Text Box: A LESSON IN QUALIFIED RETIRMENT PLANS The information contained in these page focuses on pension benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA), particularly those plans considered qualified for special tax considerations under the Internal Revenue Code. These plans are commonly referred to as “qualified plans.” Money Purchase Pension Plans From the participant’s perspective, a money purchase pension plan looks very similar to a profit sharing plan. The difference, however, is that the employer has made a commitment to contribute a specific percentage of the participant’s pay to the plan each year. The contribution formula is specified in the plan. An annual contribution is required. Failure to meet the contribution, or funding, requirements will result in an excise tax on the deficiency. An example of a money purchase plan contribution formula is “…10 percent of compensation.” An employer who chooses to implement both a money purchase plan and a profit sharing plan to provide benefits generally selects a 10 percent of compensation formula for the money purchase plan. Tax law limits the employer’s deduction for a profit sharing plan to 15 percent of the compensation of employees eligible to participate in the plan. Thus, the employer achieves an overall 25 percent of compensation allocation for participants between the two plans. The significance of this planning technique will become clearer as the pension administrator becomes more experienced. In most money purchase plans the formula for allocating the contribution to a participant’s account is the same as the contribution formula. The plan document must be scrutinized to decide whether the contribution formula and the allocation formula are the same. As with the profit sharing plan, a money purchase pension plan may be integrated with Social Security. Text Box: Profit Sharing Plans A profit sharing plan is a type of defined contribution plan. Through a profit sharing plan, employees can share in the employer’s profits. The employer has discretion as to the amount to contribute to the plan each year; however, the plan must contain a formula for allocating the contribution to participants. For example, an employer contributes $40,000 to its profit sharing plan. The allocation formula states that a participant will share in the contribution on a pro rata basis according to his or her compensation. If total eligible wages are $500,000 and a participant earns $50,000, he or she will be allocated 10 percent ($50,000/$500,000) of the employer contribution, or $4,000. An employer often selects a profit sharing plan for its employees because the employer/plan sponsor has the flexibility to choose each year how much to contribute to the plan. The employer does not need to make a contribution in years when it has little or no profits, or when its income is needed for expanding operations. The business has no fixed annual contribution commitment as it does when funding a defined benefit plan. Certain other defined contribution plans have annual funding requirements, as explained in the sections on money purchase and target benefit plans. Since 1989, the age-weighted (or age-based) profit sharing plan has afforded many employers the opportunity to use both age and compensation as a basis for allocating employer contributions among plan participants. Another allocation method for profit sharing plans is often referred to as “new comparability” plans. These plans generally allocate a different contribution level to different groups of employees within the same plan. Both of these allocations require special nondiscrimination testing each year, and generally can be utilized very effectively in the small plan market.¨
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