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Frequently Asked Questions
1) How much money is needed at
retirement?
2) Why do businesses adopt qualified
retirement plans?
3) Must the qualified plan include
all employees?
4) What types of plans are available?
5) How can a participant get money
out of the qualified plan while still employed by the plan sponsor?
6)What happens to the money a
business contributes for an employee once He/She leaves?
7) How are taxes assessed when a
participant retires or takes distributions after leaving the
business?
8) How should an existing qualified
plan be evaluated?
9) How much paper work is required
for the administration of the qualified plan?
10) What are the typical steps to
establish and maintain a qualified plan for a small business?
QUESTIONS AND ANSWERS ON QUALIFIED
RETIREMENT PLANS
How can you prepare for the future by planning for your retirement?
Read on to understand the advantages of qualified retirement plans.
1)How much money
is needed at retirement?
This is a personal decision based on an individual's desired
lifestyle at retirement. The analysis by the President's Council on
Social Security estimated that individuals earning more than the
Social Security Wage Base require a 60% income replacement to
maintain their lifestyle at retirement. Due to inflation and current
estimated longevity, the replacement becomes 85-90%. Assuming that
Social Security provides 15% of income for highly compensated
individuals, they need to replace about three-quarters of their
income received before retirement through personal savings, IRA and
other retirement programs. At today's annuity rates, one must save
$8 to pay $1 a year for the rest of an actuarially determined
lifetime. Using the three-quarters guideline, an individual earning
$70,000 today with no increases needs $52,500 of income to maintain
his or her lifestyle or $420,000 in savings by age 65!
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2)
Why do businesses adopt qualified retirement plans?
Contributions to the plan are tax deductible; the earnings on the
contributions are tax deferred; and the money drawn out at
retirement has tax preferred treatment.
Example: An owner-employee of a corporation takes a $70,000 salary,
is in the 33% marginal tax bracket, has no other employees in the
plan, and can contribute $10,000.
TAXABLE INCOME BEFORE
PLAN CONTRIBUTION $70,000
PLAN CONTRIBUTION
(tax deductible) $10,000
TAX REDUCTION
(contribution times 33%) $ 3,300
NET COST OF CONTRIBUTION
TO THE OWNER
($10,000-$3,300) $ 6,700
CONTRIBUTION TO THE
OWNER $10,000
NET GAIN TO THE OWNER AFTER
ESTABLISHING A PLAN
($10,000-$6,700) + $ 3,300
By placing a portion of the owner's income in a qualified retirement
plan, the owner increases his net worth by the tax reduction amount.
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3) Must
the qualified plan include all employees?
NO. Certain employee groups may be excluded. These include union
employees (provided that retirement plans were the subject of good
faith collective bargaining), employees younger that 21, employees
who have completed less that 12 months (or in some instances, 24
months) of service, and those employees who work less than 1,000
hours per year.
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4) What types of plans
are available?
That depends entirely on the type of plan adopted. A business may
select a plan that requires an annual contribution based on a
percentage of each participant's compensation, another allows the
business and the participant to elect to contribute on a year to
year basis and another has the contribution amount actuarially
determined each year.
*Defined benefit plans
A defined Benefit Plan establishes the annual payment that each
participant will receive at retirement up to 100% of three year
average compensation to a maximum of $175,000 (in 2006) each year
starting at their Social Security Retirement Age. An actuary
calculates the contributions to fund for these future benefits
annually.
*Defined contribution plans
Businesses may contribute up to 25% of each participants'
compensation annually to a maximum of $44,000. The ultimate benefit
at retirement can grow with investment earnings, without
limitations, but also without any guarantees.
TYPES OF DEFINED
CONTRIBUTION PLANS INCLUDE:
MONEY PURCHASE PENSION PLANS- require annual contributions based on
a pre-selected formula not to exceed 25% of covered compensation;
PROFIT SHARING PLANS- allow the business the option to contribute 0%
up to 25% of covered compensation;
AGE WEIGHTED PROFIT SHARING PLANS- Employer contributions to this
type of plan are not necessarily based on profits. Contributions are
totally flexible and at the discretion of the employer, and need not
be yearly, so long as they are "substantial and recurring." Employer
contributions are allocated to provide an assumed retirement benefit
at normal retirement age.
410 (k) PLANS- permit an employee to reduce his/her taxable
compensation and put the compensation reductions into a profit
sharing plan. The maximum allowable compensation reduction in 2006
is $15,000.
*EXAMPLE: The following chart shows estimated maximum deductible
contributions for a participant earning $70,000 with no other
participants:
Participant's Defined Defined
Age Contribution Benefit
39 $17,500 $11,480
43 $17,500 $15,260
47 $17,500 $20,860
51 $17,500 $29,960
55 $17,500 $46,690
*assumed level to age 65
A Defined Benefit Plan may be the choice of an older business owner
who wants to shelter as much as possible, while a younger owner may
be able to get a larger contribution from a Defined Contribution
Plan.
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5) How can a participant get money out of the qualified plan while
still employed by the plan sponsor?
Any participant, except an owner-employee in an unincorporated
business or a shareholder-employee in an S corporation, may borrow
against the vested portion of their benefits, up to the statutory
limits. This is a very useful privilege since the participant can
use the monies and still receive tax benefits of a qualified plan.
