What are the types of qualified plans?
Defined Benefit Plans:
- Traditional Plans
The traditional defined benefit plan provides retirement benefits, not based on an account balance, but based on a benefit formula. Employer contributions are not allocated to individuals, but pooled to pay all participant benefits. The Employer bears the risk of the performance of the assets. Generally contributions are required to be made. Funding of the plan must be maintained at a specific level.
- Cash Balance Plans
A Cash Balance Plan is a hybrid type of defined benefit plan, except retirement benefits are based upon a hypothetical account balance. The benefits are calculated as if account balances (as in a defined contribution plan) are maintained, although each participant does not actually have a separate account. Contributions are generally required. This type of plan provides higher contribution levels and an easier to understand format than the traditional defined benefit plan.
Defined Contribution Plans:
- 401(k) Profit Sharing Plans
Participants are permitted to make contributions from their wages on a pre-tax or post-tax basis (salary deferrals). These contributions are always 100% vested. The Employer may then make contributions – either matching contributions (for those participants making salary deferrals) and/or profit sharing contributions. Account balances are maintained for each type of contribution for each participant. Retirement benefits are based upon these account balances.
- Profit Sharing Plans
Contributions to profit sharing plans are made by the employer and are discretionary, providing flexibility as to whether or not a contribution is made for a particular year. Participants can easily understand the contributions made to their accounts and the associated earnings. Account balances are maintained for each participant. Retirement benefits are then based upon these account balances.
- Money Purchase Plans
This type of defined contribution plan generally requires that the Employer make contributions to the Plan. This type of plan was more popular before contribution limits for profit sharing plans were increased. It provided an additional way to save more for retirement. Those limits can now be reached with a stand-alone profit sharing plan. Currently a money purchase plan is more frequently used as a “frozen” plan, with zero future contributions in order to continue the tax deferral on the growth of the assets. Account balances are maintained for each participant.