What is a Qualified Retirement Plan (QRP)?

Qualified Retirement Plans

What is a Qualified Retirement Plan (QRP)?

A qualified retirement plan is a retirement plan sponsored by an employer that qualifies for special tax treatment as specified in Section 104(a) of the Internal Revenue Code.

There are numerous types of qualified retirement plans; however it is easiest to break them into three primary categories: Individual Retirement Arrangement, Defined Benefit Plans, and Defined Contribution Plans.

Individual Retirement Arrangement (IRA)

Most often, an IRA is a retirement arrangement that is established by an individual affording you the opportunity to save for your retirement by making contributions into your account. Employers however can also help their employee’s setup an IRA and help them fund their IRA. Contributions to your IRA can be made in one of three ways:

Types of IRA’s:
1. Payroll Deduction IRA: Even if an employer doesn’t want to adopt a retirement plan, the employer can allow its employees to contribute to an IRA through payroll deductions, proving a simple and direct way for employees to save. In this type of arrangement, the employee always makes the decisions about whether, when, and how much to contribute to the IRA ($5,500 for 2016 and $6,500 for 2016 if age 50 or older, increasing thereafter). Some individuals eligible to contribute to an IRA wait until the end of the year to set aside the money and then find that they don’t have sufficient funds to do so. Payroll deductions allow employees to plan ahead and save smaller amounts each pay period. Payroll deduction contributions are tax-deductible by the employee, to the same extent as other IRA contributions.

2. Simplified Employee Pension Plan: Known as SEP, this type of retirement plan allows employers to contribute to a traditional IRA’s (SEP-IRA’s) set up for employees. Employers must generally contribute a uniform percentage of pay for each employee – however employer contributions are not required each year.

Each year, you the employer, decides how much to put into a SEP. This benefit allows business owners flexibility when business conditions vary. A business of any size, even self-employed, can establish an SEP

A SEP plan allows employers to set up SEP IRA’s for themselves and each of their employees. Employers generally must contribute a uniform percentage of pay for each employee, although they do not have to make contributions every year. Employer contributions are limited to the lesser of 25 percent of pay for $53,000 for 2016. (Note: the dollar amount is indexed for inflation and may increase.) Most employers, including those who are self-employed, can establish an SEP.

SEP’s have low start-up and operating costs and can be established using a two-page form. You can also decide how much to put into an SEP each year – offering you some flexibility when business conditions vary.

3. Simple IRA: Savings Incentive Match Plan for Employees (SIMPLE) IRA is a savings option for employers with 100 or fewer employees.

This plan allows employees to contribute a percentage of their salary each paycheck and requires employer contributions. Under SIMPLE IRA plans, employees can set aside up to $12,500 in 2016 ($15,500 in 2016 if age 50 or older) by payroll deduction (subject to cost-of-living adjustment in later years). Employers must either match employee contributions dollar for dollar, up to 3 percent of an employee’s compensation, or make a fixed contribution of 2 percent of the compensation for all eligible employees even if the employees choose not to contribute.

If your plan provides for it, you can choose to automatically enroll employees in SIMPLE IRA plans – As long as the employees are allowed to choose not to have their salary reduction contributions made to their SIMPLE IRA’s or to have salary reduction contributions made in a different amount.

SIMPLE IRA plans are easy to setup. You fill out a short form to establish a plan and ensure that SIMPLE IRA’s (to hold contributions made under the SIMPLE IRA plan) are established for each employee. A financial institution can do much of the paperwork as the administrative costs are low.

You may have your employees setup their own SIMPLE IRA’s at a financial institution of their choice or have all SIMPLE IRA’s maintained at one financial institution you choose. Employees can decide how and where the money will be invested, and keep their SIMPLE IRA’s even when they change jobs.

4. Profit Sharing: Employer contributions to a profit sharing plan can be discretionary. Depending on the plan terms, there is often no set amount that employer needs to contribute each year.

