PRESENT LAW AND BACKGROUND RELATING TO 

CHALLENGES IN THE RETIREMENT SYSTEM

Scheduled for a Public Hearing

Before the

SENATE COMMITTEE ON FINANCE

on May 14, 2019

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

May 10, 2019

JCX-20-19
i

CONTENTS

Page

INTRODUCTION AND SUMMARY....................................................................................... 1

I. PRESENT LAW................................................................................................................. 7

A. Tax-Favored Employer-Sponsored Retirement Plans .................................................. 7

1. Overview of employer-sponsored tax-favored retirement plans.............................. 7

2. Qualified retirement plans and annuities.................................................................. 8

3. Special types of plans for governmental and tax-exempt employers..................... 18

4. Taxation of distributions ........................................................................................ 19

B. Defined Contribution Plans......................................................................................... 22

1. General description and rules................................................................................. 22

2. General types of defined contribution plans........................................................... 23

3. Section 401(k) plans............................................................................................... 24

4. ESOPs..................................................................................................................... 28

5. Plan loans and hardship distributions..................................................................... 31

6. Lifetime income under defined contribution plans ................................................ 34

C. Individual Retirement Arrangements.......................................................................... 37

1. Traditional and Roth individual retirement arrangements ..................................... 37

2. Taxation of distributions from IRAs...................................................................... 39

3. Employer retirement plans using IRAs.................................................................. 40

D. Early Distributions and Required Minimum Distributions......................................... 43

1. Early distributions .................................................................................................. 43

2. Minimum distribution requirements....................................................................... 43

II. DATA RELATING TO RETIREMENT SAVINGS ....................................................... 48

A. Overview..................................................................................................................... 48

B. General Data on Qualified Retirement Plan Participation.......................................... 51

C. Data Related to Social Security Benefits as a Source of Retirement Income............. 59

D. Assets Held Outside of Qualified Plans and Individual Retirement Arrangements... 61
1

INTRODUCTION AND SUMMARY

The Senate Committee on Finance has scheduled a public hearing on May 14, 2019, on 

Challenges in the Retirement System. This document,1 prepared by the staff of the Joint 

Committee on Taxation, provides a discussion of present law and data. 

Present Law

Tax-favored Employer-Sponsored Retirement Plans

Overview

Whether to offer a tax-favored retirement plan is a voluntary choice by an employer, with 

various factors entering into the decision. The Code provides for multiple types of tax-favored 

employer-sponsored retirement plans, including qualified retirement plans and annuities 

(secs. 401(a) and 403(a)), tax-deferred annuities (sec. 403(b)), governmental eligible deferred 

compensation plans (sec. 457(b)), SIMPLE (savings incentive match plan for employees) IRAs 

(sec. 408(p)), and simplified employee pensions (“SEPs”) (sec. 408(k)). These plans afford 

employers flexibility in the design and structure of the retirement plans they adopt, subject to the 

requirements applicable to each type of plan under the Code and, in some cases, under the 

Employee Retirement Income Security Act of 1974 (“ERISA”).

Qualified retirement plans and annuities

Qualified retirement plans (and other tax-favored employer-sponsored retirement plans) 

are accorded special tax treatment under present law. Most contributions, earnings on 

contributions, and benefits are not included in gross income until amounts are distributed, even 

though the arrangement is funded and even if benefits are vested. Additionally, many 

distributions can be rolled over to another plan for further deferral of income inclusion. In the 

case of a taxable employer, the employer is entitled to a current deduction (within certain limits) 

for contributions even though the contributions are not currently included in an employee’s 

income. Contributions and earnings are held in a tax-exempt trust, which enables the assets to 

grow on a tax-free basis.

Qualified retirement plans are of two general types: defined benefit plans, under which 

benefits are determined under a plan formula and paid from general plan assets, rather than 

individual accounts; and defined contribution plans, under which benefits are based on a separate 

account for each participant, to which are allocated contributions, earnings and losses. Defined 

benefit plans generally are subject to minimum funding requirements and benefits are 

guaranteed, within limits, by the Pension Benefit Guaranty Corporation (“PBGC”). Some 

qualified retirement plans are referred to as hybrid plans because they have features of both a 

 1

 This document may be cited as follows: Joint Committee on Taxation, Present Law and Background 

Relating to Challenges in the Retirement System (JCX-20-19), May 10, 2019. This document can also be found on 

the Joint Committee on Taxation website at www.jct.gov.
2

defined benefit plan and a defined contribution plan; for example, cash balance plans are defined 

benefit plans, but plan benefits are defined by reference to a hypothetical account balance.

Qualified retirement plans are subject to various requirements to receive tax-favored 

treatment. Some of these requirements define participant rights and provide participant 

protections, such as minimum participation, vesting, exclusive benefit and minimum funding 

requirements. These requirements generally have parallels under ERISA. Some qualified plan 

requirements limit tax benefits, such as the limit on compensation taken into account under a 

plan and limits on contributions and benefits. Minimum coverage and nondiscrimination 

requirements and top-heavy requirements are intended to ensure that qualified retirement plans 

achieve the goal of retirement security for both lower-paid and higher-paid employees.

The Code generally prohibits certain transactions between qualified retirement plans and 

a disqualified person, including a fiduciary. The Code requirements apply also to individual 

retirement arrangements (“IRAs”) and certain other tax-favored savings arrangements. Under 

ERISA, similar prohibited transaction rules apply to employer-sponsored retirement plans and 

welfare benefit plans. Violation of the Code requirements may result in the imposition of an 

excise tax.

Qualified retirement plans are also subject to regulation under ERISA, which generally is 

under the jurisdiction of the Department of Labor. Some of the provisions of the Code and 

ERISA that apply to qualified retirement plans are identical or very similar. ERISA also 

contains general fiduciary duty standards that apply to all fiduciary actions.

Enforcement of the qualified retirement plan requirements depends on the source of the 

requirements. Failure to meet a qualification requirement may mean the loss of tax-favored 

status; however, in practice, the IRS rarely disqualifies a plan. Certain Code requirements are 

enforced through an excise tax rather than through disqualification of the plan. ERISA 

requirements are generally enforced through administrative actions or lawsuits by the 

Department of Labor, lawsuits brought by plan participants or beneficiaries or plan fiduciaries, 

or, in some cases, the imposition of a civil penalty.

Qualified annuity plans are similar to qualified retirement plans in treatment, but plan 

assets are invested in annuity contracts rather than held in a trust or custodial account.

Special types of plans for governmental and tax-exempt employers

Tax-exempt charitable organizations (sec. 501(c)(3)) and educational institutions of State 

or local governments may offer their employees a section 403(b) plan. State and local 

government employers may offer their employees a section 457(b) plan. Section 403(b) plans 

and governmental section 457(b) plans are similar to section 401(k) plans.

Taxation of distributions

Distributions from tax-favored employer-sponsored plans are generally includible in 

income, except to the extent a portion of the distribution is treated as a recovery of the 

employee’s basis (if any). Subject to certain limitations, distributions from a plan may generally 

be rolled over to another tax-free retirement plan with a deferral of income inclusion. A 
3

distribution may be rolled over directly to another plan or may be paid to the participant who 

may roll it over to another plan if, in general, the rollover is completed within 60 days. A 

distribution that is eligible for rollover is subject to income tax withholding at a 20-percent rate 

unless rolled over directly to another plan.

Defined Contribution Plans

In general

Defined contribution plans may provide for nonelective contributions and matching 

contributions by employers and pretax (that is, contributions are either excluded from income or 

deductible) or after-tax contributions by employees. Total contributions made to an employee’s 

account for a year cannot exceed the lesser of $56,000 (for 2019) or the employee’s 

compensation. The deduction for employer contributions to a defined contribution plan for a 

year is generally limited to 25 percent of the participants’ compensation. A participant must at 

all times be fully vested in his or her own contributions to a defined contribution plan and must 

vest in employer contributions under three-year cliff vesting or two-to-six-year graduated 

vesting.

Defined contribution plans often provide for loans to participants and generally provide 

for distributions on severance from employment and, depending on the type of plan, may provide 

for in-service distributions. Defined contribution plans may provide for distributions to be made 

in a lump sum or installments; defined contribution plans may offer annuity distributions, but 

most are not required to offer annuities.

General types of defined contribution plans

Defined contribution plans may themselves be of different types, specifically, profitsharing plans, stock bonus plans, or money purchase plans, and may include special features, 

such as a qualified cash or deferred arrangement (sec. 401(k)) or an employee stock ownership 

plan (“ESOP”). Rules requiring annuity benefits for surviving spouses and spousal consent to 

certain distributions apply to money purchase plans and, in some cases, other defined 

contribution plans offering annuities. However, most defined contribution plans are exempt 

from these requirements as long as they provide that a participant’s account balance will be paid 

to the participant’s surviving spouse (unless the spouse consents to a different beneficiary).

Section 401(k) plans

Under a section 401(k) plan, an employee may elect to have contributions (elective 

deferrals) made to the plan, rather than receive the same amount in cash. For 2019, elective 

deferrals of up to $19,000 may be made, plus, for employees aged 50 or older, up to $6,000 in 

catch-up contributions. Elective deferrals generally cannot be distributed from the plan before 

the employee’s severance from employment, death, disability or attainment of age 591⁄2 or in the 

case of hardship or plan termination. 

Elective deferrals are generally made on a pretax basis. However, a section 401(k) plan 

may include a qualified Roth contribution program under which elective deferrals are made on 

an after-tax basis (designated Roth contributions), and certain distributions (“qualified 
4

distributions”) are excluded from income. Many section 401(k) plans provide for matching 

contributions and may also provide for employer nonelective contributions and after-tax 

employee contributions.

Section 401(k) plans may be designed so that elective deferrals are made only if the 

employee affirmatively elects them. However, a section 401(k) plan may provide for “automatic 

enrollment,” under which elective deferrals are made at a specified rate unless the employee 

affirmatively elects not to make contributions or to make contributions at a different rate. 

Various rules have been developed to provide favorable treatment for plans that provide for 

automatic enrollment, subject to certain notice requirements.

Elective deferrals under a section 401(k) plan are subject to a special nondiscrimination 

test, called the actual deferral percentage test or “ADP” test, which compares the average 

deferral rates for highly compensated employees and nonhighly compensated employees. A 

similar test, the actual contribution percentage test or “ACP” test, applies to employer matching 

contributions and after-tax employee contributions. Designed-based safe harbors are also 

available for satisfying the special nondiscrimination requirements.

ESOPs

An ESOP is a stock bonus plan that is designated as an ESOP and is designed to invest 

primarily in employer stock. An ESOP can be an entire plan or it can be a portion of a defined 

contribution plan. 

ESOPs are subject to additional requirements that do not apply to other plans that hold 

employer stock, including a requirement that certain participants must be permitted to diversify a 

portion of their accounts. However, certain benefits are available to ESOPs that are not available 

to other types of qualified retirement plans, including an exception to the prohibited transaction 

rules for certain loans and, in the case of a C corporation, higher deduction limits. ESOPs 

maintained by S corporations are subject to special rules, including some restrictions on the grant 

of stock options (or the provision of other “synthetic equity”) by the S corporation.

Plan loans and hardship distributions

A defined contribution plan may provide for loans to participants, subject to certain 

conditions on the amount of the loan and repayment terms. A loan that does not meet these 

conditions is a deemed distribution. If a loan meets the required conditions, but the participant’s 

account balance is later reduced (offset) to repay the loan, a distribution occurs in the amount of 

the plan loan offset. 

Despite general restrictions on in-service distributions of elective deferrals, defined 

contribution plans and section 403(b) plans may offer hardship distributions. Section 457 plans 

may provide for distributions in the case of an unforeseeable emergency, a similar, but narrower, 

concept than hardship.
5

Lifetime income under defined contribution plans

Although pension plans are required to offer annuity forms of distribution, most defined 

contribution plans are not required to offer annuities. Instead, a participant’s benefit consists of 

an account balance, which can be depleted during the participant’s lifetime. Factors contributing 

to concerns that participants will outlive their account balances include the increase in the 

number of employees who are covered only by defined contribution plans as well as general 

longevity gains. Similar concerns arise with respect to IRA owners.

These concerns have been a focus of an initiative by the Department of the Treasury and 

the IRS in collaboration with DOL to expand the availability of lifetime income options under 

defined contribution plans and IRAs. This initiative has led to the issuance of IRS and DOL 

guidance relating to lifetime income options.

Individual Retirement Arrangements

There are two basic types of IRAs: traditional IRAs, to which deductible or 

nondeductible contributions can be made, and Roth IRAs, contributions to which are not 

deductible. The total contributions made to all IRAs for a year cannot exceed $6,000 (for 2019), 

plus an additional $1,000 (not indexed) in catch-up contributions for individuals age 50 or older. 

Certain individuals are not permitted to make deductible contributions to a traditional IRA or to 

make contributions to a Roth IRA, depending on their income.

Distributions from traditional IRAs are generally includible in income, except to the 

extent a portion of the distribution is treated as a recovery of the individual’s basis (if any). 

Qualified distributions from a Roth IRA are excluded from income; other distributions from a 

Roth IRA are includible in income to the extent of earnings. IRA distributions generally can be 

rolled over to another IRA or qualified retirement plan; however, a distribution from a Roth IRA 

generally can be rolled over only to another Roth IRA or a designated Roth account.

SIMPLE IRAs and SEPs are special types of employer-sponsored retirement plans under 

which the employer makes contributions to IRAs established for each of its employees in 

accordance with the Code requirements for each type of plan. Deemed IRAs are permitted to be 

provided in conjunction with a qualified retirement plan, section 403(b) plan, or governmental 

section 457(b) plan. An employer may also establish a payroll deduction IRA program, under 

which employees can elect to have amounts withheld from their pay and contributed to an IRA 

opened by the employee. 

Early Distributions and Required Minimum Distributions

Distributions before age 591⁄2 that are includible in income are also subject to an 

additional 10-percent early distribution tax unless an exception applies.

Under the minimum distribution requirements, distributions from a qualified retirement 

plan are required to begin within a certain period after a participant attains age 701⁄2 or, in certain 

circumstances, after a participant retires, if later, and distributions must be taken over the life or 

life expectancy of the participant (or the participant and a beneficiary). Minimum distribution 
6

requirements also apply after a participant’s death. An excise tax may apply if required 

minimum distributions are not made.

Data Relating to Retirement Savings

Data show that, in 2017, 66 percent of private-sector workers had access to a qualified 

retirement plan and 50 percent of those with access participated. Over the period 1975-2013, the 

number of participants in private single-employer defined contribution plans has steadily 

increased while participation in private single-employer defined benefit plans and multiemployer 

defined contribution and defined benefit plans has remained steady. Among private defined 

benefit plan participants, a steadily decreasing portion consists of active participants and a 

steadily increasing portion consists of inactives. Within the private sector, rates of access to and 

participation in qualified retirement plans vary between full-time and part-time workers and 

between union and non-union workers. Rates of access to and participation in qualified 

retirement plans also vary between workers in the private sector and in State and local 

government. 

Data show that married households are more likely to have savings in tax-favored 

retirement arrangements than single households. Older households are more likely than younger 

households to have defined benefit plan pensions and younger households are more likely than 

older to have defined contribution plan accounts. 

In 2013, assets in private defined benefit plans totaled about $3.1 trillion; assets in private 

defined contribution plans totaled about $4.9 trillion; and assets in IRAs totaled about $6.5 

trillion. The investment composition of total assets held in private defined benefit plans, private 

defined contribution plans and IRAs varies among the types of arrangements.
7

I. PRESENT LAW

A. Tax-Favored Employer-Sponsored Retirement Plans

1. Overview of employer-sponsored tax-favored retirement plans

Whether to offer a tax-favored retirement plan to employees is a voluntary choice by an 

employer. As with other components of a compensation package, an employer may have a 

variety of motivations in deciding whether to offer a retirement plan. The motivations to offer a 

plan may be different for a large public company that is broadly owned by its stockholders than 

for an owner-operated company where the plan is providing retirement benefits for both the 

owners and their employees. For a large public company that is competing for employees with 

other employers that offer retirement plans, the motivation may be primarily recruitment and 

retention of employees. For an owner-operated company, providing for the owner’s retirement 

may play a larger role, with providing benefits also to employees as a further consideration. For 

some employers, the decision to offer a plan may be subject to collective bargaining

negotiations. 

A key element in an employer’s decision is the value that employees place on being 

provided benefits under a retirement plan versus receiving current compensation. A basic reason 

for employees to value being provided benefits under an employer-sponsored retirement plan as 

a portion of their total compensation is the tax deferral and savings opportunity inherent in these 

plans. For example, the amount of elective deferrals an employee can make to an employersponsored retirement plan is greater than the contributions an individual can make to an IRA. In 

addition, the employer may separately make nonelective or matching contributions. 

For employers that decide to offer a tax-favored retirement plan, the Code provides rules 

as to the amount of benefits, the timing of benefit distributions, and the deductibility of 

contributions. The Code also imposes protections for employees to ensure that they receive the 

benefits promised under the plan, for example, by requiring defined benefit plans to be 

adequately funded and protecting the integrity of individual accounts under defined contribution 

plans by making sure account assets are not misused or diverted; parallel rules generally apply 

under ERISA. However, subject to these rules, an employer has a great deal of flexibility in 

deciding the structure of its retirement plan and the level of benefits, as permitted under the 

various types of plans available.

