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A qualified plan is an employer-sponsored employee benefit arrangement established for the purpose of providing retirement income for eligible employees. The term qualified plan means that the written document and the operation of the plan meet specific qualification requirements outlined in the Internal Revenue Code (IRC) Sec.401 (a). When a plan meets these requirements the business establishing the plan and the employees benefiting from the plan are entitled to special tax consideration.
An employer may make tax-deductible contributions to a Profit Sharing Plan. The contributions are discretionary and are usually made out of profits generated by the business (although profits are not a prerequisite). The employer is not locked into any particular contribution level from year to year, however if an employer elects to make a contribution, the same contribution percentage must be made for all eligible employees. Also, the employer must make a contribution at least once every 5 years.
The maximum tax-deductible contribution that can be made to a Profit Sharing Plan is 25% of eligible compensation up to $49,000 for 2010. Eligible compensation is total compensation paid to the eligible plan participants during the employer's tax year, including any salary deferrals. Employer contributions are not considered taxable income to employees for the year in which the contribution is made.
Unlike a Profit Sharing Plan in which the contribution level may vary from year to year, a Money Purchase Pension Plan requires the employer to contribute a fixed percentage of compensation to the plan, annually. The fixed rate of contribution can be from 0% to 25% of eligible compensation. If the employer elects a rate of 15% of pay in the plan documents, then the employer must contribute 15% of compensation for all eligible employees each and every year.
The maximum tax-deductible contribution to a Money Purchase Pension Plan is 25% of eligible compensation up to $49,000 for 2010.
Although Profit Sharing and Money Purchase Plans have the same contribution limits (due to EGTRRA 2001), a Money Purchase Pension Plan may be best suited for an employer who wants to freeze future contributions to the plan while sheltering the plan benefits from creditors' garnishment. This is accomplished with a contribution rate of 0% of eligible compensation.
Previously, the Combined Pension Plan provided an employer with the maximum flexibility benefits of the Profit Sharing Plan and the maximum contribution benefits of the Money Purchase Pension Plan under one trust account. However, with the EGTRRA tax law changes, the Money Purchase Plan may be merged into the Profit Sharing Plan; eliminating the need for the Money Purchase Plan. Employers can maximize their contribution in a Profit Sharing Plan AND retain the flexibility of choosing their contribution percentage each and every year.
A 401(k) Plan is a Profit Sharing Plan with a salary reduction plan feature known as a 401(k) contribution or Salary Deferral. It benefits both the employer and the employee. The employer may make tax-deductible contributions such as Discretionary, Matching and Safe Harbor Contributions. The employee may reduce his/her taxable wages by making 401(k) pre-tax contributions to the plan, hence, a Salary Deferral. The employee may also make Roth after-tax contributions. Our Flexible 401(k) Plan generally requires the services of a pension-service provider to perform annual compliance testing and reporting to the IRS/DOL. Below is a synopsis of the contribution types and limits:
- Safe Harbor Contribution: An example is 3% of an employee's compensation. By making a Safe Harbor Contribution, the plan generally passes the annual compliance tests.
- 401(k) Pre-tax Contributions (Salary Deferrals): An employee may defer 100% of compensation up to $16,500 for 2010.
- Catch-up Contributions: If an employee is age 50 or older, a catch-up contribution of $5,000 for 2010 may be made for a total deferral of $22,000 for 2010.
- Roth 401(k) After-tax Contributions: An employee may make after-tax Roth contributions of 100% of compensation up to $16,500 for 2010 and, if age 50 or over, a catch-up contributions of $5,500 for 2010. An employee can make both a 401(k) pre-tax and a Roth 401(k) after-tax contribution, but is limited to the same dollar limitation for the 2008 or 2010 calendar tax year.
- Employer Discretionary Contribution: The maximum the employer may contribute is 25% of eligible compensation, up to $49,000 for 2010.
- Employer Matching Contribution: An example is 100% of an employee's deferral, up to 3% of the employee's compensation.
The Individual 401(k) Plan is designed for businesses consisting solely of the owners and their spouses. The business can be a Sole-Proprietorship, Partnership and a Corporation (whether incorporated or not), but cannot have any common-law employees. The Individual 401(k) Plan consists of employer Profit Sharing contributions, in addition to owner-employee Salary Deferrals. The Profit Sharing contribution is 25% of compensation to a maximum of $49,000 for 2010. The Salary Deferral limit is 100% of compensation to a maximum of $49,000 for 2010. If a participant is age 50 or older, then a Catch-up contribution of $5,500 for 2010 may be made. The overall limit that may be allocated to a participant is 100% of compensation up to $49,000 for 2010. The catch-up contribution of $5,500 is not included in the overall limit; hence a total of $54,500 could be credited to a participant's account in one taxable year.
For example, John Doe is the sole owner and employee of John Doe, Inc., which sponsors the John Doe, Inc. Individual 401(k) Plan. John's gross compensation for 2010 is $130,000.
- John's Salary Deferral is $16,500 (100% of $130,000, up to $16,500).
- Company (Tax-Deductible) Contribution is $32,500 (25% of $130,000, up to $49,000).
- Total allocation is $49,000 ($16,500, plus $32,500) and within the overall limit of 100% of income up to $49,000.
- If John is age 50 or older, then a Catch-up contribution of $5,500 can increase his Salary Deferral to $22,000; resulting in a total allocation of $54,500 in one tax year. As an individual taxpayer, John reduces his taxable income from $130,000 to $108,000.
Please keep in mind that the percentages given here assume an incorporated business. A slight adjustment must be made for sole proprietors. For more information and calculations specific to you, please see the www.individualk.com; a website designed by our prototype plan sponsor, Ascensus Company.
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