The Internal Revenue Service allows businesses to establish retirement plans for their employees that are tax deductible, provided the plans adhere to IRS Code 401(a) and the Employee Retirement Income Security Act, or ERISA. Check with your employer about whether your contribution into a retirement plan is deductible by asking if the employer has received a “Determination Letter” from the IRS, ensuring they are covered under a “qualified plan” for tax purposes.
Tax Deductible Plan Requirements
A plan has to be open to all employees who are at least 21 years old and have been with the company for a year. The employee must be allowed to participate either when the plan year starts or within six months of turning 21 or being employed for a year. The plan needs to be operated in strict accordance with plan documents that describe employees covered and the benefits and contributions that will be made. Employees must be 100 percent vested, and a business cannot reduce accumulated benefits. Employee contributions can be made with pre-tax dollars that lower their taxable income for a given year provided the plan documents allow such contributions. Failure to abide by plan documents, or poorly written plans uncovered during an IRS audit, could disqualify the beneficial tax treatments of the contributions made under those plans.
An accrued pension tax deduction is possible, according to Section 404 of the U.S. Code, with the following plans: 401(k), Simplified Employee Pension (SEP), Salary Reduction Simplified Employee Pension (SARSEP) – provided the plan was established before 1997, Savings Incentive Match Plans for Employees of Small Businesses (SIMPLE), traditional IRA accounts, 403(b) and 457(b) plans, defined benefit plans and “catch-up” contributions. All this is outlined in IRC 404 of the IRS. Tax-deductible contribution limits apply to each plan.
Other Types of Plans
The pension plans of federal, state and Indian tribal government employees and the employees of their subdivisions, agencies and instrumentalities are covered under IRS Code 401(a). Employees cannot contribute to this plan and do not receive a tax deduction. Teachers in public schools, hospitals and some 501(c)3 tax-exempt organizations are covered under the 403(b) government pension plan and can contribute and receive a tax deduction.
ERISA was created to protect the employees of private employers that institute a pension plan for their workers. The act established the minimum requirements an employer must meet to establish a pension plan for their employees and gives participants certain rights if the employers don't meet these minimum requirements. The act covers participation requirements, how benefits are accrued, the fiduciary responsibilities of plan managers and the rights of participants if the plan is not operated in accordance with the plan documents. ERISA also allows for payment of some benefits for terminated defined plans through the Pension Benefit Guaranty Corporation.
2018 Tax Rules
Annual contribution plan limits for employees who participate in 401k, 403b, most 457 plans and the federal government's Thrift Savings Plan increased from $18,000 to $18,500 in 2018. For those over 50, the annual tax deductible catch-up contribution, or extra amount allowed into a qualified retirement plan, is still $6,000. That goes for anyone who turns 50 by Dec. 31, 2018. There are also changes to income limitations for Roth IRA and tax deductible traditional IRA contributions for those who are already covered by an employer-sponsored plan.
2017 Tax Rules
For those of you doing your 2017 taxes, make sure your pension plan contribution didn't exceed $18,000, or you'll be taxed on that extra contribution.
- IRS: A Guide to Common Qualified Plan Requirements
- IRS Retirement Topics: Contributions
- IRS: IRS Announces 2018 Pension Plan Limitations; 401k Contribution Limit Increases to $18,500 for 2018
- Forbes: IRS Announces 2018 Retirement Plan Contribution Limits for 2018 and More
- Money Under 30: IRS Retirement Plan Changes for 2018
Griffith Pritchard served as a senior branch manager and banking officer for M&T Bank. He specialized in small business and personal financial, credit and banking products. He also has extensive experience in small business sales and non-profit management. Pritchard is a graduate of Hobart College.