Qualified Retirement

What is a qualified retirement plan?

There are two distinct elements embodied in the term “qualified retirement plan.” The main element is the term “retirement plan.”; A retirement plan means any plan or program maintained by an employer or an employee organization (or both) that (1) provides retirement income to employees or (2) results in a deferral of income by employees for periods extending generally to the end of employment or beyond, regardless of how plan contributions or benefits are calculated or how benefits are distributed. [ERISA § 3 (2)] 

The other element is the term “qualified,” which means that the retirement plan is afforded special tax treatment for meeting a host of requirements of the Internal Revenue Code (the Code).  Qualified retirement plans fall into two basic categories: defined contribution plans and defined benefit plans.  A defined contribution plan provides benefits based on the amount contributed to an employee’s individual account, plus any earnings and forfeitures of other employees that are allocated to the account.  A defined benefit plan provides a definitely determinable annual benefit; that is, the benefits are determined on the basis of a formula contained in the plan. 

Defined contribution plan
A defined contribution plan is a retirement plan that “provides an individual account for each participant and for benefits based solely upon the amount contributed to the participant’s account, and any income, expenses, gains and losses, and any forfeitures of accounts of other participants which may be allocated to such participant’s account.”  [ERISA § 3(34); IRC § 414(i)] 

Profit sharing plan
A profit sharing plan is a defined contribution plan to which the company agrees to make “substantial and recurring”, although generally discretionary, contributions.  Amounts contributed to the plan are invested and accumulate (tax-free) for eventual distribution to participants or their beneficiaries either at retirement, after a fixed number of years, or upon the occurrence of some specified event (e.g., disability, death, or termination of employment). 

Unlike contributions to a pension plan, contributions to a profit sharing plan are usually keyed to the existence of profits.  However, neither current nor accumulated profits are required for a company to contribute to a profit sharing plan.  [IRC § 401(a)(27)] 

Even if the company has profits, it can generally forgo or limit its contribution for a particular year if the plan contains a discretionary formula. 

Money purchase pension plan
A money purchase pension plan is a defined contribution plan in which the company’s contributions are mandatory and are usually based solely on each participant’s compensation. 

The obligation to fund the plan makes a money purchase pension plan different from most profit sharing plans.  In most profit sharing plans, there are generally no unfavorable consequences for the company if it fails to make a contribution.  However, if the company maintains a money purchase pension plan, its failure to make a contribution can result in the imposition of a penalty tax.  Contributions must be made to a money purchase pension plan even if the company has no profits.  With the increase in the primary limitation on tax-deductible contributions to a profit sharing plan from 15% to 25% of total compensation, there appears to be little reason for an employer to adopt or continue to maintain a money purchase pension plan. 

Forfeitures that occur because of employee turnover may reduce future contributions of the company or may be used to increase the benefits of remaining participants. 

Retirement benefits are based on the amount in the participant’s account at the time of retirement, that is, whatever pension the money can purchase. 

401(k) plan
A 401(k) plan is a qualified profit sharing or stock bonus plan that offers participants an election to receive company contributions in cash or to have these amounts contributed to the plan.  A participant in a 401(k) plan does not have to include in income any company contributions to the plan merely because an election could have been made to receive cash instead.  [IRC §§ 401(k) (2), 402(a)(8)] 

A 401(k) plan may also be in the form of a salary reduction agreement.  Under this type of arrangement, each eligible employee may elect to reduce current compensation or elect to forgo a salary increase and have these amounts contributed to the plan.  [Treas Reg § 1.401(k)-1(a)(3)(i)] 

Benefits attributable to employer contributions to a 401(k) plan generally may not be distributed without penalty until the employee retires, becomes disabled, dies, or reaches age 59 1/2.  Contributions made by the employer to the plan at the employee’s election are nonforfeitable (i.e., 100% vesting is required at all times). 

Defined benefit plan
A defined benefit plan is a retirement plan “other than an individual account plan.”  In other words, a plan that is not a defined contribution plan is classified as a defined benefit plan.  Under a defined benefit plan, retirement benefits must be definitely determinable.  For example, a plan that entitles a participant to a monthly pension for life equal to 30 percent of monthly compensation is a defined benefit plan.  [ERISA § 3(35); IRC § 414(j)]  The most common types of defined benefit plans are flat benefit plans and unit benefit plans. 

If a plan is categorized as a defined benefit plan:  (1) plan formulas are geared to retirement benefits and not to contributions (except for cash balance plans); (2) the annual contribution is usually actuarially determined; (3) certain benefits may be insured by PBGC; (4) early termination of the plan is subject to special rules; and (5) forfeitures reduce the company’s cost of providing retirement benefits. 

Hybrid plan
Plans that use features of a Defined Benefit and Defined Contribution to achieve a specific result. 

Miscellaneous Information
Cost of Living Increases (10/18/2006) 

Here are some of the plan limits as adjusted for cost-of-living increases.

Retirement Administration Fees

The above fees cover the following: 

• Standardized Prototype Documents (Adoption Agreement, Plan Document and Summary Plan Description)
• Annual Reports and Related Schedules
• Quarterly Reports
• Testing
• Vesting Calculations
• Assistance with Eligibility and Contribution Calculations
• Distribution Calculations
• Toll Free Customer Assistance

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* The above fees are current but subject to change 

The financial services are intended to serve as a basis for further discussion with your other professional advisors.  The actual application of some of these concepts may be the practice of law, and is the proper responsibility of your attorney.