What are the basic tax advantages of a qualified retirement plan?
A qualified retirement plan is afforded special tax treatment. These tax advantages include the following:
1. The sponsoring company is allowed an immediate tax deduction for the amount contributed to the plan for a particular year. [I.R.C. § 404 LK:NON: PENIRC S404 ]
2. Participants pay no current income tax on amounts contributed by the company on their behalf. [I.R.C. §§ 402 LK:NON: PENIRC S402 , 403 LK:NON: PENIRC S403 ]
3. Earnings of the plan are tax-exempt —permitting the tax-free accumulation of income and gains on investments. [I.R.C. §§ 401 LK:NON: PENIRC S401 , 501 LK:NON: PENIRC S501 ]
4. Income taxes on certain types of distributions may be deferred by rolling over the distribution to an IRA or to another eligible retirement plan. [I.R.C. §§ 401(a)(31) LK:NON: PENIRC S401(A)(31) , 402(c) LK:NON: PENIRC S402(C) , 403(a)(4) LK:NON: PENIRC S403(A)(4) , 403(a)(5) LK:NON: PENIRC S403(A)(5) ]
5. Income taxes on certain types of distributions to a deceased participant's spouse may be deferred by rolling over the distribution to an IRA or to an eligible retirement plan in which the surviving spouse participates. [I.R.C. § 402(c)(9) LK:NON: PENIRC S402(C)(9) ]
6. Income taxes on certain types of distributions to a deceased participant's nonspouse beneficiaries may be deferred by transferring the distribution directly to an IRA. [I.R.C. § 402(c)(11) LK:NON: PENIRC S402(C)(11) ]
7. Installment or annuity payments are taxed only when they are received. [I.R.C. §§ 72 LK:NON: PENIRC S72 , 402(a) LK:NON: PENIRC S402(A) , 403(a) LK:NON: PENIRC S403(A) ]
Earnings of the plan may be taxable if the earnings are unrelated business taxable income (UBTI; see Q 30:11 LK:NON: PAB01 30:11 ). [I.R.C. §§ 511 LK:NON: PENIRC S511 , 512 LK:NON: PENIRC S512 , 513 LK:NON: PENIRC S513 , 514 LK:NON: PENIRC S514 ] One court ruled that ERISA did not preempt a California law taxing the UBTI of tax-exempt trusts, including those trusts covered by ERISA. The court held that the state law neither referred to nor had a connection with ERISA plans; and, accordingly, it did not relate to ERISA plans, as described in ERISA's preemption clause. [ERISA § 514(a) LK:NON: ERISA-LAW ERISA+514(A) ; Hattem v. Schwarzenegger, 449 F.3d 423 (2d Cir. 2006); but see In re McKinsey Master Retirement Plan Trust, 2003 WL 21133964 (N.Y. Tax App. Trib. 2003)]
IRS has ruled that a qualified retirement plan that invests funds in a common trust fund has UBTI from the trust fund to the same extent as it would have had it made the same investment directly. A common trust fund is a fund maintained by a bank or trust company for the collective investment of funds contributed to the fund by the bank in its capacity, for example, as a trustee. A common trust fund is not subject to taxation, but its income is included in the gross income of the participants (e.g., a qualified retirement plan) in the fund. Therefore, if a common trust fund operated an active business, income from that business would be UBTI when passed through to the qualified retirement plan. [I.R.C. § 584 LK:NON: PENIRC S584 ; Treas. Reg. § 1.584-2(c)(3) LK:NON: PTR01 S1.584-2(C)(3) ; Rev. Rul. 98-41 LK:NON: RULINK REVRUL98-41 , 1998-2 C.B. 256; Rev. Rul. 67-301 LK:NON: RULINK REVRUL67-301 , 1967-2 C.B. 146; Priv. Ltr. Rul. 200148074 LK:NON: RULINK LTR200148074 ]
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