What is a Qualified Retirement Plan? A Resource Guide

Most people understand the importance of saving for retirement. But when it comes to retirement planning specifics, there are some concepts that may seem mysterious. Qualified retirement plans may be one of these for you. What is a qualified retirement plan, and why is it relevant to you?

You may be familiar with the concept of asset allocation. As you age, you’ll change the percentage of your assets held in stocks or bonds. This modifies the amount of risk in your portfolio. So asset allocation directs how you invest.

Besides how you invest, it’s important to consider where you invest your money. What kind of plans are the best plans for you to save for retirement?

Qualified retirement plans are one option to save for your future. These plans offer benefits in regard to taxes, and depending on your situation they might be appropriate to help you reach your retirement goals.

In this article, we will explain what a qualified retirement plan is, what plans are available, and what advantages they offer.

What is a Qualified Retirement Plan?

A qualified retirement plan is a retirement plan adhering to requirements in the Employee Retirement Income Security Act of 1974 (ERISA). This act governs voluntary retirement plans sponsored by employers and dictates how these plans are set up and how they operate. It also governs the tax benefits these plans provide.

Some qualified plans also meet the guidelines laid out in various sections of the Internal Revenue Code including 401(k) and 403(b) plans, pension plans and profit-sharing plans. These are various plans offered by employers and there are legal requirements in place to protect employees who contribute to these plans.

In fact, most of these are plans offered by employers. The legal requirements mentioned above are there to protect employees who contribute to these plans.

Requirements for these plans cover various areas, such as:

• What are the eligibility requirements of the plan?
• Do the plans allow tax deferrals and what are the limits of those deferrals?
• What kind of contributions are available to those who participate?
• How much are plan participants allowed to contribute each year?
• What is the maximum compensation factored in for each employee?

Defined Contribution vs. Defined Benefit Plans

There is another distinction between qualified plans: defined contribution vs defined benefit plans. 

Defined contribution plans allow employers and employees to pay into individual accounts that change value over time. This means there’s not a fixed benefit paid to you upon retirement. 401(k), 403(b), and profit-sharing plans are common examples of defined contributions plans.

Defined benefit plans, on the other hand, pay a fixed monthly amount once you retire. Traditional pension plans are a good example of this type of plan.

So what does all this mean for you? Qualified plans meet rigorous standards which work toward your benefit. These types of investments allow you to save for retirement and reap some tax benefits.

Now, let’s highlight some of the different qualified retirement plans.

What Kind of Plans Qualify?

There are several different kinds of plans that meet the requirements of a qualified retirement plan. Some you may already be familiar with. Here are some of the most common examples.

401k

This is likely the qualified plan you are most familiar with. A 401(k) is a common plan sponsored by for profit companies to its employees. Such a plan allows you to put a part of each paycheck into an investment account. 

As mentioned above, this is a defined contribution plan, meaning you contribute a set amount from your salary each pay-period. How much you earn in retirement depends on how much the investment account earns over time.

These plans are only available through an employer. Many employers offer a matching plan, meaning they will also contribute to your account up to a certain amount. If your employer offers a 401k matching program, it would be a good idea to enroll and take advantage of it.

You are eligible to withdraw from a 401k at age 59 1/2. Although there are exceptions, in most cases early withdrawals result in a 10% tax penalty. 

Traditional vs. Roth 401k

Like IRAs, 401(k) plans have both traditional and Roth varieties. Traditional plans are tax-deferred, meaning the money that goes into that account is not subject to income tax. You will have to pay taxes when you retire. 

Roth 401(k) plans are after-tax, so you pay no further taxes once you begin withdrawing those funds. But this does increase your taxable income. One point of note: if your employer offers a Roth 401k plan, their matching contributions can only go into a traditional account. 

You’re going to pay taxes either way, but the choice of Roth or traditional determines whether you pay now or later.

403b

403(b) plans are like 401(k) plans, but for public employees or employees of non-profit institutions. Examples include non-governmental organizations or religious institutions.

