contributions or trust earnings that have been applied during the year to provide pure insurance on the employee's life. This is the so-called "Table 2001 cost." (60) The employee includes this as income just as if he or she had received a bonus in that amount; however, such costs will be recovered income tax free when benefits are received under the contract. (If life insurance is purchased with deductible employee contributions, the amount spent is treated as a distribution. (61))

When an employee first becomes eligible to receive benefits, those benefits do not have to be paid and immediately rolled over into an IRA to avoid current income taxation. If the plan allows, they can be left in the plan and are not taxed until paid (but if paid to a child or creditor of the employee, they are treated as if paid to the employee).

The plan must place some limits on this deferral of receipt of benefits. Distributions generally must begin by April 1 of the year following the year the participant reaches age 701/2 (see item (8) under "What are the Requirements" above). The plan must provide that the entire interest of the participant will be distributed over one of the following permissible periods: (1) the life of the participant; (2) the lives of the participant and his or her "designated beneficiary"; (3) a period not extending beyond the life expectancy of the participant; or (4) a period not extending beyond the life expectancy of the participant and his or her "designated beneficiary." Under regulations issued in 2003, a "Uniform Distribution Period" is used to determine the participant's lifetime distributions, regardless of who is named as the beneficiary. (62) However, the amount required to be distributed will be somewhat less if the designated beneficiary is the participant's spouse and is more than 10 years younger than the participant. (63) A designated beneficiary is generally any individual designated by the participant to receive the balance of his or her benefits remaining at the participant's death.

5. An employee who retires and receives periodic payments from the retirement plan is taxed on the receipt of such payments in accordance with the annuity rules, which vary depending on the annuity starting date.

Effective for annuity starting dates that are later than November 18, 1996, a table is set forth in the Code for determining the excludable portion of each monthly payment from such an annuity. The excludable portion of an annuity subject to this provision is determined by dividing the employee's investment in the contract by the number of anticipated payments based on the age of the annuitant, as follows: (64)
Age on annuity                       Number of
starting date                        anticipated payments

Not more than 55                     360
More than 55 but not more than 60    310
More than 60 but not more than 65    260
More than 65 but not more than 70    210
More than 70                         160

In the case of annuity starting dates after December 31, 1997, a separate table is provided for annuities payable over two or more lives. The excludable portion of such an annuity is determined by dividing the employee's investment in the contract by the number of anticipated payments based on the age of the annuitant, as follows: (65)
If the combined ages                   Number of
of the annuitants are:                 payments

Not more than 110                      410
More than 110 but not more than 120    360
More than 120 but not more than 130    310
More than 130 but not more than 140    260
More than 140                          210

For annuity starting dates beginning after July 1, 1986 and before November 19, 1996, an exclusion ratio is used to determine the taxable portion of the annuity payouts. The exclusion ratio is the ratio of the employee's "investment in the contract" (cost) to the employee's "expected return," expressed as follows:

Investment In Contract/ Expected Return

The employee's cost or "investment in the contract" is essentially his nondeductible contributions. Where life insurance is included in the plan, it also includes the total of all one year term insurance costs that have been reported as taxable income. The "expected return" is the annual payment the employee will receive multiplied by the employee's life expectancy (see Table V, One Life-Expected Return Multiples in Appendix B). (Adjustments must be made for payouts made over differing time periods or where minimum payout guarantees are present.) Once the fraction is determined, it is multiplied by the annual payment. The product is the amount not subject to taxation. The balance of each payment is taxable as ordinary income. (66) A simplified safe harbor method for taxing annuity payments (see IRS Pub. 575) is available for individuals whose annuity starting date is after July 1, 1986. (67)

Distributions of deductible employee contributions are generally taxed under a pro-rata recovery rule. (68)

6. Distributions before the participant attains age 591/2 are subject to a 10% penalty tax with certain exceptions (death, divorce, disability, payments made over the participant's life starting from separation from service, and medical expenses). (69) The penalty is increased to 25% in the case of distributions from a SIMPLE IRA during the first two years of participation in the plan.

7. A beneficiary receiving death benefits from a qualified retirement plan is taxed on the amount received for income tax purposes under either the lump sum or annuity rules. However, voluntary employee contributions that were deductible are not allowed the relief granted lump-sum distributions and are includable in ordinary income. (70) In computing the amount of taxable income the beneficiary must report as a result of the distribution, if the distribution is made in a lump sum and if any portion of the distribution consists of life insurance proceeds for which the employee paid the insurance costs or reported the Table 2001 cost as taxable income on his return, then the difference between the face amount of the insurance contract and the insurance contract cash value (this difference is called the "pure insurance") passes to the beneficiary free of income tax. (71) Thus, the beneficiary treats only the cash value portion of any death benefit plus any other cash distributions from the plan as income subject to tax.

If, on the other hand, the employee did not pay the insurance cost of the life insurance contract or did not report the cost of such insurance as taxable income, the portion of the insurance proceeds consisting of pure insurance (as defined above) will be considered taxable income to the beneficiary.

8. If the plan participant suffers permanent loss or loss of use of a member or function of the body, or permanent disfigurement, it may be possible for him or her to receive benefits under a qualified plan free of income tax under Code section 105(c). In order for the payment to qualify, the plan must provide 100% vesting of benefits if the participant ceases employment due to total and permanent disability, and must also include statutory language from Section 105(c) to establish the dual purpose of the plan (i.e., a retirement plan and an "accident and health" plan).

Code section 105 applies to amounts received under "Accident and Health Plans." A minority of courts have found that a qualified plan can serve a dual function of providing retirement benefits and disability benefits. To the extent benefits are provided due to the participant's disability, they may be income tax free if the requirements of Section 105(c) are satisfied.

Section 105(c)(2) requires that the disability payment be computed by taking the nature of the injury into account in determining the benefit without regard to the period the employee is absent from work. This requirement may be difficult to satisfy in most pension plan contexts. However, a provision giving the committee discretion to determine disability benefits with reference to the nature of the injury may enable the disabled participant to overcome this hurdle.


The entire value of a qualified plan death benefit is subject to inclusion in the decedent's gross estate for federal estate tax purposes. However, only high-income plan participants will actually be subject to estate tax. First, there is a substantial unified credit applicable to the estate tax, which essentially eliminates estate taxes for gross estates of less than $2,000,000 for 2006, 2007, and 2008; and $3,500,000 for 2009. In 2010, the estate tax is repealed for a year. Finally, in 2011, the exemption equivalent of the unified credit reverts to $1,000,000. (72) In addition, the unlimited marital deduction for federal estate tax purposes defers federal estate tax on property transferred at death to a spouse in a qualifying manner until the death of the second spouse. (73)

Avoiding federal estate tax can be significant if the estate is relatively large, the participant is single, or, for whatever reason, the participant is unwilling to pay the death benefit to the spouse. In each of these situations, the marital deduction would not be available. Also, even when the death benefit is payable to a spouse, federal estate tax is merely delayed and is not really avoided; a spouse is often about the same age as the decedent, and thus within a few years much of the property transferred to the spouse is potentially subject to federal estate tax at the surviving spouse's death.

