Types of Retirement Plans - Factors affecting contributions or benefits

Employer contributions to a qualified plan are deductible up to certain limits. The contributions, along with any earnings and gains, are generally tax free until distributed.

  1. Deduction limits - The deduction limit depends on the type of qualified plan.
    • Defined contribution plans - Deduction cannot be more than 25% of the employee's compensation.
      • Self-employed - Must reduce this figure to take into account the deduction for one-half of the self-employment tax and the deduction for contributions on the self-employed individual's behalf to the plan. The self-employed individual uses a net earnings figure to calculate the appropriate deduction limit.
    • Defined benefit plans - Deduction is based on actuarial assumptions and computations. An actuary must calculate the deduction limit.
  2. Defined contribution limits - Annual contributions and other additions (excluding earnings) cannot exceed the lesser of the following amounts:
    • 100% of the participant's compensation.
    • $52,000 (for 2014).
    • Excess annual additions - Amounts contributed to a defined contribution plan that exceed contribution limits. A plan can correct excess annual additions caused by the following actions:
      • Reasonable error in estimating participant's compensation.
      • Reasonable error in determining the permitted elective deferrals.
      • Forfeitures allocated to participant's accounts.
    • Correcting excess annual additions - A plan can correct excess annual additions in the following ways:
      • Allocate the excess to other plan participants to the extent of their unused limits.
      • If these limits are exceeded, do one of the following:
        1. Hold the excess in a separate account and allocate to participants in the following year before making any contributions for that year.
        2. Return employee after-tax contributions or elective deferrals.
  3. Defined benefit limits - The maximum contribution is the amount needed to provide an annual benefit no larger than the smaller of $210,000 (for 2014) or 100% of the participant's average compensation for his or her highest three consecutive calendar years.
  4. Annual compensation limit - The maximum compensation that may be considered for qualified plan purposes is $260,000 (2014, indexed for inflation).
  5. Definition of compensation - The IRS defines compensation to include all of the following:
    • Defined contribution plans - Deduction cannot be more than 25% of the employee's compensation.
      • Self-employed - Must reduce this figure to take into account the deduction for one-half of the self-employment tax and the deduction for contributions on the self-employed individual's behalf to the plan. The self-employed individual uses a net earnings figure to calculate the appropriate deduction limit.
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