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Qualified Retirement Plans

What is a Qualified Plan?

Qualified retirement plans set up by self-employed persons are sometimes called Keogh or H.R.10 plans.

The plan must be for the exclusive benefit of employees or their beneficiaries.

Qualified plans are subject to a variety of stringent rules under federal law. Some laws come under the jurisdiction of the Treasury Department and the IRS and others fall under the Department of Labor.

Deducting Plan Contributions

As an employer, you can deduct, within limits, contributions made to a qualified plan on behalf of your employees. A self-employed person can make contributions to his/her own retirement plan.

Plan contributions, earnings, and gains are tax free until distributed.

Status of sole proprietors for retirement plan purposes:

For retirement plan purposes, a sole proprietor is treated as both the employer and employee of his/her business.

This is an important distinction because what it means is, a sole proprietor can make contributions for himself/herself as an "employee" and additional contributions for himself/herself as his/her own "employer".

For income tax purposes, a sole proprietor is treated as a self-employed person. This means, a sole proprietor does not receive paychecks (like regular employees do), nor are any taxes withheld from income taken out of the business.

A sole proprietor pays estimated tax installments to cover federal income taxes and self-employment taxes (which are social security and Medicare taxes).

Partners' status for retirement plan purposes:

Like sole proprietors, partners in a partnership are also treated as employees of the partnership for retirement plan purposes.

However, unlike sole proprietors, partners are not treated as their own employers. Instead, the partnership entity is treated as the employer of its partners for retirement plan purposes.

For income tax purposes, partners are treated as self-employed persons and not employees. They do not receive paychecks, nor are any income taxes withheld from income taken out of the partnership.

Each partner pays estimated tax installments to cover federal income taxes and self-employment taxes.

Who Can Set Up a Qualified Plan

A sole proprietor and a partnership may set up a qualified plan. However, employees and partners cannot set up their own qualified plan.

Professional Assistance

Qualified plans are more complex to set up and administer than SEP or SIMPLE plans and may require additional costs for professional assistance.

For example, if you set up a defined benefit plan you'll need to pay for the services of an actuary each year to determine the annual funding requirement for the plan.

In addition, you may need a pension professional to help you...

Tip: SIMPLE 401(k) Plan - If you had 100 or fewer employees who earned $5,000 or more in compensation during the preceding year, you may be able to set up a SIMPLE 401(k) plan which is not subject to the nondiscrimination and top-heavy plan requirements. Check with a pension plan professional.

Qualification Rules for Qualified Plans

To qualify for the tax benefits available to qualified plans, a plan must meet certain requirements (qualification rules) of the tax law.

Qualification rules include:

Qualified Plan Participation Rules

In general, an employee must be allowed to participate in your plan if he or she meets both the following requirements:

  1. Has reached age 21
  2. Has at least one year of service (two years if the plan is not a 401(k) plan and provides that after not more than two years of service the employee has a nonforfeitable right to all his or her accrued benefit).

Restrictions on Conditions of Participation in Qualified Plan

The qualified plan cannot require, as a condition of participation, that an employee complete more than one year of service.

A plan cannot exclude an employee because he or she has reached a specified age.

Minimum Vesting Standards for Qualified Plans

Your plan must satisfy minimum vesting standards.

A benefit is vested when it becomes nonforfeitable. In other words, the plan participant has a fixed right to the benefit.

Next:

Qualified Plans: Two Kinds of Qualified Plans; Defined Contribution Plan; Funding Requirement for Defined Contribution Plans; Maximum Deductible Percentage for Contributions

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