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Qualified Plans

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Two Kinds of Qualified Plans

Qualified plans can be set up as either:

A defined contribution plan, or
A defined benefit plan

Defined Contribution Plan

No specific benefit amount is promised:

Unlike a defined benefit plan, which promises a specific benefit amount at retirement (e.g., $3,000 per month), a defined contribution plan does not promise a specific benefit amount at retirement.

With a defined contribution plan, the benefit you ultimately receive at retirement depends on:

Contributions made to the plan plus
Earnings and gains on plan assets, minus
Losses and expenses incurred by the plan

A defined contribution plan can be either:

A Money Purchase Pension Plan, or
A Profit-Sharing Plan

1) Money Purchase Pension Plan:

Under a money purchase pension plan:

Contributions are fixed.
Contributions are based on compensation, regardless of business profits.

For example, if the plan calls for contributions of 10% of a participant's compensation, you must make those contributions without regard to whether you have a profit or loss.

Self-employed persons (sole proprietors and partners):

You, as a self-employed person, can only make contributions for yourself to a qualified plan if you have net earnings from self-employment in the business for which the plan was set up.

For a sole proprietor, net earnings from self-employment is net profit on Schedule C (or Schedule F) minus one-half of your self-employment tax liability, figured on Schedule SE and deducted on Form 1040, line 27 (2011).

Each partner must also reduce his/her share of partnership earnings (from Schedule K-1) by one-half of his/her self-employment tax liability.

2) Profit-Sharing Plan:

Under a profit-sharing plan:

Contributions are geared toward profits; it is a plan for sharing business profits with your employees.
- However, you do not have to actually make contributions out of profits to have a profit-sharing plan.
The plan does not need to provide a definite formula for figuring the profits to be shared.
- However, if their is a formula, there must be systematic and substantial contributions.
There must be a definite formula for:
- Allocating the contributions among the participants and
- Distributing the accumulated funds to the employees after they reach a certain age, after a fixed number of years, or upon certain other occurrences.

Funding Requirement for Defined Contribution Plans

If your plan is a money purchase plan or defined benefit plan, you must pay enough into the plan to satisfy the minimum funding standard for each year.

Maximum Deductible Percentage for Contributions to Defined Contribution Plans

The maximum deductible percentage for contributions (other than elective deferrals) to your own and your employee's profit-sharing, money-purchase, or SEP is:

20% for yourself, as a self-employed person, and
25% of the compensation paid (or accrued) during the year to your eligible employees participating in the plan.

The following rules apply when figuring the deduction limit:

Elective deferrals:
- These are employee contributions deducted from each employee's gross compensation.
Compensation:
- Includes elective deferrals.
Maximum compensation:
- The maximum compensation that can be taken into account for each employee in figuring his/her deductible contribution limit is $245,000 for tax year 2010 and 2011.

Qualified Plans: Defined Benefit Plan; Funding Requirement for Defined Benefit Plans; Annual Benefit Limit Under a Defined Benefit Plan

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