Only a limited exclusion is available from the federal estate tax for retirement plan distributions payable at an employee's death. The Tax Reform Act of 1984 contained a provision that permitted individuals who were both in pay status and had made an irrevocable election as to the form of benefit distribution to continue to have the benefit of the estate tax exclusion (the unlimited exclusion for participants in pay status prior to January 1, 1983, or the $100,000 exclusion for participants in pay status prior to January 1, 1985). TRA '86 somewhat liberalized the grandfathering provisions by providing that the participant no longer needs to be in pay status as of the applicable date. The participant needs only to have separated from service prior to the applicable date and not to have made any change in the form of benefit to be paid prior to death.

State inheritance tax laws covering distributions from qualified pension and profit sharing plans vary widely. In Pennsylvania, for example, death benefits are excludable from inheritance taxes as long as such amounts are not available to pay death taxes and other estate expenses (i.e., payments will be state death tax free if payable to a named beneficiary other than the decedent-employee's estate). On the other hand, New Jersey, a neighboring state, taxes retirement plan death benefits payable to any beneficiary other than the deceased employee's spouse, regardless of the manner in which benefits are paid.


Many community property implications and issues have been discussed in previous chapters. Some additional tax implications should also be mentioned.

Generally, for purposes of divorce, the community property laws are recognized; however, there will be a substantial difference in rights in the event of the prior death of the nonparticipant spouse. Generally, if the participant spouse is married, the required form of distribution on the death of either spouse is in the form of a survivor annuity for the surviving spouse. Where the participant spouse is the first to die, this means the surviving spouse will receive the required annuity regardless of the community nature of the qualified plan benefit.

Further, where the nonparticipant spouse is the first to die, one court (74) has held that his or her community interest in a pension plan in effect passes to the surviving participant spouse regardless of any direction of the deceased spouse, or any contrary provisions in the will of the deceased spouse. In effect, the required survivor rights supersede state community property laws.

This position was affirmed in a landmark 1997 case, (75) where the U.S. Supreme Court held in a 5-4 decision that a deceased spouse may not make a bequest of her community property interest in her participant spouse's undistributed qualified plan benefits, as further discussed in Chapter 49.

Note that the survivor annuity rule does not apply to distributions from IRAs, SIMPLE IRAs, or Simplified Employee Pensions, as discussed in Chapter 51, and that the survivor annuity may be waived, as discussed at the end of this chapter.


Question--Who is a fiduciary and what are the fiduciary responsibility rules established by ERISA?

Answer--A fiduciary is a person who (a) exercises any discretionary authority or discretionary control respecting management of the plan or exercises any authority or control respecting management or disposition of assets; (b) renders investment advice for a fee or other compensation, direct or indirect, with respect to any monies or other property of the plan, or has any authority or responsibility to do so; or (c) has any discretionary authority or discretionary responsibility in the administration of the plan. (76) The term "fiduciary" also includes persons named by a fiduciary to carry out fiduciary responsibilities (other than trustee responsibilities) under the plan. ERISA established rules governing the conduct of fiduciaries and other persons dealing with the plan. The Department of Labor administers certain provisions that pertain to rules and remedies similar to those under traditional trust law governing the conduct of fiduciaries.

Specifically, these fiduciary responsibility rules relate to plan administration, provide general standards of conduct for fiduciaries, and make certain transactions "prohibited transactions" in which plan fiduciaries may not engage. (77) Other provisions that are enforced by the Treasury Department impose an excise tax on certain persons who violate the prohibited transaction rules. (78)

Basically, ERISA requires each fiduciary of a plan to act with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in conducting an enterprise of like character and with like aims.

Furthermore, ERISA requires that a qualified retirement plan be for the exclusive benefit of the plan's employees and their beneficiaries. (79) Under the "exclusive benefit" umbrella:

1. the cost of plan assets must not exceed fair market value at the time of purchase;

2. assets should bring a fair return commensurate with the prevailing rate;

3. the plan should maintain sufficient liquidity to permit distributions; and

4. the safeguards and diversity that would be adhered to by a prudent investor must be present.

Question--How does plan termination insurance work?

Answer--ERISA established, within the Department of Labor, a public corporation named the Pension Benefit Guaranty Corporation (PBGC). The PBGC is a federal insurance company that provides mandatory plan termination insurance to protect the benefit rights of workers whose defined benefit pension plans go out of existence. As one of its main duties, the corporation administers plan termination insurance for defined benefit pension plans, up to specified limits. (80)

Premiums for PBGC coverage are $30.00 per participant (in 2006), plus an additional amount, calculated by dividing the plan's unfunded vested benefits as of the end of the preceding plan year by the number of plan participants at that time. The additional premium is equal to $9.00 per thousand (or fraction thereof) of the plan's unfunded vested benefits as of the end of the preceding plan year. Beginning after 2006, the $30 per participant amount is indexed for inflation. (81)

Question--Can a pension plan make a loan to a participant or plan beneficiary?

Answer--Yes, if the loan is made in accordance with specific provisions in the plan governing such loans, a reasonable charge is made for the use of plan assets, and the loan is adequately secured. Loans must be available to all participants on a reasonably equivalent basis. (82)

Plan loans can also be offered from HR-10 plans to owner employees, such as partners, S corporation shareholders, and sole proprietors. (In plan years prior to 2002, such loans constituted "prohibited transactions"; therefore, they could not be made without specific Department of Labor approval. (83))

Limits are imposed on tax-free participant borrowing from qualified plans, from tax sheltered annuities, and from plans (qualified and nonqualified) of federal, state, and local governments and their agencies and instrumentalities.

Certain loan transactions are treated as distributions. Special rules apply if the loan constitutes a qualified hurricane distribution. (84)

Loan transactions include: (1) the direct or indirect receipt of a loan, and (2) the assignment (or agreement to assign) or the pledging (or agreement to pledge) of any portion of an employee's interest in a plan. (85)

The following rules and exceptions apply to plan loans:

1. Loan agreement. The plan loan must be evidenced by a legally enforceable agreement, specifying the date, amount and term of the loan; (86)

2. Term requirement and dollar limitation. The term of the loan must be no longer than five years. (87) Loans which are to be repaid within five years are taxed as distributions only to the extent that the amount of the loan (together with any other outstanding loans the employee has made from plans with the same employer) exceeds the lesser of (a) $50,000 reduced by the highest outstanding loan balance during the prior 12 months, or (b) half of the employee's vested benefits under the employer plans from which he has borrowed (or $10,000, if greater). (88) If the loan exceeds the dollar limitation, a distribution of the amount in excess of the dollar limit is deemed to occur when the loan is made. (89)

3. Loans that do not have to be repaid within five years are fully taxable as distributions. Whether or not a loan must be repaid within five years is ascertained as of the date the loan is made.

