Glossary of Employee Benefit Terms

You may want to have a copy of this glossary on hand when you start reading about the different kinds of plans and how they work. It also may help you as you work with your lawyer in setting up a plan. It is not intended to be a complete glossary, in that its focus is on terms relating to deciding on and setting up a plan.

401(k) plan. The name of this kind of plan comes from the section number of the Internal Revenue Code that authorizes it. It is a plan that allows an employee to choose what kind of investments the employer will make for that employee. The employer selects different kinds of investments to offer, and the employee chooses which ones he or she prefers. The selections may vary in how risky the investments are, the kind of business the companies do (such as technology companies or pharmaceutical companies or utility companies), and other factors.

Administrator. The person or company who handles day-to-day details of operating a pension plan, such as processing claims for benefits, employer and employee contributions, record-keeping, and reports. The administrator is appointed in the documents creating the plan.

Beneficiary. A beneficiary is usually a member of an employee's family who is covered by the employee-benefits plan and may receive benefits under the plan.

Cafeteria plan. A plan in which the employer offers a variety of different benefits, and the employees choose those benefits that fit their individual needs. Examples of benefits offered in the cafeteria include group-term life insurance, dental insurance, disability and accident insurance, reimbursement of healthcare expenses, and the like.

COBRA. A law that requires employers to offer employees continuing medical insurance after the employee leaves the company. The employee pays the premiums and may continue to participate in the company's medical plan for up to eighteen months.

Defined benefit plan. This kind of plan also may be referred to as a unit benefit plan. These terms refer to a plan in which employees are promised that upon retirement they will receive a specific amount of money according to a formula, which may be some calculation based on how long an employee worked for a company and how much he or she earned. See "Fixed benefit plan."

Defined contribution plan. This kind of plan refers to one for which the employer makes regular contributions of a specified amount of money. In contrast to a defined benefit plan, it does not promise the employees any specific amount of retirement benefits. The employee's retirement benefit will depend on how much was contributed to his or her account and how the plan's investments performed over the years. Examples of this kind of plan include a profit-sharing plan, a money-purchase plan, a target-benefit plan, stock bonus plans, and employee stock ownership plans.

Eligibility. Different plans have different requirements about who is entitled to participate in a plan. These eligibility requirements can include the employee's age or how long he or she has been employed by the company. Generally, an employee is eligible when he or she turns twenty-one or has been employed for one year.

Employee Stock Ownership Plan (ESOP). This plan primarily is funded by the company's own stock and does not depend on whether the company has made a profit.

ERISA. You will see and hear this word a lot. It is an acronym for the "Employee Retirement Investment Savings Act," the federal law that covers employee benefits. The full name is a mouthful, and ERISA is used in its place.

Employee welfare plan. See "welfare plan."

Fixed benefit plan. For this kind of plan, the amount of retirement benefits is based on a formula that does not include the number of years the employee worked for the company. It could be a particular dollar amount, and it may be based on some percentage of the employee's pay.

Flexible benefit plan. See "cafeteria plan."

Individual Retirement Account (IRA). People who are not covered by any pension plan at work may use an IRA to save for retirement. In a traditional IRA, the contributions are made from the person's taxable income and grow tax-free in the IRA. A Roth IRA, named for the United States Senator who shepherded it through Congress, is funded from a person's income, but that income is not taxed in the year it is earned. Instead, the income grows over the years and is taxed when the person withdraws it after he or she retires. Note that an IRA is not considered a "Pension Plan," and the provisions of ERISA do not apply.

IRC. This is an acronym for the Internal Revenue Code.

Keogh Plan. A Keogh plan is available to people who are self-employed.

Money-purchase plan. A defined-benefit plan in which the employer must contribute a specific amount of money each year to each participant's account. The amount of each contribution generally depends on that person's pay.

Multi-employer plan. In this kind of plan, two or more employers pool their contributions for the benefit of their employees. The plan may be established and maintained according to the terms of a collective bargaining agreement between the employers and a labor union. But this kind of plan may also be set up for the employers' non-union employees.

Normal retirement age. By law, an employer cannot dictate when an employee must retire. That's age discrimination. The employer may, however, create a pension plan based on an assumption that employees will decide to retire at some age and decide what age that will be. That's the normal retirement age for that particular plan. Companies frequently pick age 65; others pick 62 or 59.

Participant. Another way of saying employee. It refers to an employee who is covered by or opts to participate in any employee-benefits arrangement.

Plan sponsor. The entity that establishes and maintains a benefits plan, usually an employer, but it also may refer to an employee organization created for the purpose offering benefits. If the plan is a "multi-employer plan," the committee or other entity that established the plan is considered the plan sponsor.