One element in a plan’s structure is whether the employer offers retirement benefits as a 

unilateral benefit that the employee accepts implicitly by accepting employment with, or 

remaining employed by, the employer. Alternatively, within limits, the employer may allow a 

year-by-year choice by the employee whether to accept current compensation or make 

contributions to the plan. Employers may structure a retirement plan in part as a retention tool so 

that only employees who work for a certain number of years become vested in the benefits 

accrued under the plan (within limits as discussed below). 
8

The most common type of tax-favored plan is a qualified retirement plan,2 which may be 

a defined benefit plan or a defined contribution plan. A defined contribution plan may include a 

qualified cash or deferred arrangement (commonly called a “section 401(k) plan”),3 which offers 

an employer great flexibility in designing a retirement program for its employees. Another 

option is a qualified annuity plan,4 which is similar to and subject to requirements similar to 

those applicable to qualified retirement plans. 

Additional options are available to certain tax-exempt or governmental employers, 

including tax-deferred annuities5 and eligible deferred compensation plans,6 which are 

sometimes offered in lieu of a section 401(k) plan. Certain small employers have the option of 

maintaining a SIMPLE IRA plan7 or a simplified employee pension (“SEP”),8 both of which are 

funded through direct contributions by the employer to an IRA established for each employee.

Tax credits are available to small employers that start new retirement plans and to lowerincome individuals who contribute to a retirement plan (or an IRA). 

2. Qualified retirement plans and annuities

In general

A plan of deferred compensation that meets the qualification requirements under the 

Code (a “qualified retirement plan”) is accorded special tax treatment. Employees do not include 

employer contributions, earnings on contributions, or benefits in gross income until amounts are 

distributed, even though the arrangement is funded and even if benefits are vested. Certain 

distributions (such as lump sums) can be rolled over to another tax-favored plan with further 

deferral of income inclusion. In the case of a taxable employer, the employer is entitled to a 

current deduction (within limits) for contributions even though the contributions are not currently 

included in an employee’s income.9 Contributions to a qualified retirement plan (other than 

elective deferrals and after-tax contributions) are exempt from FICA tax, as are plan 

distributions. Pretax contributions are exempt from income tax withholding, and special 

withholding rules apply to distributions. Contributions to a qualified retirement plan, and 

 2

 Sec. 401(a).

3

 Sec. 401(k).

4

 Sec. 403(a).

5

 Sec. 403(b).

6

 Sec. 457(b).

7

 Sec. 408(p).

8

 Sec. 408(k).

9

 Sec. 404. Under section 4972, an excise tax may apply if contributions in excess of the deduction limits 

are made.
9

earnings thereon, are held in a tax-exempt trust, which enables the assets to grow on a tax-free 

basis.

Defined benefit and defined contribution plans

Qualified retirement plans are broadly classified into two categories, defined contribution 

plans and defined benefit plans, based on the nature of the benefits provided.10 Although both 

types of plans are subject to the qualification requirements, the requirements differ somewhat for 

the two types of plans.

Under a defined contribution plan, a separate account is maintained for each participant, 

to which contributions are allocated and investment earnings (and losses) are credited, and a 

participant’s benefits are based solely on the participant’s account balance.11 Defined 

contribution plans commonly allow participants to direct the investment of their accounts. 

Because the account balance, and thus the participant’s benefits, depends on the rate of return on 

the account, the risk of investment loss (and reward of investment gain) under a defined 

contribution plan lies with the participant rather than the employer. 

Under a defined benefit plan, benefits are determined under a plan formula.12 Benefits 

under a defined benefit plan are funded by the general assets of the trust established under the 

plan, which are invested by plan fiduciaries in accordance with plan terms; individual accounts 

are not maintained for employees participating in the plan. Employer contributions to a defined 

benefit plan are subject to minimum funding requirements to ensure that plan assets are sufficient 

to pay the benefits under the plan.13 The amount of required annual contributions depends on the 

type of plan and is determined under certain actuarial methods taking into account this valuation. 

This structure generally results in the risk of investment gain or loss under a defined benefit plan 

being borne by the employer through increases or decreases in required contributions to fund the 

promised plan benefits. An employer is subject to an excise tax for a failure to make required 

 10 Under the Code as in effect since before ERISA, retirement plans fall into three general types - pension 

plans, profit-sharing plans, and stock bonus plans, defined respectively at Treas. Reg. sec. 1.401-1(b)(1)(i), (ii), and 

(iii). Defined benefit plans and money purchase pension plans (a type of defined contribution plan) are pension 

plans under the Code; other defined contribution plans are either profit-sharing plans or stock bonus plans. The 

application of some Code requirements depends on whether the plan is a pension plan, a profit-sharing plan, or a 

stock bonus plan. Under ERISA, the term “pension plan,” defined at ERISA section 3(2)(A), includes both defined 

benefit plans and defined contribution plans.

11 Defined contribution plan is defined at section 414(i) and ERISA section 3(34). Under ERISA, a 

defined contribution plan is also referred to as an individual account plan.

12 As defined in section 414(j) and ERISA section 3(35), a defined benefit plan is any plan that is not a 

defined contribution plan. For a more detailed discussion of defined benefit plans, see Joint Committee on Taxation, 

Present Law and Background Relating to Defined Benefit Plans (JCX-99-14), September 15, 2014. This document 

is available at www.jct.gov. 

13 Secs. 412 and 430.
10

contributions, unless the employer obtains a funding waiver.14 Benefits under defined benefit 

plans are generally guaranteed (within limits) by the Pension Benefit Guaranty Corporation 

(“PBGC”).15

Certain types of qualified retirement plans are referred to as hybrid plans because they 

have features of both a defined benefit plan and a defined contribution plan. However, legally, 

the plan is either a defined contribution plan or a defined benefit plan.16

Qualified retirement plan requirements

Present law imposes a number of requirements on qualified retirement plans that must be 

satisfied for favorable tax treatment to apply.17 Some of these requirements define the rights of 

plan participants and beneficiaries, such as the minimum participation and vesting requirements. 

In addition, assets of the plan must be held in a trust or custodial account for the exclusive 

benefit of plan participants, and prohibited transaction rules (that is, rules prohibiting self-dealing 

by employers and plan fiduciaries) apply to plan assets.18 Defined benefit plans and money 

purchase pension plans (a type of defined contribution plan) are also subject to minimum funding 

requirements. 

Under the minimum participation rules, a plan generally cannot delay an employee’s 

participation in the plan beyond the later of completion of one year of service (i.e., a 12-month 

period with at least 1,000 hours of service) or attainment of age 21.19 In addition, a plan cannot 

exclude an employee from participation on the basis of attainment of a specified age. Employees 

can be excluded from plan participation on other bases, such as job classification, as long as the 

other basis is not an indirect age or service requirement.

Under the vesting rules, a participant’s right to the benefits he or she has accrued under a 

plan (“accrued benefit”) generally must become nonforfeitable after a specified period of service 

 14 Sec. 4971.

15 To the extent benefits are not guaranteed by the PBGC, participants in an underfunded defined benefit 

plan bear the risk of losing benefits in the case of a distress termination of a single-employer defined benefit plan or 

insolvency of a multiemployer defined benefit plan.

16 Under section 414(k) and ERISA section 3(35), a defined benefit plan that provides a benefit based 

partly on the balance of a separate account for a participant is treated as a defined contribution plan for certain 

purposes.

17 In general, for purposes of these requirements, members of controlled groups under section 414(b) or (c) 

and affiliated service groups under section 414(m) or (o) are treated as a single employer.

18 Secs. 401(a)(2) and 4975. Under this exclusive benefit requirement, prior to satisfaction of all liabilities 

under the plan with respect to employees and their beneficiaries, assets are not allowed to be used for or diverted to 

purposes, other than the exclusive benefit of employee or their beneficiaries. 

19 Sec. 410(a).
11

or, if earlier, at attainment of normal retirement age under the plan.20 Benefits under either a 

defined benefit plan or a defined contribution plan that are attributable to employee contributions 

(including elective deferrals) must be fully vested at all times. The period of service after which 

benefits attributable to employer contributions must be vested depends on the type of plan 

(defined benefit or defined contribution). A plan may provide for vesting earlier than when 

required, but not later. 

The vesting rules also generally prohibit amendments that reduce previously accrued 

benefits or eliminate optional forms of benefit with respect to previously accrued benefits. 

Reductions in an employee’s rate of accrual under a defined benefit plan, or rate of allocation 

under a defined contribution plan, due to increasing age generally are also prohibited.

The vesting rules also prohibit distribution of an employee’s accrued benefit without 

consent (an “involuntary” distribution) before the later of the time the participant has attained 

normal retirement age under the plan or attained age 62. An exception generally allows an 

involuntary distribution if the present value of the employee’s accrued benefit at the time of the 

distribution is not more than $5,000 (“mandatory cash-out”).21

Some qualified retirement plan requirements provide limits on the tax benefits for 

qualified retirement plans, such as the limit on compensation that may be taken into account for 

qualified retirement plan purposes ($280,000 for 2019) and limits on contributions, benefits and 

deductions.22 The limits on contributions, benefits and deductions apply separately to defined 

benefit and defined contribution plans.

Minimum coverage, nondiscrimination and top-heavy requirements

In general

A qualified retirement plan is prohibited from discriminating in favor of highly 

compensated employees, referred to as the nondiscrimination requirements. These requirements 

are intended to ensure that a qualified retirement plan provides meaningful benefits to an 

employer’s rank-and-file employees as well as highly compensated employees, so that qualified 

retirement plans achieve the goal of retirement security for both lower-paid and higher-paid 

employees. The nondiscrimination requirements consist of a minimum coverage requirement 

and general nondiscrimination requirements.23 For purposes of these requirements, an employee 

 20 Sec. 411. A plan may specify the plan’s normal retirement age but may not specify a normal retirement 

age later than age 65 or, if later, the fifth anniversary of the time the participant commenced plan participation.

21 In determining present value for this purpose, benefits attributable to a rollover to the plan may be 

disregarded.

22 Secs. 401(a)(16) and (17), 404 and 415.

23 Sections 401(a)(3) and 410(b) deal with the minimum coverage requirement; section 401(a)(4) deals 

with the general nondiscrimination requirements, with related rules in section 401(a)(5). Detailed regulations 

implement the statutory requirements. In addition to the minimum coverage and general nondiscrimination 

requirements, under section 401(a)(26), the group of employees who accrue benefits under a defined benefit plan for 
12

generally is treated as highly compensated if the employee (1) was a five-percent owner of the 

employer at any time during the year or the preceding year, or (2) had compensation for the 

preceding year in excess of $125,000 (for 2019).24

The minimum coverage and general nondiscrimination requirements apply annually on 

the basis of the plan year. In applying these requirements, employees of all members of a 

controlled group or affiliated service group are treated as employed by a single employer. 

Employees who have not satisfied minimum age and service conditions under the plan, certain 

nonresident aliens, and employees covered by a collective bargaining agreement are generally 

disregarded.25 If a plan does not satisfy the nondiscrimination requirements on its own, it may in 

some circumstances be aggregated with another plan, and the two plans tested together as a 

single plan.

Minimum coverage requirement

Under the minimum coverage requirement, the plan’s coverage of employees must be 

nondiscriminatory. This is determined by calculating the plan’s ratio percentage, that is, the ratio 

of the percentage of nonhighly compensated employees (of all nonhighly compensated 

employees in the workforce) covered under the plan over the percentage of highly compensated 

employees covered. If the plan’s ratio percentage is 70 percent or greater, the plan satisfies the 

minimum coverage requirement. If the plan’s ratio percentage is less than 70 percent, a multipart test applies. First, the plan must cover a group (or “classification”) of employees that is 

reasonable and established under objective business criteria, such as hourly or salaried 

employees (referred to as a reasonable classification), and the plan’s ratio percentage must be at 

or above a specific level specified in the regulations. In addition, the average benefit percentage 

test must be satisfied. Under the average benefit percentage test, the average rate of 

contributions or benefit accruals for all nonhighly compensated employees in the workforce 

(taking into account all plans of the employer) must be at least 70 percent of the average 

contribution or accrual rate of all highly compensated employees. 

General nondiscrimination requirements

Under a general nondiscrimination requirement, a qualified retirement plan may not 

discriminate in favor of highly compensated employees with respect to contributions or benefits. 

The general nondiscrimination requirements are met if (1) the amount of contributions or 

benefits provided under the plan are nondiscriminatory, (2) each benefit, right or feature under 

the plan is available to a nondiscriminatory group of employees, and (3) the timing of plan 

 a year must consist of at least 50 employees, or, if less, 40 percent of the workforce, subject to a minimum of two 

employees accruing benefits. Governmental plans are not subject to these requirements. 

24 Sec. 414(q). At the election of the employer, employees who are highly compensated based on 

compensation may be limited to the top 20 percent highest paid employees. A nonhighly compensated employee is 

an employee other than a highly compensated employee. 

25 A plan or portion of a plan covering collectively bargained employees is generally deemed to satisfy the 

nondiscrimination requirements.
13

amendments does not have the effect of discriminating significantly in favor of highly 

compensated employees.26

In some circumstances, two or more plans may be aggregated and tested as a single plan 

for purposes the nondiscrimination requirements. In addition, the regulations implementing the 

general nondiscrimination requirements, allow a plan to be segmented into multiple plans, 

referred to as component plans, with each component plan tested separately. For example, a 

defined benefit plan may cover different divisions, with different benefit formulas for the 

employees of each division. For purposes of applying the general nondiscrimination 

requirements, the plan could be segmented into components, based on the portions of the plan 

covering employees of each division, and the requirements applied separately with respect to 

each component.

Nondiscrimination in the amount of contributions or benefits

There are three general approaches to testing the amount of contributions or benefits 

under a qualified retirement plan: (1) design-based safe harbors under which the benefit formula 

under a defined benefit plan, or the formula for allocating employer nonelective contributions 

under a defined contribution plan to participants’ accounts, satisfies certain uniformity 

standards;27 (2) a general test; and (3) cross-testing of equivalent accruals or allocations.28 A 

plan is not discriminatory merely because benefit accruals or allocations for highly compensated 

and nonhighly compensated employees are provided as a percentage of compensation (up to 

$280,000 for 2019).29 Thus, the various testing approaches are generally applied to the amount 

of contributions or benefits provided as a percentage of compensation.

The general test is generally satisfied by measuring the allocation rate (under a defined 

contribution plan) or accrual rate (under a defined benefit plan) of each highly compensated 

employee to determine if the group of employees with the same or higher rate of accrual or 

allocation (referred to as a rate group) is a nondiscriminatory group.30 This test generally is 

 26 Treas. Reg. sec. 1.401(a)(4)-1. With respect to the amount of contributions, employee elective deferrals 

under a section 401(k) plan and employer matching contributions and after-tax employee contributions to a defined 

contribution plan are subject to special testing rules, rather than being included in applying the general 

nondiscrimination requirements. In addition, the amount of employer contributions to an ESOP is tested separately 

from other employer contributions. Rules applicable to benefits, rights and features and the timing of plan 

amendments are provided in Treas. Reg. secs. 1. 401(a)(4)-4 and -5 respectively.

27 Sections 401(a)(5)(C)-(D) and 401(l) and Treas. Reg. secs. 1.401(l)-1 through -6 provide rules under 

which the benefit or allocation formula may take into account the employer-paid portion of social security taxes or 

benefits, referred to as permitted disparity.

28 These approaches are explained in Treas. Reg. secs. 1.401(a)(4)-2, -3 and -8. As discussed below, 

special nondiscrimination tests apply to elective deferrals under a section 401(k) plan and to employer matching 

contributions and after-tax employee contributions.

29 Sec. 401(a)(5)(B).

30 An employee’s allocation rate generally is the amount of employer contribution allocated to an 

employee’s account for the plan year, expressed as a percentage of the employee’s compensation for the plan year. 
14

satisfied if the ratio percentage of the rate group (that is, the percentage of nonhighly employees 

in the rate group, compared with the percentage of highly compensated employees) satisfies the 

minimum coverage requirement. For this purpose, if the ratio percentage of the rate group is less 

than 70 percent, a simplified standard applies, which disregards the reasonable classification 

requirement and instead applies a minimum ratio percentage for the rate group (and still requires 

satisfaction of the average benefit percentage test). The minimum ratio percentage under this 

simplified standard depends on the percentage of the employer’s workforce that consists of 

nonhighly compensated employees (the nonhighly compensated employee percentage) and 

ranges from (1) a minimum ratio percentage of 45 percent if the nonhighly compensated 

employee percentage is 60 percent (or less) to (2) a minimum ratio percentage 20.375 percent if 

the nonhighly compensated employee percentage is 99 percent.

Cross-testing involves the conversion of allocations or accruals to actuarially equivalent 

accruals or allocations, with the resulting equivalencies tested under the general test.

Top heavy requirements 

Top-heavy requirements apply to limit the extent to which accumulated benefits or 

account balances under a qualified retirement plan can be concentrated with key employees.31 

Whereas the general nondiscrimination requirements are designed to test annual contributions or 

benefits for highly compensated employees, compared to those of nonhighly compensated 

employees, the top-heavy rules test the portion of the total plan contributions or benefits that 

have accumulated for the benefit of key employees as a group. If a plan is top-heavy, minimum 

contributions or benefits for nonkey employees and, in some cases, faster vesting is required.

For this purpose, a key employee is an officer with annual compensation greater than 

$180,000 (for 2019), a five-percent owner, or a one-percent owner with compensation in excess 

of $150,000. A defined benefit plan generally is top-heavy if the present value of cumulative 

accrued benefits for key employees exceeds 60 percent of the cumulative accrued benefits for all 

employees. A defined contribution plan is top-heavy if the aggregate of accounts for key 

employees exceeds 60 percent of the aggregate accounts for all employees. The nature of the 

top-heavy test is such that a plan of a large business with many employees is unlikely to be topheavy. The top-heavy requirements are therefore viewed as primarily affecting plans of smaller 

employers in which the owners participate.

