As a business owner, there are several reasons you might want to implement a qualified retirement plan for you and your employees. Not the least of which is that qualified plans provide numerous tax advantages.
- Contributions for all participants are 100% tax-deductible to the business up to certain limits.
- Annual contributions by the business are not considered taxable income to the plan participants.
- Capital gains and interest earned are deferred from taxation during the accumulation years. Income taxes are payable upon withdrawal.
- At retirement, favorable tax treatments may apply such as spreading payments over the participant's lifetime and special averaging formulas.
In addition to the obvious tax advantages, there are many other, equally important, reasons to implement a qualified plan.
A qualified plan can aid in the recruiting and retention of key employees. A formal plan provides an extra incentive for a prospective employee to sign on with the company. Further, through the proper use of vesting schedules, a qualified plan can be an important employee retention tool.
Plan assets are also creditor-proof. The assets of the plan are not subject to malpractice lawsuits or bankruptcy rulings.
These and other advantages combine to help improve morale as the participants realize that their company provides the mechanism to help secure their retirement.
Types of Plans
The two most common types of qualified retirement plans are pension and profit-sharing plans. A business can also sponsor an IRA or SEP (simplified employee pension plan).
Defined Contribution Profit Sharing Plans
A Defined Contribution Profit Sharing plan is a type of retirement plan in which the employer and/or the employee both make contributions on a regular basis. Participants can elect to defer a portion of their gross salary via a pretax payroll deduction the plan, and the company may match the contribution if it chooses, up to certain limits the employer sets. Individual accounts are set up for participants and benefits are based on the amounts credited to these accounts plus any investment earnings on the money in the account. Defined Contribution plans are funded by the employee who defers a portion of their gross salary via a pretax payroll deduction. The most common type of Defined Contribution plan is a 401(k).
Defined Benefit Pension Plans
Defined Benefit plans provide eligible employees guaranteed income for life when they retire. Employers guarantee a specific retirement benefit amount for each participant that is based on factors such as the employee’s salary and years of service. Defined Benefit Pension plans are funded by the employer there are no employee contributions.
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