Corporate and Private Pension Plans in the United States

Diplomarbeit von Yildiz Saglik

Introduction:

This thesis gives in chapter A an understanding of the relevance of corporate and private pension plans for the U.S. work force. Chapter B examines the regulatory environment of qualified pension plans, the tax treatment of transactions on the employer and employee side and the multitudinous pension plan qualification standards. The main part of this thesis, chapter C, navigates the reader through basic plan types in the private sector including employer-sponsored plans and individual retirement arrangements. Chapter D deals critically with the opportunities and risks as a result of the structural shift in the retirement plan landscape from defined benefit to defined contribution plans in general, and to 401(k) plans in particular. Further, it gives a forecast on pension shortfalls for future retirees according to recent studies of governmental and private institutions and captures the impact of the current financial crisis on plan funds and the reactions of plan participants thereon.

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Chapter IV, Individual Tax-Favored Plans:

Originally, individual tax-favored plans were intended to allow persons not covered by pension plans by an employer to save for retirement. With the Economic Recovery Tax Act of 1981 the eligibility provisions were extended to employees and self-employed already covered by other retirement programs to set up additional individual retirement accounts (IRAs). After the Tax Reform Act of 1986 the deduction of contributions is subject to certain income limits and to the existence of any qualified plan. The main type of an individual saving plan is the individual retirement account (IRA) also called the traditional IRA. The alternative instrument under a traditional retirement plan is an individual retirement annuity. Such annuity is purchased directly from a life insurance, does not involve a trust or custodial account, and is subject to several restrictions.

Eligible for an IRA is every individual who is an active participant in any qualified retirement plan during the year. Individual retirement arrangements have to be funded by earned income and are a form of self provided retirement income. When they are established and maintained by an employer, they belong to the group of simplified employee arrangements (SEP IRAs), where the employer directly funds individual retirement accounts or annuities by or on behalf of its employees.

The Roth IRA is a new category of IRA added by the Tax Payer Relief Act of 1997 and is being distinguished from a traditional IRA in the tax treatment of both contributions and distributions. Whereas in a traditional IRA employee contributions are deductible and distributions are taxable, contributions to a Roth IRA are nondeductible and distributions, if qualified, are tax-free.

Traditional IRAs:

The most common individual savings plan with a share of 89 percent of all types of individual retirement arrangements is the traditional individual retirement account. The term ‘traditional’ was added to the IRA after the emerging of Roth IRAs, to describe the classic individual retirement account. Eligible for the traditional IRA is any employee, sole proprietor, or self-employed person, actually almost anyone who receives compensation. Compensation comprises wages, salaries, professional fees, and other amounts received for professional services actually rendered. Contributions may be accumulated in a trust or custodial account managed by a bank, trust company, or other qualified financial institution. The IRA can also be self-directed, so that the trustee or the custodian just acts as executive body and keeps record of the transactions.

Plan Qualifications:

An individual retirement account is not subject to the 401(a) general provisions for qualified retirement plans, instead special requirements of IRC Section 408(a) has to be satisfied for plan qualification:

An IRA has to be a written instrument under a trust providing exclusive benefits to an individual or his beneficiaries.

Except for the case of a rollover distribution, contributions are accepted up to certain limits.

The trustee can be a bank, trust company, or any other qualified financial institution.

No part of the trust funds can be invested in life insurance contracts.

The interest in an individual’s account must be immediately non-forfeitable.

Distributions cannot be made before age 59 ½ and have to be made at age 70 ½.