4. Repayment. The loan agreement must specify the amount and terms of the loan and the repayment schedule. Failure to make a repayment of a plan loan installment when it is due will generally result in a deemed distribution, unless payment is made within specified "cure" (grace) periods. (90)

Some loans of five years or less may be subsequently extended. The loan balance at the time of the extension is considered a distribution at that time. If repayment under a "5-year-or-less" loan is not made (so at the end of five years, the participant still owes the plan money), any remaining amounts due are considered plan distributions.

"More-than-5-year" loans are not converted to "5-year-or-less" loans or in any other way favorably treated merely because they are repaid in five years or less (regardless of the reason for the early repayments).

Exception 1: Housing loans. A loan of more than five years generally is not treated as a distribution to the extent that it is used by the plan participant to purchase the participant's principal residence. (91)

Exception 2: Certain mortgage loans. Where plan trustees invest a specific percentage or amount of plan assets in residential mortgages or in other types of mortgage investments, such investments are not considered loans as long as the amount lent does not exceed the fair market value of the property the loan was used to purchase. Loans to officers, directors, or owners (or their beneficiaries) are not protected under this exception.

Question--What are the reporting and disclosure requirements of ERISA?

Answer--In general, every plan that is not specifically exempted must file certain reports each year. The annual report for plans with 100 or more participants must include an audited financial statement. Annual reports of defined benefit plans must contain a certified actuarial report. If the plan terminates, additional special reports are required.

The number of participants covered by a plan has no effect on the reporting and disclosure requirements -an annual report must be filed regardless of how many or how few participants are covered. However, where a plan contains less than 100 participants, a simplified report may be authorized.

Furthermore, certain information must be provided to plan participants and beneficiaries. They must be given a summary of the plan written in a manner understandable by the average participant or beneficiary (i.e., a Summary Plan Description). Furthermore, beneficiaries and participants can request a status report once a year showing total benefits accrued and nonforfeitable pension benefit rights. Employees who have terminated employment during the plan year must also be given a statement of their deferred vested rights in the plan. Many of these documents become public information and can be inspected. (92)

Failure to meet the reporting and disclosure requirements can result in serious civil and/or criminal penalties, which include fines and imprisonment.

Question--What is a target benefit pension plan?

Answer--It is a retirement plan under which the required contribution is initially based upon an assumed retirement benefit for each participant, but under which the actual retirement benefit received is based upon the market value of the assets in the individual participant's account at the time of retirement.

Question--What is an age-weighted profit sharing plan?

Answer--Under traditional profit sharing plan arrangements, employer contributions are generally allocated each year to employees either in proportion to relative compensation or in proportion to relative compensation together with integration with Social Security benefits. However, an employer may maintain a qualified profit sharing plan in which the participant's age is taken into account when allocating the employer's contribution. (93) The result is that somewhat larger allocations (as a percentage of pay) are provided to older employees than to younger employees. Nonetheless, the allocations must satisfy either a "minimum allocation gateway" (e.g., generally 5% of compensation for non-highly compensated employees or one-third of that provided to highly compensated employees) or "broadly available allocation rates" must be used. (94)

Question--What limitations are imposed on a qualified retirement plan regarding the purchase of ordinary life insurance?

Answer--In a profit sharing plan, less than 50% of the aggregate employer contributions and forfeitures allocated to each participant's account can be used to purchase ordinary life insurance. If insurance may be purchased only with funds that have been accumulated in the plan for two or more years, the 50% rule does not apply. (95) In addition to this requirement, a profit sharing plan must require the trustee at or before retirement either (a) to convert the policies into cash, or (b) to distribute the policies to the employee. A money-purchase plan has the same "less than 50%" rule with regard to the purchase of ordinary life insurance.

Life insurance is a permissible purchase in a defined benefit pension plan if it meets either of two tests. The first test is essentially the same as the money-purchase plan test. The alternative test is the "100 to 1" test whereby the insurance is permissible if the insurance amount does not exceed 100 times the expected monthly retirement benefit. (96) For example, if the projected monthly benefit is $1,000, the life insurance cannot exceed $100,000.

Question--What is a thrift and savings plan?

Answer--The major characteristic of a thrift and savings plan is that employee-participants must contribute some percentage of compensation to the plan. The employer matches contributions of employees according to some formula. For example, an employer may match each dollar of employee contribution with more or less than $1 of employer contribution. A thrift and savings plan can be tax qualified or can be informal.

A tax qualified thrift and savings plan will result in a current employer deduction for contributions to the plan and, yet, employees will not be currently taxed on employer contributions. Both employer and employee contributions will grow tax-free within the plan. When distributions from a qualified thrift and savings plan are made, they are subject to the same rules applicable to other qualified retirement plans. Typically, a thrift and savings plan will require employees to contribute a percentage of compensation in order to participate. It is important when incorporating thrift and savings features in a plan that such required contributions meet a special nondiscrimination test. (97) All contributions are counted for purposes of the annual additions limitation.

Question--Can a qualified pension or profit sharing plan provide for voluntary deductible employee contributions?

Answer--No. Prior to 1987, anyone who had earned income, regardless of whether he was an active participant in a qualified plan, could establish an IRA. A voluntary deductible contribution of up to $2,000 could be made to an employer's plan (if the plan so provided), to an IRA, or as a combination split in any proportion between the two. (98)

Voluntary nondeductible employee contributions to qualified pension, profit sharing, or stock bonus plans are allowed, providing they meet a special nondiscrimination test. (99) Also, 100% of employee contributions, whether voluntary or mandatory, will be included in the annual addition for purposes of the dollar limitation. Accordingly, both employer and employee contributions to a defined contribution plan count toward the $44,000/100% (in 2006) limitation. (100)

Question--What is a 401(k) plan (or cash or deferred arrangement) and is it subject to current taxation?

Answer--Under a 401(k) plan, an employee can elect to have the employer make an elective contribution to the plan on the employee's behalf or to receive an equivalent amount in cash. (101)

To the extent the employee elects to receive cash or make after-tax (Roth) contributions, the payment or contribution will be subject to all payroll taxes currently. (102) If the employee elects to make a traditional elective contribution, such contributed amount will not be subject to payroll tax withholding, but it will be subject to Social Security taxes and the Federal Unemployment Taxes Act (FUTA). (103) Of course, amounts contributed in excess of the elective deferral limit of $15,000 (in 2006), are subject to income tax as well. (104) The $15,000 limitation will be adjusted for inflation in future years.

A 401(k) plan may also allow special catch-up contributions by participants who have reached age 50 by the close of the plan year. The elective deferral limit for such individuals is increased by the lesser of (a) an "applicable dollar amount," or (b) the amount of the participant's compensation, reduced by any other elective deferrals of the participant for the year. The applicable dollar amount is $5,000 for 2006, and is adjusted for inflation thereafter. (105)

Question--What special nondiscrimination tests apply to 401(k) plans?

