The qualified plan rules are more
complex than the SEP plan and SIMPLE plan rules. However, there are
advantages to qualified plans, such as increased flexibility in designing
plans and increased contribution and deduction limits in some cases.
There are two basic kinds of qualified plans—defined
contribution plans and defined benefit plans—and different rules apply to
each. You can have more than one qualified plan, but your contributions to
all the plans must not total more than the overall limits.
Defined Contribution Plan
A defined contribution plan provides an individual account
for each participant in the plan. It provides benefits to a participant
largely based on the amount contributed to that participant's account.
Benefits are also affected by any income, expenses, gains, losses, and
forfeitures of other accounts that may be allocated to an account. A defined
contribution plan can be either a profit-sharing plan or a money purchase
pension plan.
Profit-sharing
plan. A
profit-sharing plan is a plan for sharing your business profits with your
employees. However, you do not have to make contributions out of net profits
to have a profit-sharing plan.
The plan does not need to provide a definite formula for
figuring the profits to be shared. But, if there is no formula, there must
be systematic and substantial contributions.
Forfeitures under a profit-sharing plan can be allocated
to the accounts of remaining participants in a nondiscriminatory way or they
can be used to reduce your contributions
Money purchase
pension plan. Contributions to a money purchase pension plan are fixed and are not based
on your business profits. For example, if the plan requires that
contributions be 10% of the participants' compensation without regard to
whether you have profits (or the self-employed person has earned income),
the plan is a money purchase pension plan. This applies even though the
compensation of a self-employed individual as a participant is based on
earned income derived from business profits.
Setting Up a Qualified Plan
There are two basic steps in setting up a qualified plan.
First you adopt a written plan. Then you invest the plan assets.
You, the employer, are responsible for setting up and
maintaining the plan.
If you are self-employed, it is not necessary to have
employees besides yourself to sponsor and set up a qualified plan.
Set-up deadline. To take a deduction for contributions for a tax year, your plan
must be set up (adopted) by the last day of that year (December 31 for
calendar year employers).
Minimum Funding Requirement
In general, if your plan is a money purchase pension plan
or a defined benefit plan, you must actually pay enough into the plan to
satisfy the minimum funding standard for each year. Determining the amount
needed to satisfy the minimum funding standard for a defined benefit plan is
complicated. The amount is based on what should be contributed under the
plan formula using actuarial assumptions and formulas.
A qualified plan is generally funded by your
contributions. However, employees participating in the plan may be permitted
to make contributions.
Self-employed
individual. You can make contributions on behalf of yourself only if you have net
earnings (compensation) from self-employment in the trade or business for
which the plan was set up. Your net earnings must be from your personal
services, not from your investments. If you have a net loss from
self-employment, you cannot make contributions for yourself for the year,
even if you can contribute for common-law employees based on their
compensation.
Limits on Contributions and
Benefits
Your plan must provide that contributions or benefits
cannot exceed certain limits. The limits differ depending on whether your
plan is a defined contribution plan or a defined benefit plan.
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