How much you can contribute to a Qualified Plan and claim as a deduction

There are limits on the amount you can contribute to the plan each year, and there are also limits on the amount of benefits that can be paid.

In a defined benefit plan, annual benefits cannot exceed the greater of 100% of the the participant’s average compensation for his or her highest 3 consecutive calendar years, or a fixed dollar amount for the year. This amount generally changes each year and is published by the IRS.

In a defined contribution plan, the annual contributions cannot exceed the greater of 100% of the employee’s compensation, or a fixed dollar amount (also published by the IRS each year, but different from the amount for a defined benefit plan).

Under a qualified plan, participants can make their own contributions, but they are not tax-deductible. Even though the contributions are not deductible, earnings on the contributions can accumulate tax-free until they are distributed.

You can usually deduct contributions you make to a qualified plan, including those you make for your own retirement, subject to certain limits. The contributions (and the earnings on them) are generally tax free until they are distributed. The deduction limit for your contributions to a qualified plan depends on the kind of plan you have.

For a defined contribution plan, either a profit-sharing plan or a money purchase pension plan, your deduction for contributions cannot be more than 25% of the compensation paid to your eligible employees during the year.

For a defined benefit plan, the deduction for contributions is based on the actuarial assumptions made and the calculations done in order to determine the amount of contributions required to cover the pre-determined benefits. In order to determine the deductible contributions you make for your own retirement as a self-employed individual, you need to make a special calculation. You can do this by using either the Rate Table for Self-Employed or the Rate Worksheet for Self-Employed in IRS Publication 560 - Retirement Plans for Small Business, and then figuring your maximum deduction on the Deduction Worksheet for Self-Employed.