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Qualified retirement plans are set up by employers to provide employees with opportunities to save for retirement.  A self-employed person or small business owner can also set up some of these plans, even if there are no employees in the business.

Qualified plans are referred to as qualified because they qualify for favorable tax treatment under the Internal Revenue Code. Provided they meet the requirements for maintaining such plans, employers and self-employed individuals get to deduct their contributions to the plan. Also, employees are not immediately taxed on the contributions made on their behalf, they can often make additional contributions on a pre-tax basis, and earnings on their retirement plan funds get to accrue on a tax-deferred basis. This is a pretty good deal for both the employer and the employee.

If you are an employee, chances are pretty good that your employer offers a qualified retirement plan as part of your compensation package. According to 1997 data released by the Bureau of Labor Statistics at the end of 2000, 79 percent of private-sector employers with 100 or more employees offered some type of retirement program. For small private establishments, 1996 data shows that 46 percent of full-time workers were covered by a retirement plan. These numbers are likely to increase as people realize that our troubled Social Security system is likely to provide limited benefits in the years to come.

The type of qualified plan offered by your employer affects the type of benefits you will receive at retirement. Generally speaking, a qualified retirement plan will fall under one of the following three broad categories:

• Defined contribution plans. This type of plan does not guarantee an employee a fixed level of benefits upon retirement. Instead, the employer contributes a fixed amount to an account set up for the employee. At retirement, the employee will have the amount contributed to the account before retirement, with adjustments up or down due to income, expenses, losses, etc. Under such plans, an employee can only make an educated guess as to the exact amount of assets that will be available in the account for retirement.
• Defined benefit plans. The tax code defines this type of plan as any plan that is not a defined contribution plan. More specifically, these pension and annuity plans promise the employee a fixed or determinable monthly payment upon retirement (e.g., 25 percent of average annual compensation or $400 a month).
• Hybrid plans. A hybrid plan has the features of both a defined contribution and a defined benefit plan. These types of plans have increased in popularity as the workforce becomes more mobile.

Drilling down even further, there are five general types of plans that may qualify for tax benefits. The five types of plans are:

• Pension plans. A pension plan is designed to pay definitely determinable benefits to the employee for a prescribed number of years after retirement. Although a pension plan may be structured as a defined benefit or defined contribution plan, a defined benefit plan is always a pension plan for tax purposes.
• Profit-sharing plans. An employer providing this type of plan will allow its employees to participate in the employer's profits. Contributions to the plan are made under a predetermined formula.
• Money purchase plans. Unlike profit-sharing plans, contributions to this type of plan are fixed (often a percentage of the participant's compensation) and are not based on business profits.
• Stock bonus plans. This type of plan provides benefits similar to those of a profit-sharing plan except that the employer's contributions are not necessarily dependent on profits and benefits are distributable in the form of the employer's stock. A stock bonus plan is always a defined contribution plan.
• Annuity plans. An annuity plan is a type of pension plan. Unlike other pension plans, however, annuity plans are administered by insurance companies that receive contributions and hold funds in the form of premiums.

Within the respective broad categories mentioned above, qualified retirement plans come in various flavors. To find out about the benefits they offer, take a closer look at the following most commonly used qualified plans:

401(k) Plans

Many employers set up a retirement plan that allows an employee to make an election between receiving current compensation or having part of the compensation go to a qualified retirement plan, such as a profit-sharing or a stock bonus plan. This type of plan is generally called a 401(k) plan (referring to the tax code section that created this type of plan),  a cash or deferred arrangement (CODA), or a salary reduction plan.

If your employer offers its employees a 401(k) plan, consider yourself lucky. Your employer has the difficult part of setting up the plan, administering it and paying any costs related to the plan, which can be quite high. All you have to do, however, is make sure you reap the rewards of having a 401(k) plan.

As an employee, there really is no downside to contributing to a 401(k) plan. As an initial benefit, contributions to a 401(k) are made on a pre-tax basis so the employee sees an immediate tax savings. In addition, the money in your 401(k) will grow on a tax-deferred basis, making it even easier to save for retirement. This allows you to build your retirement nest egg quicker than if you saved on an after-tax basis.

Keogh Plans

Keogh or H.R. 10 plans are nothing more than qualified retirement plans for self-employed individuals. A Keogh plan can take the form of a defined contribution plan, like a profit-sharing plan or money purchase plan, or a defined benefit plan.

When originally enacted in 1963, Keogh plans were rather limited, but they provided the only option for a self-employed individual to save for retirement. Over the years, the tax laws have changed to eliminate the distinctions between corporate and Keogh plans. In addition, other plans for the self-employed have developed, like Simplified Employee Pensions, (SEPs) and Savings Incentive Match Plans for Employees (SIMPLEs).