 An employee’s accrual rate generally is the amount of the annual payments under the employee’s accrued benefit 

payable at normal retirement age in the form of a straight life annuity divided by the employee’s years of service and 

expressed as a percentage of average annual compensation. Under the permitted disparity rules of section 401(l), 

allocation and accrual rates are then permitted to be increased by a factor to reflect the employer paid portion of 

social security taxes or benefits. If a defined benefit plan provides subsidized optional forms of benefit, the accrual 

rate for the actuarially most valuable benefit under the plan available to each employee is also calculated and tested.

31 Secs. 401(a)(10)(B) and 416.
15

Prohibited transactions

The Code prohibits certain transactions between qualified retirement plans and a 

disqualified person.32 If a prohibited transaction occurs, the disqualified person is subject to a 

two-tier excise tax.33 The first level tax is 15 percent of the amount involved in the transaction. 

The second level tax is imposed if the prohibited transaction is not corrected within a certain 

period and is 100 percent of the amount involved. Amount involved generally means the greater 

of the amount of money and the fair market value of the other property given or the amount of 

money and the fair market value of the other property received.34

Prohibited transactions include certain direct or indirect transactions between a plan and a 

disqualified person: (1) the sale, exchange, or leasing of property; (2) the lending of money or 

other extension of credit; and (3) the furnishing of goods, services or facilities. Prohibited 

transactions also include any direct or indirect: (1) transfer to, or use by or for the benefit of a 

disqualified person of the income or assets of the plan; (2) in the case of a fiduciary, an act that 

deals with the plan’s income or assets for the fiduciary’s own interest or account; and (3) the 

receipt by a fiduciary of any consideration for the fiduciary’s own personal account from any 

party dealing with the plan in connection with a transaction involving the income or assets of the 

plan. 

In general, “disqualified person” means: (1) a fiduciary; (2) a person providing services 

to the plan; (3) an employer any of whose employees are covered by the plan; (4) an employee 

organization any of whose members are covered by the plan; (5) a direct or indirect owner of a 

specified interest in such an employer or employee organization; (6) a member of the family of 

an individual which meets certain definitions of a disqualified person; (7) a corporation, 

partnership, or trust or estate of which (or in which) a specified interest is owned by certain other 

disqualified persons; (8) offers and directors (or individuals having powers or responsibilities 

similar to those of officers or directors), 10-percent or more shareholders, or highly compensated 

employees (earning 10 percent or more of the yearly wages of the employer) of certain other 

disqualified persons; or (9) a 10-percent or more (in capital or profits) partner or joint venturer of 

certain other disqualified persons. Disqualified persons also include corporations of which 50 

percent or more of: (1) the combined voting power of all classes of stock entitled to vote; or (2) 

the total value of shares of all classes of stock of such corporation, is owned directly or 

indirectly, or held by certain other disqualified persons.

A fiduciary includes any person who: (1) exercises any authority or control respecting 

management or disposition of the plan’s assets; (2) renders investment advice for a fee or other 

 32 Sec. 4975. The prohibited transaction rules under the Code also apply to IRAs, health savings accounts 

(sec. 223), medical savings accounts (sec. 220), and Coverdell education savings accounts (sec. 530). The 

prohibited transaction rules do not apply to governmental plans or church plans. However, under section 503, a 

governmental or church plan that engages in a prohibited transaction as defined under that section may lose its 

tax-exempt status.

33 Sec. 4975(a)-(b).

34 Sec. 4975(f)(4).
16

compensation with respect to any plan moneys or property, or has the authority or responsibility 

to do so; or (3) has any discretionary authority or responsibility in the administration of the plan. 

The Code exempts certain transactions that meet specified conditions from the definition 

of prohibited transaction. Examples of exempt transactions are plan loans to participants, the 

acquisition of qualifying employer securities or employer real property, and loans to a leveraged 

ESOP. 35 

ERISA

Qualified retirement plans are also subject to regulation under ERISA, which generally is 

under the jurisdiction of the Department of Labor (“DOL”).36 The ERISA rules generally relate 

to the rights of plan participants and beneficiaries, reporting and disclosure, and the obligations 

of plan fiduciaries. Some of the provisions of the Code and ERISA that apply to qualified 

retirement plans are identical or very similar.37 For example, ERISA includes minimum 

participation and vesting requirements and prohibited transaction rules that parallel those under 

the Code.

ERISA contains general fiduciary duty standards that apply to all fiduciary actions, 

including investment decisions.38 ERISA requires that a plan fiduciary generally must discharge 

its duties solely in the interests of participants and beneficiaries and with the care, skill, 

prudence, and diligence under the circumstances then prevailing that a prudent man acting in a 

like capacity and familiar with such matters would use in the conduct of an enterprise of a like 

character and with like aims. With respect to plan assets, ERISA requires a fiduciary to diversify 

the investments of the plan so as to minimize the risk of large losses unless under the 

circumstances it is clearly prudent not to do so.

A plan fiduciary that breaches any of the fiduciary responsibilities, obligations, or duties 

imposed by ERISA is personally liable to make good to the plan any losses to the plan resulting 

from such breach and to restore to the plan any profits the fiduciary has made through the use of 

plan assets.39 A plan fiduciary may be liable also for a breach of responsibility by another 

 35 Sec. 4975(c)(2), (d), and (f).

36 Governmental plans and church plans are generally exempt from ERISA and from the Code 

requirements that correspond to ERISA requirements. The PBGC has jurisdiction over the defined benefit plan 

insurance program under Title IV of ERISA. 

37 Reorganization No. 4, Pub. L. No. 99-524, divides interpretive jurisdiction between Treasury and the

Department of Labor with respect to these provisions so that generally only one agency has interpretative 

jurisdiction with respect to each provision that is in both the Code and ERISA. 

38 ERISA sec. 404(a).

39 ERISA sec. 409. Under ERISA section 502(a)(2), an action for a breach of fiduciary responsibility may 

be brought by DOL, a plan participant or beneficiary, or another fiduciary. 
17

fiduciary (a “co-fiduciary”) in certain circumstances, for example, if the fiduciary’s failure to 

fulfill its own fiduciary duties enabled the co-fiduciary to commit the breach.40

Enforcement of requirements 

Enforcement of a qualified retirement plan requirement depends on the source of the 

requirement. The qualification requirements under the Code are enforced by the Internal 

Revenue Service (“IRS”). If a plan fails to meet the qualification requirements, the favorable tax 

treatment for such plans may be denied; that is, the employer may lose tax deductions and 

employees may have current income inclusion. As a practical matter, the IRS rarely disqualifies 

a plan. Instead, the IRS generally may impose sanctions short of disqualification and require the 

employer (or other plan sponsor) to correct any violation of the qualification rules.41

Certain Code requirements for qualified plans, such as the prohibited transaction rules, 

are enforced through an excise tax rather than through disqualification. Employees do not have a 

right to sue to enforce the qualified retirement plan requirements under the Code.

ERISA’s requirements generally may be enforced through administrative actions by DOL 

or by lawsuits brought by DOL, plan participants or beneficiaries, or plan fiduciaries. Certain 

violations of ERISA may result in the imposition of a civil penalty.42

Qualified annuity plans

A qualified annuity plan is a type of retirement plan that is subject to the same 

requirements as qualified retirement plans and receives comparable tax-favored treatment, but 

plan assets consist of annuity contracts, rather than investments held in a trust or custodial 

account.43

 40 ERISA sec. 405.

41 The IRS has established the Employee Plans Compliance Resolution System (“EPCRS”), a formal 

program under which employers and other plan sponsors may correct compliance failures and continue to provide 

their employees with retirement benefits on a tax-favored basis. EPCRS has three components, providing for selfcorrection, voluntary correction with IRS approval, and correction on audit. The Self-Correction Program (“SCP”) 

generally permits a plan sponsor that has established compliance practices and procedures to correct certain 

insignificant failures at any time (including during an audit), and certain significant failures generally within a 2-

year period, without payment of any fee or sanction. The Voluntary Correction Program (“VCP”) permits an 

employer, at any time before an audit, to pay a limited fee and receive IRS approval of a correction. For a failure 

that is discovered on audit and corrected, the Audit Closing Agreement Program (“Audit CAP”) provides for a 

sanction that bears a reasonable relationship to the nature, extent, and severity of the failure and that takes into 

account the extent to which correction occurred before audit. Rev. Proc. 2019-19, 2019-19 I.R.B. ____ (May 6, 

2019).

42 DOL also has a correction program entitled the Voluntary Fiduciary Correction Program (VFCP), 71 

Fed. Reg. 20261 (May 19, 2006), designed to encourage the voluntary correction of fiduciary violations under Title I 

of ERISA. 

43 Secs. 403(a) and 404(a)(2). Except when otherwise indicated, references herein to a qualified retirement 

plan include a qualified annuity plan.
18

3. Special types of plans for governmental and tax-exempt employers

Tax-sheltered annuities (section 403(b) plans)

Section 403(b) plans are another form of tax-favored employer-sponsored plan that 

provide tax benefits similar to qualified retirement plans. Section 403(b) plans may be 

maintained only by (1) charitable organizations tax-exempt under section 501(c)(3), and 

(2) educational institutions of State or local governments (i.e., public schools, including colleges 

and universities). Many of the rules that apply to section 403(b) plans are similar to the rules 

applicable to qualified retirement plans, including section 401(k) plans. Employers may make 

nonelective or matching contributions to such plans on behalf of their employees, and the plan 

may provide for employees to make elective deferrals, designated Roth contributions or other 

after-tax contributions. 

Contributions to a section 403(b) plan are generally subject to the same contribution 

limits applicable to qualified defined contribution plans, including the special limits for elective 

deferrals ($19,000 for 2019) and catch-up contributions ($6,000 for 2019) under a section 401(k) 

plan, or, if less, the employee’s compensation. If elective deferral and catch-up contributions are 

made to both a qualified defined contribution plan and a section 403(b) plan for the same 

employee, a single limit applies to the elective deferrals under both plans. Special contribution 

limits apply to certain employees under a section 403(b) plan maintained by a church. In 

addition, under a special catch-up rule, an increased elective deferral limit applies under a plan 

maintained by an educational organization, hospital, home health service agency, health and 

welfare service agency, church, or convention or association of churches in the case of 

employees who have completed 15 years of service. In this case, the limit is increased by the 

least of (1) $3,000, (2) $15,000, reduced by the employee’s total elective deferrals in prior years, 

and (3) $5,000 times the employee’s years of service, reduced by the employee’s total elective 

deferrals in prior years.44

Section 403(b) plans are generally subject to the minimum coverage and 

nondiscrimination rules that apply to qualified defined contribution plans.45 However, pretax 

contributions and designated Roth contributions made by an employee under a salary reduction 

agreement (i.e., elective deferrals) are not subject to nondiscrimination rules similar to those 

applicable to elective deferrals under section 401(k) plans. Instead, all employees of the 

employer generally must be eligible to make salary reduction contributions. Certain employees 

may be disregarded for purposes of this rule.

 44 Because contributions to a defined contribution plan cannot exceed an employee’s compensation, 

contributions for an employee are generally not permitted after termination of employment. However, under a 

special rule, a former employee may be deemed to receive compensation for up to five years after termination of 

employment for purposes of receiving employer nonelective contributions under a section 403(b) plan.

45 As in the case of a qualified retirement plan, a governmental section 403(b) plan is not subject to these 

nondiscrimination rules.
19

Governmental section 457(b) plans

Special rules with respect to deferred compensation arrangements of State and local 

government and tax-exempt employers.46 Amounts deferred under an eligible deferred 

compensation plan, i.e., a section 457(b) plan, are not currently included in income. In the case 

of a State or local government employer, a section 457(b) plan is generally limited to elective 

deferrals and provides tax benefits similar to a section 401(k) or 403(b) plan in that deferrals are 

contributed to a trust or custodial account for the exclusive benefit of participants, but are not 

included in income until distributed (and may be rolled over to another tax-favored plan).47

Deferrals under a governmental section 457(b) plan are subject to the same limits as 

elective deferrals ($19,000 for 2019) and catch-up contributions ($6,000 for 2019) under a 

section 401(k) plan or a section 403(b) plan, or, if less, the employee’s compensation. However, 

the section 457(b) plan limits apply separately from the combined limit applicable to section 

401(k) and 403(b) plan contributions, so that an employee covered by a governmental section 

457(b) plan and a section 401(k) or 403(b) plan can contribute the full amount to each plan. In 

addition, under a special catch-up rule, for one or more of the participant’s last three years before 

normal retirement age, the otherwise applicable limit is increased to the lesser of (1) two times 

the normal annual limit ($38,000 for 2019) or (2) the sum of the otherwise applicable limit for 

the year plus the amount by which the limit applicable in preceding years of participation 

exceeded the deferrals for that year.

A governmental section 457(b) plan may include a qualified Roth contribution program, 

allowing a participant to elect to have all or a portion of the participant’s deferrals under the plan 

treated as designated Roth contributions.

4. Taxation of distributions

In general 

Distributions from qualified retirement plans and annuities, section 403(b) plans, and 

governmental section 457(b) plans (other than distributions from designated Roth accounts, 

discussed below) are generally includible in gross income (to the extent the distribution exceeds 

basis) as ordinary income in the year in which distributed.48 The part of any distribution that 

represents the participant’s investment in the contract (i.e., basis) is not includible in gross 

income. A participant generally has basis under the plan to the extent that the participant has 

made after-tax contributions to the plan that have not been recovered. The basis recovery rules 

differ depending on whether or not the distribution is received as an annuity payment. 

As discussed below, an additional 10-percent tax applies to distributions before age 591⁄2 

from qualified retirement plans and annuities and section 403(b) plans unless an exception 

 46 Sec. 457.

47 In the case of a tax-exempt employer, section 457(b) and 457(f) limit the amount of unfunded 

nonqualified deferred compensation that can be provided on a tax-deferred basis.

48 Secs. 72, 402(a)(1), 403(a)(1), 403(b)(1) and 457(a).
20

applies. In addition, participants in qualified retirement plans and annuities, section 403(b) 

plans, and governmental section 457(b) plans are required to begin receiving distributions at the 

later of age 701⁄2 or retirement.

Rollovers

A distribution from a qualified retirement plan, section 403(b) plan, or a governmental 

section 457(b) plan that is an eligible rollover distribution may be rolled over to another such 

plan or an IRA. The rollover generally can be achieved by direct rollover (direct payment from 

the distributing plan to the recipient plan) or by contributing the distribution to the eligible 

retirement plan within 60 days of receiving the distribution (“60-day rollover”).49 Amounts that 

are rolled over are usually not included in gross income. Generally, any distribution of the 

balance to the credit of a participant is an eligible rollover distribution with exceptions, for 

example, certain periodic payments, required minimum distributions, and hardship 

distributions.50 

Any distribution to a beneficiary other than the participant’s surviving spouse is only 

permitted to be rolled over to an IRA using a direct rollover; 60-day rollovers are not available to 

nonspouse beneficiaries.51

Qualified retirement plans, section 403(b) plans, and governmental section 457(b) plans 

are required to offer a direct rollover with respect to any eligible rollover distribution before 

paying the amount to the participant or beneficiary.52 If an eligible rollover distribution is not 

directly rolled over into an eligible retirement plan, the taxable portion of the distribution 

generally is subject to mandatory 20 percent income tax withholding.53 Participants who do not 

elect a direct rollover but who roll over eligible distributions within 60 days of receipt also defer 

tax on the rollover amounts; however, the 20-percent withheld will remain taxable unless the 

participant substitutes funds within the 60 day period.54 The direct rollover and 20-percent 

 49 Beginning January 1, 2018, the deadline for a rollover of a qualified plan loan offset amount is the due 

date for the participant’s income tax return (including extensions) for the taxable year in which the offset amount is 

distributed. See Part I.B.5 for a discussion of qualified plan loan offset amounts.

50 Section 402(c)(4). Treas. Reg. sec. 1.402(c)-1 identifies certain other payments that are not eligible for 

rollover, including, for example, certain corrective distributions, loans that are treated as deemed distributions under 

section 72(p), and dividends on employer securities as described in section 404(k). 

51 Sec. 402(c)(11).

52 Sec. 401(a)(31). Unless a participant elects otherwise, a mandatory cash-out of more than $1,000 must 

be directly rolled over to an IRA chosen by the plan administrator or the payor. 

53 Treas. Reg. sec. 1.402(c)-2, Q&A-1(b)(3). 

54 For example, if Adam receives an eligible rollover distribution of $10,000 and elects to have the entire 

amount paid directly to him, he will receive $8,000 since $2,000 would have been withheld as income tax. If within 

60 days of receiving the distribution Adam decides to roll over the distribution into an IRA he will need to 

contribute an additional $2,000 to the IRA in order to defer taxes on the entire distributed amount.
21

withholding rules are designed to encourage tax-free rollovers, and thereby, to keep retirement 

funds in eligible retirement plans.

Distributions from qualified retirement plans, section 403(b) plans, and governmental 

section 457(b) plans may be rolled into a Roth IRA. Distributions from these plans that are 

rolled over into a Roth IRA and that are not distributions from a designated Roth account 

(discussed below) must be included in gross income.
22

B. Defined Contribution Plans

1. General description and rules

As discussed above, benefits under a defined contribution plan are based solely on the 

contributions, earnings, and losses credited to the separate accounts maintained for plan 

participants. For defined contribution plans, a participant’s accrued benefit is the participant’s 

account balance. Accordingly, the participant benefits from investment gains and bears the risk 

of investment losses on the account.

A defined contribution plan may provide for various types of contributions by employees 

or the employer. In the case of a section 401(k) plan, employees may elect to have pretax 

contributions made to the plan, referred to as elective deferrals, rather than receive the same 

amount as current compensation. A section 401(k) plan may also allow employees to designate 

some or all of their elective deferrals as after-tax Roth contributions. A defined contribution plan 

may also allow employees to make other after-tax contributions. Possible employer 

contributions consist of two types: nonelective contributions and matching contributions. 

