What is a qualified retirement plan?

A way to save money for retirement on a tax-deferred basis. Any money you put into a qualified retirement plan is tax deductible to the business. The investment income earned on it is also tax-deferred. The employer pays no current tax on either.

What type of business can have such a plan?

Any legitimate US business can sponsor a qualified retirement plan, including corporations, S-corporations, sole proprietors, partnerships, LLC's, PS, or non-profits.

Can a person without a business have a qualified retirement plan?

No. Only a business can have a quialified retirement plan. Under current US retriement law, individuals are only permitted to have an IRA.

What's the use of saving taxes now for retirement? We get taxed on that money eventually, don't we?

Yes. But the idea is that if you save enough, early enough, most of the money you eventually pull out will come from the investment earnings and not the contributions. Example: if you put $20,000 per year into a qualified retirement plan, for 25 years, and earn just 6% on the money, you end up with $1.2 Million. And you only contributed $500,000.

Also, you are likely to be in a lower tax bracket when you retire than while you are working. You will save whatever taxes you would have owed on the $20,000 each year; and you will likely withdraw the total in small increments and ultimately pay taxes in a lower tax bracket. So you create wealth for yourself all the way around.

What kinds of retirement plans are available?

The two major types are Defined Contribution and Defined Benefit.

Read about Kinds of Qualified Retirement Plans.

Does the money have to come from the employer?

Yes. The employer owns, sponsors, and funds the plan. Personal money can't be used - unless you make a loan to the company.

By when does the contribution have to be made?

For a defined contribution plan, you have until you file the company tax return, with extensions. For most employers, that means 9 1/2 months after the end of the year. For defined benefit plans, it is 8 1/2 months.

What if I can't make the employer contribution by then?

The deadline is the deadline. For a defined contribution plan, usually employer contributions are discretionary - so you can opt not to do it. For defined benefit plans, a minimum contribution is usually required. If you don't think you'll be able to make the contribution, you can talk to your actuary about: (a) amending the plan to a lower benefit level, (b) freezing the plan, or (c) terminating the plan. These decisions need to be made before the end of the year.

NOTE - IRS literature tends to emphasize that a defined benefit plan MUST make a minimum contribution every year. In normal operation of the plan, that is true. However, as the employer who owns and operates the plan, you have almost unlimited ability to amend or freeze the plan (reducing the contribution to zero, or close to it), as long as you do it timely.

Must the plan contribution be made in cash?

In a defined contribution plan, no - you may contribute stock or other property owned by the company (not property that you personally own). You must be careful to properly value the property on the date it was contributed, as that determines the "amount" of your contribution (and hence your tax deduction). For a defined benefit plan, you must contribute cash - property contributions are not allowed.

How is the money invested?

You can open an investment account for a qualified retirement plan with most investment firms. As the plan trustee, you would make all investment decisions, or authorize your investment rep to do so for you.

Are there any limits as to how the money is invested?

Very few. You can invest in any mainstream investment, such as publicly traded stocks, bonds, or mutual funds. You can't invest in uncovered options, collectibles (such as artwork or a stamp collection), or anything whose maket value cannot be readily established. You also cannot sell anything to the plan yourself.

What about real estate?

Plan assets can be invested in real estate - although this is usually not recommended for liquidity reasons. If you have to sell a piece of property quickly in order to pay out a benefit, the plan will probably suffer a loss.

Can I take money out of the plan whenever I want to?

No. Benefit distributions are allowed upon (a) retirement, (b) termination of employment, (c) disability, (d) death, or (e) financial hardship (401k plans only). Plans can also allow loans of up to $50K per person.

IRA's charge a penalty if I take it out before age 59 1/2. Does that also apply in qualified retirement plans?

Not if the benefit is taken out at the plan's "Normal Retirement Age", which can be as low as age 55. Otherwise it does apply.

IRA's also require distributions beginning at age 70 1/2. Does that also apply to qualified plans?

Yes, the same rule applies. In a defined contribution plan, the minimum distribution is calculated the same way as in an IRA. In a defined benefit plan, you must withdraw your accrued annual benefit.

By when do I have to start such a plan to get a deduction for the year?

If you are a calendar year tax-payer, you must have signed an adoption agreement by December 31. If you pay taxes on any other basis, you have until the last day of such year.

Don't I have until April 15?

No. If you adopt a SEP (Simplifed Employee Pension), then you have until April 15, if you are a calendar year tax-payer. But for any other qualified plan, the adoption agreement must be signed by the last day of the year. No grace period.

I already have a SEP. Can I add a qualified plan as well?

Usually not, for two different reasons. (1) If you adopted the SEP through the IRS Model SEP document (Form 5305), then NO, you can't. But if you adopted it any other way, YES, you can. (2) When you have two retirement plans, combined plan limits kick in. So you may not be able to contribute to both plans anyway. If both plans are of the defined contribution type (profit sharing, 401k, SEP, or money purchase), then the combined limit is 25% of payroll. If one of the plans is a defined benefit plan, it can be a bit higher. The combined plan limits are complicated, so ask your actuary.

What regulatory requirements must I meet if I sponsor a qualified plan?

The plan must file a tax return (Form 5500) each year, once the plan assets exceed $250K. This rule also applies if you have two plans less than $250K each but the combined assets exceed $250K. If you have employees, more rules apply, such as: (1) notifying each eligible employee about the plan, (2) giving them a statement of their benefits each year, (3) paying out their benefits when due, and (4) generally notifying them of any plan changes. Defined benefit plans may also owe a small premium to the Pension Benefit Guaranty Corporation each year. Ask your actuary what else may apply in your situation.

I have no employees - but can I get a bigger contribution if I include my spouse in the plan?

Yes. Your spouse can also get a contribution if paid a wage. Even if paid no wage, $10,000 is assumed in a defined benefit plan if you are a sole proprietor.

How much can I likely contribute to a a defined benefit plan?

For a one-life plan, see our Pension Calculator.

Okay this calculator says I can contribute $150K this year - but my accountant says that's impossible!

Well...that's why your accountant is an accountant and not an actuary. Our pension calculator is accurate. The new pension funding rules, effective in 2008, allow an employer to fund up to 150% of the value of the plan benefits. For an older employee, say over age 45, that can be a huge number each year - sometimes even exceeding 100% of pay. A defined benefit plan is the largest legal tax deduction available to a small employer.

How do I sign up to open a qualiifed retirement plan?

You can do it on our webpage.

If you are ready:    Adopt A Pension Plan Now    Or:    Adopt a 401(k) Plan Now

I'd lik to do this but I still have more questions.

Call me at 919-357-2267, or email me at bmarotta@aliactuary.com


Qualified retirement plans have many limits that need to be addressed by a qualified plan specialist.  If you have any more questions about any of these issues, please contact us at ALI Actuarial & Retirement Plan Services.