Portability. This term refers to an employee's ability to transfer vested benefits to an IRA or some other pension plan after he or she leaves the company. Without portability, the employee could be subject to large tax bills. These days, the term "portability" also may refer to an employee's ability to transfer eligibility for medical insurance coverage without running into the problem of coverage denials based on a pre-existing medical conditions. This kind of portability is the subject of great debate in Congress.

Profit-sharing plan. The name of this kind of plan is a little misleading. A profit-sharing plan may be, but is not required to be, funded from the company's profits. That kind of funding is permitted, of course. But the terms of the plan will set forth a formula to determine how much should be contributed each year, or the plan may leave the amount to the employer's discretion. Unlike other kinds of plans, it may be set up in a manner that makes it tax-exempt. Refer to the entries for "employee stock option plan," above, and "stock bonus plan," below, for a description of two common forms of a profit-sharing plan.

Qualified plan. A qualified plan is one that complies with ERISA. It requires certain standards of vesting and accrual of benefits and compliance with "nondiscrimination rules." A qualified plan entitles the employer and its employees to the favorable tax treatment provided in the IRC.

Retirement plan. A retirement plan provides retirement income, or it is a savings device in which contributions appreciate over time, with income taxes deferred until withdrawals are made when an employee reaches a certain age or takes money out before that time.

SIMPLE plan. "SIMPLE" is an acronym for "savings incentive match plans for employees." It describes a plan in which employees can make tax-deferred investments and the employer makes matching contributions. The plan can take the form of an IRA or a 401(k) plan.

Simplified Employee Pension (SEP). In a SEP, the employer directly funds IRAs or annuities that are established by or on behalf of the employees.

Stock bonus plan. This plan is funded by shares of the company's stock.

Summary plan description. This document summarizes the major features of an employee-benefit plan, such as what kind it is, how it is funded, who is eligible to participate, what steps must be taken to participate, how benefits will be paid out, and the like. It should be written in ordinary English rather than legalese or ERISA-ese, so a person can understand it without this glossary.

Target-benefit plan. In this kind of plan, the employer has some idea of what participants should receive for retirement benefits. The employer then uses an actuarial formula that will meet that target amount by the time the employee is ready to retire. It does not promise a particular amount of benefits, however.

Thrift or savings plan. This kind of plan indicates that the participating employees must make contributions. The employer may make matching contributions, but isn't required to do so.

Top-hat plan. This term demonstrates the legal profession's propensity to make an area of law sound exciting by giving it an intriguing name. ("ERISA," "golden parachute," and "poison pill" are other examples of those kind of names.) A top-hat plan is one offering unfunded deferred-compensation plans for upper management or highly compensated employees. A top-hat plan is not subject to some provisions of ERISA. See "top-heavy plan."

Top-heavy plan. This plan provides benefits for key employees, such as officers or owners of the company, that are worth more than 60 percent more than the benefits offered to regular employees. A top-heavy plan may require shorter vesting periods for regular employees to balance things out. See "vesting."

Vesting. The process by which contributions to a pension plan for a particular employee may no longer be forfeited. It usually requires that the employee must be with the company for a specified period of time before he or she will be eligible for the benefits after retirement. Until then, the employee is "not vested," which means if something happens, like the employee quits or is fired, or if the company has lay-offs, the employee may lose those benefits (the contributions are paid out in a lump-sum, see "Portability" above). Some plans provide for "graded vesting," which means that an employee is vested over time, so that each year, a higher percentage of contributions are nonforfeitable, until 100% are nonforfeitable. With graded vesting, the vesting period may be up to seven years. A plan providing that an employee is not vested at all until the specified amount of time elapses is referred to as "cliff vesting." With cliff vesting, the vesting period cannot exceed five years.

Welfare benefit plan. A welfare benefit plan provides medical benefits and other non-pension benefits to employees and their families. The kinds of benefits that may be offered are those that are provided to individual employees as money or services. These benefits include, for example, various kinds of insurance, special arrangements for pre-paid legal services, scholarships, training programs, education, day-care and the like. In some cases, the employees can choose which benefits they would like to participate in, according to their individual needs. These kinds of plans are described further under "cafeteria plans."

Withdrawal liability. If an employee takes money out of a retirement plan too early, he or she probably will be liable for income taxes and a tax penalty. The idea is to make early withdrawals unattractive so that funds will stay invested for retirement.

Disclaimer

This publication and the information included in it are not intended to serve as a substitute for consultation with an attorney. Specific legal issues, concerns and conditions always require the advice of appropriate legal professionals.

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