2. Self Employed Plans (HR 10 or Keogh Plans)
HR-10 or Keogh plans make it possible for self-employed persons to be covered under an IRS qualified retirement plan. These plans allow the self-employed individuals to fund their retirement programs with pre-tax dollars as if under a corporate retirement or pension plan. To be covered under a Keogh retirement plan, the person must be self-employed or a partner working part time or full time who owns at least 10% of the business.
Contribution limits are the lesser of an established dollar limit or 100% of their total earned income. The contribution is tax deductible, and it accumulates tax deferred until withdrawal.
Upon a participant's death, payouts can be available immediately. If a participant becomes disabled, he or she may collect benefits immediately or the funds can be left to accumulate. When a participant enters retirement, distribution of funds must occur no earlier than 59½ and no later than 70½. If withdrawn before 59½, there is a 10% penalty. At any time payments may be discontinued with no penalty, and funds can be left to accumulate.
Under eligibility requirements, any individual who is at least 21 years of age, has worked for a self-employed person for one year or more, and worked at least 1,000 hours per year (full time) must be included in the Keogh Plan. The employer must contribute the same percentage of funds into the employee’s retirement account as he/she contributes into his/her own account.
3. Simplified Employee Pensions (SEPs)
A Simplified Employee Pension (SEP) is a type of qualified plan suited for the small employer or for the self-employed. In a SEP, an employee establishes and maintains an individual retirement account to which the employer contributes. Employer contributions are not included in the employee’s gross income. The primary difference between a SEP and an IRA is the much larger amount that can be contributed each year to a SEP (an IRS established annual dollar limit or 25% of the employee’s compensation, whichever is less).
4. SIMPLE Plans
A SIMPLE (Savings Incentive Match Plan for Employees) plan is available to small businesses that employ no more than 100 employees who receive at least $5,000 in compensation from the employer during the previous year. To establish a SIMPLE plan, the employer must not have a qualified plan already in place. Employees who elect to participate may defer up to a specified amount each year, and the employer then makes a matching contribution, dollar for dollar, up to an amount equal to 3% of the employee's annual compensation. Taxation is deferred on both contributions and earnings until funds are withdrawn.
5. Profit Sharing and 401(k) Plans
Profit-sharing plans are qualified plans where a portion of the company's profit is contributed to the plan and shared with employees. If the plan does not provide a definite formula for figuring the profits to be shared, employer contributions must be systematic and substantial.
A 401(k) qualified retirement plan allows employees to take a reduction in their current salaries by deferring amounts into a retirement plan. The company can also match the employee's contribution, whether it is dollar for dollar or on a percentage basis.
Under a 401(k) plan, participants may choose to do one of the following:
- Receive taxable cash compensation; or
- Have the money contributed into the 401(k), in cash or deferred arrangement plans (CODA).
Contributions into the plan are excluded from the individual employee's gross income up to a specified dollar amount. The ceiling amount is adjusted annually for inflation. The plan allows participants age 50 or over to make additional catch-up contributions (up to a limit) at the end of the calendar year.
A 401(k) plan may be arranged as:
- Pure salary reduction plan;
- Bonus plan; or
- Thrift plan.
Under the bonus or thrift plan, the employer will contribute certain amount or percentage for each dollar contributed by the employee; however, employee contributions are not always required.
Plans permit early withdrawal for specified hardship reasons such as death or disability. Loans are also permitted in certain instances up to 50% of the participant's vested accrued benefit or the annual IRS-established dollar amount.
6. 403(b) Tax Sheltered Annuities (TSAs)
A 403(b) plan or a tax-sheltered annuity (TSA) is a qualified plan available to employees of certain nonprofit organizations under Section 501(c)(3)of the Internal Revenue Code, and to employees of public school systems.
Contributions can be made by the employer or by the employee through salary reduction and are excluded from the employee’s current income. As with any other qualified plan, 403(b) limits employee contributions to a maximum amount that changes annually, adjusted for inflation. The same catch-up provisions also apply.
ELIGIBILITY
| WHO CONTRIBUTES | |
HR-10 (Keogh)
| Self-employed |
Employer matches employee's contributions
|
SEP
|
Small employer or self-employed
| Employer only |
SIMPLE
| Small employers (no more than 100 employees) |
Employer matches employee's contribution
|
| 401(k) | Any employer | Employer matches employee's contribution |
| 403(b) - TSA | Nonprofit organizations | Employer and employee |
7. Corporate Pension Plans
Corporate pension plans can be divided into two categories:
- Defined benefit plans; and
- Defined contribution plans.
Under a defined benefit plan, the employer specifies an amount of benefits promised to the employee at his or her normal retirement date. The payments are based on a specified formula that considers age, years of service and salary history, and is adjusted each year for inflation.
In defined benefit plans, the employer is responsible for maintaining adequate funds to provide the promised benefit, and an actuarial calculation is required to determine the annual deposit for each year. Among other factors, the actuary considers the age of the employee, projected earnings of the plan and employee turnover. It helps to remember that defined benefit plans favor older employees nearing retirement age, and allow for higher benefits for high-salaried owners and key employees.
Defined contribution plans have become much more popular than defined benefit plans because they are generally more flexible and less expensive for employers to administer. These plans are focused on contributions rather than on the benefits they will pay out. These plans favor young employees just starting out, with many years to retirement.
8. Section 457 Plans
IRS Section 457 plans are deferred compensation plans available to certain state and local governments, or tax-exempt organizations under the Internal Revenue Code (IRC) 501(c). Employers and employees may contribute to the plan up to a specified annual maximum through salary reductions (currently $18,000). These plans provide significant tax advantages to their participants: both contributions and earnings on the retirement money are tax deferred.
The specified amount will be forfeited if the employee leaves the employment except in the cases of death, disability or retirement.
C. Chapter Recap
In this chapter you learned about different types of individual and group qualified plans and their characteristics. Let’s recap the major points:
| GENERAL CONCEPTS | |
| General Requirements |
|
| TYPES OF PLANS | |
| Individual Qualified Plans |
Traditional IRA requirements and features:
Roth IRA:
|
| Employer-sponsored Qualified Plans |
General characteristics:
Types of plans:
|