Looking to set up a retirement plan for your small business employees? For both employers and staff, a qualified retirement plan offers plentiful perks. In this post, we will answer the question, “What is a qualified retirement plan,” and outline how you can set up a qualified retirement plan for your business. Join our CPAs as we begin by outlining exactly what constitutes a qualified retirement plan.
What Is a Qualified Retirement Plan?
A qualified retirement plan is a retirement plan that has been established by an employer, designed to ensure retirement income to an employee and their beneficiaries. These plans have to meet certain IRS Code requirements to be considered “qualified retirement plans”. These plans allow for both the employer and employee to make contributions to the retirement fund.
Such plans are typically categorized as either defined-benefit or defined-contribution plans. 401(k)s, pension plans, and profit-sharing plans are all examples of qualified retirement plans.
In order for a plan to continue to be a qualified retirement plan, the employer must keep up with the IRS Code requirements. Some of those code requirements include:
- Minimum levels of participation
- Non-discrimination
- Minimum levels for vesting
- Adherence to Required Minimum Distributions (RMDs)
If the plan does not meet these requirements, they risk being disqualified. Now that we’ve answered the question, “What is a qualified retirement plan?” we’ll dive into the defined-benefit plan.
Defined-benefit Plan
One of the most common types of qualified plans is a defined-benefit plan. These plans put the responsibility of retirement funds largely on the employer. In some of these plans, the employee isn’t required to contribute to the retirement fund at all, and in others, they may be required to contribute some of their income to the plan. Regardless of the employer’s performance or investments, the employee is promised a set benefit upon their retirement.
Defined-contribution Plan
The other most commonly utilized qualified retirement plan is the defined contribution plan. The most familiar defined contribution plan is a 401(k). In this type of plan, the responsibility falls on the employee to make regular contributions to a retirement fund to reach a sufficient amount. Most of these also allow for the employer to match the amount contributed by the employee each month up to a certain percentage.
What Are the Benefits of Setting Up a Qualified Retirement Plan?
Qualified retirement plans offer some enticing benefits for both the employee and the employer.
For employers, the tax benefits and employee retention rates are some of the most commonly-cited advantages, including:
- Tax-deductible contributions
- Popularity among employees, making them an asset for hiring and retention
- Potential eligibility for tax credits
Employees are drawn to qualified retirement plans as well, thanks to benefits that include:
- Pre-tax contributions
- Ease-of-use (Deposits may be made through deductions from a regular paycheck)
- Potential eligibility for tax credits simply by having a 401(k)
- Short-term loans may be taken out of certain qualified retirement plans
On top of offering a substantial nest egg to retire comfortably, a qualified retirement plan is often the most convenient and financially sound choice for both the business and the staff.
FAQs About Qualified Retirement Plans
Let’s clear up some of the most common questions about qualified retirement plans.
Does a 401k count as a qualified retirement plan?
Yes, a 401(k) counts as a qualified retirement plan. This would be considered a defined-contribution plan, as it involves an employee making regular investments into their account, often matched by the employer.
Is an IRA a qualified or nonqualified retirement plan?
Both Roth IRAs and traditional IRAs—also known as individual retirement accounts—are nonqualified retirement plans.
Are there tax advantages associated with a qualified retirement plan?
Yes, there are tax advantages associated with a qualified retirement plan. For employers, all contributions made to an employee’s qualified plan are tax deductible, and in some cases, a business that offers these plans can be given a tax credit.
Employees may enjoy the fact that their retirement contributions are not taxed right away.
Are withdrawals from this plan subject to taxes?
Yes, deductions or withdrawals from qualified plans are taxed at the same rate as your income or salary.
Early withdrawals from your qualified retirement plans are subject to a penalty rate of up to 10% of the amount, in addition to income tax.
What is a nonqualified retirement plan?
A nonqualified retirement plan does not meet the IRS Code requirements. It’s mainly used to pay top executives and does not have as many tax advantages as a qualified retirement plan. For instance, employers typically cannot claim their contributions as a tax deduction.
Tax Benefits of Qualified Retirement Plans Explained
Some of the most appealing perks of qualified retirement plans are the tax benefits associated with them.
For employers, those include a tax credit for some businesses, designed to help with the costs of establishing a qualified plan for each of their employees. Depending on the costs accrued by the company in the process of setting up these plans, and on the number of employees who utilize the plan, a business can receive up to $5,000 per year.
They must meet the following requirements:
- The business must have no more than 100 employees.
- Those employees must have received at least $5,000 in pay during the tax year.
- The plan must apply to at least one non-highly compensated employee.
On top of the potential credit, employers often prefer qualified retirement plans because their payments to these plans are tax deductible.
For employees, the tax benefits are just as attractive. Contributions made by employees to these plans are pre-tax, which means that money goes into their account before it is taxed. Plus, all contributions are tax-deferred, so the retiree won’t owe income tax on the amount until it is withdrawn upon retirement.
How To Set Up a Retirement Plan for Small Business Employees
If you’re in the process of setting up a retirement plan for your small business employees, there are some steps you can take to be sure you are setting both yourself and your team up for success in the long run.
The first, and perhaps the most important step is to do your research. Look carefully into any third-party services that may be able to help, such as brokerage firms, insurance providers, and a local accountant, to determine who the best retirement services provider is for you. Once you have your provider picked out, it’s time to look into the best kind of plan for your team.
You may opt for a traditional 401(k), a safe harbor 401(k), an automatic enrollment 401(k), a Roth IRA, or another type of plan. Your provider can help you decide which plan is the right fit, and what criteria to keep in mind. Your provider can also help you set up your retirement plan. The steps may vary slightly, but most of the time you will need to follow them closely:
1. Create your qualified retirement plan document
When creating this document, you’ll need to outline the plan you have selected, the employees who are eligible for it, the criteria for use, and the benefits allowed. Plus, working with a business tax accountant can ensure your document complies with the IRS code regulations.
2. Set up a trust
The contributions and assets of the plan should be put into a trust, which means that a trust must be set up and a trustee must be appointed.
3. Set up a method of recordkeeping
Whether it’s an Excel spreadsheet or software custom-made for this purpose, you’ll want a way to track employee contributions and plan values. While Quickbooks Accounting software is the most commonly used software program, is it right for your business? Our Raleigh CPA firm can help you determine what software option will help you save the most time so you can focus on your business growth and day-to-day business activities.
4. Communicate with plan participants
Make sure to have a clear and effective way of communicating the benefits and requirements, —and any associated fees—of the plan to those who are participating in it, as well as their beneficiaries.
This process, though it sounds lengthy and expensive, can actually be quick and cost-effective without cutting any corners when you select the right service provider.
Contact Our Raleigh CPA Firm for Assistance Setting Up a Qualified Retirement Plan
If you are a small business owner looking for help setting up a qualified retirement plan in Raleigh, our Raleigh CPA firm can help. With over 20 years of experience in small business qualified retirement plans, we are dedicated to ensuring the security of both local business owners and their employees in the long term.
Call us today at (919) 872-0866 or fill out the form below to schedule a consultation with our Raleigh or Durham retirement services team.
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