If you do make contributions, you will need to have a set formula for determining how the contributions are allocated among plans participants. The funds are accounted separately for each employee.

Profit sharing plans can vary greatly in their complexity. Many financial institutions offer prototype profit sharing plans that can reduce the administrative burden on individual employers.

Defined Benefit Plan

A Defined Benefit Plan is a retirement plan or pension plan which is funded through contributions from the employer. The employer promises a specified monthly benefit to your employees based on a predetermined fixed formula. Factors involved in this formula include an employee’s earning history, year of service with your firm, and the employee’s age. With defined benefit plan, the employer is responsible for managing all contributions into the plan. As a result, employers will use outside investment managers to manage these assets.

Some employers find that defined benefit plans offer business advantages. For instance, business can generally contribute (and therefore deduct) more each year than in defined contribution plans. In addition, employees can often value the fixed benefit provided by this type of plan and can often receive a greater benefit at retirement than under any other type of retirement plan. However, defined benefit plans are often more complex, and likely more expensive to establish and maintain than other types of plans.

Types of Defined Benefit Plans:
1. Traditional Pension: With a traditional pension plan, the employer is responsible for making contributions into the plan on your employee’s behalf. The employer also assumes the responsibility of making the investment decisions for all contributions into the plan.

2. Cash Balance: A type of pension plan in which the employer credits employee accounts with a set percentage of your employees earning plus interest charges. This type of plan is similar to a defined contribution plan in that the promised benefit is stated in terms of an account balance.

Defined Contribution Plan

A Defined Contribution Plan is a retirement plan established by the employer but is funded from contributions made by employees. Contribution amounts are determined as either a percentage or specific dollar amount of each employee’s earnings. Employers may choose to contribute to their employee’s retirement, however this is not mandatory. With a defined contribution plan the employees are responsible for the investment choices and management of their contributions.

Types of Defined Contribution Plans:
1. Traditional 401(k): 401(k) plans have become a widely accepted retirement savings option for small business owners with an estimated 52 million U.S. workers participating in 401(k) plans.

With a 401(k) plan, eligible emplyees who choose to participate determine what portion of their earning they want to defer. This amount can be either a set dollar amount of percentage with deductions taking place each pay period. Deferrals are made on a pre-tax basis but, if allowed by the plan, deferrals can be made on an after-tax (Roth) basis. 401(k) plans, can vary significantly in their complexity. Vermillion Financial Advisors will help you work through these complexities and offer guidance when what makes most sense for your business.

Like most profit sharing plans, 401(k) plans can vary significantly in their complexity. However many financial institutions and other organizations offer prototype 401(k) plans, which can greatly lessen the administrative burden of establishing and maintaining these plans.

2. Safe Harbor 401(k) Plans: A safe harbor 401(k) plan allows employees to contribute a percentage of their salary per pay period and requires employer contributions .These mandatory employer contributions are always 100 percent vested for employees.

A safe harbor 401(k) plan is intended to encourage plan participation among rank-and-file employees and to ease the administrative burden by eliminating the test ordinarily applied under a traditional 401(k) plan. This plan is ideal for businesses with highly compensated employee’s whose contributions would be limited in a traditional 401(k) plan.

3. 403(b): Is a retirement plan offered by public schools and certain 501(c) (3) tax-exempt organizations. 401(b) retirement plans allows you to save for retirement by contributions to individual accounts. Employers can also contribute to employee’s retirement accounts. Participants in these plans are employees of tax-exempt organizations, publish school systems, or employees of cooperative hospital service organizations.

The first step in offering a qualified retirement plan is making the commitment to offer a retirement plan. Deciding on the particular plan to offer can be challenging, however Vermillion Financial Advisors offers expertise in helping you with this process. Your VFA advisor will work closely with you to identify the specific needs or goals desired for your plan. This information will help determine which type of plan makes the most sense for your business.