What is a Qualified Retirement Plan?

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A qualified plan is a retirement plan that meets tax law tests, such a discrimination tests, and allows for tax deferment and tax-free accumulation of income until benefits are withdrawn.

When benefits are withdrawn they are included in income and are subject to income taxes.

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, while others fall under the Department of Labor. The law and regulations applicable to retirement plans change frequewntly. The company's plan document and determination letter, if applicable, must be kept up to date.

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.

Who Can Set Up a Qualified Plan?

If you are self-employed, it is not necessary to have employees besides yourself to sponsor and set up a qualified plan. Corporations and partnerships may also set up a qualified plan.

There are two basic steps in setting up a qualified plan.

  1. First you adopt a written plan
  2. Then you invest the plan assets

A One-Participant 401(k) Plan

A one-participant 401(k) plan is sometimes referred to as a solo-401(k), individual 401(k), or uni-401(k). It is generally the same as other 401(k) plans, but because there are no employees who work for the business, otherthan your spouse, it is exempt from discrimination testing.

What is the Tax Benefit of a QualifiedPlan?

The benefit of a qualified retirement plan is that contributions, plan earnings and gains are tax-free until distributed.

Employer Deduction for Plan Contributions

If you set up a qualified retirement plan for your employees, you may deduct, within limits, the contributions you make to the plan on their behalf.

Employment Status of Self-Employed Persons for Retirement Plan Purposes

Normally, for income tax purposes, a self-employed person, such as a sole proprietor (a Schedule C filer) or partner in a general partnership, is not treated as an employee of his own business.

However, for retirement plan purposes a self-employed person is treated as an employee of his own business and therefore, retirement plan rules that apply to regular employees also apply to self-employed persons. In other words, for retirement plan purposes, a self-employed person is treated as both employer and employee of his own business.

This is an important distinction. It means a sole proprietor may make contributions for himself as an employee and additional contributions for himself as his own employer, resulting in a substantially greater contribution amount.

Note Self-employed persons do not get a paycheck or receive a W-2 at year end. If a self-employed person takes funds out of the business for personal use, no taxes are withheld from those funds. A withdrawal of funds for personal use is treated as a reduction of capital and not an expense. To keep track of owner-withdrawals, a Draw account is used and is included in the capital (equity) section of the balance sheet.

Self-employed persons pay quarterly estimated tax installments to cover federal income taxes and self-employment taxes (which are social security and Medicare taxes).

On the other hand, for retirement plan purposes, an exception is made regarding the employment status of a sole proprietor. For retirement plan purposes, a sole proprietor is treated as both employer and employee of his own business.

Partners' Status for Retirement Plan Purposes

Like sole proprietors, partners are also treated as self-employed persons for federal income tax purposes. However, for retirement plan purposes, partners are treated as employees of the partnership and the the partnership entity is treated as the employer of each partner..

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, which is a plan that pays fixed benefits based on actuarial projections, you'll need to pay for the services of an actuary. An actuary determines the annual funding requirement for the plan, which is designed to ensure that retirees receive their expected benefits.

An actuary analyzes the financial consequences of risk. Actuaries use mathematics, statistics, and financial theory to study uncertain future events, especially those of concern to insurance and pension programs

In addition, you may need a pension professional to help you comply with the variety of rules governing qualified plans. For example, nondiscrimination rules, top-heavy rules, coverage rules, and participation rules. You may also need professional help to amend the plan to reflect changes in the law when they occur.

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:

  • Nondiscrimination in coverage, contributions, and benefits.
  • Minimum age and service requirements.
  • Minimum vesting standard
  • Limits on contributions and benefits.
  • Top-heavy plan requirements.

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:

  • Has reached age 21
  • 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. And a plan cannot exclude an employee because he 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.

File your personal and small business taxes (Schedule C)