Answer--In order to meet the nondiscrimination requirement, qualified 401(k) plans must either satisfy the actual deferral percentage (ADP) test, adopt a safe harbor plan (see below), or adopt a SIMPLE 401(k) plan, as described below.

The ADP test is designed to limit the extent to which elective contributions made on behalf of highly compensated employees may exceed the elective contributions made on behalf of nonhighly compensated employees. (106)

The amount of elective deferrals to be credited to a participant's account for any plan year must satisfy the following tests.
If the nonhighly compensated     The highly compensated
group contributes                group may contribute an
an average of:                   average of:

Under 2% of                      2 times the rate of the
compensation.                    nonhighly compensated

Between 2-8% of                  2% of pay more than the
compensation.                    non-highly compensated

Over 8% of                       11/4 times the rate of
compensation.                    the nonhighly compensated

The ADP test can be performed by comparing the ADP of highly compensated employees for a plan year to the ADP of nonhighly compensated employees for either the same plan year (current year testing) or the preceding plan year (prior year testing). (107)

Question--What is a safe harbor 401(k) plan?

Answer--A safe harbor 401(k) plan is one that meets the nondiscrimination requirement by satisfying an alternative safe harbor in place of the traditional ADP test. Under the safe harbor, the plan will be considered nondiscriminatory if (a) the employer satisfies a matching contribution requirement for nonhighly compensated employees (100% of the employee contribution up to 3% of compensation, plus 50% from 3% to 5% of compensation) and certain design requirements, including 100% vesting; or (b) the employer makes a nonelective (nonmatching) contribution for all eligible nonhighly compensated employees equal to at least 3% of compensation. (108)

Question--What is a SIMPLE 401(k) plan?

Answer--A SIMPLE 401(k) plan is a cash or deferred arrangement that satisfies the nondiscrimination requirement by meeting special design requirements instead of the ADP test. Among these requirements are that: (a) the employer must have 100 or fewer employees (only employees with at least $5,000 in compensation for the preceding year are counted) on any day in the year; (b) employees must be eligible to make elective salary reductions contributions for the year of up to $10,000 annually (in 2006; adjusted for inflation in $500 increments after 2005); (c) the employer is required to make a contribution equal to either (i) a dollar for dollar matching contribution up to 3% of the employee's compensation, or (ii) 2% of compensation for all eligible employees earning at least $5,000 (whether or not they elect salary reductions); (d) the employer may not maintain any other plan (e.g., qualified plan, SEP, 403(a) annuity, 403(b) tax-sheltered annuity) that covers any of the same employees as the SIMPLE 401(k) plan; and (e) all contributions to the SIMPLE 401(k) plan must be nonforfeitable. SIMPLE 401(k) plans are not subject to the top-heavy requirements, nor to separate nondiscrimination testing; however, they are subject to the other qualification, administrative and ERISA requirements that apply to a qualified Section 401(k) plan. (109)

Question--What are excess contributions to a 401(k) plan?

Answer--Excess contributions are the excess of the elective contributions (including qualified nonelective and matching contributions that are treated as elective contributions) made on behalf of highly compensated employees for the plan year over the maximum amount permitted under the ADP test for such plan year. (110)

Question--How can excess contributions be corrected?

Answer--A 401(k) plan will not fail the ADP test for any plan year, and thus will maintain its qualified status if: (1) the amount of excess contributions for such plan year, along with any income attributable thereto, is returned to highly compensated employees within 12 months after the close of the applicable plan year; or (2) the highly compensated employee elects to recharacterize the excess amount contributed as an after-tax voluntary contribution. (111)

Question--What happens if a 401(k) plan fails to correct excess contributions?

Answer--A 10% excise tax is imposed on the employer unless the excess contributions are corrected within 21/2 months after the end of the plan year for which they were made. (112) If excess contributions are not corrected before the end of the plan year following the plan year for which the excess contributions were made, the plan will fail to qualify for the plan year for which the excess contributions were made and for all subsequent plan years during which the excess contributions remain in the plan. (113)

Question--Are there any measures that can be taken to assure compliance with the special nondiscrimination tests for 401(k) plans?

Answer--Yes. The plan may limit the amount subject to deferral and, if necessary, provide for a minimum level of nonelective employer contributions. For example, if a profit sharing plan provides for nonelective employer contributions of 2% of compensation, which are nonforfeitable and subject to appropriate distribution restrictions, and if eligible employees are limited to deferring an additional 2% of compensation, the nondiscrimination tests will be satisfied in all cases. An alternative would be to make the cash-or-deferred election irrevocable for the entire plan year. Adoption of either the safe harbor or SIMPLE 401(k) design will also assure that the plan remains in compliance with the nondiscrimination requirement.

Question--Are there any restrictions on the distribution of elective contributions?

Answer--Yes. A 401(k) plan must provide that amounts attributable to elective contributions may not be distributed before the occurrence of one of the following events:

1. The participant's retirement, death, disability, or other termination of service;

2. The termination of the plan without the establishment of a successor defined contribution plan;

3. The sale of the business or subsidiary;

4. The participant's attainment of age 591/2, or

5. The participant's financial hardship. (114)

Question--What constitutes "financial hardship" for purposes of permissible distributions?

Answer--For a distribution to be considered as having been made on account of financial hardship it must be made due to an immediate and heavy financial need of the employee and it must be necessary to satisfy that need. The determination of the existence of the immediate and heavy financial need must be made in accordance with nondiscriminatory and objective standards set forth in the plan.

Question--What amounts from the plan may be distributed on account of a financial hardship?

Answer--A distribution that is made due to hardship must be limited to the distributable amount. The "distributable amount" is equal to the employee's total elective contributions as of the date of distribution, reduced by the amount of previous distributions on account of hardship.

Question--What are some examples of permissible hardship distributions?

Answer--A distribution is treated as being made on account of immediate and heavy financial need if it is for:

1. The payment of expenses for medical care that were either previously incurred by, or are necessary for the medical care of, the employee or the employee's spouse or dependents;

2. The costs directly related to the purchase, excluding mortgage payments, of the employee's principal residence;

3. The payment of tuition, related educational fees and room and board for the next 12 months of post-secondary education for the employee, his spouse, children, or dependents; and

4. The payment of amounts necessary to prevent the eviction of the employee from his principal residence or to prevent foreclosure on the mortgage on the employee's principal residence.

The IRS has the authority to expand the above list of expenses found under the regulations, through the issuance of revenue rulings, notices and other documents of general applicability, rather than on an individual basis. (115)

Question--What are examples of distributions that are not treated as necessary to satisfy an immediate and heavy financial need?

