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Explain Employer-Qualified Retirement Plans

There are many reasons why companies offer qualified retirement plans. Companies may offer these plans because of competition. Since most companies offer a qualified retirement plan, a company that does not offer a qualified retirement plan is at a disadvantage; most companies must offer benefits to attract qualified personnel.

Tax advantages make retirement plans attractive to companies. Money set aside in qualified plans has specific tax advantages. Companies may be motivated to offer these qualified retirement plans because the company owner may wish to use these qualified retirement plans to save money for retirement in a tax-efficient manner. These funds offer tax advantages to the company, and these funds may be tax deferred for the employee as well.

Concern for employees may also be a reason that companies offer qualified retirement plans. Companies may reason that the better prepared for retirement employees are, the better the employees will perform their work.

There are two main types of employer-qualified retirement plans: defined-benefit plans and defined-contribution plans. Defined-benefit plans provide a predetermined payout based on specific employee data, such as years of employment and annual salary. Defined-contribution plans are investment plans in which both the employee and the employer contribute funds to the plan; the amount contributed by the employer is generally fixed. With defined-benefit plans, the company bears most of the risk associated with funding a specific amount each year. With defined-contribution plans, the employee bears most of the risk involved in funding the plan. Table 29.1 lists the major types of defined-benefit and defined-contribution plans.


Table 1

Characteristic Defined Benefit Defined Contribution
Employer’s contribution Actuarially determined Specified by formula
Benefit amount Certain Uncertain
IRC limit applicable Maximum Contributions
Types of benefits funded


Cash balance

Profit sharing


Stock bonus

Target benefit

Money purchase

Employee contribution


There are limits to the amounts of money that may be contributed to defined-benefit and defined-contribution plans. These limits are set forth in Code 415 of the Internal Revenue Code. Code 415 limits the amount of that individuals and employers may contribute in 2007 (see Table 2).


Table 2

Plan Type Participant Limit Employer Limit
Defined contribution: 100% or $45,000 (indexed) if less 25% of participant’s total compensation
Defined benefit 100% or $180,000 (indexed) if less Amount necessary to fund compensation
Profit sharing: 100% or $45,000 (indexed) if less 25% of participant’s total compensation


 In recent years, there has been a significant shift away from defined-benefit plans and toward defined-contribution plans. Even companies that continue to offer defined-benefit plans have tried to reduce their risk by reducing benefits. This change suggests that companies are shifting the responsibility of retirement planning onto individual employees. Because of this change, it is critical that you understand qualified retirement plans and make retirement planning an important part of your personal investment plan.


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