In profit sharing plans, distributions are permitted in the event of
certain financial hardships such as accidents or health problems.
Distributed amounts are generally taxed as ordinary income.
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6)What happens to the money a business contributes for an employee
once He/She leaves?
Ownership rights of the monies within a qualified plan for an
employee are governed by the vesting schedule. This schedule states
what percentage of the accrued benefit or account balance the
employee owns based on the number of years of service with the
business, or since the plan started. The law allows a maximum of
seven years before an employee is entitled to 100% vesting, or six
if the plan is "Top Heavy" (based on legal definition).
Depending on the type of plan adopted, the non-vested portion of the
employee's account may be used to reduce future contributions or
redistributed to remaining participants. If redistribution applies,
the business owner will often receive a substantial portion of the
"forfeitures" over a long period of time.
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7) How are taxes assessed when a participant retires or takes
distributions after leaving the business?
There are three principle ways a plan may allow a participant to
receive distributions; each one has different tax ramifications.
*IRA ROLLOVER: Within 60 days of a distribution, the monies can be
rolled over into an IRA and no taxes will be assessed until the
funds are withdrawn from IRA.
*Distributions which are eligible for this rollover treatment will
be subject to 20% mandatory tax withholding unless they are
transferred directly into an IRA or another qualified plan.
*PERIODIC PAYMENTS: The monies can be paid out either as an annuity
or as installments over specific time period. The payments are
considered ordinary earned income are taxed at the appropriate
income tax rate.
*LUMP-SUM PAYMENTS: A participant who receives, as taxable income,
100% of his plan benefits in one taxable year and meets other
requirements may be entitled to special income tax averaging in
order to reduce his income tax obligation. Other favorable tax
alternatives may also be available.
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8)
How should an existing qualified plan be evaluated?
*Is the Plan Design Still Appropriate?
The data and objective that influenced the original plan selections
may not currently be valid. The ability to contribute, the number
and type of employees, as well as the incomes and personal needs of
the business managing are all variables and might have changed since
the plan's inception.
In order to determine which type of plan is best suited to the needs
of the business and its management, the following is a partial list
of what should be considered:
-overall financial plans
-investment objectives
-the amount the business is able to contribute annually
-the flexibility needed to change the contributions
-the ages of the key employees
*Does the plan provide the maximum income tax relief?
Based on the cash flow of the business and the retirement or
tax-shelter needs of the management, contributions may be increased
by adding plans, changing plans, amending plan formulas, or
adjusting options.
*Do the business owners have different needs and investment
objectives?
The individual business owners often have different financial
obligations which the current plan may not recognize. There may be
ways to design a plan to allow for these differences.
*Can contributions to rank and file employees be restricted?
Many plans are required by law to provide "minimum benefits". Some
plans, however, can limit plan costs for younger employees. The plan
can be integrated to allow highly compensated employees to have
contributions or benefits weighted towards them.
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9) How much paper work is required for the administration of the
qualified plan?
Comprehensive administrations assures the operation of the plan
follows the plan documents, as well as current laws, rules and
regulations. This includes determining eligibility, calculating
vested benefits and contributions, annual government reporting and
disclosure to participants, and maintaining plan records. The
following are primary reporting and disclosure requirements:
- ANNUAL IRS FILING (FORM 5500) generally must be filed with the IRS
on or before the last day of the seventh month following the end of
the plan year.
- SUMMARY PLAN DESCRIPTION (SPD)
must be filed with the Department of Labor and distributed to
participants within 120 days after the plan is adopted and to new
plan participants within 90 days after becoming a participant.
- INSURANCE STATEMENT (SCHEDULE A TO FORM 5500) is required for each
plan whose benefits are funded in part or whole by insurance
products.
- ACTUARIAL STATEMENT (SCHEDULE B TO FORM 5500) is required for
defined benefit plans.
- SUMMARY ANNUAL REPORT (SAR)
must be distributed to each participant or beneficiary within the
nine months after the end of the plan year, or two months after an
extension for filing the IRS Form 5500, if later.
- BENEFIT STATEMENT must be furnished to each participant or
beneficiary upon request, but no more often then one per individual
in any 12 month period.
-ANNUAL PENSION BENEFIT GUARANTEE CORPORATION (PBGC) FILING PENSION
BENEFIT GUARANTEE CORP. is required for certain defined benefit
plans and generally must be filed to PBGC on or before the 15th day
of the 8th full calendar month following the month in which the plan
year began.
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10) What are the typical steps to establish and maintain a qualified
plan for a small business?
*INSTALLATION
-PLAN DESIGN
-DRAFTING THE PLAN AND TRUST DOCUMENTS
-SUBMITTING THE PLAN TO THE IRS
-PREPARING THE SUMMARY PLAN DESCRIPTION
-PLAN ENROLLMENT WITH EMPLOYEES
*ANNUAL ADMINISTRATION
-ELIGIBILITY, VESTING, CONTRIBUTION CALCULATIONS AND ANNUAL
ALLOCATION
-ACTUARIAL WORK
-DETERMINATION OF DISTRIBUTION AMOUNTS
-PREPARATION OF ALL GOVERNMENT REPORTS
-PREPARATION OF ALL PARTICIPANT AND
BENEFICIARY REPORTS
OUR EXPERTISE MAKES QUALIFIED PLANS EASY FOR YOU.
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