Nonelective contributions are employer contributions that are made without regard to whether 

the employee makes pretax or after-tax contributions. Matching contributions are employer 

contributions that are made only if the employee makes contributions and can relate to pretax 

elective deferrals, designated Roth contributions, or other after-tax contributions. 

The total contributions made to an employee’s account for a year cannot exceed the lesser 

of $56,000 (for 2019) or the employee’s compensation.55 Contributions made to more than one 

plan for an employee are aggregated for purposes of this limit, and employee contributions to a 

defined benefit plan, if any, are taken into account in applying the limit. However, catch-up 

contributions (discussed below) are not taken into account in applying the limit.

A defined contribution plan can use one of two alternative minimum vesting schedules 

with respect to the portion of a participant’s account balance that is attributable to employer 

contributions, including investment returns on employer contributions. Under the first vesting 

schedule, the account balance attributable to employer contributions must be 100 percent vested 

upon completion of no more than three years of service (often referred to as “three-year cliff 

vesting”). Under the second vesting schedule (referred to as “graduated vesting”), the 

participant’s account balance attributable to employer contributions must become vested at a rate 

of no less than 20 percent, 40 percent, 60 percent, 80 percent, and 100 percent, respectively, over 

the period from two to six years of service.

Defined contribution plans often provide for loans to participants, subject to certain 

conditions. Defined contribution plans generally provide for distributions on severance from 

employment and, depending on the type of plan, may provide for distributions before severance 

from employment (“in-service” distributions). Defined contribution plans may provide for 

distributions to be made in a lump sum or installments. Defined contribution plans may also 

 55 Sec. 415(c).
23

provide for distributions in the form of a life annuity (through the purchase of an annuity 

contract), but generally are not required to provide annuity distributions.

The deduction for employer contributions to a defined contribution plan for a year is 

generally limited to 25 percent of the participants’ compensation.56 For this purpose, a 

participant’s compensation in excess of $280,000 (for 2019) is not taken into account. Elective 

deferrals (including designated Roth contributions) and employee contributions are not counted 

in applying the 25 percent limit. Special deduction rules apply to an ESOP (discussed below), or 

if an employer maintains both a defined contribution plan and a defined benefit plan. An excise 

tax may apply if contributions in excess of the deduction limits are made.

57

2. General types of defined contribution plans

Defined contribution plans fall into three general types: profit-sharing plans, stock bonus 

plans, and money purchase pension plans. The type of plan must be specified in the plan 

document. Within the three general types of defined contribution plans are plan designs that 

contain special features, such as a section 401(k) plan or an ESOP.

Profit-sharing plans were originally intended as a means of enabling employees to share 

in the profits of the employer’s business. However, under present law, contributions to a profitsharing plan are permitted regardless of whether the business has profits. A profit-sharing plan 

may provide for regular employer contributions each year or may provide that contributions are 

made each year at the discretion of the employer (called a “discretionary” profit-sharing plan). A 

profit-sharing plan must provide a definite formula under which contributions are allocated to 

participant accounts and must specify the events upon which distributions will be made to 

participants, such as severance from employment.

A stock bonus plan is similar to a profit-sharing plan except that benefits are distributable 

in stock of the employer. The plan may provide for cash distributions, but must also allow 

participants to take distributions in the form of employer stock. In the case of employer stock 

that is not publicly traded, participants generally must be given the right to require the employer 

to repurchase the stock under a fair valuation formula.

A money purchase pension plan must provide for a set level of required employer 

contributions, generally as a specified percentage of participants’ compensation. A money 

purchase pension plan is subject to the minimum funding requirements, and the employer is 

generally subject to an excise tax if it fails to make the contributions required under the plan. A 

money purchase pension plan may not provide for in-service distributions except at normal 

retirement age (or age 62, if earlier) or in the case of plan termination.

 56 Sec. 404.

57 Sec. 4972.
24

Certain spousal protections apply to qualified retirement plans.58 In the case of a pension 

plan (that is, a money purchase pension plan or a defined benefit plan), these protections 

generally require that benefits be paid in the form of a qualified joint and survivor annuity 

(“QJSA”) unless the participant elects a different form of distribution and the participant’s 

spouse consents in writing to the election. A QJSA is generally a life annuity for the participant 

with an annuity of at least 50 percent of the participant’s annuity amount payable to the surviving 

spouse after the participant’s death.59 If a married participant dies before benefits begin, the plan 

must offer a survivor benefit for the spouse in the form of a qualified preretirement survivor 

annuity (“QPSA”), which is a survivor annuity for the spouse that is at least 50 percent of the 

employee’s accrued benefit.

Profit-sharing plans and stock bonus plans are generally not subject to these spousal 

protection requirements unless the participant elects an annuity form of distribution. However, a 

profit-sharing or stock bonus plan must provide that a participant’s entire vested account balance 

under the plan will be paid to the participant’s surviving spouse unless the spouse consents in 

writing to a different beneficiary.

3. Section 401(k) plans

In general

A section 401(k) plan legally is not a separate type of plan, but is a profit-sharing or stock 

bonus plan that contains a qualified cash or deferred arrangement.60 Thus, such arrangements 

are subject to the rules generally applicable to qualified defined contribution plans. In addition, 

special rules apply to such arrangements.

An employee may make elective deferrals to a section 401(k) plan. The maximum annual 

amount of elective deferrals that can be made by an employee for a year is $19,000 (for 2019) or, 

if less, the employee’s compensation.61 An employee who will attain age 50 by the end of the 

year may also make catch-up contributions to a section 401(k) plan.62 As a result, the dollar 

limit on elective deferrals is increased by $6,000 (for 2019) for an individual who has attained 

age 50. An employee’s elective deferrals must be fully vested.

 58 Sec. 401(a)(11); ERISA sec. 205.

59 A married participant must also be offered a qualified optional survivor annuity (“QOSA”), which is 

also a life annuity for the participant with an annuity payable to the surviving spouse as a percentage of the 

participant’s annuity, with the required percentage depending on the QJSA percentage. 

60 Certain pre-ERISA money purchase plans and rural cooperative plans may also include a qualified cash 

or deferred arrangement. In addition, certain small employers may adopt a SIMPLE section 401(k) plan similar to a 

SIMPLE IRA plan discussed in Part I.C.3. Except for certain grandfathered plans, a State or local governmental 

employer may not maintain a section 401(k) plan.

61 Sec. 402(g).

62 Sec. 414(v).
25

Elective deferrals, and attributable earnings, generally cannot be distributed from the plan 

before the earliest of the employee’s severance from employment, death, disability or attainment 

of age 591⁄2 or termination of the plan. However, subject to certain conditions, these amounts can 

be distributed in the case of hardship.

Elective deferrals are generally made on a pretax basis. However, a section 401(k) plan 

is permitted to include a “qualified Roth contribution program” that permits a participant to elect 

to have all or a portion of the participant’s elective deferrals under the plan treated as designated 

Roth contributions. Designated Roth contributions are elective deferrals that the participant 

designates as not excludable from the participant’s gross income. The annual dollar limit on a 

participant’s designated Roth contributions is the same as the limit on elective deferrals, reduced 

by the participant’s elective deferrals that are not designated Roth contributions. Designated 

Roth contributions are generally treated the same as any other elective deferral for certain 

purposes, including the restrictions on distributions. 

Qualified distributions from a designated Roth account are excluded from income, even 

though they include earnings not previously taxed. A qualified distribution is a distribution 

made after the end of a specified period (generally five years after the participant’s first 

designated Roth contribution) and that is (1) made on or after the date on which the participant 

attains age 591⁄2, (2) made to a beneficiary (or to the estate of the participant) on or after the death 

of the participant, or (3) attributable to the participant’s being disabled. 

A section 401(k) plan that includes a designated Roth program may permit participants to 

transfer amounts from a nonRoth account under the plan to a designated Roth account, whether 

or not the amounts in the nonRoth account are permitted to be distributed from the plan at the 

time of the transfer.63 In effect, this transfer is a Roth conversion (discussed below), with related 

income recognition, for any nonRoth amounts within the plan.

Section 401(k) plans are not required to provide for matching contributions, but often do. 

Many employers provide matching contributions because doing so encourages lower-paid 

employees to make elective deferrals, which makes it easier for the plan to satisfy the applicable 

nondiscrimination rules. A section 401(k) plan may also provide for employer nonelective 

contributions.

Automatic enrollment

Section 401(k) plans may be designed so that the employee will receive cash 

compensation unless the employee affirmatively elects to make elective deferrals to the section 

401(k) plan. Alternatively, a plan may provide that elective deferrals are made at a specified rate 

(when the employee becomes eligible to participate) unless the employee elects otherwise (i.e., 

affirmatively elects not to make contributions or to make contributions at a different rate). This 

plan design is referred to as automatic enrollment. 

 63 Prior to 2013, transfers of nonRoth amounts to a designated Roth account were permitted only for 

amounts that were available for distribution from the plan at the time of the transfer. 
26

Under a section 401(k) plan, an employee must have an effective opportunity to elect to 

receive cash in lieu of contributions. Whether an employee has an effective opportunity to 

receive cash is based on all the relevant facts and circumstances, including the adequacy of 

notice of the availability of the election, the period of time during which an election may be 

made, and any other conditions on elections.64

Automatic enrollment was originally authorized by IRS guidance65 and has been 

furthered by subsequent statutory changes providing special rules for automatic enrollment.66 

These rules include a nondiscrimination safe harbor for a section 401(k) plan that includes a 

qualified automatic contribution arrangement. In addition, if a section 401(k) plan includes an 

eligible automatic contribution arrangement, elective deferrals that were automatically 

contributed to the plan (i.e., without an affirmative deferral election by an employee) may be 

distributed to the employee in accordance with an election by the employee within 90 days after 

the first automatic contribution.67 Such a distribution is permitted, despite the general restriction 

on in-service distributions of elective deferrals, and the amount distributed is not subject to the 

10-percent early distribution tax.

Use of these special rules is generally predicated on automatic contributions at a uniform 

rate (as a percentage of compensation) for all participants. In addition, a notice must be provided 

to participants explaining the choice between making or not making contributions and 

identifying the default contribution rate and investment, and each participant must be given a 

reasonable period of time after receipt of the notice to make an affirmative election with respect 

to contributions and investments. 

Special nondiscrimination tests for section 401(k) plans

General rule

A special annual nondiscrimination test, called the actual deferral percentage test (the 

“ADP” test) applies to elective deferrals under a section 401(k) plan.68 The ADP test generally 

compares the average rate of deferral for highly compensated employees to the average rate of 

deferral for nonhighly compensated employees. The ADP test allows the average deferral rate 

for highly compensated employees to exceed that for nonhighly compensated employees within 

 64 Treas. Reg. sec. 1.401(k)-1(e)(2). Similar rules apply to elective deferrals under section 403(b) plans 

and section 457(b) plans.

65 Rev. Rul. 2000-8, 2000-7 I.R.B. 617; Rev. Rul. 2000-33, 2000-31 I.R.B. 142; Rev. Rul. 2000-35, 

2000-31 I.R.B. 138; and Treas. Reg. sec. 1.401(k)-1(a)(3)(ii).

66 The Pension Protection Act of 2006 (“PPA”), Pub. L. No. 109-280, added a number of special rules to 

the Code and ERISA with respect to automatic enrollment in section 401(k) plans. The Code rules generally apply 

also to section 403(b) plans and governmental section 457(b) plans. 

67 Sec. 414(w).

68 Sec. 401(k)(3). 
27

limits: (1) the average deferral rate for highly compensated employees can be up to 125 percent 

of the average deferral rate for nonhighly compensated employees; or (2) the average deferral 

rate for highly compensated employees can be two percentage points greater than the average 

deferral rate for nonhighly compensated employees or, if less, twice the average deferral rate for 

nonhighly compensated employees. Employer matching contributions and after-tax employee 

contributions are subject to a similar special nondiscrimination test (the actual contribution 

percentage test or “ACP test”) which compares the average rate of matching and after-tax 

contributions to the plan of the two groups.69

If the ADP test is not satisfied, a mechanism is provided for the employer to make 

immediately vested additional contributions for nonhighly compensated employees (and certain 

other corrections) or to distribute deferrals of highly compensated employees to such employees, 

so that the ADP test is satisfied. Similar correction mechanisms apply for purposes of satisfying 

the ACP test. 

Design-based safe harbor nondiscrimination tests

There are also designed-based safe harbor methods of satisfying the ADP and ACP tests. 

These safe harbors are based on the premise that, for a 401(k) plan with certain design features 

with respect to contributions (elective, matching, and nonelective) and enrollment, satisfaction of 

the minimum coverage requirement is a sufficient test of the amount of whether the amount 

elective deferrals and matching contributions are nondiscriminatory.70 Under one safe harbor, a 

section 401(k) plan is deemed to satisfy the special nondiscrimination test if the plan satisfies 

one of two contribution requirements and satisfies a notice requirement.71 A plan generally 

satisfies the contribution requirement under the safe harbor rule if the employer either 

(1) satisfies a matching contribution requirement or (2) makes a nonelective contribution to a 

defined contribution plan of at least three percent of an employee’s compensation on behalf of 

each nonhighly compensated employee who is eligible to participate in the plan. The matching 

contribution requirement under the safe harbor is 100 percent of elective contributions of the 

employee for contributions not in excess of three percent of compensation, and 50 percent of 

elective contributions for contributions that exceed three percent of compensation but do not 

exceed five percent, for a total matching contribution of up to four percent of compensation. 

The required matching contributions and the three percent nonelective contribution must be 

 69 Sec. 401(m)(2).

70 The safe harbors that only require certain matching contributions potentially allow satisfaction of the 

nondiscrimination requirement with respect to elective and matching contributions under a 401(k) plan for a year 

even though no contributions are ultimately provided to nonhighly compensated employees under the plan for the 

year due to a lack of voluntary participation.

71 Sec. 401(k)(12). The plan satisfies the notice requirement if, within a reasonable time before the 

beginning of the plan year, the plan provides written notice to each eligible employee of the employee’s rights and 

obligations under the plan. 
28

immediately nonforfeitable (i.e., 100 percent vested) when made. Other requirements also apply, 

including requirements for satisfying the ACP test on a safe harbor basis.72

Another safe harbor applies for section 401(k) plans that include a qualified automatic 

contribution arrangement.73 Under a qualified automatic contribution arrangement, unless an 

employee elects otherwise, the employee is treated as electing to make elective deferrals equal to 

a percentage of compensation as stated in the plan, not in excess of 10 percent and at least 

(1) three percent of compensation for the first year the deemed election applies to the participant, 

(2) four percent during the second year, (3) five percent during the third year, and (4) six percent 

during the fourth year and thereafter.74 Under the safe harbor, the matching contribution 

requirement is 100 percent of elective contributions of the employee for contributions not in 

excess of one percent of compensation, and 50 percent of elective contributions for contributions 

that exceed one percent of compensation but do not exceed six percent (for a total matching 

contribution of up to 3.5 percent of compensation). The rate of the safe harbor nonelective 

contribution is three percent, as under the regular safe harbor. However, under a qualified 

automatic contribution arrangement, the matching and nonelective contributions are allowed to 

become 100 percent vested only after two years of service (rather than being immediately 

vested). 

4. ESOPs

In general

An ESOP is a stock bonus plan that is designated as an ESOP and is designed to invest 

primarily in stock of the employer, referred to as “qualifying employer securities.”75 An ESOP 

can be maintained by either a C corporation or an S corporation.76 For purposes of ESOP 

investments, a “qualifying employer security” is generally defined as: (1) publicly traded 

common stock of the employer or a member of the same controlled group; (2) if there is no such 

publicly traded common stock, common stock of the employer (or member of the same 

controlled group) that has both voting power and dividend rights at least as great as any other 

class of common stock; or (3) noncallable preferred stock that is convertible into common stock 

 72 Sec. 401(m)(11).

73 Secs. 401(k)(13) and (m)(12).

74 These automatic increases in default contribution rates are required for plans using the safe harbor. Rev. 

Rul. 2009–30, 2009-39 I.R.B. 391, provides guidance for including automatic increases in other plans using 

automatic enrollment, including under a plan that includes an eligible automatic contribution arrangement.

75 Sec. 4975(e)(7). Participant accounts in other types of defined contribution plans can also be invested in 

employer stock.

76 A C corporation is so named because its tax treatment is governed by subchapter C of the Code. An 

S corporation is so named because its tax treatment is governed by subchapter S of the Code. An S corporation is a 

passthrough entity for income tax purposes. That is, income tax does not apply at the S corporation level. Rather, 

items of income, gain, or loss are taken into account for tax purposes by the S corporation shareholders on their own 

tax returns.
29

described in (1) or (2) and that meets certain requirements. In some cases, an employer may 

design a class of preferred stock that meets these requirements and that is held only by the ESOP. 

An ESOP can be an entire plan or it can be a portion of a defined contribution plan. An 

ESOP may provide for different types of contributions, including employer nonelective 

contributions and others. For example, an ESOP may include a section 401(k) feature that 

permits employees to make elective deferrals. ESOPs are subject to additional requirements that 

do not apply to other plans that hold employer stock. For example, voting rights must generally 

be passed through to ESOP participants and employees must generally have the right to receive 

benefits in the form of stock. 

Diversification requirements for ESOPs

ESOPs are subject to a requirement that a participant who has attained age 55 and who 

has at least 10 years of participation in the plan must be permitted to diversify the investment of 

the participant’s account in assets other than employer securities.77 The diversification 

requirement applies to a participant for six years, starting with the year in which the individual 

first meets the eligibility requirements (i.e., age 55 and 10 years of participation). The 

participant must be allowed to elect to diversify up to 25 percent of the participant’s account (50 

percent in the sixth year), reduced by the portion of the account diversified in prior years.

