Qualified Retirement Plan

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 qualified retirement plans must meet.

Qualified retirement plan sponsors are entities, often employers, who implement and 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 minimum standards set by 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 benefits promised to employees are adequately funded. ERISA also sets accountability standards for fiduciaries who manage or control the funds. This means that qualified plan sponsors must meet these requirements or potentially face financial repercussions or lawsuits.

According to the Internal Revenue Code, some of the more important qualified retirement plan requirements include:

• Minimum Participation Requirements: Participants or employees must meet minimum age and service requirements.
• Operate in Accordance with Plan: Plan documentation must accurately reflect the actual benefits given to participants.
• Nondiscrimination Requirements: Employer matching must be the same regardless of compensation level.
• 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 in the calendar year the employees reach 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: Employees cannot elect to contribute more than $22,500 out of their compensation to a retirement plan in 2023. Employees who are age 50 or older at the end of the calendar year can make additional contributions of $7,500 in 2023.
• Defined Benefit Plan Limits: The annual benefit limitation for a defined benefit plan is $265,000 for 2023.
• Defined Contribution Plan Limits: The limitation on annual combined employer/employee contributions to a defined contribution plan is $66,000 in 2023.
• 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.

Spouse and beneficiary protections also apply, and there are guidelines for rollovers and other specific circumstances.

How Does a Qualified Retirement Plan Work?

Qualified retirement plans fall within one of two categories: defined-benefit or defined-contribution.

Categories of Qualified Retirement Plans

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.

Qualified vs. Nonqualified Retirement Plans

Most employer-sponsored plans are qualified. Employees can contribute pre-tax dollars or, in the case of designated Roth contributions, after-tax dollars to a qualified retirement plan directly from their paychecks. Employers can deduct any matching contributions from their taxable income each year.

With qualified retirement plans, you don’t pay taxes on contributions made with pre-tax funds or earnings on those contributions until you make withdrawals, unless you contribute to a Roth 401(k) where you pay taxes upfront and withdrawals are tax free.

Nonqualified retirement plans can also offer tax benefits, but they do not follow the same ERISA guidelines as qualified plans. Types of nonqualified retirement plans include deferred-compensation plans, executive bonus plans and split-dollar life insurance plans.

Traditional and Roth IRAs, which are individual plans, are not qualified retirement plans. But they offer tax benefits similar to those of qualified plans with different contributions 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