Setting up a Keogh plan is fairly easy. The employer (including self-employed individuals) can adopt a generic master or prototype plan already approved by the IRS.  The IRS-approved plans can be provided by banks, trade or professional organizations, insurance companies, and mutual funds. If you are a regular employee working for an employer with a Keogh plan, you simply have to contribute to the extent allowed under the plan.

Contributions. The maximum amount you can contribute to a Keogh depends on whether it is a defined contribution or a defined benefit plan. For 2002 and 2003, the annual benefit for a defined benefit plan participant cannot exceed the lesser of 100 percent of the participant's average compensation for his or her highest three consecutive years or $160,000. If it is a defined contribution plan, annual contributions and other additions in 2002 and 2003 (except for earnings) to an account cannot exceed the lesser of 100 percent of the compensation actually paid to the participant or $40,000.

Rollovers and Distributions. The rules for rollovers and distributions from a Keogh plan are generally the same as those for other qualified plans. As with 401 (k) rollovers, Keoghs can usually be rolled over to another qualified plan that accepts rollovers or to an IRA type arrangement. Unlike the rule for 401 (k) distributions, however, hardship distributions are not permitted for Keogh plans.

SIMPLE Plans

A qualified retirement plan known as a Savings Incentive Match Plan for Employees (SIMPLE plan) is one of the easiest and most convenient methods for a small business to provide retirement income to its owner and employees. Under a SIMPLE plan, an employer and an employee make contributions to a savings account set up for the employee. SIMPLE plans may take the form of either an IRA or a 401 (k) qualified cash or deferred arrangement.

Setting up a SIMPLE plan is very easy because many financial institutions will help an employer with setting one up. Such plans are also fairly straightforward, inexpensive, and low-maintenance when it comes to administrating them.

A SIMPLE plan may be adopted by employers with 100 or less employees who earned $5,000 or more in compensation during the preceding calendar year. An employer is free to use less restrictive eligibility requirements (like lowering the compensation amount), but cannot impose any other conditions for participation. An employer, however, cannot start a SIMPLE plan if another qualified plan is maintained.

An employer's SIMPLE plan does not have to include employees who are covered by a union agreement that includes retirement benefits that were bargained for in good faith. The plan also does not have to include nonresident alien employees who have received no U.S. source wages, salaries, or other compensation from the employer.

Insecurity of Social Security

Will Social Security be there for you? According to the Social Security Administration's (SSA) web site, the answer is "absolutely" and "of course it will." They also point out, quite correctly, that the real question is what kind of Social Security system will it be?

Anyone who has examined the workings of the Social Security system to any extent knows that there appears to be very little security in Social Security. Created in 1935, the program was originally intended to help a small percentage of the population through hard times. Today, however, Social Security is the major source of income for two-thirds of the elderly. For a third of the elderly, it is virtually their only source of income.

At the same time, the number of Americans reaching age 65 is steadily increasing. By the year 2030, 70 million Americans will be looking to retire. This amount represents a staggering 20 percent of the expected population.

The really scary part is how the Social Security system is funded. The best way to describe it is a legalized Ponzi or pyramid scheme.

A Ponzi scheme, named after the swindler who invented it, involves an investment swindle in which some early investors are paid off with money put in by later investors, with the person at the top taking in all the money and deciding who gets what (usually less than participants expect). The Social Security system involves the federal government collecting money from those who are still working to pay for early investors (referred to by the SSA as an "intergenerational compact"), while deciding when and how much those retirees get (usually less than participants expect). See the difference?

The similarity to the typical Ponzi scheme is even more dramatic when you consider what the federal government does with the Social Security taxes it takes out of your paycheck. You would think that the money collected goes into a separate fund that earns interest and helps fund Social Security benefits. Think again. Money that comes in either gets directly paid out to retirees or, worse, is loaned to another federal government agency that is financially troubled in exchange for an effectively worthless IOU.

Now the enormity of the problem should be clear. Whether you run your own business or just balance your checkbook, you know that you have a problem when more money is going out than coming in. With no funds to fall back on, the Social Security will start become insolvent in 2015 when its benefit payments exceed tax collections. After 2037, only about 73 percent of benefits would continue to be paid based on incoming revenues.

Of course, the Social Security system is not really a Ponzi scheme. The federal government does not actually intend to defraud the taxpayers who are required to pay into the system.

There are, in fact, numerous proposals out there to improve the system. The proposals all share the motto "no pain, no gain" because they involve either raising taxes or cutting benefits. For this reason, Social Security is a political hot potato that no politician wants to touch.

These statisitics prove the importance of retirement planning,  because Social Security benefits alone will not allow you to retire comfortably. Instead, it is up to you realistically factor Social Security benefits into your retirement planning equation.