What Are the Types of Qualified Retirement Plans?

The most common types of qualified plans are the following:

• 401(k) plans
• Profit sharing plans
• Money purchase pension plans
• Defined benefit pension plans
• ESOPs
• New comparability plans

401(k) Plans

Today, 401(k) plans are the fastest growing type of retirement plan. A 401(k) plan allows employees to set aside a percentage of their income, before taxes, into a retirement plan that offers various investment options. Typically, the participating employees direct the investment of their contributions. The money in the plan is allowed to grow and compound tax-deferred until withdrawn, usually at retirement. The name 401(k) comes from the section of the Internal Revenue Code that defines the plan.

Important facts about 401(k) plans:

• The sponsoring employer has the option of matching a portion of the employee's contribution and may establish a vesting schedule for the company match portion of the account.
• Participant deferral contributions are always 100% vested.
• The sponsoring employer has the option of limiting eligibility for the plan.
• Social Security benefits are still based on the participant's full pay.
• Participant deferrals may reduce the amount of contributions the employer is required to make to maximize benefits for key employees.
• Daily valuation information for accounts is available. back to top

Profit Sharing Plans

A profit sharing plan is one of the most flexible of all qualified retirement plans. In a profit sharing plan, the employer makes annual contributions of between 0-15% of earned income to each plan participant. All contributions to the plan and investment earnings compound tax-deferred until withdrawn at retirement.

Important facts about profit sharing plans:

• Profits are no longer required to make a contribution to the plan.
• The sponsoring employer may adopt a discretionary profit sharing contribution formula, which allows the employer to forego, limit, or increase contributions based on company performance.
• Contributions to a profit sharing plan are deductible for Federal and, in most cases, state income tax purposes (up to the allowable limit), which can reduce the company's tax burden. back to top

Money Purchase Pension Plans

A money purchase pension plan allows the sponsoring employer to make annual contributions that are larger than those allowed with other plans. It operates much like a profit sharing plan, except that the employer is required to contribute the same, fixed percentage of employees' salaries each year. Employers may contribute up to 25% of earned income each year. All contributions to a money purchase pension plan compound tax-deferred until withdrawn at retirement.

Important facts about money purchase pension plans:

• The benefit of the higher contribution limit must be weighed against the fact that, once the contribution level is selected, it is fixed. That is, annual contributions must be made at that level.
• Contributions to a money purchase pension plan are deductible for Federal and, in most cases, state income tax purposes (up to the allowable limit), which can reduce the company's tax burden.back to top

Defined Benefit Pension Plans

Defined benefits pension plans represent a "traditional" pension plan and are one of the most complex of all qualified retirement plans. Suited for older business owners, a defined benefit pension plan is a pension plan for which the benefits are first defined and then the annual employer contributions needed to provide those benefits are actuarially determined. Defined benefit pension plans must be carefully designed and administered. Sophisticated actuarial calculations are required to determine a benefit formula that is consistent with the employer's objectives and budget.

Important facts about defined benefit pension plans:

• Forfeitures and investment gains reduce the employer's cost of providing benefits.
• Plan administration and compliance requirements must be assigned and monitored to avoid mistakes that could result in plan disqualification by the IRS.
• Defined benefit pension plans are regaining popularity with aging baby-boomers. back to top

ESOPs

An ESOP, or Employee Stock Ownership Plan, is a unique qualified retirement plan that makes the employees of a company owners of stock in that company. An ESOP is the only qualified retirement plan that is required by law to invest primarily in the securities of the sponsoring employer. An ESOP allows the employer to use either cash or employer securities for the company's contributions. ESOPs can be used as an employee benefit or incentive plan, as an estate-planning tool, or to provide a market for the stock of controlling shareholders in a closely held corporation.

Important facts about ESOPs:

• Research has shown that giving workers a significant stake in their companies through an ESOP can improve employee attitudes and increase productivity.
• Contributions to an ESOP are deductible for Federal and, in most cases, state income tax purposes (up to the allowable limit), which can reduce the company's tax burden.
• When employer securities are contributed directly, the employer may take a tax deduction (up to the contribution limits) for the full value of the stock contributed, which can increase the company's cash profits by the value of the taxes saved through the deduction.
• An ESOP is unique among qualified retirement plans in its ability to borrow money, which allows leveraged ESOPs to be used as a technique of corporate finance. back to top

New Comparability Plans

Important facts about new comparability plans:

• New comparability plans are often more advantageous to the employer than age-based or integrated plans.
• To be effective, these plans require an HCE group that is generally older than the NHCE group. back to top