Whether you are a sole proprietor, partnership or a corporation, there are several types of qualified retirement plans that can meet your needs. A retirement plan can serve many purposes, from tax sheltering income to attracting and retaining employees.
Here is general information about the most popular types of retirement programs. Our consultants will help you choose the plan that is best for you. Click below to learn more about qualified retirement plans.
Qualified Retirement Plans
A qualified plan must meet a certain set of requirements outlined in the Internal Revenue Code such as minimum coverage, participation, vesting, and funding requirements. In return, the IRS provides tax advantages to encourage businesses to establish retirement plans, including:
- Employer contributions to the plan are tax-deductible.
- Earnings on investments accumulate tax-deferred, allowing contributions and earnings to compound at a faster rate.
- Employees are not taxed on the contributions and earnings until they receive the funds.
- Employees may make pretax contributions to certain types of plans.
- Ongoing plan expenses are tax-deductible.
In addition, sponsoring a qualified retirement plan offers the following advantages:
- Attract experienced employees in a very competitive job market: Retirement plans have become a key part of the total compensation package.
- Retain and motivate good employees: You don't want to lose them to your competitors because of the qualified plans they are offering.
- Help employees save for their future since Social Security retirement benefits alone will be an inadequate source to support a reasonable lifestyle for most retirees.
Qualified plan assets are protected from creditors of the employer and employee. Employers can choose between two basic types of retirement plans: defined contribution and defined benefit. Both a defined contribution and a defined benefit plan may be structured to maximize benefits. Our consultants can help you choose the right plan for your company. Listed below is a description of the types of plans that are available.
Defined Contribution Plans
Under a defined contribution plan, the contribution that the company will make to the plan and how the contribution will be allocated among the eligible employees is defined. Individual account balances are maintained for each employee. The employee's account grows through employer contributions, investment earnings, and, in some cases, forfeitures (amounts from the non-vested accounts of terminated participants). Some plans may also permit employees to make contributions on a before- and/or after-tax basis.
Since the contributions, investment results, and forfeiture allocations vary year by year, the future retirement benefit cannot be predicted. The employee's retirement, death, or disability benefit is based upon the amount in his or her account at the time the distribution is payable. Employer account balances may be subject to a vesting schedule. Non-vested account balances forfeited by former employees can be used to reduce employer contributions or can be reallocated to active participants.
The maximum annual amount that may be credited to an employee's account (taking into consideration all defined contribution plans sponsored by the employer) is limited to the lesser of 100% of compensation or $54,000 in 2017.
Tax deduction limits must also be taken into consideration. Employer contributions cannot exceed 25% of the total compensation of all eligible employees. For example, a company with only one employee earning $100,000 in 2017 would have a maximum deductible employer contribution of $25,000 (25% of $100,000). However, the employee could also make an $18,000 401(k) contribution to the plan. As a result the total amount credited to his account for the year would be $43,000 (43% of his compensation), and the contributions would meet the 2017 maximum annual limit since total contributions are less than $54,000.
The profit-sharing plan is generally the most flexible qualified plan that is available. Company contributions to a profit-sharing plan are usually made on a discretionary basis. Each year the employer decides the amount, if any, to be contributed to the plan.
The contribution is usually allocated to employees in proportion to compensation. It may be allocated using a formula that is integrated with Social Security, resulting in more substantial contributions for higher-paid employees.
Amounts contributed to the plan accumulate tax deferred and are distributed to participants at retirement, after a fixed number of years or upon the occurrence of a specific event such as disability, death, or termination of employment.
Age-Weighted Profit-Sharing Plans
Profit-sharing plans may also use an age-weighted allocation formula that takes into account each employee's age and compensation. This formula results in a significantly larger allocation of the contribution to eligible employees who are closer to retirement age. Age-weighted profit-sharing plans combine the flexibility of a profit-sharing plan with the ability of a pension plan to provide benefits in favor of older employees. The age-weighted plan allows the company to contribute up to 25% of eligible payroll each year. Unlike the typical profit-sharing plan, the total contribution to an age-weighted plan is allocated based on the employee's age. The older employees will receive a higher contribution than younger employees. This plan type is favorable when the employees targeted to receive larger allocations, are both older and more highly compensated than all other employees.
More and more employees view 401(k) plans as a valuable benefit, which has made them the most popular type of retirement plan today. Employees can benefit from a 401(k) plan, even if the employer makes no contribution. Employees can voluntarily elect to make pre-tax contributions through payroll deductions up to an annual maximum limit. The plan may also permit employees age 50 and older to make additional “catch-up” contributions, up to an annual maximum limit. Employee contributions are 100% vested at all times.
The plan may also permit employees to make after-tax Roth contributions through payroll deductions instead of pre-tax contributions. Roth contributions allow an employee to receive a tax-free distribution of the contributions and the earnings on the employee’s Roth contributions if the distribution meets specific requirements.
The employer will often match some portion of the amount deferred by the employee in order to encourage greater employee participation (e.g., 25% match on the first 4% deferred by the employee). Since a 401(k) plan is a type of profit-sharing plan, profit sharing contributions may be made in addition to, or instead of, matching contributions. Many employers offer employees the opportunity to take hardship withdrawals or to borrow from the plan.
Employee and employer matching contributions are subject to special nondiscrimination tests, which limit how much the group of employees referred to as “highly compensated employees” can defer based on the amounts deferred by the “non-highly compensated employees.” In general, employees who fall into the following two categories are considered to be highly compensated employees:
- An employee who owns more than 5% of the business at any time during the current plan year or immediately preceding plan year (ownership attribution rules apply which treat an individual as owning stock owned by his or her spouse, children, grandchildren or parents); or
- An employee who received compensation in excess of the indexed limit in the preceding plan year. The employer may elect that this group is limited to the top 20% of employees based on compensation.
401(k) Safe Harbor Plans
401(k) plans require special nondiscrimination testing (ADP & ACP) which limit the deferrals of highly compensated employees to the average deferrals of the non-highly compensated employees. Quite often the passing of these tests will limit the deferrals of highly compensated employees; or will require additional contributions from the employer. The employer must provide a safe harbor notice to all employees on a timely basis. The safe harbor may be changed from plan year to plan year with appropriate notice to employees.
New Comparability Plans
New comparability plans, sometimes referred to as “cross-tested plans,” are usually profit-sharing plans that are tested for nondiscrimination as though they were defined benefit plans. By doing so, certain employees may receive much higher allocations than would be permitted by standard nondiscrimination testing. New comparability plans are generally utilized by small businesses that want to maximize contributions for owners and higher paid employees while minimizing contributions for all other eligible employees.
Employees are divided into groups based on valid business classifications, e.g., owners and non-owners. Each group may receive a different contribution percentage. For example, a higher contribution percentage may be given for the owner group than for the non-owner group, as long as the plan satisfies the nondiscrimination requirements.