What is a Qualified Retirement Plan?

If someone asks you if you have a qualified retirement plan, would you know how to answer them? Sure, you may have a 401k or a pension, but what does that mean for your retirement and which ones can you benefit from the most?

We’re going to take a closer look at what is a qualified retirement plan, as well as the different types to help give you a clearer picture of your financial future.

What is a Qualified Retirement Plan?

In simple terms, a qualified retirement plan is one where investment income can accumulate tax-deferred. Qualified retirement plans meet specifications laid out in Section 401 (a) of the U.S. tax code.

The IRS recognizes these plans as most retirement plans offered by employers fall under the qualified retirement plan umbrella.

Types of qualified retirement plans include:

• 401k plans
• 403b plans
• Keogh plans
• Pensions
• SEP IRAs
• Employee Stock Ownership Plans
• Stock bonus plans
• Profit-sharing plans

When employers offer qualified retirement plans, they can put a designated portion of their employees’ salaries into these plans. This reduces their workers’ taxable income. 

Types of Qualified Retirement Plans

Now that we have a basic idea of what a qualified retirement plan is, it’s time to dive into the different types because all retirement plans are not created equal. If you want to know what is a qualified retirement plan that could work for me, here are some answers.

Defined-Contribution Plans

A defined-contribution plan allows employees to contribute a percentage of their salary to the plan annually. Employers can also choose to contribute a percentage. Contributions can change from year to year as can the return on investment. Popular defined-contribution plans are:

• 401k Plans
• 403b Plans

With a defined-contribution plan, pre-tax dollars grow in investments on a tax-deferred basis. Tax will be paid on withdrawals, but not until retirement age. These types of plans are popular with employers because they are low-maintenance and cost less to administer. The employees are in the driver’s seat as they decide what percentage of their salaries they want to contribute which can impact their employer’s contributions.

Defined-Benefit Plans

When it comes to qualified retirement plans, defined-benefit plans are more the exception rather than the rule. These plans promise workers a set amount of money when they retire, regardless of the employee’s contributions. These plans include:

• Pensions
• Annuities

With a pension, the amount of retirement money distributed annually is based on an employee’s salary. An annuity distributes a fixed amount every year after retirement. These plans can be difficult for employers because they have to make sure they contribute enough money to be able to make payments when their workers retire.

Defined-benefit plans are not common in private-sector jobs as more opt for defined contribution plans. But, defined-benefit plans are still seen in the public sector, such as in government jobs.

Qualified Retirement Plans and Taxes

Qualified retirement plans are more popular because they give tax breaks to employers and their employees. Employers get a break on the contributions they make into their employees’ accounts. Employees can defer a part of their salaries into the plan which reduces their taxable income at the end of each year.

If you choose to take money from qualified plans before retirement age, the distributions will be taxable.

Can You Take Money Out of a Qualified Retirement Plan Before Retirement?

While some plans allow early withdrawals, you’re not only going to have to pay taxes on that money, but you may also face a penalty. This is why withdrawing from qualified retirement plans is not usually recommended.

Some plans allow employees to borrow from their plans. But, there are strict rules about how they have to repay the loan. They may have a certain time frame to repay it or be required to pay interest.

Benefits of Qualified Retirement Plans

Many employees and employers opt for qualified retirement plans because of the many benefits that come along with them. These include:

• Tax-Deductible Contributions
• Tax-Free Growth
• Possibility of Matching Contributions
• Diverse Investments
• Convenient Way to Save for Retirement

As you prepare for retirement, it’s important to look at the different types of plans that your employer may offer so that you can plan for your financial future.

Contact Us for Financial Planning and Tax Services

If you need assistance with financial or tax planning, we have a CPA firm in Durham and Raleigh that can help. Schedule a consultation today at  (919) 872-0866 or by filling out the contact form below to get started.