In most practical ways, these are a very similar retirement vehicle to 401k plans. The contribution limits and minimum age for withdrawal are the same. There are also Roth varieties of these plans. The primary difference is the type of employer who offers these plans and the lesser variety of investment options.

SEP

SEP IRA stands for Simplified Employee Pension IRA. These plans are available for people who are self-employed or who own a small business. 

SEP IRAs are an attractive choice for small business owners or self-employed workers because they are easy to set up. These are like traditional IRAs but with the benefit of higher contribution limits. 

Unlike some other plans, the employer makes contributions on behalf of the employee. This can be another attractive feature. It allows the employer to receive a tax deduction for contribution amounts.

SIMPLE IRA

Continuing with more acronyms, SIMPLE stands for Savings Incentive Match Plan for Employees. SIMPLE IRA plans are for small businesses with fewer than 100 employees. 

Like 401(k) plans, employees can elect to pay a certain percentage of their paycheck into the account. As with traditional IRAs, the IRS considers these plans pre-tax which results in a lower tax liability today.

This type of plan requires an employer to contribute to the plan. Like SEP IRAs above, SIMPLE IRAs are easier to set up and maintain than 401k plans.

Keogh Plans

Keogh or HR 10 plans are another plan available for professionals who are self-employed or for very small businesses. Once again, these plans have a similar structure to 401k plans. 

Keogh plans allow higher contributions, which could make them attractive for high-income earners.

There is a downside though—these plans are more complicated to set up. They have to meet ERISA requirements and require a lot of complex paperwork. 

Employee Stock Purchase Programs/Employee Stock Ownership Plans

Some companies allow their employees to buy stock in the company for a discount. Some of these plans are qualified retirement plans, meaning an employee wouldn’t owe taxes on the discount. Only when you sell the shares would you pay taxes.

There are other qualified plans out there as well. These may include profit-sharing plans, stock bonus plans, or cash balance plans.

Advantages of Qualified Retirement Plans

So now that we’ve looked at common examples, what are the advantages of a qualified retirement plan?

Tax Advantages

Many of these plans are tax-deferred, which means you contribute money before the IRS takes out taxes. Your accounts would grow tax-free until you reach retirement age and begin to make withdrawals. This also helps to reduce your amount of taxable income, ensuring you get to keep more of your money.

Employer Match

It’s common for employers to offer a matching program, as mentioned above. This is free money, so it’s an easy decision to contribute to such plans.

Automatic Withdrawals

Qualified plans through an employer are convenient because your contributions come straight from your paycheck—which means you don’t have to think about it. As you budget, you can rest assured that you’re already putting away money for your future.

Non-Qualified Retirement Plans

There are non-qualified plans as well. These are plans that don’t meet the Internal Revenue Code or ERISA requirements mentioned above. Employers direct qualified plans, but non-qualified plans are often self-directed.

Traditional IRAs

Traditional Individual Retirement Accounts are an account that you set up for yourself. These plans do offer some tax benefits though. Contributions to traditional IRAs are pre-tax, but they are also tax deductible.

Roth IRAs

As opposed to traditional IRAs, Roth contributions are after-tax. When you retire, you’ll pay no further taxes on your withdrawals.

Self-directed IRAs

These are IRAs that allow you to invest in other vehicles beyond stocks or bonds. For example, these IRAs allow you to invest in real estate. To get tax benefits though, you will have to follow specific IRS rules.

Companies may offer more non-qualified plans. These could include executive bonus plans, deferred compensation plans, or 457 plans. Talk to your employer about these plans if they offer any.

Saving for retirement should be a priority in your financial life. Qualified retirement plans allow you to save toward your financial goals while reaping tax benefits. If your employer offers such a plan, it may be in your best interest to sign up.

Need more advice on how to choose a plan, or how much to contribute? Working with a financial advisor might help you. Strategic Wealth Designers has a team of fiduciary financial advisors willing to help you reach your retirement goals. Get in touch today for a consultation.