Answer--Distributions are not treated as necessary to satisfy an immediate and heavy financial need of an employee:

1. To the extent the amount of the distribution is in excess of the amount required to relieve the financial need. The amount of the immediate and heavy financial need may include amounts necessary to pay federal, state or local income taxes or penalties reasonably anticipated to result from the distribution; and

2. To the extent the need may be relieved from other sources that are reasonably available to the employee, referred to as an "employee resource." For example, a vacation home owned by the employee and his spouse is treated as an employee resource. However, property held in an irrevocable trust for the benefit of the employee's children is not treated as an employee resource.

Question--What are the advantages of life insurance in a qualified retirement plan?

Answer--There are a number of advantages. These include (1) protection against the premature death of a participant, (2) securing the right to use guaranteed annuity rates at a future retirement date, (3) assurance that insurance can be purchased at original age rates when the participant retires or terminates employment, and (4) in a profit sharing plan providing key person insurance on the lives of corporate officers or valuable employees for the benefit of the trust and its participants.

Question--Can a qualified pension or profit sharing plan provide any protection from the claims of creditors?

Answer--Yes. ERISA provides that a pension, profit sharing, or HR-10 plan will not be qualified unless it provides that benefits provided under the plan may not be assigned or alienated, voluntarily or involuntarily. An exception to this rule exists for assignments used to secure plan loans to a participant and voluntary and revocable assignments that do not exceed 10% of any benefit payment to a participant, unless the assignment is made for purposes of defraying plan administrative costs. (116)

It has generally been accepted in the non-bankruptcy context that the anti-alienation provision protects pension interests from the reach of creditors. In the bankruptcy context, federal bankruptcy law provides broad protection for the retirement benefits of participants against the claims of creditors, for personal bankruptcies filed on or after October 17, 2005. This protection is subject to a $1 million limit for the total of an individual's IRAs and Roth IRAs, but this limit does not apply rollover amounts transferred from qualified plans, nor to simplified employee pensions or SIMPLE IRAs. (117) For earlier bankruptcies, the Supreme Court extended the reach of the federal Bankruptcy Code to shield IRA assets in a 2005 decision, (118) having resolved the issue of bankruptcy protection in 1992 with respect to qualified plan assets. (119)

The creation, assignment, or recognition of a right to any benefit payable from a plan under a "qualified domestic relations order" (QDRO) is not treated as a prohibited assignment or alienation under ERISA or the Internal Revenue Code, thus allowing enforcement of state QDROs. (120) All qualified retirement plans are required to provide for the payment of benefits in accordance with the terms of any QDRO.

The term "domestic relations order" means a judgment, decree, or order (including approval of a property settlement agreement) which relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child or other dependent of a participant, and is made pursuant to state domestic relations law. To be qualified, a domestic relations order must (1) create or recognize the existence of an alternate payee's right to receive all or a portion of the benefits payable with respect to a participant under a plan; (2) clearly specify certain facts (e.g., name and address of participant and alternate payee, amount of benefits to be paid and the number of payments); and (3) not alter the amount or form of benefits under a plan. The term "alternate payee" means any spouse, former spouse, child or other dependent of a participant who is recognized by a domestic relations order as having a right to receive all, or a portion of, a participant's benefits under a plan. (121)

A QDRO can require benefits to be paid to an alternate payee at the participant's earliest retirement age under the plan without regard to whether the participant has separated from service or retired.

Question--When does an employee become subject to tax on benefits accruing in a qualified plan?

Answer--An employee or beneficiary of a qualified plan will not be taxed until benefits are received from the plan. For example, even though a participant in a profit sharing plan has the unrestricted right to make withdrawals of employer or deductible employee contributions, or the earnings on nondeductible employee contributions, there will be no current tax based on constructive receipt. This increases the appeal of making contributions to qualified plans even when such contributions are nondeductible.

Question--Are there any restrictions on pension or profit sharing plan investments in "collectibles"?

Answer--Yes. Investment in "collectibles" by an individually directed account under a qualified plan is treated as a current taxable distribution. Collectibles are defined as (1) art, (2) rugs or antiques, (3) metals or gems, (4) stamps or coins, (5) alcoholic beverages, or (6) any other tangible personal property designated as a "collectible" by the Secretary of the Treasury. (122)

Question--Is a qualified plan required to provide a participant's surviving spouse survivor benefits?

Answer--Yes. A participant's surviving spouse must be provided "automatic survivor benefits." (123) Defined benefit plans and defined contribution plans are required to provide automatic survivor benefits (1) in the form of a "qualified joint and survivor annuity," to a vested participant who receives a plan distribution for reasons other than the participant's death (i.e., termination of employment, retirement or disability); and (2) in the form of a "qualified pre-retirement survivor annuity" to a vested participant who dies before reaching the "annuity starting date" under the plan and who has a surviving spouse.

For automatic survivor coverage purposes, a vested participant means a participant who has a nonforfeitable right to any portion of the accrued benefit or account balance, whether or not the participant is still employed by the employer. The term "annuity starting date" means the first day of the first period for which an amount is payable as an annuity (or, in the case of a non-annuity benefit, the first day on which all events have occurred entitling the participant to the benefit). (124)

The automatic survivor coverage rules do not apply to a profit sharing or stock bonus plan if (a) the plan provides that the participant's vested account balance will be paid to his or her surviving spouse (or to a designated beneficiary if there is no surviving spouse or if the surviving spouse gives the proper consent); (b) the participant does not elect payment of benefits in the form of a life annuity; and (c) with respect to the participant, the plan is not a transferee of a plan required to provide automatic survivor benefits. (125)

A "qualified joint and survivor annuity" is an annuity for the life of the participant with a survivor annuity for the life of the spouse that is not less than 50% (and not greater than 100%) of the amount that is payable during the joint lives of the participant and spouse, and that is the actuarial equivalent of a single life annuity for the life of the participant. (126)

A "qualified pre-retirement survivor annuity" is an annuity for the life of the surviving spouse of the participant with payments to the surviving spouse which are not less than the payments that would have been made under the qualified joint and survivor annuity (or the actuarial equivalent thereof), under the rules set forth in Code section 417(c).

A qualified joint and survivor annuity and a qualified pre-retirement survivor annuity need not be provided by a plan unless the participant and the surviving spouse have been married throughout the one-year period ending on the earlier of the participant's retirement, disability or the date of the participant's death. (127)

A plan participant may elect not to receive the qualified joint and survivor annuity and/or the qualified pre-retirement survivor annuity at any time during an applicable election period and to receive benefits in another form offered under the plan. The participant is permitted to revoke any such election during the applicable election period. The applicable election period, in the case of a qualified joint and survivor annuity, is the 90-day period ending on the annuity starting date. The applicable election, in the case of a qualified pre-retirement survivor annuity, is a period beginning on the first day of the plan year in which the participant attains age 35 and ending on the date of the participant's death. If the participant separates from service, the applicable election period begins not later than the date of separation. (128)

An election by the participant not to take survivor coverage is effective only if the participant's spouse consents in writing, the consent is witnessed by a plan representative or a notary public, and the spouse's consent acknowledges the effect of the election. Spousal consent is not required if it is established (to the satisfaction of a plan representative) that there is no spouse or that the spouse cannot be located. (129)

Question--Will a plan participant on a 1-year leave of absence from work due to a maternity/paternity reason incur a "break-in-service" and therefore cease to participate in the plan?

