What Is a 501c Plan?

According to the IRS, "organizations must be organized and operated exclusively for exempt purposes" to receive the status of a 501(c) trust. Further, the organization cannot "organize or operate for private interests." Created before June 25, 1959, 501(c) trusts are exempt from some federal taxes and were created to fund retirement plans for employees.

Employee contributions fund 501(c) retirement plans. Each year, you can contribute the lower of 25 percent of your annual salary or $7,000. Because the plan makes no allowances for increases in the cost of living index, 501(c) plan maximum contributions have remained the same since 1969. Further, the IRS assesses a 10 percent penalty if your contribution exceeds the maximum allowable contribution. Contributions to a 501(c) retirement plan also count against the limit set for any other retirement plans, including individual retirement arrangements.

Aside from the necessary expenses needed to take care of and make the fund grow, your plan administrator cannot use funds from 501(c) retirement plans for anything other than paying retirement benefits to you and other contributors. For example, in the case of a lawsuit, your administrator cannot use funds from the plan to pay for damages. Unlike other plans such as the 401k or 403(b) plan that allows employer contributions, 501(c) plans are employee contributions only. Also, 401k and 403(b) plans increase the maximum allowable contributions to match current cost of living indexes while 501(c) plan maximums remain unchanged. Because 401k plans are better funded than a 501(c) plans, there are more opportunities for 401k plans to grow.

Only a valid trust created before June 25, 1959, contributes to a 501(c) plan, and the fund can only use contributions from the member employees. The trust may be modified, but remains acceptable as long as there are no fundamental character changes. Adding beneficiaries is not considered a fundamental change, provided that the additions are of the same industries or related industries. Addition of beneficiaries may occur through trust mergers, but the merged trusts must operate in the same industry and one trust must have an initiation date earlier than June 25, 1959. You can begin contributing to a 501(c) retirement plan as soon as you obtain membership, but keep in mind that contributions are subject to an the annual limit.

An advantage of 501(c) retirement plans is that as a member of the trust, you are assured of a pension when you retire, so long as you actively contribute and the trust survives. This guarantee is possible because, under the law, the trust must be used solely to provide the pension payments and other benefits stated within the trust; these include other benefits such as death benefits and any other predetermined benefit included in the bylaws of the trust. Unfortunately, the 501(c) plan does not integrate well with other retirement plans. For example, you cannot roll over contributions to 501(c) retirement plans to any other eligible retirement plan tax-free. Further, if you are older than 70 1/2 years, you may no longer contribute to the plan.