John, an employee of ABC, Inc., is concerned because he has not received an annual addition to the ABC profit-sharing plan for the past two years. John, who earns $100,000 per year, is age 40 and married. Which of the following are true?
- All defined contribution plans are subject to minimum funding rules.
- He cannot contribute to an IRA because he is an "active participant" in an employer plan.
- He can make a deductible contribution of $6,000 to an IRA.
- He can't make a deductible IRA contribution because ABC hasn't made contributions to the profit-sharing plan.
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Correct answer: C. He can make a deductible contribution of $6,000 to an IRA.
Defined Benefit Plans (i.e., money purchase & defined benefit pension plans) are subject to minimum funding rules, but profit-sharing plans are a type of Defined Contribution Plan and are not subject to minimum funding rules.
To be considered an active participant in an employer-provided Defined Contribution Plan, no reallocated forfeitures, employer contributions, and/or employee deposits can be credited to the employee account.
In John’s scenario, if ABC, Inc. does not contribute to the profit-sharing plan in a given year, John is not considered an active plan participant (even though he is covered under the plan). Note: relocated forfeitures and employee contributions were not credited, as well.
If one spouse is an active participant and the other spouse is not an active participant, the non-active participant spouse may make a deductible IRA contribution if their combined adjusted gross income (AGI) is less than $196,000 [phased out at $206,000 (2020)]*.
For active participants, deductible IRA contributions are phased out between the AGI limits shown*.
Single taxpayers (active)
$65,000 - $75,000
Married filing jointly (active)
$104,000 - $124,000
*In both cases, each spouse may elect to make non-deductible contributions to their traditional IRAs if they are above phaseout limits. Phaseout numbers are provided on your CFP® exam.
CFP® Exam tip:
Determining active participation status is essential to figuring out if a deductible IRA contribution is permitted. Defined Benefit Plans and Defined Contribution Plans have different active participation criteria.
- Defined Benefit Plans: If an employee is eligible to participate in the plan, they are considered an active participant.
- Defined Contribution Plans: If any of the following were deposited to an employee’s account they are considered an active participant:
- employee contributions
- employer contributions