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What Is a Qualified Retirement Plan? Everything You Need To Know

What Is a Qualified Retirement Plan? Everything You Need To Know

Are you thinking about your retirement? Whether it seems far away or is right around the corner, reaching your retirement savings goal is your ultimate focus.

How much you need for retirement is one criterion to calculate. How you plan to get there is another objective. Many people elect a qualified retirement plan when they start saving.

Qualified retirement plans are common. They are popular due to the tax advantages they offer to plan participants.

Let’s continue by identifying what they are and how you can start contributing to one today.

What Are Retirement Plans?

Retirement plans are a convenient way to build growth for the future. Everyone has a retirement age in mind. It could be the legal age mandated by the government, or it could be sooner for those that are ambitious and want to try early withdrawal.

Whichever it is, retirement is bound to happen at one time in everyone’s life — provided that your personal finances are in order — so it’s best to be prepared financially to reap your retirement benefits.

Retirement plans come with boundaries. For example, there is an annual contribution limit set for some, and there are tax considerations to make with others.

For purposes of this article, we will break retirement plans down into two categories:

  1. Qualified Retirement Plans
  2. Non-Qualified Retirement Plans

What Is a Qualified Retirement Plan?

Let’s get started by introducing qualified retirement plans. Focus on the term “qualified.” This means that specific requirements need to be met.

Qualified retirement plans are sponsored by a small business or corporation on behalf of the company’s eligible employees. The company handles the plan and is required to obey the governing rules of the Employee Retirement Income Security Act of 1974 and other guidelines.

There are two guidelines governing a qualified retirement plan:

  1. Section 401(a) of the Internal Revenue Code
  2. The Employment Retirement Income Security Act of 1974 (ERISA)

Both of the laws above define necessary requirements. These include set-up and how the plan is operated, including any associated tax benefits. If one is met but not the other, the plan is not considered qualified.

Outline of the Qualified Retirement Plan Requirements

The following requirements must be met by employee sponsors:

  • Minimum age and service requirements must be met for employees to participate in the plan and receive matching contributions and other plan assets.
  • The benefits provided must be accurately reflected in the plan documents.
  • Employee level is not to be considered during the employer matching process. All participants receive the same match.
  • Timely submission of tax forms, distributions, and account balances
  • The maximum annual contribution limit is not to be exceeded.
  • Employees must vest or own a percentage of interest in a plan for a minimum of one year.

What Are the Types of Qualified Retirement Plans?

Here is a list of qualified retirement plans to consider:

  • 401(k) and 403(b)
  • SEP and SIMPLE IRAs
  • Pension Plans
  • Keogh Plans
  • Profit-Sharing Plans
  • Stock Bonus Plans
  • Employee Stock Ownership Plans
  • Cash Balance Plans

These are broken down into two types of retirement plans: defined benefit plans and defined contribution plans.

Defined Benefit Plans

How does it sound to have a designated monthly benefit at the time of retirement, in addition to your Social Security benefit?

Defined benefit plans work in this manner. They distribute either a pre-set monthly amount or a calculated amount based on a plan that factors in your salary and years of service with your employer.

Pension Plans

Pension plans fall under the umbrella of defined benefit plans. In most cases, they are protected and insured by the Pension Benefit Guaranty Corporation (PBGC).

Cash Balance Plans

A “pay credit” and an “interest credit” are awarded to participants annually. The “pay credit” is calculated as a percentage of the employees' salary. The “interest credit” can be fixed or variable.

The employer assumes the risk of cash balance plans. The employee does not absorb any gains or losses.

At the time of retirement, the participant can take the account balance as a lump sum payment or as an annuity, receiving pre-determined monthly installments. Lump sums generally can be rolled over to an IRA if the employee chooses to do so.

Defined Contribution Plans

Defined contribution plans are dependent on what you subsidize. You are the one who decides what amount of money you want to contribute from your paycheck. This amount is invested into a retirement plan by an employer on your behalf.

Your employer may assist, too, if they offer to match your annual contributions up to a specified percentage.

Your contributions are then invested. The value of your retirement plan is expected to fluctuate with the rise and fall of the market, but growth is the goal.

