A qualified retirement plan is an employer‑sponsored plan that provides tax‑favored retirement savings. These plans follow specific rules for contributions, participation, and benefits. Employers may deduct contributions made to the plan, and employees may receive benefits through employer contributions, elective deferrals, or both. A qualified plan for a self‑employed individual is often called a Keogh plan.
Qualified plans include profit‑sharing plans, money purchase pension plans, defined benefit plans, and 401(k) plans. These plans offer higher contribution limits and more design flexibility than SEP or SIMPLE plans.
Defined Contribution Plans
A defined contribution plan maintains an individual account for each participant. Benefits depend on contributions, investment performance, and allocations of gains, losses, and forfeitures.
Types include:
Profit‑Sharing Plan (PSP)
- Discretionary employer contributions
- Employer is not required to make a profit to contribute
- Must include a formula for allocating contributions and distributing benefits
Money Purchase Pension Plan (MPPP)
- Fixed employer contributions
- Contribution rate is stated in the plan (e.g., 10% of compensation)
- Contributions are required regardless of business profits
Defined Benefit Plans
A defined benefit plan promises a specific benefit at retirement. Contributions are based on actuarial calculations needed to fund the promised benefit. These plans require ongoing professional administration due to actuarial assumptions and funding rules.
Qualified Plan Requirements
To operate as a qualified plan, the plan must meet several requirements:
- Written plan document
- Exclusive benefit rule
- Coverage requirements: must cover the lesser of 50 employees or the greater of 40% of employees or two employees
- Nondiscrimination rules
- Minimum vesting standards
- Participation rules:
- Age 21
- One year of service (1,000‑hour rule)
- Some plans may require two years of service if immediate vesting applies
- Part‑time rule: employees with at least 500 hours for three consecutive years must be allowed to participate in certain plans
Establishing a Plan
A plan must be established by the due date of the employer’s tax return, including extensions. Defined benefit plans should not be established after the minimum funding deadline.
Minimum Funding Requirement
For MPPPs and defined benefit plans:
- Required contributions must meet the minimum funding standard
- Quarterly installments may be required
- Installments are due 15 days after each quarter
- Full required contributions must be made within 8.5 months after year‑end
Contributions
Employer contributions generally fund the plan. Some plans allow employee contributions through elective deferrals. Elective deferrals and PSP employer contributions must be made by the employer’s tax return due date, including extensions.
Contribution and Benefit Limits
Defined Benefit Plans
Annual benefits cannot exceed the lesser of:
- 100% of the participant’s highest three‑year average compensation, or
- The annual defined‑benefit limit
Defined Contribution Plans
Annual additions (employer contributions + employee contributions + forfeitures) cannot exceed the lesser of:
- 100% of compensation, or
- The annual defined‑contribution limit
401(k) Elective Deferrals
A 401(k) plan allows employees to defer part of their compensation into the plan.
Key rules:
- Elective deferral limit applies to all salary‑reduction contributions
- Deferrals are excluded from taxable income
- Catch‑up contributions allowed for participants age 50+
- Higher catch‑up contributions allowed for ages 60–63
Participation cannot require more than one year of service or 500 hours for three consecutive years.
401(k) Employer Contributions
Employers may make:
- Matching contributions
- Nonelective contributions
Compensation above the annual compensation limit cannot be used to calculate employer contributions.
Roth Contributions
A plan may allow employees to designate elective deferrals as Roth contributions. These contributions:
- Use after‑tax compensation
- Are included in taxable income
- Must be kept in a separate Roth account
Some plans also allow Roth treatment of nonelective or matching contributions.
Employer Deduction Limits
Defined Contribution Plans
Employer deductions cannot exceed 25% of total eligible compensation. Elective deferrals do not count toward this limit.
Defined Benefit Plans
Deduction limits depend on actuarial calculations.
Reporting on Wage Statements
- Employer contributions are not included in taxable wages
- Elective deferrals are excluded from taxable wages but included in Social Security and Medicare wages
- Roth contributions are included in taxable wages
- Retirement plan participation must be indicated on the wage statement
Loans
A qualified plan may allow participant loans. Maximum loan amount is the greater of:
- $10,000, or
- 50% of vested account balance, up to $50,000
Repayment rules:
- Must be repaid within 5 years (longer for a principal residence)
- Level payments at least quarterly
- Failure to repay results in a taxable distribution
Prohibited Transactions
Prohibited transactions involve improper use of plan assets by a disqualified person.
Examples:
- Using plan assets for personal benefit
- Self‑dealing by fiduciaries
- Selling, leasing, or lending between the plan and a disqualified person
A disqualified person includes fiduciaries, service providers, employers, certain owners, and family members.
Penalties include an initial tax and an additional tax if not corrected.
Reporting Requirements
Plans must file an annual return:
- Form 5500‑SF for small plans meeting simplified criteria
- Form 5500‑EZ for one‑participant plans
- Form 5500 for all other plans
One‑participant plans with assets of $250,000 or less do not need to file annually except for the final year.