The participant must be given 90 days after the end of each plan year in the election 

period to make the election to diversify. In the case of participants who elect to diversify, the 

plan satisfies the diversification requirement if: (1) the plan distributes the applicable amount to 

the participant within 90 days after the election period; (2) the plan offers at least three 

alternative investment options and, within 90 days of the election period, invests the applicable 

amount in accordance with the participant’s election; or (3) the applicable amount is transferred 

within 90 days of the election period to another qualified defined contribution plan of the 

employer providing investment options in accordance with (2).78

Special ESOP rules

Certain benefits are available to ESOPs that are not available to other types of qualified 

retirement plans that hold employer stock. Under an exception to the prohibited transaction 

rules, an employer maintaining an ESOP may lend money to the ESOP, or the employer may 

 77 Sec. 401(a)(28). Under sec. 401(a)(35) and ERISA sec. 204(j), diversification rights with respect to 

amounts invested in employer securities under an applicable defined contribution plan, generally defined as a 

defined contribution plan holding securities issued by the employer or a member of the employer’s controlled group 

of corporations that are publicly traded, that is, readily tradable on an established securities market. An ESOP 

generally is not an applicable defined contribution plan unless it holds elective deferrals, employee contributions, 

employer matching contributions, or nonelective employer contributions used to satisfy the special 

nondiscrimination tests applicable to section 401(k) plans. An ESOP that is an applicable defined contribution plan 

and subject to the related diversification requirements is excepted from the specific ESOP diversification 

requirements.

78 Notice 88-56, 1988-1 C.B. 540, Q&A-16.
30

guarantee a loan made by a third-party lender to the ESOP, to finance the ESOP’s purchase of 

employer securities.79 An ESOP that borrows funds to acquire employer securities is generally 

called a leveraged ESOP. 

In the case of an ESOP maintained by a C corporation, payments of principal on the 

ESOP loan are deductible to the extent permitted under the general deduction limits for 

contributions to qualified retirement plans (which generally limit the deduction for contribution 

to a defined contribution plan for a year to 25 percent of the participants’ compensation), and 

interest payments are deductible without regard to the limitation.80 In addition, a C corporation 

may deduct dividends paid on employer stock held by an ESOP if the dividends are used to 

repay a loan, if they are distributed to plan participants, or if the plan gives participants the 

opportunity to elect either to receive the dividends or have them reinvested in employer stock 

under the ESOP and the dividends are reinvested at the participants’ election.81 This deduction 

is also allowed without regard to the general deduction limits on contributions to qualified plans. 

Moreover, subject to certain requirements, a taxpayer may elect to defer the recognition of longterm capital gain on the sale of qualified securities to an ESOP maintained by a C corporation.82

ESOPs maintained by S corporations are subject to special rules. Generally, if a 

tax-exempt entity, including a trust holding qualified retirement plan assets, holds S corporation 

stock, it is treated as holding an interest in an unrelated trade or business and is subject to 

unrelated business income tax (“UBIT”).83 However, an ESOP holding employer securities 

issued by an S corporation is exempt from UBIT. 

In part to prevent interests in income attributable to employer stock of an S corporation 

held by an ESOP (and thus not subject to current taxation) from being concentrated in a small 

group of persons, a number of adverse tax consequences may apply if a “nonallocation year” 

occurs with respect to an ESOP maintained by an S corporation. If any “disqualified person” has

an interest in the S corporation in the form of “synthetic equity”84 during a nonallocation year, an 

 79 Sec. 4975(d)(3). To qualify for the loan exemption, the loan must be primarily for the benefit of 

participants and beneficiaries of the plan, the interest on the loan must be at a reasonable rate, and any collateral 

given to a disqualified person by the plan must consist only of qualifying employer securities.

80 Sec. 404(a)(9). 

81 Sec. 404(k). If a dividend is paid with respect to stock allocated to a participant’s account and is used to 

make a payment on an ESOP loan, the plan must allocate employer securities with a fair market value of not less 

than the amount of such dividend to the participant’s account for the year in which such dividend would have been 

allocated to such participant. Distributions with respect to S corporation stock held in an ESOP may also be used to 

repay an ESOP loan under similar conditions, but the distribution is not deductible by the S corporation.

82 Sec. 1042. 

83 Sec. 512(e). Section 511 imposes UBIT on a tax-exempt entity’s income from an unrelated trade or 

business.

84 Pursuant to Sec. 409(p)(5) and (6)(C), and Treas. Reg. sec. 1.409(p)-1(f), “synthetic equity” is any stock 

option, warrant, restricted stock, deferred issuance stock right, or similar interest that gives the holder the right to 

acquire or receive stock of the S corporation in the future; a stock appreciation right, phantom stock unit, or similar 
31

excise tax is imposed on the S corporation equal to 50 percent of the amount of such synthetic 

equity. If there are “prohibited allocations”85 for the benefit of disqualified persons during a 

nonallocation year, the amount of the prohibited allocations is treated as distributed to the 

disqualified persons; an excise tax equal to 50 percent of the amount of the prohibited allocation 

applies to the S corporation; the qualified plan ceases to be an ESOP; and there is a potential for 

disqualification of the plan. 

A “nonallocation year” is a plan year of an ESOP maintained by an S corporation in 

which disqualified persons own (directly or indirectly) at least 50 percent of the S corporation 

shares. For this purpose, a person’s interest in the S corporation in the form of synthetic equity is 

treated as ownership of S corporation shares and is taken into account, but only if taking it into 

account causes a plan year to be a nonallocation year or a person to be a disqualified person.86 

Thus, both determinations are done with and without synthetic equity. “Disqualified persons” 

generally are persons who have at least a 10-percent interest (or who are a member of a family 

group having at least a 20-percent interest) in the portion of the S corporation shares held by the 

ESOP, either by having shares of S corporation employer stock allocated to the person’s account 

under the ESOP (or being treated as having a portion of unallocated shares), or by having an 

interest in the S corporation in the form of synthetic equity. 

5. Plan loans and hardship distributions

In general

The rules for tax-favored retirement savings include provisions aimed at limiting or 

discouraging withdrawals before retirement (referred to as “leakage”), which deplete the assets 

available to provide retirement income. Such provisions include the 10-percent early distribution 

tax, discussed in Part I.D.1, and restrictions on distributions before termination of employment 

 right to a future cash payment based on the value of such stock or appreciation in such value; and rights to 

nonqualified deferred compensation (even though it is neither payable in, nor calculated by reference to, stock in the 

S corporation) and rights to acquire interests in certain related entities. A person can be a disqualified person, and a 

nonallocation year can occur based solely on interests in the S Corporation in the form of synthetic equity, even if 

the person is not a participant in the ESOP. Synthetic equity is an interest in income attributable to employer stock 

held by an ESOP, and reduces the ESOP’s economic ownership of the S corporation. On the other hand, it is 

possible in certain circumstances to grant options or warrants for S corporation stock (or other synthetic equity) to a 

single person that, when combined with the outstanding shares of the S corporation, are options for up to 49 percent 

of the S corporation stock without causing a nonallocation year.

85 Generally a “prohibited allocation” for the benefit of a disqualified person occurs during a nonallocation 

year to the extent that S corporation employer stock owned by the ESOP (and any assets attributable to such stock) 

is held for the benefit of a disqualified person during the nonallocation year (whether the stock is allocated to the 

person’s account under the ESOP during the nonallocation year or an earlier year). 

86 An ESOP maintained by an S corporation may be able prevent a nonallocation year (or a prohibited 

allocation during a nonallocation year) by transferring S corporation employer stock allocated to the account of 

disqualified persons (or persons expected to become disqualified persons) to a separate portion of the qualified plan 

(or another qualified retirement plan of the S corporation) that is not designated as an ESOP and allocate it to the 

accounts of those persons under the separate portion (or other plan). In that case, the qualified retirement plan is 

subject to UBIT with respect to those transferred shares of S corporation stock.
32

(referred to as “in-service” distributions), discussed in Part IV.D.1. However, restrictions on 

access to tax-favored savings before retirement may discourage individuals from making 

contributions out of concern that funds will not be available in the case of financial need. This 

concern is addressed by allowing plan loans and exceptions to the restrictions on in-service 

distributions, including in the case of hardship, as well as exceptions to the 10-percent early 

distribution tax.

Plan loans

Defined contribution plans, section 403(b) plans, and governmental section 457(b) plans 

generally are permitted, but are not required, to offer plan loans to participants. Plan loans must 

comply with certain conditions so that the loan is not treated as a taxable distribution to the 

participant.87 Generally, a loan that does not satisfy all of the requirements will be treated as a 

deemed distribution, resulting in current income taxation and, for participants younger than 591⁄2, 

a 10-percent early distribution tax. The requirements both limit the amount of the loan and the 

repayment terms. If the actual repayment of the loan does not satisfy the required repayment 

terms during the period the loan is outstanding, a deemed distribution of the loan outstanding 

occurs at that time. 

In order not to be treated as a deemed distribution, a plan loan may not exceed the lesser 

of (1) $50,000 reduced by the excess of the highest outstanding loan balance from the plan 

during the one-year period ending on the day before the date on which the loan is made over the 

outstanding loan balance on the date on which the loan is made, or (2) the greater of (a) 50 

percent of the present value of the vested accrued benefit of the participant or (b) $10,000. 

Generally, a plan loan is treated as a deemed distribution unless it provides for repayment within 

five years of the loan date88 and for substantially equal payments of both principal and interest 

no less frequently than quarterly over the term of the loan. Repayment on an accelerated 

schedule is permitted, and plan terms may require full repayment on termination of employment. 

Deemed distributions, resulting from a failure to comply with the loan requirements, are 

treated as actual distributions for tax purposes. They are not, however, treated as actual 

distributions for purposes of plan qualification or rollovers requirements.

Distribution of a plan loan offset amount occurs when, pursuant to plan terms, the 

accrued benefit of a participant or beneficiary is reduced in order to repay a loan. For example, it 

is common for plans to provide that, if a participant requests a plan distribution while a loan is 

outstanding, the loan must be repaid immediately or treated as in default. In the event of a loan 

offset, the amount of the account balance that is offset against the loan is an actual, not a 

deemed, distribution. In contrast to a deemed distribution, a loan offset amount can be an 

 87 Sec. 72(p). Generally, if a participant or beneficiary assigns or pledges any portion of his or her interest 

in a qualified plan as security for a loan, the assigned or pledged portion is treated as a loan from the plan to the 

participant for purposes of section 72(p). 

88 An exception to the five-year rule applies in the case of a loan used to purchase the participant’s 

principal residence. Rules also allow the suspension of repayment of a loan while the participant is performing 

services in the uniformed services of the United States. Treas. Reg. sec. 1.72(p)-1, Q&A-9(b) and (c).
33

eligible rollover distribution. A plan is not, however, required to offer a direct rollover with 

respect to the loan offset amount and the amount is generally not subject to mandatory 

20-percent withholding. 

The deadline for a rollover of a distributed plan loan offset amount is generally within 60 

days of receiving the distribution; however, for a qualified plan loan offset amount, the deadline 

is the due date for the participant’s income tax return (including extensions) for the taxable year 

in which the offset amount is distributed.89 A qualified plan loan offset amount is a plan loan 

offset amount that is distributed when a plan that is in good standing is offset because the plan 

terminates or the participant severs from employment. 

Hardship distributions 

Hardship distributions are an exception to the general prohibition on in-service

distributions before age 591⁄2 of amounts in a section 401(k) plan or 403(b) plan that are 

attributable to elective deferrals.90 Section 401(k) and 403(b) plans are permitted, but are not 

required, to permit participants to take hardship withdrawals, provided two conditions are met. 

First, the distribution must be made on account of an immediate and heavy financial need of the 

employee. Second, the distribution must be necessary to satisfy that financial need. 

Determinations regarding whether an immediate and heavy financial need exists, and whether a 

distribution is necessary to meet that need, must be made in accordance with nondiscriminatory 

and objective standards set forth in the plan.91 There are, however, regulatory safe harbors 

whereby the requirements may be deemed to have been met, such as for the purchase of a home 

or the payment of education expenses.92 For section 401(k) plans, hardship distributions may be 

made from the employee’s total elective deferrals as of the date of the distribution, earnings on 

such elective deferrals, as well as qualified nonelective contributions and qualified matching 

contributions (and associated earnings), reduced by the amount of any previous hardship 

distributions. 93 A similar rule applies to section 403(b) plans, except that hardship distributions 

may not be made from earnings on elective deferrals, and amounts attributable to qualified 

nonelective contributions and qualified matching contributions may be distributed on account of 

hardship only if the amounts are in a custodial account.

 89 Sec. 402(c)(3)(C). Rules regarding qualified plan loan offset amounts were added to the Code by Pub. 

L. No. 115-97.

90 Sec. 401(k)(2)(B)(i)(IV). 

91 Treas. Reg. sec. 1.401(k)-1(d)(3)(i).

92 Treas. Reg. secs. 1.401(k)-1(d)(3) and 1.403(b)-6(d)(2).

93 Proposed changes to Treasury regulations under section 401(k) implement changes relating to hardship 

distributions from the Bipartisan Budget Act of 2018, Pub. L. No. 115-123. See Prop. Treas. Reg. sec. 1.401(k)-1, 

83 Fed. Reg. 56763-01 (November 14, 2018).
34

Section 457(b) plans may provide for distributions in the case of an unforeseeable 

emergency.94 The concept of unforeseeable emergency is narrower than the concept of hardship 

under the section 401(k) and 403(b) rules and the regulatory safe harbors do not apply.

6. Lifetime income under defined contribution plans

Pension plans (defined benefit and money purchase pension plans) are required to 

provide participants with life annuity forms of benefit, including forms that provide life annuity 

benefits for surviving spouses. Pension plans are viewed as furthering retirement income 

security in that a participant (or surviving spouse) receiving benefits in life annuity form cannot 

“outlive” his or her benefits under the plan. However, profit-sharing and stock bonus plans are 

not required to offer annuity forms of distribution; instead, a participant’s (or surviving spouse’s) 

benefit consists of an account balance, which can be depleted during the participant’s (or 

surviving spouse’s) lifetime.95 Factors contributing to concerns that participants (and surviving 

spouses) will outlive their account balances include the increase in the number of employees who 

are covered only by a profit-sharing plan or stock bonus plan (including section 401(k) plans, 

which are usually profit-sharing plans) as well as general longevity gains. Similar concerns arise 

with respect to IRA owners.

96 

Discussion in recent years has focused on distribution options that enable a participant or 

surviving spouse to receive retirement savings in a form that is more likely to last over his or her 

lifetime (“lifetime income”), such as installment payments over an individual’s lifetime, as well 

as investments in annuities and other lifetime income products. The appropriateness of a lifetime 

income product for individuals may vary with circumstances. For example, as a result of the 

formula used to calculate Social Security benefits, including the annual limit on wages taken into 

account for benefit purposes, the portion of an employee’s earnings replaced by Social Security 

benefits is higher for lower-paid employees than for higher-paid employees.97 Thus, for some 

employees, Social Security benefits may provide sufficient lifetime retirement income. 

 94 Sec. 457(d)(1)(iii).

95 Although defined benefit plans are required to offer annuities, they may also offer lump sums, and many 

participants elect to receive a lump sum (perhaps rolling it over to an IRA), rather than an annuity.

96 Much of the savings in IRAs results from rollovers from qualified retirement plans. In addition, profitsharing (and stock bonus) plans often offer lump sums as the only form of distribution. In that case, a participant 

wishing to take installment distributions has to roll his or her account balance over to an IRA and take installments 

from the IRA.

97 See, for example, Congressional Budget Office, “CBO’s 2014 Long-Term Projections for Social 

Security: Additional Information,” December 2014, Exhibit 9, available at 

http://www.cbo.gov/sites/default/files/cbofiles/attachments/49795-Social_Security_Update.pdf. The portion of

retirement income provided by Social Security benefits also varies among individuals. See, for example, Social 

Security Administration, “Income of the Aged Chartbook, 2012,” April 2014, pp. 8, 16-18, available at 

http://www.ssa.gov/policy/docs/chartbooks/income_aged/2012/iac12.pdf. See also, AARP Public Policy Institute, 

“Sources of Income for Older Americans, 2012,” December 2013, Figure 1, available at 

http://www.aarp.org/content/dam/aarp/research/public_policy_institute/econ_sec/2013/sources-of-income-for-olderamericans-2012-fs-AARP-ppi-econ-sec.pdf.
35

Moreover, for individuals with modest retirement accounts, the need for access to those funds to 

cover occasional, large expenses may be greater than the need for additional lifetime income. 

However, for many, lifetime income products are a possible source of annuity income to 

supplement Social Security benefits.

Lifetime income concerns have also been a focus of an initiative by the Department of 

the Treasury and the IRS in collaboration with DOL to expand the availability of options that 

enable a participant or surviving spouse to take distributions in a form that is more likely to last 

over his or her lifetime (“lifetime income”).98 These agencies have sought public input on 

changes that would encourage employers to include lifetime income options in defined 

contribution plans and to encourage defined contribution plan participants and IRA owners to 

elect such options, at least with respect to part of their account balances.99 

In response to comments, the following guidance has been provided:100

• Treatment of an investment with lifetime income elements as a prudent default 

investment under the plan;101

• Treatment of a series of target date funds (“TDFs”) with investments in unallocated 

deferred annuity contracts as qualified default investment alternatives (“QDIAs”) 

under ERISA;102

• Special rules for applying the Code nondiscrimination requirements to a series of 

TDFs that include deferred annuities among their assets and are offered as investment 

options under a defined contribution plan, even if some of the TDFs within the series 

are available only to older participants;103

 98 An annuity by definition provides lifetime income, but lifetime income options also include, for 

example, installment payments over an individual’s lifetime.

