What Is a Defined Contribution Plan?
As a Cummins Inc employee, it is important to understand what a defined contribution plan is in order to be better prepared when planning your finances. A defined contribution plan is a qualified employer-sponsored retirement plan that provides each participating employee with an individual plan account earmarked for the employee. Depending on the type of defined contribution plan, plan contributions may be made by (1) only the employer (e.g., a profit-sharing plan), (2) only the employee (e.g., a nonmatching 401(k) plan), or (3) both the employer and the employee (e.g., a matching 401(k) plan).
In the case of Cummins Inc employer contributions, the contribution amount is generally 'defined' in the plan document, often in terms of a percentage of the employee's pre-tax compensation. For plans that allow employee contributions, each employee can generally decide how much to contribute (up to the employee contribution limit), and can usually change his or her contribution at certain times of the year. Like employer contributions, Cummins Inc employee contributions are generally expressed in terms of a percentage of the employee's pre-tax compensation.
A defined contribution plan does not guarantee a certain level of benefits to a Cummins Inc employee at retirement or separation from service. Instead, the amount of benefits paid to each participant at retirement or separation from service is the vested balance of his or her individual account. A Cummins Inc employee's vested balance consists of (1) the employee's own contributions and related earnings, and (2) any employer contributions and related earnings that the employee has earned (i.e., become vested in) due to length of service with the employer. The dollar value of the account will depend on the total amount of money contributed and the performance of the underlying plan investments.
What Are the Differences Between a Defined Contribution Plan and a Defined Benefit Plan?
A defined contribution plan is one of two major types of qualified retirement plans. [A qualified retirement plan is a plan that receives favorable federal income tax treatment and, generally, meets the requirements of the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA).] The other major type of qualified retirement plan is a defined benefit plan. Although both are types of qualified plans, as a Cummins Inc employee you should understand the fundamental differences between defined contribution plans and defined benefit plans:
- A defined benefit plan guarantees a specified level of benefits to each participating fortune 500 employee at retirement. A defined contribution plan, however, makes no guarantees as to the future benefits that participating employees will receive from the plan.
- A defined contribution plan provides each participating Cummins Inc employee with an individual plan account. By contrast, a defined benefit plan does not establish or maintain individual plan accounts. The plan assets are held in a trust fund that is managed by a trustee and are not specifically earmarked for the employee in a separate account.
- A defined benefit plan is typically funded solely by employer contributions — employees are generally not allowed to contribute to the plan. By contrast, many types of defined contribution plans are funded either solely by employee contributions, or by some combination of Cummins Inc employee and employer contributions.
How Much Will Employees Receive from a Defined Contribution Plan?
The amount of benefits that each participating Cummins Inc employee will receive from a defined contribution plan at retirement or separation from service depends on several factors, those of which include:
- The total contributions (employer and employee) allocated to the participant's plan account
- Any forfeitures of other Cummins Inc employees' accounts that are reallocated to the participant's plan account because the other employees no longer work for the employer
- The performance of the underlying plan investments, and the participant's share of gains and losses on those investments
What Type of Employer Will Benefit Most from a Defined Contribution Plan?
A Cummins Inc employer that wants to benefit its young, well-paid owners and key employees will generally find a defined contribution plan most beneficial. That's because such employees typically have many years in which annual contributions can be made and invested, creating the opportunity for significant tax-deferred growth over the long term (depending on investment performance).
Example(s): Parrot Enterprises has four owners of varying ages. As the following table illustrates, younger employees have the potential to amass extremely large sums of retirement funds through a defined contribution plan.
|
Participant |
Current age |
Annual compensation |
Years to age 65 |
25% of pay contribution |
Value of account at age 65 with 8% interest |
|
Joe |
25 |
$50,000 |
40 |
$12,500 |
$3,497,263 |
|
Mary |
35 |
$50,000 |
30 |
$12,500 |
$1,529,323 |
|
Sam |
45 |
$50,000 |
20 |
$12,500 |
$617,787 |
|
Anne |
55 |
$50,000 |
10 |
$12,500 |
$195,569 |
Caution: The above scenario is entirely hypothetical and not to be used as a reliable indicator of future benefits under a defined contribution plan. Both annual contributions and investment returns can vary from year to year — widely, in some cases. There is even the possibility that a participant's plan account may lose value if his or her plan investments perform poorly.
What Is the Maximum Tax-Deductible Contribution That an Employer Can Make to a Defined Contribution Plan?