Answer--No. An employee who is on a leave of absence for maternity/paternity reasons will not incur a 1-year break-in-service for purposes of participation or vesting in the year in which a break would otherwise occur. (130) Maternity/paternity reasons include pregnancy, childbirth, adoption or child caring immediately after childbirth or adoption.

Question--Are there any other taxes that may affect a qualified plan or its participants?

Answer--Generally, there are four other taxes affecting retirement plans (which have not been discussed elsewhere). The taxes are as follows:

1. A 20% nondeductible excise tax is imposed on the amount of any "employer reversion" from a qualified plan if (a) a significant amount of the reversion is used to fund benefits in a replacement plan, (b) a significant amount is used to increase the benefits of participants under the terminating plan, or (c) the employer is in bankruptcy. Otherwise, the tax is 50%. (131) Liability for this tax rests on the employer. An "employer reversion" is the amount of cash and the fair market value of other property received (directly or indirectly) by an employer from a qualified plan. Certain mistaken excess payments may be excluded.

2. There is a 50% nondeductible excise tax imposed on the participant in the event of a failure to make a minimum required distribution from the plan. The tax is equal to 50% of the amount by which the minimum required distribution exceeds the actual amount distributed during the taxable year. The tax is imposed on the payee. A "waiver" is allowed for "reasonable error" if steps are being taken to pay out the balance due. (132)

3. An additional penalty tax applies in cases where there is an underpayment of tax due to an overstatement of pension liabilities. The amount of the penalty depends on the amount of the overstatement: 20% for overstatements of 200% or more but less than 400% of the correct amount of liabilities and 40% for overstatements of 400% or more. (133)

4. There is a 50% excise tax on prohibited allocations of employer securities acquired in a transaction involving the tax-deferred sale to an ESOP. (134)

Question--Where a beneficiary designation for a pension plan names the surviving spouse as primary beneficiary, but with an alternate gift to a Family Trust in the event of the death of the surviving spouse before the passage of a reasonable time following the participant's death (e.g., 90 days), or in the event of a disclaimer by the surviving spouse, are there any concerns over restrictions created by the Retirement Equity Act of 1984?

Answer--REA '84 generally provides that all benefits from pension and profit sharing plans, with some exceptions, must be in the form of annuities. If the participant has died, then the general provision under REA '84 is that there be an annuity for the lifetime of the survivor as to at least one-half of the property. Whether the transfer can be made to a trust in lieu of the surviving spouse is something that has been questioned by a number of practitioners. Indeed, The REA Book says that the requirements of the Act cannot be met by naming an irrevocable trust as sole beneficiary even though the surviving spouse is the sole beneficiary of the trust and the benefits payable under the trust meet the survivor annuity benefit requirements of the Act. (135)

If the surviving spouse dies, then it may be that REA '84 no longer applies, and any normal transfer can be made and property can go to a trust outright as opposed to being in an annuity form.

On the other hand, the Act seems to lay out clearly the rule that any transfer outside the normal REA '84 rules must be done only on the basis of a written exception being made by the participant and a particular form of written waiver by the surviving spouse of any annuity rights. There have been suggestions that payments by pension plan administrators to trusts without such a formal written request and written waiver might cause the trust to be disqualified.

This is an area of the law in which a pension law expert should be consulted on beneficiary designations involving large amounts.

The beneficiary designation form reproduced at Figure 52.1 (3 pages) at the end of this chapter is used by Ralph Gano Miller in his California practice and contains language designed to overcome the problems inherent in the law as it presently reads.

Question--What are the gift and estate tax consequences of joint and survivor annuities and survivor annuities to a spouse?

Answer--These annuity payments automatically qualify for the gift and estate tax marital deduction so long as no payments can be made to anyone other than a spouse until the death of the surviving spouse. This is true even though there could be payments or distributions to another person after the death of both spouses.

Note that in the case of the estate tax marital deduction, the executor of the estate of the first spouse to die can elect out of the marital deduction.

Question--Can a life insurance trust be created within a qualified retirement plan?

Answer--Many commentators believe it can, although there is no authority on this point. The plan would provide for the creation of a separate trust, which is in effect an irrevocable life insurance trust. As discussed in Chapter 31, it is structured so that the insured has no control over the trust, and the policy proceeds cannot be distributed to the insured or his or her estate. The premiums are paid through the plan.

This technique has not been tested, and may run into problems where there is a surviving spouse, because of the survivor annuity rules. Also, some issues have been raised as to whether there could be a problem with a prohibited transaction. Finally, it must be remembered that the growth and income from investments in qualified plans is tax free until retirement, and since the inside build-up of value in life insurance policies is generally also tax free, it may be better to maintain insurance outside of qualified plans.

Question--If a distribution from a qualified plan is made to a surviving spouse on the death of the participant, can he or she roll this over into an individual retirement account (IRA)?

Answer--A spousal rollover is permitted as to all or part of such a distribution, and the distribution will not be subject to income tax to the extent it is rolled over. Spousal rollovers are discussed in Chapter 18.

ASRS: Sec. 59.


(1.) Treas. Reg. [section]1.401-1(b)(2).

(2.) IRC Sec. 401(a).

(3.) IRC Sec. 402(a)(1).

(4.) IRC Sec. 401(a)(9).

(5.) IRC Sec. 401(k)(2)(B)(ii).

(6.) IRC Secs. 401(k)(2)(C), 401(k)(3)(D).

(7.) IRC Sec. 401(k)(4)(A).

(8.) IRC Sec. 402(g); IRC Sec. 401(a)(30). It is important to note that all provisions of EGTRRA 2001 are scheduled to sunset, or expire, for years beginning after December 31, 2010.

(9.) IRC Sec. 414(v).

(10.) IRC Sec. 401(a).

(11.) IRC Sec. 415(c).

(12.) IRC Sec. 410(a)(1).

(13.) IRC Sec. 410(a)(1)(B).

(14.) IRC Sec. 410(b)(1).

(15.) IRC Sec. 410(b)(2).

(16.) IRC Sec. 401(a)(26). In years beginning before 1997, this provision applied to all qualified plans.

(17.) IRC Sec. 410(a)(3)(A).

(18.) IRC Sec. 410(b)(3)(A).

(19.) IRC Sec. 411(a)(1).

(20.) IRC Secs. 401(k)(2)(C), 401(k)(3)(D).

(21.) IRC Sec. 411(a)(2).

(22.) IRC Secs. 415(c)(1), 415(d)(1).

