Qualified Retirement Plans
A qualified plan must meet a certain set of requirements
set forth 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
- Earnings on investments accumulate tax-deferred,
allowing contributions and earnings to compound at a
- 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: A retirement
plan can help you maintain key employees and reduce
- Help employees save for their future since Social
Security retirement benefits alone will be an inadequate
source to support a reasonable lifestyle for most
- 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 benefit and a defined contribution plan may
be sponsored 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 (i.e., 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
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
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 $53,000 in 2015.
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 2015 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 2015
maximum annual limit since total contributions are less than
Profit Sharing Plans
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. For tax deduction purposes, the
company contribution cannot exceed 25% of the total
compensation of all eligible employees. The maximum eligible
compensation that can be considered for any single employee
is $265,000 in 2015.
The contribution is usually allocated to employees in
proportion to compensation and may be allocated using a
formula that is integrated with Social Security, resulting
in larger contributions for higher paid employees.
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
skew benefits in favor of older employees.
More and more employees perceive 401(k) plans as a
valuable benefit which have 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 ($18,000 in 2015).
The plan may also permit employees age 50 and older to
make additional "catch-up" contributions, up to an annual
maximum limit ($6,000 in 2015).
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 of
the earnings on the employee's Roth contributions if the
distribution meets certain 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 employer 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 (indexed
limit is $120,000 in 2015). The employer may elect that
this group be limited to the top 20% of employees based
401(k) Safe Harbor Plans:
The plan may be designed to satisfy "401(k) Safe Harbor"
requirements which can eliminate nondiscrimination testing.
The Safe Harbor requirements include certain minimum
employer contributions and 100% vesting of employer
contributions that are used to satisfy the Safe Harbor
requirements. The benefit of eliminating the testing is that
Highly Compensated Employees can defer up to the annual
limit ($18,000 in 2015) without concern for how much the
Non-Highly Compensated Employees defer.
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 separated into two or more identifiable
groups such as 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.
Defined Benefit Plans
Instead of accumulating contributions and earnings in an
individual account like defined contribution plans (profit
sharing or 401(k)), a defined benefit plan promises the
employee a specific monthly benefit payable at the
retirement age specified in the plan. Defined benefit plans
are usually funded entirely by the employer. The employer is
responsible for contributing enough funds to the plan to pay
the promised benefits, regardless of profits and earnings.
Employers that want to shelter more than the annual
defined contribution limit ($53,000 in 2015), may want to
consider a defined benefit plan since contributions can be
substantially higher, resulting in a faster accumulation of
The plan has a specific formula for determining a fixed
monthly retirement benefit. Benefits are usually based on
the employee's compensation and years of service which
rewards long term employees. Benefits may be integrated with
Social Security, which reduces the plan's benefit payments
based upon the employee's Social Security benefits. The
maximum benefit allowable is 100% of compensation (based on
the highest consecutive three-year average) to an indexed
maximum annual benefit ($210,000 in 2015). A defined benefit
plan may permit employees to elect to receive the benefit in
a form other than monthly benefits, such as a lump sum
An actuary determines yearly employer contributions based
on each employee's projected retirement benefit and
assumptions about investment performance, years until
retirement, employee turnover and life expectancy at
retirement. Employer contributions to fund the promised
benefits are mandatory. Investment gains and losses cause
employer contributions to decrease or increase. Non-vested
accrued benefits forfeited by terminating employees are used
to reduce employer contributions.
Cash Balance Plans
A cash balance plan is a type of defined benefit plan
that resembles a defined contribution plan. For this reason,
these plans are referred to as hybrid plans. A traditional
defined benefit plan promises a fixed monthly benefit at
retirement that is usually based upon a formula that takes
into account the employee's compensation and years of
service. A cash balance plan looks like a defined
contribution plan because the employee's benefit is
expressed as a hypothetical account balance instead of a
Each employee's "account" receives an annual contribution
credit, which is usually a percentage of compensation, and
an interest credit based on a guaranteed rate or some
recognized index like the 30 year Treasury rate. This
interest credit rate must be specified in the plan document.
At retirement, the employee's benefit is equal to the
hypothetical account balance which represents the sum of all
contributions and interest credits. Although the plan is
required to offer the employee the option of using the
account balance to purchase an annuity benefit, most
employees will take the cash balance and roll it over into
an individual retirement account (unlike in many traditional
defined benefit plans which do not offer lump sum payments
As in a traditional defined benefit plan, the employer
bears the investment risks and rewards in a cash balance
plan. An actuary determines the contribution to be made to
the plan, which is the sum of the contribution credits for
all employees plus the amortization of the difference
between the guaranteed interest credits and the actual
investment earnings (or losses).
Employees appreciate this design because they can see
their "accounts" grow, but they are still protected against
fluctuations in the market. In addition, a cash balance plan
is more portable than a traditional defined benefit plan
since most plans permit employees to take their cash balance
and roll it into an individual retirement account when they
terminate employment or retire.