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Qualified Plan Selections for Small Businesses
Last Updated April 19, 2016
:by Denise Appleby CISP, CRC, CRPS, CRSP, APA
If you are considering adopting a qualified retirement plan (qualified plan) for your business, comparing the features and benefits can help you to choose the one that is most suitable for you and your employees. The following is a high level overview and some points for consideration.
Qualified plans can be established by any business entity. This includes sole proprietorships, partnerships and corporations.
Choosing the Right Qualified Plan
When deciding which qualified plan to adopt for your business, consider comparing the features and benefits of each. These include funding flexibility, the level of complexity, the administrative requirements and the level of ease with which the plan can be communicated to employees. For starters, please see the Employer Plan Comparison Chart available here.
Establishing a Qualified Plan
Authorizing the plan adoption
Once you decide which qualified plan is right for your business, the next step is to ensure that the business is authorized to adopt the plan. If the business is a corporation, a corporate resolution may need to be adopted to ensure that the plan establishment is authorized by the business. For partnerships, the partnership agreement may need to be amended to allow for the adoption of the plan, if those provisions were not already included.
Choosing the plan document
A business owner has several options to choose from when selecting a plan document. The choices include the following:
- Individually designed plans, where a customized plan document is used. This is usually the most expensive, and requires the assistance of an ERISA attorney and other experts to draft the plan and obtain approval from the IRS. This is usually used by larger businesses
- Prototype or Master plans, which are usually offered by approved document providers for use by an unlimited number of employers. The adoption agreements for these plans are usually ‘fill in the blanks’, allowing you limited flexibility. However, while flexibility may be limited, the options under the plan are usually sufficient for small businesses
- Volume submitter plans, which is usually a cross between an individually designed plan and a prototype plan
Establishing employee eligibility requirements
If your business has employees, those who satisfy the eligibility requirements must be allowed to participate in the plan. While an employer can allow all of its employees to participate in the plan, it can also exclude employees who do not meet certain requirements. At a minimum, the following employees must be allowed to participate in the plan:
- Employees who performed service with the company for at least two years (one year for 401(k) plans). It is important to note that if you chooses to implement a two-year service eligibility requirement, employer contributions are immediately 100% vested.
- Employees who are at least age 21
- Employees who are not part of a collective bargaining agreement
These eligibility requirements are usually selected or included in the adoption agreement. Once you complete the adoption agreement, the next step is to notify eligible employees about the plan.
The notification provided to employees must be in an easy-to-understand form, and must include pertinent information, such as features, benefits, requirements for distributions, eligibility requirements and rules regarding contributions. The document detailing these explanations is called the summary plan description, and it must be provided to eligible employees within 120 days after the adoption of the plan.
A qualified plan must be established by the end of the plan year. For instance, if the plan is maintained on a calendar year, it must be established by December 31. However, unlike employer contributions which can be based on compensation earned for the entire year, salary deferral contributions to 401(k) plans must be made from compensation earned after the plan is established and the salary deferral election is made. Therefore, it is more practical that a plan with a 401(k) feature is established as early as possible in the year, in order to allow participants to make salary deferral contributions.
The dollar limit on contributions is available in the employer plan comparison table. For 401(k) plans, employees can defer up to 100% of eligible compensation, providing the amount does not exceed statutory limits. Click here to see limits.
The compensation cap applies, which means that no more than the compensation cap in effect for the year can be taken into consideration for purposes of determining plan contributions for an employee.
The contribution formula chosen depends on what is available under the plan document. The following are some options from which you could choose.
- A prorata formula, where each eligible participant receives the same percentage of their eligible compensation as contributions
- A flat dollar formula, where each eligible participant receives the same dollar amount as contributions
- A social security integration formula, where employees who receive contributions in excess on the taxable wage base receive a higher percentage of contributions than other employees
- An age weighted formula, where contributions are based on the age of the participants, resulting in older employees receiving larger contribution percentages.
- New comparability formula, where contribution percentages are determined by groups, such as years of service, age and job classification.
Check to ensure the preferred contribution formula is available under the plan document, before starting the adoption process.
Employer Contribution Deadline
Employer contributions must be made to the plan by the business’ tax filing deadline, including extensions.
Salary Deferral Contribution Deadline
Salary deferral contributions must be deposited to the plan as soon as they can be separated from the employer’s assets, but no later than the 15th business day of the month, following the month to which the deferral applies. For instance, salary deferrals withheld from an employee’s salary for January, must be deposited to the plan by the 15th business day in February. Plans with fewer than 100 participants as of the beginning of the plan year, may remit salary deferrals within 7 business days after the date the amount is received or withheld.
Deduction of Contributions
Profit Sharing and 401(k) Plans
Generally, an employer may deduct an amount up to 25% of the aggregate compensation paid to all eligible employees for the year. Generally, this 25% does not include salary deferral contributions, and the compensation used to determine deductibility is calculated before salary deferral contributions are deducted. For instance: If the aggregate compensation paid to employees is $100,000, the maximum deductible contribution is $25,000(25%). If employees made salary deferral contributions to the plan, those amounts are not included in the $25,000.
Money Purchase Pension Plans
For money purchase pension plans, the deductible amount is limited to the percentage of contribution elected in the plan agreement. For instance, if the employer elected to contribute 10% of compensation, the deduction is limited to that amount.
One of the attractive features of a qualified plan is that employer contributions can usually be subject to a vesting schedule. This means that employees can be required to work a certain number of years in order to ‘own’ contributions made by the employer. Employees who leave the company before being 100% vested will lose contributions in which they are not vested.
The distribution rules are usually determined by the terms of the plan document. For instance, a plan could provide that participants can make withdrawals from the plan after reaching age 59 ½, after they have separated from employment with the employer, or that they must meet both requirements. The plan document must be consulted to determine the distribution rules that apply to the plan.
Adopting a qualified plan for a business not only provides tax benefits such as receiving a tax deduction for contributions, it can also help to attract and retain high quality employees. Additionally, employers may be able to receive tax credits for certain expenses incurred as a result of establishing and administering the plan.
Before choosing a plan for your business, consult with a financial planner and/or retirement counselor who should be able to assist with ensuring that the plan chosen is the most suitable for your business. In some cases, an IRA based plan such as SEP IRA or a SIMPLE IRA may be more suitable.