99 Request for Information Regarding Lifetime Income Options for Participants and Beneficiaries in 

Retirement Plans, 75 Fed. Reg. 5253 (February 2, 2010).

100 As part of the same lifetime income project, the IRS issued guidance to increase annuity distributions 

from defined benefit plans. Final regulations under section 417(e), relating to the calculation of minimum lump 

sums, address the situation in which a participant’s accrued benefit under a defined benefit plan is bifurcated and the 

bifurcated portions paid in separate forms, such as an annuity and a lump sum. Treasury Decision 9783, 81 FR 

62359-01 (Sept. 9, 2016) and Treas. Reg. sec. 1.417(e)-(1).. In addition, Rev. Rul. 2012-4, 2012-8 I.R.B. 386, 

provides guidance on transferring a participant’s account balance under a defined contribution plan to a defined 

benefit plan in order to provide an increased annuity under the defined benefit plan.

101 Letter dated December 22, 2016, from Louis J. Campagna to Christopher Spence, available at 

https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/information-letters/12-22-2016.

102 Letter dated October 23, 2014, from Phyllis C. Borzi to J. Mark Iwry, available at 

https://www.dol.gov/sites/default/files/ebsa/employers-and-advisers/guidance/information-letters/10-23-2014.pdf

103 Notice 2014-66, 2014-46 I.R.B. 820.
36

• Regulations relating to minimum required distributions under the Code (discussed 

further below), providing special rules for annuity contracts under which payments 

may begin at age 85;104

• ERISA regulatory changes under consideration with respect to periodic benefit 

statements provided to defined contribution plan participants, under which a 

participant’s account balance would be expressed also as an estimated lifetime stream 

of payments;105

• Clarification of the application of the spousal consent and QJSA and QPSA 

requirements when a deferred annuity contract is offered as an investment option 

under a profit-sharing plan.106

 104 Treasury Decision 9673, 79 F.R. 37633 (July 2, 2014) and Treas. Reg. secs. 1.401(a)(9)-5, A-3 and 

1.401(a)(9)-6, A-12. Because the annuity is scheduled to begin at a time when an individual’s life expectancy has 

declined, such an annuity contract generally costs much less than a contract providing an annuity with an earlier start 

date. Because the individual’s retirement account balances are likely to have been at least partially depleted by the 

time the annuity is scheduled to begin, such an annuity is sometimes referred to as a longevity annuity or longevity 

insurance.

105 78 Fed. Reg. 26727 (May 8, 2013), issued under ERISA section 105.

106 Rev. Rul. 2012-3, 2012-8 I.R.B. 383.
37

C. Individual Retirement Arrangements 

1. Traditional and Roth individual retirement arrangements

In general

There are two basic types of IRAs under present law: traditional IRAs,107 to which both 

deductible and nondeductible contributions may be made,108 and Roth IRAs, to which only 

nondeductible contributions may be made.109 The principal difference between these two types 

of IRAs is the timing of income tax inclusion. For a traditional IRA, an eligible contributor may 

deduct the contributions made for the year, but distributions are includible in gross income to the 

extent attributable to earnings on the account and the deductible contributions. For a Roth IRA, 

all contributions are after-tax (that is, no deduction is allowed) but, if certain requirements are 

satisfied, distributions are not includible in gross income. 

Contribution and AGI limits

Annual contribution limit

An annual limit applies to contributions to IRAs. The contribution limit is coordinated so 

that the aggregate maximum amount that can be contributed to all of an individual’s IRAs (both 

traditional and Roth) for a taxable year is the lesser of a certain dollar amount ($6,000 for 2019) 

or the individual’s compensation. In the case of a married couple, contributions can be made up 

to the dollar limit for each spouse if the combined compensation of the spouses is at least equal 

to the contributed amount. 

An individual who has attained age 50 before the end of the taxable year may also make 

catch-up contributions to an IRA. For this purpose, the aggregate dollar limit is increased by 

$1,000. Thus, for example, if an individual over age 50 contributes $7,000 to a Roth IRA for 

2019 ($6,000 plus $1,000 catch-up), the individual will not be permitted to make any 

contributions to a traditional IRA for that year. In addition, deductible contributions to 

traditional IRAs and after-tax contributions to Roth IRAs generally are subject to AGI limits. 

IRA contributions generally must be made in cash. 

Traditional IRAs

An individual may make deductible contributions to a traditional IRA up to the IRA 

contribution limit if neither the individual nor the individual’s spouse is an active participant in 

an employer-sponsored retirement plan. If an individual (or the individual’s spouse) is an active 

participant in an employer-sponsored retirement plan, the deduction is phased out for taxpayers 

with adjusted gross income (“AGI”) for the taxable year over certain indexed levels. In the case 

of an individual who is an active participant in an employer-sponsored plan, the AGI phase-out 

 107 Sec. 408. 

108 Sec. 219.

109 Sec. 408A.
38

ranges for 2019 are: (1) for single taxpayers, $64,000 to $74,000; (2) for married taxpayers filing 

joint returns, $103,000 to $123,000; and (3) for married taxpayers filing separate returns, $0 to 

$10,000. If an individual is not an active participant in an employer-sponsored retirement plan, 

but the individual’s spouse is, the deduction is phased out for taxpayers with AGI for 2019 

between $193,000 and $203,000.

To the extent an individual cannot or does not make deductible contributions to a 

traditional IRA or contributions to a Roth IRA for the taxable year, the individual may make 

nondeductible contributions to a traditional IRA (that is, no AGI limits apply), subject to the 

same contribution limits as the limits on deductible contributions, including catch-up 

contributions. An individual who has attained age 701⁄2 prior to the close of a year is not 

permitted to make contributions to a traditional IRA.

Roth IRAs

Individuals with AGI below certain levels may make nondeductible contributions to a 

Roth IRA. The maximum annual contribution that can be made to a Roth IRA is phased out for

taxpayers with AGI for the taxable year over certain indexed levels. The AGI phase-out ranges 

for 2019 are: (1) for single taxpayers, $122,000 to $137,000; (2) for married taxpayers filing 

joint returns, $193,000 to $203,000; and (3) for married taxpayers filing separate returns, $0 to 

$10,000. Contributions to a Roth IRA may be made even after the account owner has attained 

age 701⁄2.

Separation of traditional and Roth IRA accounts

Contributions to traditional IRAs and to Roth IRAs must be segregated into separate 

IRAs, meaning arrangements with separate trusts, accounts, or contracts, and separate IRA 

documents. Except in the case of a conversion or recharacterization, amounts cannot be 

transferred or rolled over between the two types of IRAs. 

Taxpayers generally may convert a traditional IRA into a Roth IRA through a distribution 

from a traditional IRA and rollover to a Roth IRA as discussed below. The amount converted is 

includible in the taxpayer’s income as if a withdrawal had been made, except that the early 

distribution tax (discussed below) does not apply. However, the early distribution tax is imposed 

if the taxpayer withdraws the amount within five years of the conversion.

If an individual makes a contribution to an IRA (traditional or Roth) for a taxable year, 

the individual is permitted to recharacterize (in a trustee-to-trustee transfer) the amount of that 

contribution as a contribution to the other type of IRA (traditional or Roth) before the due date 

for the individual’s income tax return for that year.110 In the case of a recharacterization, the 

contribution will be treated as having been made to the transferee plan (and not the transferor 

plan). The amount transferred must be accompanied by any net income allocable to the 

contribution and no deduction is allowed with respect to the contribution to the transferor plan. 

Unlike regular contributions, conversion contributions to a Roth IRA cannot be recharacterized 

 110 Sec. 408A(d)(6).
39

as having been made to a traditional IRA.111 In addition, Treasury regulations limit the number 

of times a regular contribution for a taxable year may be recharacterized.112

Excise tax on excess contributions

To the extent that contributions to an IRA exceed the contribution limits, the individual is 

subject to an excise tax equal to six percent of the excess amount.113 This excise tax generally 

applies each year until the excess amount is distributed. Any amount contributed for a taxable 

year that is distributed with allocable income by the due date for the taxpayer’s return for the 

year will be treated as though not contributed for the year.114 To receive this treatment, the 

taxpayer must not have claimed a deduction for the amount of the distributed contribution. 

2. Taxation of distributions from IRAs

Traditional IRAs 

Amounts held in a traditional IRA are includible in income when withdrawn, except to 

the extent that the withdrawal is a return of the individual’s basis.115 All traditional IRAs of an 

individual are treated as a single contract for purposes of recovering basis in the IRAs. The 

portion of the individual’s basis that is recovered with any distribution is the ratio of the amount 

of the aggregate basis in all the individual’s traditional IRAs to the amount of the aggregate 

account balances in all the individual’s traditional IRAs. 

Roth IRAs 

Amounts held in a Roth IRA that are withdrawn as a qualified distribution are not 

includible in income. A qualified distribution is a distribution that (1) is made after the fivetaxable-year period beginning with the first taxable year for which the individual first made a 

contribution to a Roth IRA, and (2) is made after attainment of age 591⁄2, on account of death or 

disability, or is made for first-time homebuyer expenses of up to $10,000. 

Distributions from a Roth IRA that are not qualified distributions are includible in 

income to the extent attributable to earnings; amounts that are attributable to a return of 

contributions to the Roth IRA are not includible in income. All Roth IRAs are treated as a single 

contract for purposes of determining the amount that is a return of contributions. To determine 

the amount includible in income, a distribution that is not a qualified distribution is treated as 

made in the following order: (1) regular Roth IRA contributions (including contributions rolled 

over from other Roth IRAs); (2) conversion contributions (on a first in, first out basis); and 

 111 The restrictions on conversion contributions were enacted as part of Pub. L. 115-97. 

112 Treas. Reg. sec. 1.408A-6.

113 Secs. 4973(b) and (f).

114 Sec. 408(d)(4).

115 Basis results from after-tax contributions to the IRA or a rollover to the IRA of after-tax amounts from 

another eligible retirement plan.
40

(3) earnings. To the extent a distribution is treated as made from a conversion contribution, it is 

treated as made first from the portion, if any, of the conversion contribution that was required to 

be included in income as a result of the conversion. Thus, nonqualified distributions from all 

Roth IRAs are excludable from gross income until all amounts attributable to contributions have 

been distributed. 

Rollovers

Distributions from IRAs are permitted to be rolled over tax-free to another IRA or any 

other eligible retirement plan. The general 60-day rollover rule (discussed above) applies to IRA 

rollovers as well as rollovers from qualified retirement plans, section 403(b) annuities, and 

governmental section 457(b) plans. There is no provision for direct rollovers from an IRA, but 

direct payment to another eligible retirement plan generally satisfies the requirements. 

Distributions from an inherited IRA (except in the case of an IRA acquired by the surviving 

spouse by reason of the IRA owner’s death) and required minimum distributions are not 

permitted to be rolled over.116 The portion of any distribution from an IRA that is not includible 

in gross income is only permitted to be rolled over to another IRA. Generally, distributions from 

a traditional IRA may only be rolled over tax-free to another IRA and distributions from a Roth 

IRA may only be rolled over tax-free to another Roth IRA. However, a distribution from a 

traditional IRA may be rolled over to a Roth IRA as a Roth conversion with the required income 

inclusion (as discussed above). 

3. Employer retirement plans using IRAs

SIMPLE IRA plan

A small employer that employs no more than 100 employees who earned $5,000 or more 

during the prior calendar year can establish a simplified tax-favored retirement plan, which is 

called the SIMPLE retirement plan. A SIMPLE IRA plan is generally a plan under which 

contributions are made to an IRA for each employee (a “SIMPLE IRA”). A SIMPLE IRA plan 

allows employees to make elective deferrals to a SIMPLE IRA, subject to a limit of $13,000 (for 

2019). An individual who has attained age 50 before the end of the taxable year may also make 

catch-up contributions under a SIMPLE IRA plan up to a limit of $3,000 (for 2019).

In the case of a SIMPLE IRA plan, the group of eligible employees generally must 

include any employee who has received at least $5,000 in compensation from the employer in 

any two preceding years and is reasonably expected to receive $5,000 in the current year. A 

SIMPLE IRA plan is not subject to the nondiscrimination rules generally applicable to qualified 

retirement plans. 

Employer contributions to a SIMPLE IRA must satisfy one of two contribution formulas. 

Under the matching contribution formula, the employer generally is required to match employee 

elective contributions on a dollar-for-dollar basis up to three percent of the employee’s 

 116 A trustee-to-trustee transfer between IRAs is not treated as a distribution and rollover. Thus, nonspouse 

beneficiaries of IRAs can move funds to another inherited IRA established as a beneficiary of the decedent IRA 

owner. In contrast, a surviving spouse is permitted to roll over a distribution to his or her own IRA. 
41

compensation. The employer can elect a lower percentage matching contribution for all 

employees (but not less than one percent of each employee’s compensation); however, a lower 

percentage cannot be elected for more than two years out of any five year period. Alternatively, 

for any year, an employer is permitted to elect, in lieu of making matching contributions, to 

make a nonelective contribution of two percent of compensation on behalf of each eligible 

employee with at least $5,000 in compensation for such year, whether or not the employee 

makes an elective contribution.

The employer must provide each employee eligible to make elective deferrals under a 

SIMPLE IRA plan a 60-day election period before the beginning of the calendar year and a 

notice at the beginning of the 60-day period explaining the employee’s choices under the plan.117

No contributions other than employee elective contributions, required employer matching 

contributions, or employer nonelective contributions can be made to a SIMPLE IRA plan, and 

the employer may not maintain any other qualified retirement plan. 

Simplified employee pensions

A simplified employee pension (“SEP”) is an IRA to which the employer may make 

contributions for an employee up to the lesser of 25 percent of the employee’s compensation or 

the dollar limit applicable to contributions to a qualified defined contribution plan ($56,000 for 

2019).118 All contributions must be fully vested. Any employee must be eligible to participate 

in the SEP if the employee has (1) attained age 21, (2) performed services for the employer 

during at least three of the immediately preceding five years, and (3) received at least $600 (for 

2019) in compensation from the employer for the year. Contributions to a SEP generally must 

bear a uniform relationship to compensation.

Effective for taxable years beginning before January 1, 1997, certain employers with no 

more than 25 employees could maintain a salary reduction SEP (“SARSEP”) under which 

employees could make elective deferrals. The SARSEP rules were generally repealed with the 

enactment of the SIMPLE IRA plan rules. However, contributions may continue to be made to 

SARSEPs that were established before 1997. Salary reduction contributions to a SARSEP are 

subject to the same limit that applies to elective deferrals under a section 401(k) plan ($19,000 

for 2019). An individual who has attained age 50 before the end of the taxable year may also 

make catch-up contributions to a SARSEP up to a limit of $6,000 (for 2019).

Deemed IRAs 

Certain types of employer-sponsored retirement plans are permitted to provide IRAs to 

employees as a part of the plan.119 This option is available to qualified retirement plans, section 

403(b) plans, and governmental section 457(b) plans. The Code permits these plans to allow 

 117 Notice 98-4, 1998-1 C.B. 269.

118 Sec. 408(k).

119 Sec. 408(q).
42

employees to elect to make contributions to a separate account or annuity under the plan that are 

treated as contributions to a traditional IRA or a Roth IRA. To receive this treatment, under the 

terms of the plan, the account or annuity must satisfy the requirements of the Code for being a 

traditional or Roth IRA. Implementing the basic provision that the account satisfy the 

requirements to be an IRA, Treasury regulations require that the trustee with respect to the 

account be a bank or a nonbank trustee approved by the IRS.120 

Payroll deduction IRA 

An employer is permitted to establish a program under which each employee can elect to 

have the employer withhold an amount each pay period and contribute the amount to an IRA 

established by the employee. In the Conference report to the Taxpayer Relief Act of 1997,121

Congress indicated that “employers that chose not to sponsor a retirement plan should be 

encouraged to set up a payroll deduction system to help employees save for retirement by 

making payroll deduction contributions to their IRAs.” Congress encouraged the Secretary of 

the Treasury to “continue his efforts to publicize the availability of these payroll deduction 

IRAs.”122 In response to that directive, the IRS published guidance to remind employers of the 

availability of this option for their employees.123

In 1975, DOL issued a regulation describing circumstances under which the use of an 

employer payroll deduction program for forwarding employee monies to an IRA will not 

constitute an employee pension benefit plan subject to ERISA.124 In 1999, DOL restated and 

updated its positions on these programs.125 Under the DOL guidance, the general rule is that, in 

order for an IRA payroll program not to be a pension plan subject to ERISA, the employer must 

not endorse the program. To avoid endorsing the program the employer must maintain neutrality 

with respect to an IRA sponsor in its communication to its employees and must otherwise make 

clear that its involvement in the program is limited to collecting the deducted amounts and 

remitting them promptly to the IRA sponsor and that it does not provide any additional benefit or 

promise any particular investment return on the employee’s savings.

 120 Treas. Reg. sec. 1.408(q)-1. Special rules apply in the case of deemed IRAs under plans of State and 

local government employers.

121 Pub. L. No. 105-34.

122 H. Rep. No. 102-220, p. 775 (1997).

123 Announcement 99-2, 1999-1 C.B. 305. The IRS also includes information on its website concerning 

the rules for this option and the pros and cons for an employer adopting a payroll deduction IRA program.

124 29 C.F.R. sec. 2510.3-2(d).

125 Interpretive Bulletin 99-1, 64 Fed. Reg. 32999 (June 18, 1999); 29 C.F.R. sec. 2509.99-1.
43

D. Early Distributions and Required Minimum Distributions

1. Early distributions

The Code imposes an early distribution tax on distributions made from qualified 

retirement plans, 403(b) plans and IRAs before employee or an IRA owner attains age 591⁄2.