(23.) IRC Sec. 404(a)(3)(A).

(24.) IRC Sec. 404(n).

(25.) IRC Sec. 415(c)(3)(C).

(26.) IRC Sec. 415(b)(1).

(27.) IRC Secs. 415(b)(2)(C), 415(b)(2)(D).

(28.) IRC Sec. 415(b)(5)(A).

(29.) IRC Sec. 415(b)(4).

(30.) IRC Sec. 415(b)(5)(B).

(31.) IRC Sec. 415(b)(2)(B).

(32.) IRC Sec. 415(b)(2)(C).

(33.) IRC Sec. 415(b)(2)(D).

(34.) IRC Secs. 415(b)(2)(B); 415(b)(2)(E)(ii).

(35.) IRC Sec. 415(c)(1).

(36.) IRC Sec. 404(a)(1).

(37.) IRC Sec. 404(a)(3). Pre-1987 unused contribution carryforwards may still be available.

(38.) IRC Sec. 404(a)(7).

(39.) IRC Sec. 219(e).

(40.) IRC Sec. 72(o)(3).

(41.) IRC Sec. 404(a)(3).

(42.) IRC Sec. 404(n).

(43.) IRC Sec. 408(q).

(44.) Vinson & Elkins v. Comm., 93-2 USTC 50,632 (5th Cir. 1993); Rhoades, McKee & Boer v. U.S., 93-2 USTC 50,425 (W.D.MI 1993); Wachtell, Lipton, Rosen & Katz v. Comm., TC Memo 1992-392, aff'd 94-1 USTC 50,272 (2d Cir. 1994).

(45.) Treas. Reg. [section]1.401-7.

(46.) Treas. Reg. [section]1.401-4(a)(1)(iii).

(47.) IRC Sec. 401(a)(8).

(48.) IRC Secs. 411(b)(1)(H), 411(b)(2).

(49.) IRC Sec. 411(a)(8).

(50.) IRC Sec. 401(l).

(51.) IRC Sec. 416.

(52.) IRC Sec. 416(g).

(53.) IRC Sec. 416(i)(1).

(54.) IRC Sec. 416(b).

(55.) IRC Sec. 416(c).

(56.) IRC Sec. 401(a)(17).

(57.) IRC Secs. 404(a)(1), 404(a)(3).

(58.) IRC Sec. 501(a).

(59.) IRC Sec. 402(a).

(60.) Notice 2002-8, 2002-1 CB 398; see also Notice 2001-10, 2001-1 CB 459, revoking Rev. Rul. 55-747, 1955-2 CB 228, which set forth "P.S. 58" rates; see also Treas. Reg. [section]1.72-16(b).

(61.) IRC Sec. 72(o)(3).

(62.) IRC Sec. 401(a)(9)(A); see Treas. Reg. [section]1.401(a)(9)-9.

(63.) Treas. Reg. [section]1.401(a)(9)-5(a)(4).

(64.) IRC Sec. 72(d)(1)(B)(iii).

(65.) IRC Sec. 72(d)(1)(B)(iv).

(66.) IRC Sec. 72(b).

(67.) Notice 88-118, 1988-2 CB 450.

(68.) IRC Sec. 72(e)(8).

(69.) IRC Sec. 72(t).

(70.) IRC Sec. 402(d)(4)(A), prior to repeal after 1999 by SBJPA '96.

(71.) See Notice 2002-8, 2002-1 CB 398; see also Notice 2001-10, 2001-1 CB 459, revoking Rev. Rul. 55-747, 1955-2 CB 228; Treas. Reg. [section]1.72-16(c).

(72.) IRC Sec. 2010(c).

(73.) IRC Secs. 2001(c), 2010(a), 2505(a), 6018(a).

(74.) Ablamis v. Roper, 937 F.2d 1450 (9th Cir. 1991).

(75.) Boggs v. Boggs, 117 S.Ct. 1754 (1997).

(76.) ERISA Sec. 3(21)(A).

(77.) ERISA Sec. 406(a)(1)(D).

(78.) IRC Sec. 4975(a).

(79.) ERISA Sec. 404(a)(1).

(80.) ERISA Sec. 4022(b)(3); PBGC Reg. [section]2621.

(81.) ERISA Sec. 4006(a)(3)(A)(i), as amended by DRA 2005 (signed February 8, 2006); ERISA Sec. 4006(a)(3)(E).

(82.) ERISA Sec. 408(b)(1); Labor Reg. [section]2550.408(b)-1.

(83.) IRC Sec. 4975(f)(6), ERISA Sec. 408(d).

(84.) See IRC Sec. 1400Q(c), as added by GOZA 2005; see also Notice 2005-29, 2005-52 IRB 1165. For this purpose, qualified hurricane distributions include distributions during designated periods after Hurricanes Katrina, Rita and Wilma.

(85.) IRC Sec. 72(p)(1).

(86.) Treas. Reg. [section]1.72(p)-1, A-3 (b).

(87.) IRC Sec. 72(p)(2)(B)(i).

(88.) IRC Sec. 72(p)(2)(A).

(89.) Treas. Reg. [section]1.72(p)-1, A-4 (a).

(90.) See Treas. Regs. [section][section]1.72(p)-1, A-3 (b), 1.72(p)-1, A-10.

(91.) IRC Sec. 72(p)(2)(B)(ii).

(92.) ERISA Secs. 101-105.

(93.) Treas. Reg. [section]1.401(a)(4)-2(b)(4).

(94.) See Treas. Reg. [section]1.401(a)(4)-8(b)(1).

(95.) Rev. Rul. 61-164, 1961-2 CB 99; Rev. Rul. 66-143, 1966-1 CB 79.

(96.) See e.g., Rev. Rul. 60-83, 1960-1 CB 157.

(97.) IRC Sec. 401(m).

(98.) IRC Sec. 219(e).

(99.) IRC Sec. 401(m).

(100.) IRC Sec. 415(c)(2)(B).

(101.) IRC Sec. 401(k)(2(A).

(102.) Employers may offer a qualified Roth contribution program as part of a 401(k) plan beginning in 2006. IRC Secs. 402A(a), 402A(e)(1).

(103.) IRC Secs. 402(g), 3121(v).

(104.) IRC Sec. 402(g).

(105.) IRC Sec. 414(v).

(106.) IRC Sec. 401(k)(3).

(107.) IRC Sec. 401(k)(3)(A); see also Notice 98-1, 1998-1 CB 327.

(108.) IRC Sec. 401(k)(12).

(109.) IRC Sec. 401(k)(11).

(110.) IRC Sec. 401(k)(8)(B).

(111.) IRC Sec. 401(k)(8)(A).

(112.) IRC Sec. 4979.

(113.) IRC Sec. 401(k)(8).

(114.) IRC Sec. 401(k)(2)(B).

(115.) Treas. Reg. [section]1.401(k)-1(d)(2)(iv).

