A basic rule that applies to all types of plans is that the plan must not discriminate against the lower paid rank and file employees. IRS has established very strict rules to enforce this basic tenant. The rules are set forth in three separate categories; eligibility for plan participation, benefit or contribution limits and vesting. A brief outline of each follows:
Note for 401(k) plans: In addition to the rules described above, 401(k) plans must comply with additional rules.
- Generally 70% of all employees who meet the age and service requirements must participate in the plan. The eligibility period, or waiting period, can be one year of service if the plan has a graded vesting schedule or two years of service if the plan provides for full and immediate vesting once the waiting period has been satisfied. A minimum age of 21 in addition to the waiting period is also acceptable.
- The contributions in a defined contribution plan must bear a reasonable relationship as a percentage of compensation for all employees. Integration will skew the allocation of the contribution to the higher paid employees and does meet IRS regulations. An allocation method that provides an equal benefit at retirement is also permissible. This would be used in an age weighted profit sharing plan. The benefit paid at normal retirement age in a defined benefit plan is used as the basis for testing discrimination. Again integration is acceptable. The amount of the contribution is not tested. Whatever contribution that is required to provide the benefit is generally deductible.
- If a one year waiting period for eligibility is required, the plan can vest at the rate of 20% after one year of service so that a participant is fully vested after 6 years of service. If a two year waiting period is used, all benefits or contribution must be immediately and fully vested.
For a description of these special rules, see 401k Plans
Please remember this is a very general description of the Discrimination tests. These very complicated rules must be applied to each specific situation.
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