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Frequently Asked Questions
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Why should a company adopt a qualified retirement plan?
A qualified retirement plan is one of the best tax shelters available. The company is allowed a current deduction for its contributions to the plan; the employee pays no tax on money contributed for the employee's benefit until a distribution is made; earnings from investments made with funds in the plan may accumulate tax free; and distributions from the plan may be afforded favorable income tax treatment.
A qualified retirement plan is especially attractive to working owners of closely held corporations and to self-employed individuals. Their long-term service with their companies gives them the best opportunity to accumulate large sums of money through the tax-free build-up of capital. Although benefits must be provided for other employees as well, the owner usually receives a much larger benefit than the other employees.
The non-tax reasons for adopting a qualified retirement plan include the following: (1) attracting employees, (2) reducing employee turnover, (3) increasing employee incentive, and (4) accumulating funds for retirement.
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How does the adoption of a qualified retirement plan reduce a corporation's tax liability?
To illustrate how a qualified retirement plan reduces a corporation's tax liability, assume the corporation had taxable income of $45,000 in 2001 and no qualified plan. Its income tax liability would be $6,750. If, however, the owners decided to adopt a qualified retirement plan and make a tax-deductible contribution of $21,000 to the plan, the corporation's taxable income would now be $24,000 ($45,000 - $21,000). Its income tax liability would be reduced to $3,600. By adopting the plan and making the contribution, this corporation would cut its tax liability by almost 50 percent. [IRC § 11(b)]
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Must a company incorporate to have a qualified retirement plan?
No. The benefits of a qualified retirement plan are available to incorporated and unincorporated businesses alike. Sole proprietorships and partnerships can have retirement plans that are comparable to corporate retirement plans.
A plan covering a self-employed individual must, however, satisfy certain requirements in addition to the normal corporate retirement plan qualification requirements. [IRC §§ 401(c), 401(d)] A self-employed individual is an individual who has income from self-employment for the taxable year.
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What are the annual reporting requirements?
Each employer (subject to a limited exception) that maintains a qualified retirement plan is required to file an annual report. The annual report is commonly referred to as the Form 5500 series return/report.
The appropriate Form 5500 series return/report (Form 5500 or 5500-EZ) must be filed for each qualified retirement plan for each plan year in which the plan has assets. Therefore, the year of complete distribution of all plan assets is the last year for which a Form 5500 must be filed. [IRC §§ 6058, 6059]
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What penalties may be imposed for late filing of the Form 5500 series return/report?
One or more of the following five penalties may be imposed or assessed for late or incomplete filings after the date they are due unless there was reasonable cause for the improper filing:
- DOL may assess a civil penalty against a plan administrator of up to $1,000 a day for the late filing of a Form 5500 series return/report. [DOL Reg § 2575.502c-2] In addition, a Form 5500 series return/report rejected by DOL because it lacks material information will be treated as if it had not been filed. In other words, the plan administrator can be assessed a penalty for an incomplete as well as an untimely but complete filing.
- A penalty of $25 a day (up to a maximum of $15,000) is imposed for each day a Form 5500 series return/report is overdue.
- A plan administrator who fails to include all required separated participants in a timely filed annual registration statement (Schedule SSA) is subject to a penalty of $1 a day for each separated participant (the maximum penalty is $5,000).
- A penalty of $1,000 is imposed if an actuarial report (Schedule B) is not filed for a defined benefit plan.
- A penalty of $1 a day (up to a maximum of $1,000) is imposed if a notification of change of status of a plan is not filed on time. [ERISA §§ 104(a)(4), 502(c)(2); IRC §§ 6652(d)(1), 6652(d)(2), 6652(e), 6692]
DOL has opined that all penalties for the late filing of Form 5500 do not constitute a reasonable expense of administering a plan; and, therefore, the penalty is a liability of the plan administrator/plan sponsor, and not a liability of the plan. [DOL Info Ltr (Feb 23, 1996)]
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