One
of the most important and meaningful benefits an employer can offer is a retirement
plan. This is true whether the employer is a large corporation or a small business.
Retirement plans allow business owners and employees to save money in tax-deferred
accounts, delaying income tax payments until funds are withdrawn at some future
date. In many cases, a qualified retirement plan is the most appropriate type
of plan. Many types of qualified retirement plans exist, including defined contribution
plans (money purchase, target benefit, profit sharing, Keogh) and defined benefit
plans. These various plans will be covered in greater detail in future weeks.
Qualified
vs. Non-Qualified Retirement Plan
A
qualified retirement plan (QRP) receives tax benefits not available to a non-qualified
plan, but is subject to very strict government regulations. The employer receives
a deduction when contributions are made to the plan. At least 70% of non-highly
compensated employees must be covered by the plan, and government-set vesting
schedules must be followed. Earnings accumulate tax-deferred and will be taxable
to the individual at the time of distribution. No income tax deduction is available
for the employer at the time of distribution. Independent contractors or directors
are not eligible for coverage under a QRP.
Non-qualified
retirement plans receive fewer tax benefits, but are not subject to as many government
regulations. Most of the time, non-qualified retirement plans are designed for
executives or key employees, and not for a broader group of employees. Benefits
provided to employees can go beyond the limits allowed in qualified plans. Any
earnings within the plan currently will be taxable to the employer, and taxable
to the employee when distributed as benefits. However, the employer will be entitled
to an income tax deduction at the time of distribution. Independent contractors
and directors are eligible for coverage under a non-qualified retirement plan,
unlike a QRP.
Benefits
of Qualified Retirement Plans
-
Any
time a contribution is made to a plan, contributions must be made on all participants'
behalf. (This could also be considered a drawback for employers.)
-
All contributions are tax deductible
to the employer for the year the contribution is made.
-
In certain plans, annual contributions
do not have to be made to the plan by the employer. (Although for profit sharing
plans, contributions must be "substantial and recurring" or the IRS
may deem the plan as terminated.)
-
Earnings
on any investment within the plan are tax-exempt to the employer, and tax-deferred
to the employee.
-
Hardship
loans are available in most plans.
-
Contribution
limits are considerably higher in a QRP than in an IRA.
Drawbacks
of Qualified Retirement Plans
-
In
certain plans, annual contributions are required to be made whether or not the
employer is profitable.
-
In
most plans, benefits are not guaranteed.
-
Plan
participants face a 10% withdrawal penalty if distributions occur before the participant
reaches age 59½ (age 55, in some cases.)
-
Administration costs can be considerably higher in a QRP than in other retirement
plans, such as a SEP.
Reasons
for Different Types of Plans
Why
do so many types of plans exist? Each different plan is designed to accomplish
different employer objectives. Some plans are designed primarily to benefit key
employees or business owners, while others are designed as an incentive to rank-and-file
employees. Some plans are designed to provide a guaranteed benefit, while most
provide a benefit that is determined by the performance of the investments within
the plan. Some plans require an annual contribution by the employer. Some plans,
such as a defined benefit plan, generally have higher administration costs than
other types of plans, but provide more targeted benefits. Some plans, such as
a 401(k) plan, allow employees to make individual investment choices. Other plans,
such as profit sharing plans, often do not allow employees to determine how funds
are invested.
It is
important to make sure the type of plan chosen meets the objectives of the employer.
In the coming weeks, we will cover these various types of qualified plans, and
discuss the benefits and drawbacks of each.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing.