As a Cummins Inc employer, the maximum annual tax-deductible contribution that you can make to a defined contribution plan is generally limited to 25% of the total compensation of all Cummins Inc employees participating in the plan. [Employee pre-tax deferrals to a 401(k) plan are deductible separately from this 25% limit.] The specific rules regarding deductibility of employer contributions are complex, however, so you should consult a tax advisor for guidance.
Caution: For 2020, annual compensation in excess of $285,000 (up from $280,000 in 2019) for any individual plan participant cannot be included in calculating the maximum annual tax-deductible contribution.
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How Is Compensation Defined?
Annual Additions Limit
For purposes of the annual additions limit (see below), compensation generally includes all taxable personal services income, such as wages, salaries, fees, commissions, bonuses, and tips. For Cummins Inc employees, It does not include pension-type income, such as payments from qualified plans, nonqualified pensions, and taxable compensation due to participation in various types of stock and stock option plans. In addition, compensation includes voluntary salary deferrals to 401(k) plans and cafeteria plans. The maximum amount of annual compensation that can be used to determine the annual additions limit for any single plan participant is $285,000 (for 2020, up from $280,000 in 2019).
Highly Compensated Employee
For 2020, a highly compensated employee for a Cummins Inc company is an individual who:
- Was a 5% owner of the employer during 2019 or 2020, or
- Had compensation in 2019 in excess of $125,000 and, at the election of the employer, was in the top 20% of employees in terms of compensation for that year. (This $125,000 limit rises to $130,000 in 2020.)
For this purpose, compensation includes all taxable personal services income, such as wages, salaries, fees, commissions, bonuses, and tips. In addition, it includes elective or salary-reduction contributions to cafeteria and salary deferral plans such as 401(k) plans.
What Are the Maximum Annual Additions That Can Be Allocated to Each Plan Participant's Account?
Annual additions are the sum of (1) total contributions (employer and employee) made to an individual participant's plan account for the year, and (2) any forfeitures of other employees' accounts that are reallocated to the participant's plan account. The maximum annual additions that can be allocated to any individual participant's plan account are the lesser of (1) 100% of the participant's compensation for the year, or (2) $57,000 (for 2020, up from $56,000 in 2019). As mentioned, the maximum amount of annual compensation that can be used to determine the annual additions limit for any single plan participant is $285,000 (for 2020, up from $280,000 in 2019).
Caution: You must treat all qualified defined contribution plans you maintain as a single plan for purposes of calculating the annual additions limit.
Tip: For 401(k) plans, employees age 50 and older can make catch-up contributions of up to $6,500 in 2020 in excess of the $57,000 annual additions dollar limit.
What Are The Types of Qualified Defined Contribution Plans?
Here are brief descriptions of the major types of qualified defined contribution plans..
Profit-Sharing Plan
A profit-sharing plan is a defined contribution plan that allows for Cummins Inc employer discretion in determining the level of annual contributions to the plan. In fact, the business can contribute nothing at all in a given year if it so chooses. As the name suggests, a profit-sharing plan is usually a sharing of the Cummins Inc employer's profits that may fluctuate from year to year. Generally, corporations will contribute to profit-sharing plans in one of two ways: either according to a written formula or in a purely discretionary manner.
401(K) Plan
A 401(k) plan, sometimes called a cash or deferred arrangement (CODA), is a defined contribution plan in which Cummins Inc employees elect either to receive cash payments from their employer immediately or to defer receipt of the income. If deferred, the amount deferred consists of pre-tax dollars that are invested in the employee's plan account. A 401(k) plan can also allow employees to make after-tax Roth contributions. Often, the Cummins Inc employer matches all or part of the employees' deferrals to encourage employee participation. The 401(k) plan is the most widely used type of defined contribution plan. An individual 401(k) plan can be established that covers only a business owner, or the business owner and his or her spouse.
Money Purchase Pension Plan
A money purchase pension plan is a defined contribution plan in which the Cummins Inc employer makes an annual contribution to each employee's account in the plan. The amount of the contribution is determined by a set formula that cannot be changed, regardless of whether or not the corporation is showing a profit. Typically, the business's contribution will be based on a certain percentage of a Cummins Inc employee's compensation.