126 

The tax is equal to 10 percent of the amount of the distribution that is includible in gross income 

unless an exception applies. The 10-percent tax is in addition to the taxes that would otherwise 

be due on distribution. This additional tax is designed to help insure that distributions from 

qualified retirement plans are preserved for retirement. 

There are a number of exceptions to the early distribution tax. Some exceptions apply to 

all plans and others apply only to IRAs or only to qualified retirement plans and section 403(b) 

annuities. The exceptions that apply to all plans include distributions due to death or disability; 

distributions made in the form of certain periodic payments; distributions made on account of a 

tax levy on the plan; distributions to the extent that they do not exceed the amount allowable as a 

deduction for amounts paid during the taxable year due to medical care (determined without 

regard to whether the employee itemizes deductions for such year);127 or distributions made to a 

member of a reserve unit called to active duty for 180 days or longer. 

The exceptions that only apply to distributions from IRAs include distributions used to 

purchase health insurance for certain unemployed individuals; used for higher education 

expenses; and used for first-time homebuyer expenses of up to $10,000. The exceptions that 

only apply to distributions from qualified retirement plans and 403(b) plans include distributions 

made subsequent to the employee’s separation from service after attaining age 55;128

distributions made to an alternate payee pursuant to a qualified domestic relations order: and 

distribution of dividends paid with respect to stock held by an ESOP. 

2. Minimum distribution requirements

In general

Minimum distributions rules apply to tax-favored employer-sponsored retirement plans 

and IRA, and limit the tax deferral allowed for these plans and arrangements. By requiring that 

minimum annual distributions at a required beginning date (generally at age 701⁄2), the rules are 

designed to ensure that these plans are used to provide funds for retirement. Distributions to an 

employee are required to begin no later than the required beginning date and to be distributed, in 

accordance with regulations, over the life of the employee or over the lives of the employee and 

a designated beneficiary (or over a period not extending beyond the life expectancy of the 

 126 Sec. 72(t). The early distribution tax does not apply to distributions from governmental section 457(b) 

plans.

127 Sec. 213.

128 Age 50 is substituted for age 55 in the case of distributions to certain public employees.
44

employee or the life expectancy of the employee and a designated beneficiary).129 Minimum 

distribution rules also apply to benefits payable with respect to an employee or IRA owner who 

has died. 

The regulations provide a methodology for calculating the required minimum distribution 

from an individual account under a defined contribution plan or from an IRA. In the case of 

annuity payments under a defined benefit plan or an annuity contract, the regulations provide 

requirements that the annuity stream of payments must satisfy. Failure to comply with the 

minimum distribution requirement may result in an excise tax imposed on the individual who 

was required to be the distributee equal to 50 percent of the required minimum distribution not 

distributed for the year.130 The excise tax may be waived in certain cases. 

Lifetime rules 

General rules

While an employee or IRA owner is alive, distributions of the individual’s interest 

starting from the required beginning date are required to be made (in accordance with 

regulations) over the life or life expectancy of the employee or IRA owner, or over the joint lives 

or joint life expectancy of the employee or IRA owner and a designated beneficiary.131 For 

defined contribution plans and IRAs, the required minimum distribution for each year is 

determined by dividing the account balance as of the end of the prior year by a distribution 

period which, while the employee or IRA owner is alive, is the factor from the uniform lifetime 

table included in the Treasury regulations.132 This table is based on the joint life and last 

survivor expectancy of the individual and a hypothetical beneficiary 10 years younger. For an 

individual with a spouse as designated beneficiary who is more than 10 years younger (and thus 

the number of years in the couple’s joint life and last survivor expectancy is greater than the 

uniform lifetime table), the joint life expectancy and last survivor expectancy of the couple 

(calculated using the table in the regulations) is used.

Required beginning date

For traditional IRAs, the required beginning date is April 1 following the calendar year in 

which the IRA owner attains age 701⁄2. For tax-favored employer-sponsored retirement plans, for 

an employee other than an employee who is a five-percent owner in the year the employee 

attains age 701⁄2, the employee’s required beginning date is April 1 after the later of the calendar 

year in which the employee attains age 701⁄2 or retires. For an employee who is a five-percent 

owner under a tax-favored employer-sponsored retirement plan in the year the employee attains 

 129 Sec. 401(a)(9)(A). 

130 Sec. 4974.

131 Sec. 401(a)(9)(A). 

132 Treas. Reg. sec. 1.401(a)(9)-5. 
45

age 701⁄2, the required beginning date is the same as for IRAs even if the employee continues to 

work past age 701⁄2. 

Lifetime income rule for annuities commencing at age 85

In July 2014, the minimum required distribution regulations were amended to allow the 

value of a qualifying longevity annuity contract held in a defined contribution plan account or 

traditional IRA to be disregarded in some circumstances in determining minimum required 

distributions for years before annuity payments under the contract are scheduled to begin.133 

Among the conditions on such disregard, the regulations limit the portion of an account that can 

be invested in a longevity annuity contract (the lesser of 25 percent or $125,000), require the 

annuity to begin no later than age 85, and include reporting requirements for the annuity issuer. 

Distributions after death

Payments over a distribution period

The after-death rules vary depending on (1) whether an employee or IRA owner dies on 

or after the required beginning date or before the required beginning date, and (2) whether there 

is a designated beneficiary for the benefit. A designated beneficiary is an individual designated 

as a beneficiary under the plan.134 Similar to the lifetime rules, for defined contribution plans 

and IRAs, the required minimum distribution for each year after the death of the employee or 

IRA owner is generally determined by dividing the account balance as of the end of the prior 

year by a distribution period. 

If an employee or IRA owner dies on or after the required beginning date, the statutory 

rule is that the remaining interest must be distributed at least as rapidly as under the minimum 

distribution method being used as of the date of death.135 For individual accounts, if there is a 

designated beneficiary, the distribution period is the beneficiary’s life expectancy calculated 

using the life expectancy table in the regulations, calculated in the year after the year of the 

 133 Treasury Decision 9673, 79 F.R. 37633 (July 2, 2014) and Treas. Reg. secs. 1.401(a)(9)-5, A-3 and 

1.401(a)(9)-6, A-12. The regulations, and the conditions on longevity annuity contracts, do not apply to Roth IRAs 

because an individual is not required to take distributions from a Roth IRA at age 701⁄2. The regulations also do not 

apply to defined benefit plans but the preamble to the final regulation requests comments regarding the desirability 

of making available in defined benefit plans a form of benefit that replicates the structure for qualified longevity 

annuity contracts. 

134 Treas. Reg. sec. 1.401(a)(9)-4, A-1. The individual need not be named as long as the individual is 

identifiable under the terms of the plan. There are special rules for multiple beneficiaries and for trusts named as 

beneficiary (where the beneficiaries of the trust are individuals). However, if an individual is named as beneficiary 

through the employee or IRA owner’s will or the estate is named as beneficiary, there is no designated beneficiary 

for purposes of the minimum distribution requirements. 

135 Sec. 401(a)(9)(B)(i)
46

death.136 If there is no designated beneficiary, the distribution period is equal to the remaining 

years of the employee or IRA owner’s life, as of the year of death.137 

If an employee or IRA owner dies before the required beginning date and any portion of 

the benefit is payable to a designated beneficiary, distributions are permitted to begin within one 

year of the employee’s (or IRA owner’s) death (or such later date as prescribed in regulations) 

and to be paid (in accordance with regulations) over the life or life expectancy of the designated 

beneficiary.138 For individual accounts, the distribution period is measured by the designated 

beneficiary’s life expectancy, calculated in the same manner as if the individual dies on or after 

the required beginning date.139 

In all cases where distribution after death is based on life expectancy (either the 

remaining life expectancy of the employee or IRA owner or a designated beneficiary), the 

distribution period generally is fixed at death and then reduced by one for each year that elapses 

after the year in which it is calculated. If the designated beneficiary dies during the distribution 

period, distributions continue to the subsequent beneficiaries over the remaining years in the 

distribution period. If the distribution period is based on the surviving spouse’s life expectancy 

(whether the employee or IRA owner’s death is before or after the required beginning date), the 

spouse’s life expectancy generally is recalculated each year while the spouse is alive and then 

fixed the year after the spouse’s death. 

Five-year rule

If an employee or IRA owner dies before the required beginning date and there is no 

designated beneficiary, then the entire remaining interest of the employee or IRA owner must 

generally be distributed by the end of the fifth year following the individual’s death.140

Defined benefit plans and annuity distributions

The regulations provide rules for annuity distributions from a defined benefit plan or an 

annuity purchased from an insurance company paid over life or life expectancy. Annuity 

distributions are generally required to be nonincreasing with certain exceptions, which include, 

for example, increases to the extent of certain specified cost of living indexes, a constant 

 136 Treas. Reg. sec. 1.401(a)(9)-5, A-5(b).

137 Treas. Reg. sec. 1.401(a)(9)-5, A-5(a).

138 Sec. 401(a)(9)(B)(iii). Special rules apply if the beneficiary of the employee or IRA owner is the 

individual’s surviving spouse. In that case, distributions are not required to commence until the year in which the 

employee or IRA owner would have attained age 701⁄2. If the surviving spouse dies before the employee or IRA 

owner would have attained age 701⁄2, the after-death rules for death before distributions have begun are applied as 

though the spouse were the employee or IRA owner. 

139 Treas. Reg. sec. 1.401(a)(9)-5, A-5(b). 

140 Treas. Reg. sec. 1.401(a)(9)-3, A-2.
47

percentage increase (for a qualified plan, the constant percentage cannot exceed five percent per 

year), certain accelerations of payments, increases to reflect when an annuity is converted to a 

single life annuity after the death of the beneficiary under a joint and survivor annuity or after 

termination of the survivor annuity under a QDRO.141 If distributions are in the form of a joint 

and survivor annuity and the survivor annuitant both is not the surviving spouse and is younger 

than the employee or IRA owner, the survivor annuitant is limited to a percentage of the life 

annuity benefit for the employee or IRA owner.142 The survivor benefit as a percentage of the 

benefit of the primary annuitant is required to be smaller (but not required to be less than 52 

percent) as the difference in the ages of the primary annuitant and the survivor annuitant become 

greater. 

 141 Treas. Reg. sec. 1.401(a)(9)-6, A-14.

142 Treas. Reg. sec. 1.401(a)(9)-6, A-2.
48

II. DATA RELATING TO RETIREMENT SAVINGS

A. Overview

A retired individual generally has three primary sources of funds to support him or 

herself in retirement: distributions or benefits from qualified retirement plans143 or individual 

retirement arrangements (IRAs); Social Security and/or railroad retirement benefits; and other 

assets held outside of qualified plans. Some taxpayers who consider themselves to be retired 

may supplement these sources with earned income. Some retired individuals may also receive 

Supplemental Security Income (SSI),144 Medicaid, certain Veteran’s benefits, and other public 

assistance.145

Table 1 displays tabulations of the percentage of individuals, aged 65 and above, who 

draw on each particular source of income.146 Examining individuals rather than households may 

understate the overall income and standard of living for households that have two or more 

members since each source of income is attributed to only one member of the household. Based 

on these data, a large majority of individuals aged 65 and above draws on Social Security 

income. Far fewer rely on earned income. Only 3.7 percent of individuals in the lowest income 

quartile report earned income, whereas 48.4 percent of individuals in the highest income quartile 

continue to have earned income after the age of 65. These estimates change after the age of 70 

and 75 as the majority of individuals eventually retire.147 

There is a similar difference across the income distribution in the percentage of 

individuals who draw on pensions as a source of income after the age of 65. Only 5.0 percent of 

individuals in the lowest income quartile, compared to 62.4 percent of individuals in the highest 

income quartile draw on pension income, which includes interest, dividends, and capital gains on 

retirement saving, such as savings in IRAs and 401(k) accounts. As might be expected, a large 

portion of high income individuals (85.1 percent) have available income from assets outside of 

qualified plans. Lower income individuals are more likely to draw income from SSI and public 

assistance programs than are higher income individuals. 

 143 The term “qualified retirement plans” refers to defined benefit or defined contribution plans, or both. 

144 Supplemental Security Income is a Federal income supplement program funded by general tax revenues 

and designed to help aged, blind, and disabled people who have little or no income to meet basic needs for food, 

clothing, and shelter.

145 Some individuals may also receive gifts from relatives or others to provide financial support in 

retirement.

146 Calculations in Jim Poterba, “Retirement Security in an Aging Population,” American Economic 

Review, May 2014, Vol. 104, No. 5.

147 Census data show that a significant percentage of men and women aged 62 or older work in paid 

employment. For example, in 2009, 33 percent of men and 42 percent of women aged 65 to 69 worked in paid 

employment. Patrick P. Purcell, “Older workers: Employment and retirement trends,” 2009, Congressional 

Research Service.
49

Table 1.−Income Sources for Individuals Aged 65+ by Total Income Quartile, 2018

(percentage of all individuals)

Income Quartile

Income Type Lowest 25 

percent

Second 25 

percent

Third 25 

percent

Highest 25 

percent

Social Security 65.9148 93.8 88.3 76.7

Earnings 3.7 9.0 24.3 48.4

Pension Income 5.0 21.0 53.8 62.4

Asset Income 38.0 52.6 70.5 85.1

SSI/Public Assistance 8.2 2.8 1.2 0.5

Other Income 2.1 4.3 9.0 12.8

Source: Current Population Survey, 2018. Calculations in Poterba, 2014, updated for 2018 by Poterba.

Columns may not add to 100 percent because some individuals have multiple sources of income.

Note: Data is categorized by quartiles based on individual income. The lowest quartile is individuals with annual income less 

than $12,000; the second lowest quartile, $12,000 to $22,816; the third quartile, $22,816 to $48,000; the highest quartile, greater 

than $48,000. 

 Table 2 displays tabulations of the size of various sources of income for individuals 

aged 65 and above, as a percentage of total income. For individuals in the lowest income 

quartile, Social Security benefits are the predominant source of income (they constitute 84.6 

percent of total income), whereas individuals in the highest income quartile rely on a much more 

varied mix of income sources. This reflects both the progressivity of Social Security benefits as 

well as the higher participation rates of high income individuals in employer sponsored 

retirement plans (see Table 4 below) and their greater ability to save over the life cycle. 

 148 In general, survey data may contain significant reporting errors. If lower income households are 

more likely to understate their Social Security income, this estimate may understate the true percentage of 

individuals in the lowest income quartile who receive Social Security benefits. See for example, Howard Iams 

and Patrick Purcell, “Social Security Income Measurement in Two Surveys,” Social Security Bulletin, 2013, Vol. 

73, No. 3.
50

Table 2.−Percent of Total Income by Source for Individuals Aged 65+, 2018

Income Quartile

Income Type Lowest 25 

percent

Second 25 

percent

Third 25 

percent

Highest 25 

percent

Social Security 84.6 82.4 52.5 17.0

Earnings 2.5 5.0 15.1 42.4

Pension Income 2.5 6.7 22.4 24.9

Asset Income 2.7 3.6 6.8 13.2

SSI/Public Assistance 6.7 0.9 0.3 0.1

Other Income 1.0 1.4 3.0 2.4

Source: Current Population Survey, 2018. Calculations in Poterba, 2014, updated for 2018.

Notes: All income=100 percent. 

Data is categorized by quartiles based on individual income. The lowest quartile is individuals with annual income less than 

$12,000; the second lowest quartile, $12,000 to $22,816; the third quartile, $22,816 to $48,000; the highest quartile, greater than 

$48,000. 

Tables 1 and 2 above are estimated using the Current Population Survey, which some 

research suggests is prone to under-counting pension income relative to that reported on 

administrative records.149 It may therefore be useful to supplement Tables 1 and 2 with an 

examination of other sources of data, including tax data which may contain other types of 

measurement error but is less susceptible to reporting errors. 

The subsequent sections of this pamphlet provide additional data that is descriptive of the 

sources of retirement income for current retirees and the potential of such sources to provide 

income for the next generation of retirees.

 149 Chris E. Anguelov, Howard M. Iams, and Patrick Purcell, “Shifting Income Sources of the Aged,” 

Social Security Bulletin 2012, Vol. 72, No. 3.; Adam Bee and Joshua Mitchell, “Do Older Americans Have More 

Income Than We Think?” 2017, SEHSD Working Paper 2017-39. 
51

B. General Data on Qualified Retirement Plan Participation

Data show that a significant share of workers is not covered by any employer-provided 

retirement plan. However, there are disparities in the reported magnitude of coverage, depending 

on the data source, the definition of coverage, and the population considered. Coverage under a 

retirement plan may refer to whether an employee is offered access to a retirement plan 

(“access”), whether an employee chooses to participate in a retirement plan when offered (“takeup”), and whether any employee with access or not participates in a retirement plan (“employee 

participation”). The available sources of retirement coverage data include four household 

surveys (the Current Population Survey (“CPS”), the Survey of Income and Program 

Participation (“SIPP”), the Panel Study on Income Dynamics (“PSID”), and the Survey of 

Consumer Finances (“SCF”)), along with an employer survey (the National Compensation 

Survey (“NCS”)), and tax data. 

Household surveys often provide a rich source of detail about household characteristics. 

However, they may be subject to serious individual reporting error. The four household surveys 

listed above suggest estimated participation in an employer-provided defined benefit or defined 

contribution plan for private sector employees ranging between 40 and 55 percent over the 

period 1991-2012.150 In contrast to the NCS, household surveys report that employers offer 

retirement plans and employees choose to participate in these retirement plans at significantly 

lower rates, suggesting significant respondent error in the surveys.151 Researchers attempt to 

correct for possible respondent errors through a variety of methods, including using matched tax 

data from W-2 records.152 However, a lack of information about access, take-up, and 

participation in defined benefit plans in the W-2 records necessitates assumptions about such 

coverage, leading to estimates of access, take-up, and participation rates that are significantly 

higher than in the NCS.

