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THE BASICS: The employer contributes a defined
or fixed percentage of the participating employee's
salary each year. Whatever that fund grows to is what
the retiring employee receives.
HOW IT WORKS
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1. Employer
contributes a fixed percentage of the participants'
salary each year to the plan.
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2. The total
employer contribution is then allocated on a separately
defined basis.
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3. Employer
contributions are tax deductible. IRC Sec.
404(a).
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4. Contributions are not
taxed currently to the employee. IRC Sec. 402(a)
and 403(a).
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5. Earnings
accumulate income tax-deferred. IRC Sec. 501(a).
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ADDITIONAL CONSIDERATIONS
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1. MAXIMUM
ANNUAL CONTRIBUTION. Up to 25% of covered payroll
can be contributed and deducted by the employer. |
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2. CONTRIBUTION
BASE. Plan contributions are normally based on
total compensation, e.g., base salary, bonuses,
overtime, etc. |
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3. INDIVIDUAL
LIMITS (2008). The allocation of contributions
to a participant's account may not exceed the lesser
of 100% of compensation or $46,000 per year. |
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4. EXCLUDING
PERSONS. Certain persons can be eliminated on the
basis of months of service, age and coverage in
a union plan; for example, persons under age 21
can be excluded from the plan. |
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5. INVESTMENT
OF PLAN ASSETS. Plan assets can be invested in
equity products, like mutual funds, stocks, debt
free real estate, or debt
instruments, like T-Bills,
CD's; or in insurance
products, like life insurance
and annuity policies. |
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6. SOCIAL SECURITY
INTEGRATION. Since the employer already contributes
to the employee's Social Security Retirement Benefit,
these contributions can be integrated into the
contribution and/or allocation formulas of the
plan. |
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7. PARTIES
WHICH ARE FAVORED. Typically younger participants
are favored because they have a longer time for
their fund to grow and, in some instances, share
in forfeitures. |
I. HOW MUCH WILL THERE BE AT RETIREMENT?
This will depend upon three factors:
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1. The amount of
contributions,
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2. The number
of years until retirement, and
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3. The investment
return.
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The risk of poor investment returns rests upon the employee;
however, if the investment results are favorable the
participant will have a larger fund at retirement age.
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AN EXAMPLE OF WHAT $10,000
PER YEAR WILL GROW TO OVER SEVERAL YEARS
AT VARIOUS RATES OF GROWTH WITHOUT TAX |
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YEARS |
6% |
9% |
12% |
15% |
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5 |
$ 56,371 |
$ 59,847 |
$ 63,528 |
$ 67,424 |
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10 |
131,808 |
151,929 |
175,487 |
203,037 |
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15 |
232,760 |
293,609 |
372,797 |
475,804 |
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20 |
367,856 |
511,601 |
720,524 |
1,024,436 |
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25 |
548,645 |
847,009 |
1,333,339 |
2,127,930 |
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30 |
790,582 |
1,363,075 |
2,413,327 |
4,347,451 |
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35 |
1,114,348 |
2,157,108 |
4,316,635 |
8,811,702 |
II. FUTURE CONTRIBUTIONS
An employer must make annual contributions to
the plan, but to the extent that the future payroll can
be forecast, so can the approximate amount of future
contributions.
III. ADVANTAGES TO EMPLOYER
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1. Contributions are tax
deductible.
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2. Contributions and costs
are known in advance.
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3. Contributions will
rise as compensation rises, but they are controllable both
by formula and absolute dollar amounts.
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4. Forfeitures of
terminating employees may reduce
future costs or be reallocated among the accounts of those
still in the plan.
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5. The plan
is easier to understand by the employees,
than is a Defined Benefit Plan.
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6. It can provide
employees with permanent life
insurance benefits that
need not expire or require costly conversion at
retirement age.
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7. The employer
can direct investments.
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IV. ADVANTAGES TO EMPLOYEES
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1. Annual
contributions (except for the PS58 Cost for life
insurance) are not taxed to the participant.
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2. Earnings on
the account are not currently taxed.
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3. Participants
can be given the right to direct investments.
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4. Participants
can also have a deductible IRA, subject to income
levels and filing status.
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5. There is
the ability to purchase significant permanent life
insurance, which is not contingent upon the
company group insurance program.
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6. Younger
employees can accumulate a larger fund than
with a Defined Benefit Plan.
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7. Employee
can borrow from the plan within certain legal guidelines,
if provided for in the plan documents.
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V. DISADVANTAGES TO EMPLOYER
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1. In low profit
years, the employer is still obligated to make
contributions. |
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2. While contribution
levels may be changed from time to time, this should
not be done annually. |
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3. The money
purchase plan will generally not produce as large
of a contribution and deduction for older employees
(i.e., age 50 or more) as will a Defined Benefit
Plan. |
VI. DISADVANTAGE TO EMPLOYEES
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1. There is no
guarantee as to future benefits.
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2. Investment
risks rest on the participant.
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3. Older
participants may not receive as great a benefit
as with a Defined Benefit Plan.
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Arizona
Qualified Plan Services, Inc.
4000 N. Central Avenue, Suite 1200
Phoenix, Arizona 85012
Voice: (602) 234-3199
Fax: (602) 234-3256
Toll Free:
(800) 859-AQPS
E-mail: aqps@aqps.com
Bruce
Gardner,
F.S.A., E.A., M.A.A.A
Katherine M. Manker, C.E.B.S.,
E.A., M.S.P.A.
Consulting Actuaries & Retirement Plan Administrators |
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