Age-Weighted Profit-Sharing Plan
An age-weighted profit-sharing plan is a defined contribution plan in which contributions are allocated based on the age of plan participants as well as on their compensation. This type of plan benefits older participants with fewer years until retirement by allowing them to receive much larger contributions to their accounts than younger participants. As a Cummins Inc employee, you may want to consider this plan if you are older and close to retirement.
Target Benefit Plan
For Cummins Inc employees, a target benefit plan is a hybrid of a defined benefit plan and a money purchase pension plan. It resembles a defined benefit plan in that the annual contribution is based on the amount needed to fund a specific amount of retirement benefits (the 'target' benefit). It resembles a money purchase pension plan in that the actual benefit received by the participant at retirement is based on his or her individual balance.
New Comparability Plan
A new comparability plan is a variation of the traditional profit-sharing plan. This type of plan is unique in that plan participants are divided into two or more classes based on their age and other factors. The new comparability plan therefore allows Cummins Inc businesses to maximize plan contributions to higher-paid workers, key employees, and owner/employees, while minimizing contributions to the other employees.
Thrift/Savings Plan
A thrift or savings plan is a defined contribution plan that is similar to a profit-sharing plan, but has features that provide for (and encourage) after-tax employee contributions to the plan. The Cummins Inc employee must pay tax on his or her own contributions before they are invested in the plan. Typically, a thrift/savings plan supplements after-tax employee contributions with matching employer contributions.
ESOP Plan
An ESOP plan, sometimes called a stock bonus plan, is a defined contribution plan in which participants' accounts are invested in stock of the Cummins Inc employer's corporation. This type of plan is funded solely by the employer. When a plan participant retires or leaves the company, the participant receives his or her vested balance in the form of cash or employer securities.
How does Cummins determine eligibility for participation in the Cummins Pension Plan, and what are the implications for employees who temporarily leave the workforce? This inquiry should delve into the specific criteria that define an eligible employee, such as citizenship requirements and exclusions, as well as the continuation of benefits and service credit during approved leaves or breaks in service at Cummins. It would also explore the complexities surrounding vesting and how service prior to a break is credited upon re-employment at Cummins.
Eligibility and Participation in the Cummins Pension Plan: Eligibility for the Cummins Pension Plan requires being an active employee, not participating in another Cummins defined benefit pension plan, and meeting certain citizenship or residency criteria. During approved leaves of absence, employees continue to accrue service credits, ensuring continuous growth in their pension benefits. Notably, vesting occurs after three years of service, securing the employee's entitlement to pension benefits upon leaving the company. The plan handles breaks in service by allowing reemployment within 12 months to count towards vesting and benefit calculations, safeguarding employee benefits against temporary disruptions in their career with Cummins.
What are the potential benefits and limitations of the forms of distribution available under the Cummins Pension Plan, and how should employees prepare for their pension benefit election? This question requires an analysis of various forms of distributions, such as lump sums versus annuities, highlighting the financial implications of each choice, particularly in relation to the IRS rules for 2024 regarding tax treatment. Employees should also consider how their family structure (e.g., marital status, dependents) may influence their decisions when electing a distribution method.
Distribution Forms and Tax Considerations: The Cummins Pension Plan offers various distribution forms, including lump sums and annuities, each with distinct tax implications under IRS rules for 2024. Employees must consider their family structure and tax status when choosing a distribution form, as these factors influence the tax treatment and financial outcome of their pension benefits. The plan provides clear guidelines on these options, ensuring employees can make informed decisions that align with their personal and financial circumstances.
In what ways do pay credits and interest credits accrue within the Cummins Pension Plan, and how can employees gauge their potential retirement benefits over time? This question will focus on the specifics of how pay credits are calculated based on an employee's compensation and service at Cummins, as well as the impact of interest credits on the total account balance and long-term retirement planning. It will also examine how employees can track these credits through the Cummins retirement resources.
Accrual of Pay and Interest Credits: The pension benefits at Cummins accrue through pay credits based on compensation and service, along with interest credits. Employees can monitor their accumulating benefits through the Cummins retirement resources, offering transparency and planning advantages. This structured accrual method supports employees in projecting their future pension benefits and making informed decisions about their retirement timing and financial needs.
How does Cummins ensure compliance with ERISA and other regulatory standards in the management of the Cummins Pension Plan, and what rights do employees have under these regulations? This query should explore Cummins' obligations as a fiduciary in managing employee benefits and highlight the key rights of plan participants. The discussion should include access to plan documents, the process for filing claims, and the significance of ERISA protections for employees retired from Cummins.
