What Are Qualified Retirement Plans?

What is a qualified retirement plan?

To be considered qualified, a retirement plan must:

• Be maintained for the benefit of plan participants.
• Satisfy minimum participation requirements, including setting a minimum age for participation that is not over age 21.
• Provide a plan document describing which employees are covered by the retirement plan and what benefits they are eligible to receive for participating in it.
• Meet a non-discrimination test applicable to any matching contributions that the plan offers. This test must ensure that highly compensated employees do not benefit disproportionately from the plan.
• Limit any elective deferrals to the maximum limit set by the IRS each year.
• Satisfy specific vesting schedule requirements that, among other things, ensure employees are 100% vested by the time they reach normal retirement age under the plan's definition.

The IRS maintains a full list of common requirements for qualified plans. Again, most employees cannot control whether their employers meet these mandates. Employees can receive the tax benefits of participating in a qualified plan simply by signing up for and contributing to a plan offered by their employer.

What are the tax benefits of a qualified retirement plan?

A qualified plan confers tax advantages for both employers and employees.

Employers can make tax-deductible contributions. Any contributions that they make on behalf of workers are not subject to payroll taxes. Small businesses that establish qualified retirement plans may be eligible for tax credits to help defray start-up costs.

Employees can elect to contribute to qualified plans on a pretax basis via withholdings from their salaries. Money invested in a qualified plan can grow tax-free.

Plan administrators are allowed, though not obligated, to issue loans to employees who contribute to qualified plans. These loans enable employees to borrow cash from their own retirement funds. Early withdrawals (those made before the plan beneficiary reaches age 59 1/2) from qualified plans are typically subject to tax penalties, with some narrow exceptions.

It's important to note that there are other types of retirement plans that offer tax benefits similar to those of qualified plans, such as traditional and Roth IRAs (individual retirement accounts). Because these plans are used by individuals to save for retirement rather than established by employers in accordance with IRS and ERISA rules, they are not considered qualified.

However, traditional IRAs and Roth IRAs do come with tax advantages, including tax-free growth and other favorable tax treatments. Contributions to traditional IRAs are tax-deductible, and withdrawals from Roth IRAs are tax-free.

Examples of qualified retirement plans

Qualified retirement plans can be broadly divided into two categories:

• Defined benefit plan: With this type of plan, employers promise workers a certain amount of retirement income based on a pre-established formula that takes an employee's wages and tenure into account.
• Defined contribution plan: Under this type of plan, employees and employers can make tax-advantaged contributions to a worker's retirement account, but there's no guarantee the plan will provide any specific amount of retirement income. The amount of money the employee ultimately receives in retirement depends on the amount contributed and the performance of the investments held in the account.

Common examples of qualified retirement plans include, but are not limited to:

• 401(k) plans
• 403(b) plans
• Savings Incentive Match Plan for Employees (SIMPLE) IRAs
• Simplified Employee Pension (SEP) IRAs
• Salary Reduction Simplified Employee Pension (SARSEP) Plans
• Profit-sharing plans

For these or other accounts to be considered qualified, they must comply with ERISA requirements as well as the IRS mandates set forth in Section 401(a) of the Internal Revenue Code. For example, while most 401(k) plans are qualified, a particular plan might not be if the employer does not keep its plan documents updated to reflect changes to the law or does not correctly apply the plan's definition of compensation for employee deferrals.

Self-employed individuals may also establish qualified plans. These retirement plans are usually referred to as Keogh plans or H.R. 10 plans. Because establishing a qualified plan can be complicated, it's more common for businesses with employees to establish them than for self-employed individuals to use them.

Employers may also set up non-qualified retirement plans, such as executive bonus plans. These do not provide the same tax benefits as qualified plans. Employees are required to include contributions to non-qualified plans in their gross incomes for tax purposes.

How do you know if you have a qualified retirement plan?

Most employer-sponsored retirement plans are qualified retirement plans. Chances are good that your plan is qualified if it was set up by your employer, especially if you aren't a highly compensated employee or a leader at your organization and if you don't work for the government or a religious organization.

The easiest way to find out if you have a qualified retirement plan is to talk with your plan administrator or another member of your organization who set up the plan. In most cases, an employer's contributions to your qualified plan will be listed by your employer in Box 12 of your W-2 form.