What is a qualified plan? A qualified plan is simply a plan described in Section 401(a) of the Tax Code. Qualified plans are retirement plans recognized by the Internal Revenue Service in which investment funds grow tax-deferred. Defined-benefit and defined-contribution plans are the two most popular categories of qualified plans.
A 401(k) retirement plan is a qualified retirement plan. They are also categorized as a type of defined-contribution plan. 401(k) plans are generally employer-sponsored retirement plans that allow employees to contribute a portion of their salary pre-tax. Allocations are made to various investment vehicles, which would enable funds to grow tax-deferred. Once the funds are drawn upon in retirement, taxes must be paid. Many employers choose to match employees’ contributions to their sponsored 401(k) accounts up to a certain percentage or dollar amount. The benefit of a match is to improve the employee benefit, as well as, to help increase the employer’s tax deduction.
A profit-sharing retirement plan gives employees access to a share in the profits of a company. In this type of plan, which has also been known as a deferred profit-sharing plan (DPSP), the employee receives a specified percentage of the company’s profits based on annual or quarterly earnings. Profit-sharing is discretionary and often combined with a 401k to add an additional layer of tax savings for the business in profitable years or as owners get closer to retirement. Vesting schedules are often used as an incentive to keep employees from leaving and takings these contributions since unvested contributions will be forfeited.
With defined-benefit plans, employers calculate benefits on factors including salary history and length of employment. A defined-benefit plan specifies a promised monthly benefit at retirement. These plans can either state a specific dollar amount or calculate the benefit based on a formula. Defined-Benefit plans are what people think of when they hear the term “company pension”. This type of plan can be added as a third-tier tax savings vehicle. A DB plan is often combined with a 401(k) and Profit-sharing to increase tax savings and is also often used to help business owners ramp up their retirement savings up to a max of $230,000 extra each year (ie. 2021)
A cash balance plan is a type of qualified plan. In a cash balance plan, participants each have an account. These plans grow annually based on contributions and interest credits. Employers can offer cash balance plans in conjunction with other kinds of retirement plans. Cash balance plans can be a good solution for someone looking for more significant tax deductions and accelerated retirement savings.
ESOP stands for Employee Stock Ownership Plan, a type of employee benefit plan that works similarly to a profit-sharing plan. An ESOP is a trust fund set up by a company to contribute shares of its own stock or cash to buy existing shares. ESOPs provide significant tax benefits for companies. An ESOP can also provide a tax-efficient way for a Business Owner to begin the exit from their business.