According to the NCS,153 in 2017, 66 percent of U.S. workers employed in the private 

sector had access to a qualified retirement plan and 50 percent of workers employed in the 

 150 Alicia Munnell and Dina Bleckman, “Is Pension Coverage a Problem in the Private Sector?” Boston 

College Center for Retirement Research, April 2014, Number 14-7.

151 See tabulations by Munnell and Bleckman, 2014. In 2012, the CPS reports that employers offered 

coverage under a retirement plan to 52 percent of private, part-time and full-time workers, while the NCS reports 64 

percent. The CPS reports that 43 percent of private, part-time and full-time employees participated in these plans, 

while the NCS reports 48 percent. 

152 Irena Dushi, Howard M. Iams, and Jules Lichtenstein, “Assessment of Retirement Plan Coverage by 

Firm Size, Using W-2 Tax Records,” Social Security Bulletin, 2011, Vol. 71, No. 2.

153 The NCS is an annual survey conducted by the U.S. Department of Labor, Bureau of Labor Statistics 

(“BLS”). Each release contains data categorized as civilian, private industry, and State and local government 

workers in the United States. Data on the private sector refers to workers in private industry, not including State and 

local government workers. Also excluded are Federal government workers, the military, agricultural workers, 

private household workers, and the self-employed.
52

private sector participated in a qualified retirement plan (see Table 3).154 This translates to a 

take-up rate of 75 percent, meaning 75 percent of those with access participated.155 Take-up 

rates were stable at between 74 and 76 percent over the seven-year period, 2011 to 2017. These 

take-up rates indicate that while a large percentage of employees participate in an employer plan 

if available to them, some employees do not. 

Table 3.−Retirement Benefits: Access, Participation

and Take-Up Rates in the Private Sector by Year

(percentage of all workers)

Year Access Rate

Employee 

Participation 

Rate Take-Up Rate

2011 64 49 76

2012 65 48 75

2013 64 49 76

2014 65 48 75

2015 66 49 74

2016 66 49 75

2017 66 50 75

Source: Bureau of Labor Statistics, National Compensation Survey Data, 2011-2017.

Note: All workers = 100 percent. Rates are rounded to the nearest percent. As a result, take-up

rates may not be exactly equal to the employee participation rate divided by the access rate as

presented in this table.

 154 The term “qualified retirement plans” refers to defined benefit or defined contribution plans, or both. 

Employees are considered to have access to a qualified retirement plan if at least one type of plan is available for 

their use and they are participants if they have fulfilled requirements, including making required contributions. 

155 Take-up rates are calculated to be participation among those employees who are offered access to an 

employer plan. Therefore, TTTTTTTT UUUU = EEEEEEEEEEEEEEEE PPPPPPPPPPPPPP PPPPPP PP

AA AAAA .
53

Rates of access, participation, and take-up in qualified retirement plans vary by a number 

of worker and industry characteristics. Figure 1 shows that access rates are lower in the private 

sector than they are in the State and local government sector. In addition, the take-up rate in the 

private sector is 75 percent compared to an 88 percent take-up rate in the State and local 

government sector. 

Figure 1.−Access, Participation, and Take-up Rates by Sector in 2017

(percentage)

Source: Bureau of Labor Statistics, National Compensation Survey Data, 2017.

Note: All workers=100 percent.

66

91

50

80

75

88

Private State/Local

Access Employee Participation Take-up
54

The data in Figure 2 show that access, employee participation, and take-up rates are 

significantly higher for full time workers than for part time ones. Overall participation rates are 

only 21 percent for part time workers, compared to a 60 percent participation rate for full time 

workers.

Figure 2.−Access, Participation, and Take-up Rates in the Private Sector 

by Full-time Status in 2017 (percentage)

Source: Bureau of Labor Statistics, National Compensation Survey Data, 2017.

Note: All workers=100 percent.

77

38

60

21

78

56

Full time Part time

Access Employee Participation Take-up
55

There is also a disparity in take-up rates between union and non-union workers. As 

shown in Figure 3, access, employee participation, and take-up rates are significantly higher for 

union workers than they are for non-union workers. 

Figure 3.−Access, Participation, and Take-up Rates in the Private Sector 

by Union Status in 2017 (percentage)

Source: Bureau of Labor Statistics, National Compensation Survey Data, 2017.

Note: All workers=100 percent.

92

64

82

47

90

73

Union Non-union

Access Employee Participation Take-up
56

The NCS also contains data on employee occupations, along with the average wage for 

each occupation. Table 4 uses NCS data, classifying individuals by the average wage for their 

occupation, to show access, employee participation, and take-up rates across the wage 

distribution. Participation rates are 21 percent for those employees with occupations in the 

lowest quartile of the wage distribution, and they are 77 percent for those in the highest quartile. 

Access and take-up rates also differ across the wage distribution, with all rates increasing as 

wages increase. 

Table 4.−Retirement Benefits: Access, Participation, and Take-Up

Rates in the Private Sector by Wage Centile, 2017

(percentage of all workers)

Wage Centile1 Access Rate

Employee 

Participation 

Rate

Take-Up Rate

Lowest 10 percent 33 14 41

Lowest 25 percent 42 21 51

Second 25 percent 66 46 70

Third 25 percent 83 64 81

Highest 25 percent 89 77 88

Highest 10 percent 89 81 90

Source: Bureau of Labor Statistics, National Compensation Survey Data, 2017.

Notes: All workers=100 percent. 1 Hourly wages for the 10th, 25th, 50th, 75th, and 90th percentiles are $9.79, $12.25, $18.16, $29.44,

and $46.10, respectively. 

As reported above, past participation in qualified plans, including accrued defined benefit 

plan benefits, and past saving in IRAs are important financial resources for many current retirees. 

Table 5 uses tax data to estimate the percentage of tax units156 with primary taxpayer aged 65 

 156 The unit of observation in the Joint Committee’s Individual Tax Model is a tax unit. A tax unit is the 

collection of individuals appearing on a Form 1040 as primary, secondary, or dependent filers. Tax units differ from 

households in that households can be comprised of multiple tax units. For example, unmarried cohabitating couples, 

multi-generational households, and roommates will generally be comprised of multiple tax units. 
57

and above that have a taxable IRA or pension distribution.157 Keeping in mind that tabulations 

of individuals will differ from tabulations of tax units, these estimates are consistent with the 

general pattern seen in Table 1, where the percent of tax units drawing on IRA or pension 

distributions increases through much of the income distribution. In addition, the data show that 

tax units with primary filers aged 65 and above with the highest levels of AGI ($200,000 and 

above) draw on their taxable distributions and pensions at lower rates than those with AGI of 

$30,000 to $200,000. This is consistent with the ability of higher income tax units to delay 

drawing down IRA and pension income by relying on earned income (see Tables 1 and 2 above) 

and other income from assets held outside of qualified plans and IRAs.

Table 5.−Tax Units Aged 65+ with Taxable IRA

or Pension Distribution, 2019

AGI category Percent of tax units with taxable 

IRA or pension distribution

Less than $10,000 37.7

$10,000 to $20,000 76.9

$20,000 to $30,000 78.7

$30,000 to $40,000 80.5

$40,000 to $50,000 83.1

$50,000 to $75,000 83.6

$75,000 to $100,000 85.5

$100,000 to $200,000 86.2

$200,000 to $500,000 79.7

$500,000 to $1,000,000 69.4

Greater than $1,000,000 62.8

Source: JCT staff calculations based on the Individual Tax Model. 

Note: These tabulations do not include distributions from Roth accounts.

 157 Qualified Roth distributions that satisfy appropriate requirements are tax-free. As a result, information 

on distributions from Form 1040 will not account for Roth distributions, and the estimates in Table 5 will likely 

understate the amount of total IRA and pension distributions. 
58

Using data on annual distributions from retirement accounts reported on Form 1099-R, 

Table 6 provides information on the percent of individuals with distributions from defined 

contribution (“DC”) and IRA plans versus defined benefit (“DB”) plans.158 With the exception 

of those in the highest AGI categories ($200,000 and above), the percentage of individuals with 

distributions from IRAs or DC plans and DB plans and the average amount of these distributions 

generally increases with income. Furthermore, in AGI categories less than $200,000, a larger 

percentage of individuals reports distributions from DB plans than they do from IRA or DC 

plans. For AGI categories greater than $200,000, this pattern is reversed and a larger percentage 

of individuals report distributions from IRA or DC plans than they do from DB plans. 

Table 6.−Individuals Aged 65+ with Annual Distributions from Defined

Contribution (DC) and IRA versus Defined Benefit (DB) Plans, 2015

AGI category

Percent of 

individuals 

with IRA

or DC 

distribution

Average 

distribution 

from IRA or 

DC Plan

Percent of 

individuals 

with DB 

distribution

Average 

distribution 

from DB Plan

Less than $10,000 24.8 $1,156 30.8 $1,846

$10,000 to $20,000 33.7 $2,106 46.9 $4,606

$20,000 to $30,000 36.4 $2,828 50.5 $7,006

$30,000 to $40,000 38.2 $3,397 52.4 $8,984

$40,000 to $50,000 40.4 $4,071 53.9 $10,774

$50,000 to $75,000 43.5 $5,423 55.5 $13,506

$75,000 to $100,000 46.9 $7,538 55.8 $16,027

$100,000 to $200,000 49.7 $12,534 53.0 $18,996

$200,000 to $500,000 48.8 $24,399 39.1 $17,145

$500,000 to $1,000,000 42.4 $30,939 25.6 $10,489

Greater than $1,000,000 37.1 $33,773 21.9 $9,869

Source: JCT staff calculations. 

Notes: All individuals=100 percent. Data for this table are from distributions net of rollovers for accounts on Form 1099-R 

determined by Joint Committee Staff to be pension or IRA distributions, including Roth IRAs and Roth 401(k)s.

 158 Form 1099-R does not separately identify defined benefit and defined contribution distributions. 

However, Joint Committee staff have developed an algorithm to classify the type of account on a Form 1099-R, 

which is used in the construction of Table 6.
59

C. Data Related to Social Security Benefits as a Source of Retirement Income

Table 1, above, shows that nearly all individuals draw on Social Security benefits as a 

source of retirement income, and Table 2 documents that for many individuals, these benefits are 

an important source of retirement income. 

Table 7, using tax data, shows tabulations of the percentage of tax units with primary 

taxpayer aged 66 to 75 and aged 76 to 85 that draw on Social Security income. Based on these 

data, nearly all tax units aged 65 and above rely on Social Security income as a source of 

income. Higher income tax units are more likely to delay drawing on this source of income, but 

by age 85, nearly all do so. 

Table 7.−Tax Units Aged 65+ with Social Security Income, 2019

AGI category

Age 66 to 75 Age 76 to 85

Percent of 

tax units 

with Social 

Security 

income

Average 

value of 

annual Social 

Security 

income

Percent of 

tax units with 

Social 

Security 

income

Average value 

of annual 

Social Security 

income

Less than $10,000 94.1 $21,219 95.0 $19,383

$10,000 to $20,000 95.3 $23,635 98.8 $22,871

$20,000 to $30,000 92.8 $25,066 96.3 $24,548

$30,000 to $40,000 90.0 $26,331 95.8 $24,697

$40,000 to $50,000 91.8 $25,941 94.7 $25,313

$50,000 to $75,000 91.5 $25,893 97.0 $24,682

$75,000 to $100,000 92.7 $28,776 98.4 $27,997

$100,000 to $200,000 91.5 $33,994 96.8 $32,162

$200,000 to $500,000 85.6 $37,526 99.0 $36,860

$500,000 to $1,000,000 78.6 $38,569 98.0 $38,780

Greater than $1,000,000 74.1 $40,387 100.0 $42,175

Source: JCT staff calculations based on the Individual Tax Model. 

Note: Tabulations include Tier 1 Railroad Retirement benefits.
60

Table 8, using tax data, shows the percentage of tax units with a primary or secondary 

taxpayer between the ages of 50 and 59 who pays FICA or SECA taxes, by AGI category. While 

an imperfect measure of future Social Security benefits to be paid,159 this statistic offers some 

idea of the percentage of tax units that may be eligible for Social Security benefits in the future. 

Table 8.−Tax Units, Aged 50 to 59, that Pay FICA or SECA Tax, 2019

(percentage)

AGI category Percent of tax units that pay 

FICA/SECA

Less than $10,000 34.7

$10,000 to $20,000 87.6

$20,000 to $30,000 89.9

$30,000 to $40,000 92.2

$40,000 to $50,000 93.2

$50,000 to $75,000 93.3

$75,000 to $100,000 93.9

$100,000 to $200,000 94.5

$200,000 to $500,000 94.2

$500,000 to $1,000,000 91.8

Greater than $1,000,000 89.9

Source: JCT staff calculations based on the Individual Tax Model. 

 159 For individuals born in 1929 or later, Social Security benefits are eligible to be paid at age 62 or later, 

and only after 40 quarters (10 years) of FICA or SECA tax payments. Whether an individual pays FICA/SECA at 

ages 50 to 59 does not necessarily indicate whether or not he or she attains 40 quarters of credits by the end of his or 

her work life. 
61

D. Assets Held Outside of Qualified Plans and Individual

Retirement Arrangements

Tables 1 and 2, above, document that in addition to qualified retirement plans, IRAs, 

Social Security and/or railroad retirement benefits, individuals may rely on other assets held 

outside of qualified plans and IRAs as sources of income in retirement. Assets accumulated in 

bank accounts, mutual funds, and stock held directly or in a brokerage account are examples of 

such additional sources of income for retirement. These assets can provide current income 

through regular payment of interest and dividends. These assets may also provide a source of 

income as the individual decumulates asset holdings. As the individual ages he or she may draw 

down bank balances and sell shares of mutual funds or other equities to finance current 

consumption.

Table 9, below, shows the percentage of tax units with interest and dividend income, for 

primary taxpayers aged 55 to 64, 65 to 74, and 75 and above. These data provide some 

information on the extent to which current retirees, generally tax units aged 65 or greater, and the 

next generation of retirees, tax units aged 55 to 64 in the table, have assets producing interest and 

dividend income. Generally, assets with a higher valuation will generate greater annual interest 

and dividend income for the tax unit. Table 9 provides some insight regarding the extent of asset 

holdings by both current retirees and the next generation of retirees by reporting statistics on 

interest and dividend income in three categories: tax units with less than $100 in annual interest 

and dividend income; tax units with annual interest and dividend income of at least $100 but less 

than $500; and tax units with $500 or more in annual interest and dividend income. For all age 

groups, tax units in higher AGI categories are more likely to have significant interest and 

dividend income. 
62

Table 9.−Percent of Tax Units with Interest and Dividend Income, 2019

(percentage of returns)

Source: JCT staff calculations.

In addition to a lifetime of saving and the accumulation of financial assets, for many 

retired individuals, years of mortgage payments generate an important source of retirement 

income - the income they consume in kind by owning their own home. Home ownership means 

that some of the individual’s other financial resources are not consumed by rental payments.160 

The value of their home provides an important source of additional financial wealth for many 

retired individuals. Similarly, homeownership by the next generation of retirees may provide 

both a source of in-kind income and financial wealth. 

Table 10 shows the home ownership rates of those households with a householder aged 

55 or above as well as the share of those owners that have no mortgage on their residence. Home 

ownership is relatively high for these households, with older households owning at slightly 

higher rates. Furthermore, the presence of a mortgage for owners drops significantly with age, 

with only 26 percent of owners aged 75 and above having mortgages compared to nearly 64 

percent of owners aged 55 to 64. This suggests that as households enter and progress through 

retirement, a large share own their homes outright, allowing them to consume housing without 

regular housing payments (i.e., rent or principal and interest on a loan) as well as possible 

significant equity in their property. 

 160 The homeowner will incur maintenance expenses and property taxes.

AGI category

Age 55 to 64 Age 65 to 74 Age 75 +

Less 

than 

$100

$100 

and 

$500

$500 

and 

Above

Less 

than 

$100

$100 

and 

$500

$500 

and 

Above

Less 

than 

$100

$100 

and 

$500

$500 

and 

Above

Less than $10,000 91.1 4.4 4.5 82.0 7.8 9.3 75.6 11.8 12.6

$10,000 to $20,000 88.3 4.6 7.1 74.7 10.6 14.6 53.7 15.1 31.2

$20,000 to $30,000 86.5 5.0 8.5 69.7 10.5 19.8 44.0 14.9 41.1

$30,000 to $40,000 84.3 6.6 9.0 63.1 13.1 23.9 38.2 13.8 48.0

$40,000 to $50,000 81.5 8.6 9.9 61.9 11.8 26.2 32.8 16.6 50.6

$50,000 to $75,000 73.4 10.6 16.0 55.2 14.4 30.4 28.0 15.8 56.1

$75,000 to $100,000 67.1 13.4 19.5 48.6 14.8 36.5 23.0 11.1 65.9

$100,000 to $200,000 53.2 15.2 31.6 36.5 14.2 49.3 15.2 9.3 75.6

$200,000 to $500,000 29.0 14.7 56.3 21.2 11.1 67.7 7.4 3.9 88.7

$500,000 to 

$1,000,000

8.9 8.2 83.0 6.5 5.3 88.2 2.7 4.0 93.3

Greater than 

$1,000,000

3.8 3.1 93.1 2.2 2.2 95.5 2.5 2.5 97.5

Total, All Taxpayers 72.5 9.3 18.2 60.9 11.4 27.7 50.9 12.6 36.5
63

Table 10.−Home Ownership and Mortgage Status by Age Group, 2015

Age Percent of households 

that own home

Percent of owners that 

have a mortgage

55-64 68.2 63.5

65-74 72.8 44.9

75+ 75.1 26.2

Source: JCT staff calculations using the 2016 Survey of Consumer Finances. 

Note: These tabulations do not include those living on working farms and in mobile homes.