Qualified Benefit Plans
Why company set qualify benefit plans tax benefits company employees maintaining qualify plans. Also, company comply benefit laws regulations order maintain qualify status plan.
Employers sometimes offer their employees and other beneficiaries within the organization retirement plans which they sponsor. These are often referred to as qualified plans. These qualified plans are either established as defined benefit plans or defined contribution plans. When established as defined benefit plans, the employee receives benefits on a formula that factors in personal factors such as the employee’s salary history and the duration of contract or employment. In these plans, the risk of investment and management of the portfolio is run by the employer. In these schemes, the employer sometimes has to find funds from alternative sources such as the company’s profits in order to fund employee’s retirement when there is a shortfall in funding. The other type of qualified plans is the defined contribution plan where the employer defines a stipulated amount which is paid each year for the employee’s retirement. These funds do not factor in personalized factors and there are often restrictions in how these funds can be withdrawn Lipman, 1983.
Independent of the type of qualified plans, they all allow employers to offer their employees additional benefits to improve motivation and retention and their lifestyles even after retiring.
Why companies set up qualified benefit plans
Companies set up qualified benefit plans because they offer benefits to both the employer and the employees. To the employer, the qualify benefit plans enables the employer to receive deductions on tax paid on plan contributions. When employees offer qualified plans to their employees, they often get benefits such as tax deductions for their tax contributions which increases the amount available for investment or for the company to declare as earnings. Other benefits include deferral of tax on earnings on assets held under the qualified plans. These employers do not often pay tax on their plan assets until these assets are distributed to the employees.
Employers also use qualified benefit plans to attract and retain employees. These plans are often a retention strategy because they offer employees competitive compensation that differentiates employers. Generally, employees are often more motivated when working for companies that offer qualified benefit plans than those who do not.
When offering qualified benefit plans, employers are able to claim tax credits as part of their day-to-day costs of setting up such plans. They are offered a maximum tax credit of 500 U.S. dollars per year for the first three years of the plan. This reduces the amount that companies spend on setting up qualified plans by 50% because they are able to redeem 50% of their costs as tax credits. This allows them more funds to administer these plans and educate their employees regarding the plan.
Employees also benefit from these qualified benefit plans. One major benefit for employees is that their life after retirement is provided with some guarantee of an income. Therefore employees are able to become more sure about their financial security when they are covered under a qualified benefit plan.
A second benefit that employees get is that they are able to deter paying taxes on certain portions of their compensation until they start receiving the benefits under the retirement plan at which point they are often in a lower tax bracket allowing them to reduce the amount of tax to be paid considerably. This is often a benefit that employees who are covered under qualified benefit plans often enjoy to maximize.
The last benefit that employees enjoy is that they are able to borrow funds at better rates compared to commercial lending agencies such as banks. Furthermore, additional interest that is paid on the loan amount taken is credited to the account of the employee thus increasing their retirement amount considerably unlike interests on loans from financial institutions where the interest that is paid out increases the earnings of the institution.
Requirements to maintain a qualified benefit plan
In order for a company to maintain its qualified status on their retirement benefit plan, they must operate in tandem with the requirements of three regulations. These are the Internal Revenue Code, Department of Labor and the Employee Retirement Income Security Act of 1974. These three regulations provide that any business be it a sole proprietorship, partnership, corporation or government entity are allowed to adopt a qualified business plan. Employees of these businesses are not allowed to adopt qualified plans but they are allowed to participate in plans established by their employer.
In order to establish a qualified plan, organization are often required to provide an adoption agreement and a summary plan description document that provides details of the plan. If the rules that govern the organization require them to pass a resolution in order to adopt the plan, the adoption agreement and the resolution must be provided. The summary plan description document must provide the identification number and the location of the plan, the description of the plan provided and how employees are recruited in the plan, the effective date of the plan when the employees can begin to participate, and how the service and benefits for employees will be calculated. It must also provide information on when the benefits provided by the employees become vested, when the employees begin to receive payment under the plan, how the payments will be disbursed, rights of the employees under the plan, and circumstances when employees can lose or be legally denied their benefits Huberman & Jiang, 2006()
In order for the employer’s plan to be qualified, the employer is required to choose a provide for the plan. They can decide to be the providers or to choose one of the Internal Revenue Services (IRS)-approved prototype plans provided by sponsoring organizations. These plans should be designed to meet the needs of the employer and the employees. When the employer decides on an individually designed plan where they are the providers, IRS approval is not required. However, in this case the employer should seek assistance from legal and tax experts on the services and how they vary among the different professionals. When the employer chooses to use an IRS approved plan, they must choose a separate trustee or custodial account for receiving contributions Wilcox, 2006()
The qualified plan must be established on the last day of the tax year of the employer. The employer is also required to contribute to the plan for that year and all subsequent years as they provide in their plan. Employees are required to meet the minimum eligibility requirement to participate in the employer plan. However, there are certain general requirements that are required. First is that the employee should have reached a minimum of 21 years of age. The minimum age cannot exceed 21 years but can be reduced as desired by the employer. The employer is also not allowed to specify a maximum age for joining the qualified plan. For an employee to participate in a qualified plan, they are also supposed to have served in the company for a particular period of time, which is often a minimum of 1 year. For 401(k) plans, the requirement is that the employee must have served for two years and that after two years of service in the company or organization, the employee’s contribution become 100% vested. For qualified plans, on the other hand, the requirement is 1,000 hours of service which is equated to 1 year of service even if they were not performed under a 12-month period. Employers are allowed to be flexible in determining their eligibility requirements such as minimum age and years or hours of service. Employers are allowed to exclude unionized employees since they are covered under collective bargaining agreements or employees who are nonresident aliens.
For an employer to keep the qualified status, they must conform to vesting requirements provided in their plan. These provide that employees are always 100% vested in their own personal contribution to the plan. However, employers are allowed to set the vesting schedule for employer contributions. These vesting schedules should meet minimum regulatory requirements. Two vesting schedules are recognized as possible. These are cliff and graded vesting.
Under cliff-vesting schedules, the employee is required to provide at least three years of service in order to become 100% vested in employer contributions. On the other hand, over graded vesting schedules, the employee should become vested in a minimum of 20% of the employer’s contribution after two years of service, and this should increase steadily until the employee becomes vested in 100% of the employer’s contribution after a maximum of six years of service. These regulations only provide for the minimum or slowest vesting schedules and employers can have their own vesting schedules. The employer may even decide not to have a vesting schedule therefore employees are immediately 100% vested in all their employer’s contributions.
Employees are also supposed to stick to strategies by which the vesting schedule affects their assets. The regulations…