Regulatory Compliance and Employee Rights: Cummins diligently adheres to ERISA standards in managing the pension plan, emphasizing fiduciary responsibility and ensuring participants' rights are upheld. Employees have rights to access plan documents, participate in claims and appeals processes, and are protected under ERISA from any plan-related discrimination. This regulatory compliance not only secures the integrity of their pension benefits but also reinforces the legal framework protecting participant rights.
What role does the Pension Benefit Guaranty Corporation (PBGC) play in safeguarding the retirement benefits of Cummins employees, and how does this affect the perception of the plan's reliability? This question would examine the insurance coverage provided by the PBGC, what types of benefits are guaranteed, and under what circumstances benefits may not be fully covered. Employees might analyze how this federal insurance impacts their confidence in the plan, especially in light of changing economic conditions.
Role of the Pension Benefit Guaranty Corporation (PBGC): The PBGC insures the pension benefits under the Cummins Plan, providing a safety net that enhances the reliability of these benefits. Employees covered by the plan can gain confidence in the security of their pensions, knowing that even in the face of potential plan termination, the PBGC guarantees the core benefits, subject to certain legal limits and conditions.
How does the Cummins Pension Plan interface with employees' Social Security benefits, and what should retirees consider when planning for a sustainable retirement income? This inquiry will look at the coordination of benefits under the Cummins plan with Social Security, examining how pension income might influence Social Security calculations. It would require discussions on the timing of retirement elections and how they align with Social Security claims.
Interaction with Social Security Benefits: The Cummins Pension Plan is designed to integrate smoothly with Social Security benefits, offering provisions that help plan participants optimize their total retirement income. Understanding this interaction allows employees to strategically plan their retirement age and benefit commencement, maximizing their financial stability in later life.
What are the specific procedures and deadlines that Cummins employees should follow to successfully elect a distribution from the Cummins Pension Plan upon retirement? This question will necessitate a detailed look at the steps involved in initiating a benefit distribution, including the importance of spousal consent, the timing of application submissions, and any documentation that may be required. Understanding these processes can significantly affect the financial outcomes for retirees.
Procedures and Deadlines for Electing Pension Distribution: The Cummins Pension Plan outlines specific procedures and deadlines for electing a distribution upon retirement, emphasizing the importance of timely and informed decision-making. By understanding these processes, employees can avoid delays and ensure that they receive their pension benefits in the manner that best suits their post-retirement financial plans.
What are the implications of choosing to defer pension benefits and how does the Cummins Plan accommodate employees who opt not to start their benefits at the normal retirement date? This inquiry could address the potential financial consequences of deferring benefits, including eligibility requirements for such deferral and how it aligns with IRS regulations. Employees should critically evaluate their financial situations and retirement goals, weighing the allure of continued employment against starting their retirement benefits sooner.
Deferring Pension Benefits: Employees at Cummins have the option to defer their pension benefits beyond the normal retirement date, which can influence the financial value of their benefits. The plan provides guidelines on how deferral impacts benefit calculations and distributions, assisting employees in making decisions that align with their long-term financial goals.
How can Cummins employees designating beneficiaries ensure that their wishes are respected concerning death benefits, particularly in light of recent changes in the pension landscape? This question focuses on the options available to employees for designating beneficiaries, the process for updating these designations over time, and the specific forms that need to be completed to ensure compliance with the Cummins Pension Plan. It will also discuss the impact of state and federal laws on these designations.
Designating Beneficiaries and Ensuring Compliance: The plan stipulates clear processes for designating beneficiaries for pension benefits, ensuring that employees' wishes are respected and legally documented. This is crucial for planning and securing financial provisions for survivors, reflecting the plan's comprehensive approach to retirement benefits.
How can Cummins employees contact the Cummins Retirement Benefits Service Center to obtain more information about the Cummins Pension Plan and related retirement processes? This question emphasizes the various channels through which employees can reach out to the service center, the types of queries they can address regarding the Cummins Pension Plan, and the resources available online to assist with pension-related inquiries. Employees are encouraged to take advantage of these resources to make informed decisions regarding their retirement planning.
Accessing Information and Assistance: Cummins provides multiple channels for employees to access information and assistance regarding their pension plan, including online resources and a dedicated service center. This accessibility ensures that employees can obtain detailed information and personalized support, enabling them to navigate their pension benefits effectively.