Key Takeaways
- Retirement plans are either qualified or nonqualified.
- Qualified retirement plans provide additional tax benefits, but must meet specific IRS requirements.
- The main purpose behind qualified plan rules is to ensure that benefits do not favor highly compensated employees and key executives.
What Is a Qualified Retirement Plan?
According to the IRS, “a qualified plan must satisfy the Internal Revenue Code in both form and operation.” Section 401(a) in the tax code outlines the requirements that plans must meet.
Qualified retirement plan sponsors are companies that provide the retirement plans to their employees. It is their responsibility to update plan documents and make sure the rules are being obeyed.
The IRS states, “employers should establish practices and procedures to ensure the plan is operated in accordance with the plan document so participants and beneficiaries receive their proper retirement benefits.”
Qualified retirement plans that are employer-sponsored must also satisfy the minimum standards of the Employment Retirement Income Security Act of 1974 (ERISA). ERISA protects plan participants and their assets from potential mistreatment.
ERISA requires plan information transparency, and the act ensures that employers adequately fund benefits promised to employees. ERISA also sets accountability standards for fiduciaries who manage or control the funds. Qualified plan sponsors who do not meet these requirements face potential financial repercussions or lawsuits.
According to the Internal Revenue Code, some of the more important qualified retirement plan requirements include:
- Minimum Participation Requirements: At a minimum, the lesser of 50 employees or 40% of the employees must benefit from the plan.
- Operate in Accordance With Plan: Plan documentation must accurately reflect the benefits given to participants.
- Nondiscrimination Requirements: The plan must comply with specific guidelines to ensure plan benefits are not tilted in favor of highly compensated employees.
- Reporting and Disclosure: Sponsors must submit tax forms, distribution reporting and account balance statements.
- Minimum Distribution Requirements: Current and retired employees must receive their retirement payments beginning the calendar year the employee reaches 73 years old. An employee who is still working at age 73 may qualify for a 401(k) required minimum distribution exception depending on their retirement plan type and level of ownership in the company that sponsors the 401(k) plan.
- Minimum Vesting Requirements: Each employee must vest or own, at a minimum, a stated percentage of their interest in the plan each year.
- Elective Deferral Limits: The elective deferral limit for 2023 is $22,500 and $23,000 for 2024. Employees who are age 50 or older at the end of the calendar year can make additional contributions of $7,500 in 2023 and 2024. Plans may permit additional after-tax contributions up to the annual additions limit.
- Defined Benefit Plan Limits: The annual benefit limitation for a defined benefit plan is $265,000 for 2023 and $275,000 for 2024.
- Defined Contribution Plan Limits: The limitation on annual combined employer/employee contributions to a defined contribution plan is $66,000 in 2023 and $69,000 in 2024.
- Maximum Annual Compensation: The maximum annual compensation of each employee that can be taken into account under a plan must not exceed $330,000 for 2023 and $345,000 in 2024.
Spouse and beneficiary protections also apply, and there are guidelines for rollovers and other specific circumstances.
Retirement savings is top of mind for many of my clients. With the dwindling availability of pensions and growing fears that social security will not be available in the future, it is up to each individual to ensure that they are planning appropriately for the future. Using a qualified retirement plan is one way to fill the gap and maximize savings through personal contributions and employer matches.
Ricky W. Jackson, Jr. CFP®, ChFC®Certified Financial Planner™, Chartered Financial Consultant® and Managing Director at The Pelora GroupRicky, a dedicated financial planner at The Pelora Group, challenges stereotypes, empowering everyday Americans to navigate their finances confidently. With a focus on the skilled trades and service industries, Ricky fosters enduring partnerships and collaborates with employers to enhance benefits, striving to empower 10,000 middle-class individuals for prosperous financial futures.
How Does a Qualified Retirement Plan Work?
Qualified retirement plans fall within one of two categories: defined-benefit or defined-contribution.
- Defined-Benefit Plans
- These plans, sometimes referred to as traditional pension plans, guarantee employees fixed payments in retirement. Although employees can pay into these plans, employers primarily provide the funding. The employer, or sponsor, generally uses a formula to calculate employees’ future payouts based on salary, age and years of service. Otherwise, these plans may designate a specific dollar amount for payments, such as $150 monthly.
- Defined-Contribution Plans
- Employees make payments, or contributions, into defined-contribution plans. Many employers pay matching contributions into these plans, but this is not mandatory. These funds are then invested, and they weather gains and losses based on market performance. Defined-contribution plans do not have a set payment amount.
Categories of Qualified Retirement Plans
Qualified vs. Nonqualified Retirement Plans
Most employer-sponsored plans are qualified. Employees can contribute pre-tax dollars , designated Roth contributions or after-tax dollars to a qualified retirement plan directly from their paychecks. Employers can then provide contribution matching by deducting those funds from their taxable income.
With qualified retirement plans, you don’t pay taxes on contributions or their earnings until you make withdrawals, unless you contribute to a Roth 401(k) where you pay the taxes upfront and withdrawals are tax free.
Nonqualified retirement plans can also offer tax benefits, however, the ERISA guidelines do not apply to them. Nonqualified retirement plans include deferred-compensation plans, executive bonus plans and split-dollar life insurance plans. These plans tend to favor key employees and executives.
Traditional and Roth IRAs, which are individual plans, are not qualified retirement plans. They do offer similar tax benefits to qualified plans, but they have different contribution limits.
Types of Qualified Retirement Plans
- 401(k) plans
- 403(b)plans
- Money purchase pension plans
- Cash balance pension plans
- SEP IRAs
- SIMPLE IRAs
- Keogh plans
- Employee Stock Ownership Plans (ESOPs)
- Profit-sharing plans
- Stock bonus plans
Types of Nonqualified Retirement Plans
Individual-sponsored:
- Roth IRAs
- Traditional IRAs
- Self-directed IRAs
Employer-sponsored:
- 457 plans
- Deferred compensation plans
- Executive bonus plans