401(k)

A 401(k) is a tax-deferred retirement savings account.

As the employee, you choose the percentage of your earnings to contribute to the plan for each pay period. Contributions are tax-free.

Employers may or may not offer a match to the employee's contribution. If they do, it’s best for the employee to contribute, at a minimum, the percentage the employer will contribute.

In 2022, 401(k) contributions are limited up to $20,500. For individuals 50 years of age or older, a catch-up contribution is allowed up to $6,500. It’s important to note that employer contributions are not considered within these limits.

403(b)

403(b) plans are similar to 401(k)s, except that they are offered to employees of a tax-exempt organization. This includes employees working in public education, government entities, 501(c)(3) tax-exempt organizations, and ministers.

Aside from the type of employer, another difference between the 403(b) to the 401(k) is their form. 403(b) plans take the shape of an annuity contract or mutual fund custodial accounts.

Employee Stock Ownership Plans

Employees obtain stock from their employer by:

  • Purchasing shares
  • Receiving it as a bonus incentive
  • Assuming stock options
  • A Profit-Sharing plan

ESOPs have notable tax benefits for both the employee and the employer. C-Corporation contributions are tax-deductible, and S-Corporation contributions are tax-exempt. Employees are also tax-exempt on the contributions they receive but are subject to tax at withdrawal.

Profit-Sharing Plans

A profit-sharing plan allows employees to receive a share of a company’s quarterly or annual earnings. It’s a solid incentive to retain top talent and motivate employees.

The downside? Profit-sharing plans are only paid out when the company sees a profit. Also, distributions from the plan are taxable income, charged at the participant’s ordinary income tax rate.

When a company sets up a profit-sharing plan, it is required to:

  • Adopt a written plan
  • Arrange a trust
  • Build a recordkeeping system
  • Provide necessary information to employees eligible to participate

To participate, employees must:

  • Be 21 years of age or older
  • Complete a minimum of one year of service (or two in some cases)
  • Not be a nonresident alien

Stock Bonus Plans

Instead of receiving cash, companies may provide employees with stock instead. An employer can contribute up to 25% of an employee’s total compensation annually to the stock bonus plan.

The advantage of stock bonus plans is awarded to the company that contributes to it. The plan is tax-deductible. On the flip side, they are liable to buy back shares held in employees’ accounts.

The employee stock ownership plan and stock bonus plans are similar, but they are not the same. This is because ESOPs are ordinarily offered to employees of private companies to boost employee ownership.

Keogh Plans

Keogh plans can either be defined benefit plans or defined contribution plans. It is a retirement plan for self-employed individuals working for an unincorporated business.

Here are the basics of the Keogh plan:

  • Contributions are subject to annual limits but are tax-deductible
  • Taxes are deferred until the time of withdrawal
  • Minimum distributions are required at the age of 72
  • The plan is eligible for roll-over to a Traditional or Roth IRA

This type of retirement plan declined in popularity after 2001. The Economic Growth and Tax Relief Reconciliation Act reinvented the wheel, bringing changes to the plan — one of which requires high contribution limits.

What Is the Difference Between a Qualified Retirement Plan and a Non-Qualified One?

Non-qualified retirement plans may offer tax benefits, but they have one primary difference from a qualified retirement plan. They do not have to follow the same tax code rules.

Non-qualified retirement plans include:

  • Traditional IRAs
  • Roth IRAs
  • Self-directed IRAs
  • Executive Bonus Plans
  • Deferred Compensation Plans
  • 457 Plans

The Bottom Line

Wouldn’t it be nice if saving for retirement was like a walk in the park?

From budgeting to reducing debt to making consistent contributions, retirement requires a lot of your time and commitment.

It’s strongly recommended to keep your investment portfolio diversified. In addition to qualified retirement plans, have you considered physical assets? We are referring to precious metals, such as gold coins, bars, or bullion.

Visit Acre Gold to start investing in gold today. There are two monthly subscription options to choose from, making it an affordable investment that lasts a lifetime.

Sources:

Types of Retirement Plans | US Department of Labor

A Guide to Common Qualified Plan Requirements | Internal Revenue Service

Qualified Retirement Plan | Investopedia