What’s a 501 retirement plan?

The IRS gives different designations to organizations to define their tax status. The 501(c) (18) designation identifies trusts that are organized and operated for the purpose of tax exemption. 501(c)(18) trusts were created before June 25, 1959, with the goal of funding retirement plans for employees, and they cannot operate for private purposes.

A 501(c)(18) retirement plan is solely funded by employee contributions, and the funds held in the plan can be solely used to pay employee benefits. This retirement plan was originally created by unions to allow employees to fund their pension benefits, and the funds may not be used for any other purpose. Federal laws require that these organizations must refrain from discriminating against participants in the determination of benefits.

Contributions to a 501(c)(18) Plan

A 501(c)(18) is funded solely with employee contributions, and you can contribute the lower of 25% of your annual income, or $7,000 annually. If your annual contributions exceed the annual limit, the IRS imposes a 10% penalty. The plan can only be funded by member employees of a trust that was created before June 25, 1959.

New members can start contributing to a 501(c)(18) plan as soon as they obtain membership. New members can participate in a 501(c)(18) through trust mergers, as long as one trust was established earlier than June 25, 1959. Also, the merged trusts must be in the same or related industries.

501(c)(18) Retirement Plan vs. Other Retirement Plans

A 501(c)(18) retirement plan is funded with employee contributions only, unlike other retirement plans like 401(k) and 403(b), which may be funded by both employee and employer contributions.

Also, a 501(c)(18) requires that the plan funds must only be used for paying retirement benefits or pensions to members. The only exemption is expenses incurred in plan administration. However, if the plan incurs other costs like lawsuits and auditing fees, the plan administrator cannot charge these costs against the plan funds.

Workplace retirement plans like 401(k) and 403(b) are continually reviewed to adjust contribution limits based on inflation. However, the contribution amount for 501(c)(18) has remained unchanged over the years.

Requirements for a 501(c)(18) Trust to be Tax-Exempt

A 501(c)(18) trust must meet the following requirements to be tax-exempt:

Established under local law

The trust should be a valid existing trust that is created under the local law and evidenced by a written document.

Funding

The trust must be funded from employee contributions only. The employees must also be members of the trust. The employee contributions include direct contributions into the trust as well as earnings and gains from assets of the trust that were contributed by employees.

Inception

A trust must have been established before June 25, 1959, to qualify for tax exemption. A trust may also be valid if changes made to the trust do not distort the character of the trust or beneficiaries.

If a trust established before June 25, 1959 merges with a trust created after this period, the trust still qualifies for tax exemption as long as the merged trusts work for the benefit of member employees.

Purpose

The trust should be set up for the sole purpose of paying retirement benefits or pensions to its members. In this case, retirement benefits include the customary benefits and incidental benefits like the death benefit.

Discrimination

The trust should not discriminate employees against low-salaried employees or favor shareholders, trust officers, or highly compensated employees.

The benefits may be deemed to be discriminatory if the benefits paid to highly compensated employees are a larger portion of compensation than the benefits paid to other employees.

Expenses

Before the payment of all liabilities owed to employees, the income of the trust cannot be used for any other purpose other than paying pension or retirement benefits to employees. However, payments associated with the administration of the plan or benefits employees do not affect the tax-exempt status of the 501(c)(18) plan.

What is a 501(c)(3) Organization?

Non-profit organizations have access to different retirement accounts like 401(k) and 403(b) for their employees. These employees have access to different retirement plans than employees working in the private sector do not have. It is not uncommon for a 501(c)(3) employee to participate in a 401(k) or 403(b) plan. However, the IRS designates a special tax category for non-profit organizations, which exempts these entities from federal income taxes.

Section 501(c)(3) is a portion of the IRS code that exempts certain non-profits from taxation. While the IRS recognizes different types of non-profit organizations, only non-profits that meet the requirements of Section 501(c)(3) qualify to receive tax-deductible donations. The main types of non-profits that are eligible for 501(c)(3) designation include charitable organizations, private foundations, churches, and religious organizations.