|No matter what type of business you have, 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. |
Below is general information about the most popular types of qualified retirement programs. Our consultants will help you choose the plan that is best for you.
Qualified Retirement Plans
A qualifed plan must meet certain requirements in the Internal Revenue Code such as minimum participation, vesting and funding requirements. In return, the IRS provides significant tax advantages to encourage businesses to establish retirement plans including:
In addition, sponsoring a qualified retirement plan has the following advantages:
- Employer contributions to the plan are tax deductible
- Earnings on investments accumulate tax-deferred which allows contributions and earnings to compound at a faster rate
- Employees are not taxed on the contributions or earnings until they receive the funds
- Employees may make pre-tax contributions to certain types of plans
- Ongoing plan expenses are tax deductible
Employers can choose between two basic types of retirement plans - Define Contribution and Defined Benefit. Both a Defined Contribution and Defined Benefit Plan may be sponsored to maximize benefits. Our consultants can help you choose the right plan for your company. Below are descriptions of the types of plans that are available.
- Attract experienced employees in a very competitive job market. Retirement plans are fast becoming a key part of the total compensation package.
- Retain and motivate good employees. A retirement plan has the ability to keep employees from moving over to your competitors
- Help employees save for their since Social Security retirement benefits alone will be inadequate source to support a reasonable lifestyle for most retirees.
- Plan assets are protected from creditors.
Defined Contribution Plans
Defined Contribution Plans define the contributions the company will make to the plan and how the contributions will be allocated among eligible employees. Employees have separate accounts that grow through employer contributions, investment earnings and, in some cases, forfeitures (amounts from the non-vested accounts of terminated participants). Some plans also permit employees to make contributions on a before and/or after-tax basis. With changes in the market, contribution amounts and forfeiture allocations, the future retirement benefit cannot be predicted. The employees retirement, death or disability benefit is based on the amoun in his account at the time the distribution is payable.
Employer account balances may be subject to a vesting schedule. Non-vested account blances forfeited by terminated employees can be used by the employer to reduce employer contributions or be reallocated to active participants.
The maximum annual amount that may be credited to an employee's account is limited to the lesser of 100% of compensation or $50,000 for 2012. The maximum employer tax deduction limit must also be taken into consideration. Contributions made by the employer cannot exceed 25% of the total compensation for all eligible employees. For example a company with one employee earning $100,000 in 2012 would be able to contribute a maximum of $25,000 (25% of $100,000) in employer contributions, the employee could also make a $17,000 in employee contributions. For the year, his total contribution amount would be $42,000. He would satisfy the maximum annual limit since his total contributions are less than the $50,000 allowed. If the employee is age 50, or older, he can contribute an additional $5,500 in Catch-Up Contributions. This would bring his total contribution for 2012 to $47,500, still satisfying the maximum annual limit.
Profit Sharing Plans
One of the most flexible qualified plans available are Profit Sharing Plans. Contributions to a Profit Sharing Plan are generally made on a discretionary basis by the employer. Annually, the employer, determines the amount, if any, to be contributed to the plan. To company contribution cannot exceed 25% of the total compensation of all eligible employees, for tax deduction purposes.
Contributions are usually allocated to employees in proportion to compensation and may be integrated with Social Security which results in larger Profit Sharing contributions for higher paid employees.
Age-Weighted Profit Sharing Plans: Age-weighted allocation formulas may be used as well. This takes into account each employee's age and compensation. Employees that are closer to retirement age will be allocated a significantly larger contribution amount. Age-Weighted Profit Sharing Plans combine flexibility of Profit Sharing Plans with the ability to benefit in favor of older employees.
The most popular retirement plans today are 401(k) Plans. Even if the employer decides to make no contributions to the plan employees can elect to make pre-tax contributions through payroll deductions, up to an annual maximum limit of $17,000 for 2012. The plan may also allow employees over the age of 50 to make additional "catch-up contibutions," up to an annual maximum limit of $5,500 for 2012.
Often, in order to encourage employee participation, employers will match a portion of the amount deferred by employees. For example, 100% match of the first 3% deferred by the employee. 401(k) Plans are also a type of Profit Sharing Plan, so profit sharing contributions may be made in addition to, or instead of, matching contributions. Employers may also offer employees the opportunity to borrow from the plan or take hardship withdrawals, in eligible circumstances.
Employee and employer matching contributions are subject to special nondiscrimination testing which limits how much "Highly Compensated Employees" can defer based on the amount deferred by "Non-Highly Compensated Employees." Generally employees that fall into the following categories are considered Highly Compensated Employees:
- More than 5% owner of the employer at any time during the current plan year, or preceeding plan year. Stock attribution rules apply, which treat an individual as owning stock owned by a souse, children, grandchildren or parents.
401(k) Safe Harbor Plans: Plans may be designed to satisfy "401(k) Safe Harbor" requirements, which can eliminate nondiscrimination testing. Eliminating the testing allows Highly Compensated Employees to defer up to the annual limit of $17,000 for 2012, without concern of what Non-Highly Compensated Employees defer.
- An employee that earned compensation in excess of the limited amount in the preceeding plan year ($115,000 for 2012). The employer may decide that this group be limited to the top 20% of employees based on compensation.
New Comparability Plans
Referred to as "Cross-Tested Plans," these plans, are usually Profit Sharing Plans that are tested for nondiscrimination, as though they were Defined Benefit Plans. In doing so, certain employees may receive higher allocation than would be permitted by standard nondiscrimination testing. These plans are generally used by small businesses that want to maximize contributions to owners and higher paid emloyees while minimizing those for all other employees. Employees are separated into two or more groups, such as owners and non owners. Each group may receive different contribution percentages. For example, the owner group may be given a higher contribution amount than those in the non-owner group, as long as the plan meets the nondiscrimination requirements.
Money Purchase Pension Plans
Money Purchase Plans and Profit Sharing Plans operate alike. The major difference is, the employer has a set contribution rate which is stated in the Plan Document, unlike Profit Sharing Plans where the employer makes a discretionary contribution annually. Regardless of the employers profits, this contribution must be made. If the contribution is not made, the employer is subject to penalties.
Contributions are usually based on a fixed percentage of each employees compensation. The company contribution amount cannot exceed 25% of compensation to a maximum limit of $50,000 in 2011, for tax deduction purposes. Higher paid employees will result in larger contributions if Social Security and contributions are integrated.