A qualified plan can help you keep more of what you earn.
One of the most important – and popular – methods to recruit and retain quality employees and reduce business income taxes is the establishment of a qualified retirement plan. Tax-deductible qualified plans provide retirement benefits for the business owner and employees and through life insurance can provide death benefits. They give employers an edge in attracting and retaining highly qualified employees.
Plans that meet Internal Revenue Code requirements are qualified for special tax advantages, including tax deductibility of contributions to the business. Contributions are also not currently taxable to employees, and all funds within the plan accumulate on a tax-deferred basis.
Qualified plans fall into two general categories: defined contribution plans and defined benefit plans. Within each category are different plans with different provisions, allowing an employer to choose the best plan for the employer’s circumstances.
A Defined Contribution Planis a tax-qualified retirement plan in which the employer makes annual contributions on its employees’ behalf. The amount of the contribution is specified in the plan and is generally based on employee compensation. Employer contributions are tax-deductible to the employer (subject to certain limitations), accumulate tax-deferred and are not currently taxable as income to the employees (except for the economic benefit of any life insurance purchased on an employee’s behalf in an “insured” plan). At retirement, the amount available in the employee’s account is used to fund a retirement benefit. The amount of this benefit is directly affected by the performance of the plan’s underlying assets. Thus, the greater the return, the greater the retirement benefit. However, a participant’s actual benefit cannot be determined until retirement.
Some defined contribution plans offer survivor benefits to the families of participants who die after retirement. If a participant dies prior to retirement, an insured pension plan could either pay a death benefit in the form of ongoing income or in a lump sum payment to a surviving beneficiary.
Defined Benefit Plans may be an appropriate method for established businesses to provide employees with a specified level of benefits while maximizing tax deductions. Often referred to as an “employer pay-all pension,” a defined benefit plan is the only type of pension plan that provides eligible employees with a guaranteed monthly benefit at retirement (the guarantee is dependent upon the solvency of the plan and potentially the employer). The employer’s contributions to the plan must be sufficient to pay future benefits, as promised. In addition to retirement benefits, the defined benefit plan provides a survivor death benefit (as required by the IRS), and may provide larger insured death benefits, plus early retirement and disability benefits.