(116.) ERISA Sec. 206(d).

(117.) See Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA 2005) P.L. 109-8, signed April 20, 2005.

(118.) See Rousey v. Jacoway, 544 U.S. 320 (2005).

(119.) See Patterson v. Shumate, 112 S.Ct. 2242 (1992).

(120.) IRC Sec. 401(a)(13)(B).

(121.) IRC Sec. 414(p).

(122.) IRC Sec. 408(m).

(123.) IRC Secs. 401(a)(11), 417.

(124.) IRC Sec. 417(f)(2).

(125.) IRC Sec. 401(a)(11)(B).

(126.) IRC Sec. 417(b).

(127.) IRC Sec. 417(d).

(128.) IRC Sec. 417(a)(6).

(129.) IRC Sec. 417(a)(2).

(130.) IRC Secs. 410(a)(5)(E), 411(a)(6)(E).

(131.) IRC Sec. 4980.

(132.) IRC Sec. 4974.

(133.) IRC Sec. 6662(f).

(134.) IRC Sec. 4979A.

(135.) Wilf, et al., The REA Book (REA Publishing Company: Philadelphia, 1987), Qs I.54 and I.55. Q. I.67 also addresses the question of the surviving spouse's disclaimer of annuity benefits required under REA, pointing out that such a disclaimer may be a prohibited assignment or alienation, in which event payment pursuant to the disclaimer could subject the plan administrator to fiduciary liability and could endanger the qualified status of the plan.
Figure 52.1


       --                                --
Employee's Name             Employee's Soc. Security No.

1. I hereby designate the following, in the order of priority
indicated, as the beneficiary to whom (or to which) any such
benefit shall be distributed at the death of the participant:

A. To --, my spouse, or if my spouse is not then living, or if my
spouse disclaims such benefit (as provided in Paragraph 6 below),
then in accordance with Paragraph B below.

B. To the Trustees of the --, dated --, hereinafter called the
"Family Trust", to be held, managed, administered and distributed
according to the terms and provisions thereof.

2. If at the time of death, none of the above beneficiaries survive
me or are in existence, then this Plan and Trust share shall be
distributed as then provided in the Plan and Trust Agreement.

3. I reserve the right to revoke or change the designation or any
of them shown above, but such revocation or change shall be in
writing directed to the Committee, and no such revocation or change
shall be effective unless and until received by the Committee.

4. Rights of the designated beneficiaries shall be subject to the
terms and conditions of the Plan and Trust Agreement and all rules
and regulations formulated thereunder.

5. Payment of any credits or funds in the Trust Account to the
beneficiary or beneficiaries designated herein shall be a full and
complete release and discharge of the Trustee, the Committee and
the Employer to the extent of such payment.

6. Disclaimer may be by any method which is effective under the
laws of the State of California or by written transfer of the right
to receive the death benefit, provided that such transfer meets the
requirements of Section 2518(c)(3) of the Internal Revenue Code as
is from time to time amended.

7. Any voluntary contribution account benefits shall be distributed
according to the terms of this direction and shall be treated as
completely separate benefits for the purposes of disclaimer.

8. This beneficiary designation shall not be construed in any way
as a revocation of any election I have made pursuant to Section
242(b)(2) of the Tax Equity and Financial Responsibility Act of
1982 (P.L. 97-248) 1982-2 CB 462.

Dated --


[See Spousal Consent Over]


I am the spouse of Participant. I understand that I have a right to
the Qualified Preretirement Survivor Annuity ("QPSA") benefit from
the above-referenced Plan if my spouse dies before he or she begins
receiving retirement benefits (or, if earlier, before the beginning
of the period for which the retirement benefits are paid). I also
understand that is the value of the QPSA benefit is Five Thousand
Dollars ($5,000) or less, the plan will pay the benefit to me in
one lump sum payment.

I agree to give up my right to One Hundred Percent (100%) of the
QPSA benefit and to allow my spouse to name the beneficiary(ies) so
designated in the beneficiary designation to which this Consent is
attached to receive that benefit. This Consent is valid only with
respect to the above-referenced beneficiary designation and is not
valid with respect to any future beneficiary designation by my

I understand that by signing this Consent, I may receive less money
than I would have received under the special QPSA payment form and
I may receive nothing from the plan after my spouse dies.

I understand that I do not have to sign this Consent. I am signing
this Consent voluntarily.

I understand that if I do not sign this Consent, then I will
receive the QPSA benefit from the plan if my spouse dies before he
or she begins to receive retirement benefits (or, if earlier,
before the beginning of the period for which the retirement
benefits are paid). I also understand that if I do not sign this
Consent and the value of the QPSA benefit is Five Thousand Dollars
($5,000) or less, the plan will pay the benefit to me in one lump
sum payment.


Signature of Spouse


On -- before me, --, a Notary Public in and for the State of
California, personally appeared -- personally known to me or proved
to me on the basis of satisfactory evidence to be the person whose
name is subscribed to the within instrument and acknowledged to me
that _he executed the same in h__ authorized capacity, and the by
h__ signature on the instrument the person, or the entity upon
behalf of which the person acted, executed the instrument.

WITNESS my hand and official seal.



I, the undersigned, am the spouse of Participant. I understand that
I have the right to have the above-referenced Plan pay my spouse's
retirement benefits in the special Qualified Joint and Survivor
Annuity ("QJSA") payment form.

I agree to give up my right to the QJSA benefit and to allow my
spouse to name the beneficiary(ies) so designated in the
beneficiary designation to which this Consent if attached to
receive that benefit. This consent is valid only with respect to
any future beneficiary designation by my spouse.

I understand that by signing this Consent, I may receive less money
than I would have received under the special QJSA payment form and
I may receive nothing after my spouse dies.

I understand that I do not have to sign this Consent. I am signing
this Consent voluntarily.

I understand that if I do not sign this Consent, then my spouse and
I will receive payments from the plan in the special QJSA payment

I hereby acknowledge that my right to a QJSA can only be waived
during the Applicable Election Period, as defined in Section
417(a)(6) of the Internal Revenue Code, and that I will have to
re-execute this Consent during such Applicable Election Period in
order for the waiver of my rights to a QJSA hereunder to be valid.


Signature of Spouse --


On -- before me, --, a Notary Public in and for the State of
California, personally appeared -- personally known to me or proved
to me on the basis of satisfactory evidence to be the person whose
name is subscribed to the within instrument and acknowledged to me
that _he executed the same in h__ authorized capacity, and the by
h__ signature on the instrument the person, or the entity upon
behalf of which the person acted, executed the instrument. WITNESS
my hand and official seal.

No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2006 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Part 9: Planning for Employee Benefits and Retirement
Publication:Tools & Techniques of Estate Planning, 14th ed.
Date:Jan 1, 2006
Previous Article:Chapter 51: Individual retirement plans (and SEPs).
Next Article:Chapter 53: Survivor's income benefit plan.

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