Sometimes, we are asked, "How can I contribute more to my retirement than is allowed under a simple IRA plan?" In this article, we'll discuss some of the retirement plan options to address this question.
Retirement plans fall into two main groupings, qualified plans or non-qualified plans. Within the qualified plan grouping there are two types of plans, defined contribution or defined benefit plans.
Defined Contribution Plans
Defined contribution plans determine how much may be contributed to the retirement plan each year. The amount that can be added to each employees account is limited by the Internal Revenue Code. The limit is adjusted annually for inflation. For 2013 this amount is $51,000. How much is available to withdraw from the plan in the future is a result of how much is contributed to the plan and how the market performs.
The most common type of defined contribution plan is a profit sharing plan. Features that can be added to a profit sharing plan include:
- A 401(k) deferral, which allows for employees to defer a portion of their pay pre-tax into a retirement plan. The amount of the deferral is limited to $17,500 for employees under age 50. For employees 50 and older the amount is increased to $23,000.
- Age weighted formulas which allow for an allocation of the employer contribution to the plan based on the ages of employees, with older employees receiving a larger allocation of the employer contribution than younger employees.
- New comparability plans allow for the plan participants to be divided into groups based on compensation levels. Highly compensated employees can receive a larger contribution than non-highly compensated employees as long as the plan can pass testing prescribed under the Internal Revenue Code.
Other types of defined contribution plans include ESOP (Employee Stock Ownership Plans) and Stock Bonus Plans.
Defined Benefit Plans
Defined benefit plans provide for an amount to be paid to each employee at retirement. An actuarial calculation is made each year to determine how much the employer must contribute to the plan in order for there to be sufficient assets at retirement to pay the amount agreed upon. This calculation is affected by market conditions that impact investment returns. The maximum annual benefit that may be provided under a defined benefit plan is $205,000 for 2013. This amount is indexed annually for inflation.
The rules for determining who may participate in a plan and when are set forth by ERISA, Employee Retirement Income Security Act. All plans must comply with ERISA and meet annual testing to demonstrate that they are in compliance.
The staff at BHT&D CPAs can assists you in determining which retirement plan is best suited to meet your personal and company goals.