Even if your golden years are still far ahead of you, saving for retirement is one of those things that you can never start too soon. As well as considering the asset allocation of your portfolio, it’s important to consider asset location (in other words, where you keep your investments). A qualified retirement plan is one of the possibilities. As well as helping you save for the future, a qualified retirement plan offers certain tax advantages that will benefit you in the here and now. But what exactly is a qualified retirement plan, and how do you decide if it’s the right choice for you?
What is a Qualified Retirement Plan?
As Smart Asset notes, a qualified retirement plan is a plan that meets all the requirements set out by the Internal Revenue Code to allow for tax-deferred contributions. Typically, they’re provided through your employer. As they allow for both pre-tax contributions and tax-deferred growth, they’re an excellent way of saving towards retirement.
What are the Different Types of Qualified Retirement Plans?
There are several types of qualified retirement plans to be aware of, including defined-benefit and defined-contribution plans.
Defined-Benefit Plans
Defined-benefit plans follow the lines of a traditional pension plan. They pay a fixed monthly benefit upon retirement where the amount is determined by income history and years of service.
Defined-Contribution Plans
Unlike defined-benefit plans, defined-contribution plans don’t pay a fixed monthly benefit after retirement: the value of the account is subject to change over time, and the benefits will reflect this. Employees can contribute a percentage of their income to the plan each year. Employers can also choose to contribute. Plan holders can elect to make an early withdrawal from the plan prior to retirement, but penalties may sometimes be applicable in the event certain conditions aren’t fulfilled.
What are the Benefits of Qualified Retirement Plans?
Qualified retirement plans have become increasingly popular in recent times, and for good reason. They hold multiple benefits for the employee and some equally noteworthy perks for the employer. Some of the most significant points of interest include:
Employer Benefits
Tax Credits
Employers who elect to start a qualified plan may qualify for a tax credit to cover up to 50% of the start-up costs of establishing the plan. They may also qualify for a credit towards half the cost of running and educating employees about the plan, to a maximum value of $500 per year. The tax credit is limited to businesses with 100 or fewer employees making a minimum of $5000 in earnings.
Tax-Deductible Contributions
Employer contributions are tax-deductible. For sole proprietors, this means you can make significant investments towards your retirement without paying taxes on those investments during your working years.
Recruitment
A qualified plan can increase a company’s attractiveness to potential new recruits by demonstrating a willingness by the company to invest in the future of its employees. It can also encourage staff retention.
Employee Benefits
Tax Break
Taxes on contributions can usually be deferred until after retirement, with the result that you could cut your final year tax bill by hundreds or even thousands of dollars while saving towards your retirement.
Convenience
Contributions to qualified plans can be deducted automatically from your monthly paycheck, reducing the inconvenience of making payments manually.
Matched Contributions
If your employer matches employee contributions, you’ll effectively be doubling your investment towards your retirement without feeling the effect on your paycheck.
Protection from Creditors
Qualified plan assets are protected from collection actions and debt recovery. Even if you experience bankruptcy in the future, your retirement assets won’t be impacted if you hold a qualified retirement plan.
Investment Advice
Qualified retirement plans offer several investment options to choose between, with many plans offering the additional benefit of professional advice and guidance for those who require it.
How Do Qualified Retirement Plans Work?
As The Balance notes, for a retirement plan to be categorized as a qualified plan, it needs to meet certain stipulations set by the Internal Revenue Code with regards to participation, contribution limits, and certain other elements.
Contribution Limits
Total contribution limits are adjusted annually according to inflation. For 2021, the maximum contribution is either $58,000 or 100% of compensation, depending on which of the two is the lesser. The most any employee can receive in combined contributions and benefits for 2021 is $230,000.
Participation Requirements
As per the IRS, qualified plans must be made available to employees no later than the employee reaching the age of 21 or finishing one year of service with the employer, whichever is the earlier.
Minimum Funding Requirements
An enrolled actuary will have to prepare a plan document (Schedule B of Form 5500) outlining the plan’s funding status. The contributions made must then be in accordance with the plan document in order to meet the minimum funding requirements of section 412.
Compensation Limits
The maximum yearly compensation for each employee that can be taken into account under a qualified benefit plan is $290,000 for 2021. The compensation limit in future years is subject to cost-of-living adjustments.
Deferral Limits
For employees who wish to defer tax payments on contributions until after disbursement, the maximum amount that can be deferred is $19500. This increased to $26000 for employees aged 50 or over.
When Does a Qualified Retirement Plan Become Payable?
As This Matter outlines, qualified retirement plans become payable within 60 days of the following: the participant reaching the retirement age of 65. Some plans specify a different age: in these cases, the age set out in the plan takes precedence. 10 years after the participant becomes a member of the plan or the year that the participant ends their employment. Participants can choose to defer the date that they begin to receive benefits, but can not elect to be paid at an earlier date unless this is allowed by the conditions of their specific plan. If the plan allows for an early retirement age, and if an employee leaves their employment before this, they will be eligible to receive the benefit only on the condition that all services requirements for the benefit are met.
Are Qualified Retirement Plans a Good Choice?
Qualified retirement plans offer an excellent way to save towards retirement. Thanks to the tax benefits they offer, the plans have some appealing benefits to both employers and employees, with participants serving to benefit in particular if their employer makes matching contributions.
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