Retirement Plans - Qualified Retirement Plans


What is a Qualified Retirement Plan?
If it meets certain criteria, a qualified retirement plan is permitted to take advantage of special tax treatment. One key requirement for qualification is that the plan must not discriminate in favor of the employer's key employees. The special tax benefits include the following:

  • The employer may take a tax deduction for contributions made to the plan
  • Employees may take a tax deduction on their own contributions to the plan
  • Earnings on all contributions are tax deferred until withdrawn

There are two types of qualified plans: defined benefit and defined contribution plans.

Defined Benefit Plans
Defined benefit plans are traditional pension plans, where benefits are based on a specific formula. Most formulas use the number of years of service times a salary factor (often an average of the highest three, or highest five, years of salary history). An age factor is used as well, so a worker retiring at 65 receives a higher monthly benefit than one retiring at 62.

Characteristics:

  • Employer makes all contributions
  • Employer makes all investment decisions and bears the risk if investments perform badly
  • Less popular since the rise of defined contribution plans

Defined Contribution Plans
Rather than basing plan benefits on a specific formula as defined benefit plans do, defined contribution plans allocate money to plan participants based on a percentage of each employee's earnings. The longer the employee participates in the plan, the higher the account balance grows, based on the amounts contributed and the investment earnings.

Most defined contribution plans allow employees to choose their own investment mix from the specific funds made available through the employer.

Types of Plans:

  • Profit-sharing plan - this allows the employer to contribute a percentage of salary each year, but the percentage can vary each year based on corporate profits. However, contributions can be made even when there are no profits, at the employer's discretion.

  • 401(k) plan - this form of profit-sharing plan allows employees to reduce their taxable income by deferring a percentage of their salary into the plan. For 2007, the contribution limit is $15,500, with an additional catch-up contribution of up to $5,000 allowed for workers 50 and over.

  • 403(b) plan - these plans are also known as tax-sheltered annuities.

  • Money purchase pension plan - this requires the employer to contribute a set percentage of salary each year regardless of corporate profits.


Look Out!
The main thing to know about the various defined contribution plans is that 403(b) plans are available only to employees of schools, hospitals and certain nonprofit organizations. They are analogous to corporate 401(k) plans.


If you are interested in learning more about the different types of retirement plans, the tutorial, Introductory Tour Through Retirement Plans will walk you through them.

ERISA Issues


Related Articles
  1. Retirement

    What's a Defined Contribution Plan?

    A defined contribution plan is a company retirement plan that specifies the amount of money contributed to it.
  2. Professionals

    Retirement Planning for the Self-Employed

    How to select a qualified retirement plan if you are self-employed and have no employees.
  3. Taxes

    401(k) And Qualified Plans: Types Of Plans

    By Denise ApplebyDefined-Benefit PlansUnder a defined-benefit plan, employees' retirement benefits are predetermined by their compensation, years of service and age. For example, the plan ...
  4. Term

    What's a Qualified Retirement Plan?

    Employers establish qualified retirement plans to help their employees save money.
  5. Taxes

    401(k) And Qualified Plans: Contributions

    By Denise ApplebyA qualified plan may be funded by both employer and employee contributions. Contributions are mandatory for some plans and discretionary for others, but the limits on employer ...
  6. Taxes

    The Basics Of A 401(k) Retirement Plan

    This plan has become one of the most popular retirement options. Find out why.
  7. Taxes

    The 401(k) and Qualified Plans Tutorial

    Learn about eligibility requirements, contributions and distribution rules for these retirement plans.
  8. Investing News

    SEP vs. Keogh Plans: Which is Right for You?

    SEP and Keogh plans each have their pros and cons. Here's how to choose which one is right for you.
  9. Retirement

    Why are 401(k) contributions limited?

    Find out why contributions to 401(k) retirement plans are limited, including what the current contribution limits are and how limits encourage participation.
  10. Entrepreneurship

    Hey Self-Employed, Are You Making The Most Of Your Retirement Options?

    Even if you own your own business, it is still very important to save for retirement, and to understand your options for doing so.
RELATED TERMS
  1. Qualified Retirement Plan

    A plan that meets requirements of the Internal Revenue Code and ...
  2. Employee Contribution Plan

    A company-sponsored retirement plan where employees may elect ...
  3. Target-Benefit Plan

    A benefit plan that is similar to a defined benefit plan since ...
  4. Plan Participant

    A plan participant either contributes into a pension plan or ...
  5. Tax-Sheltered Annuity

    A type of annuity that allows an employee to make contributions ...
  6. Corporate Pension Plan

    A formal arrangement between a company and its employees - or ...
RELATED FAQS
  1. What are qualified retirement plan types?

    Understand the different types of qualified retirement plans and what they mean in terms of employee and employer contribution ... Read Answer >>
  2. Is a 401(k) a qualified retirement plan?

    Examine the different types of qualified retirement plans, and discover if a 401(k) meets the definition of a qualified retirement ... Read Answer >>
  3. What's the difference between a 401(k) and a pension plan?

    Discern the differences between 401(k) plans, in which employees assume the market risk, and pension plans, in which the ... Read Answer >>
  4. How do you plan for retirement if you have multiple employers? Can you combine retirement ...

    Retirement planning for those who work for more than one employer is essentially the same as for those who work for only ... Read Answer >>
  5. I'm a teacher. Which is better for me, a 401(k) or 403(b)? What is the difference? ...

    The first step is to check with your employer regarding any retirement plan(s) it provides for employees, as you can only ... Read Answer >>
  6. Is a Thrift Savings Plan (TSP) a qualified retirement plan?

    Take advantage of the government's retirement plan for employees with the Thrift Savings Plan. As with a 401(k), contributions ... Read Answer >>
Hot Definitions
  1. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  2. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  3. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  4. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
  5. Basis Point (BPS)

    A unit that is equal to 1/100th of 1%, and is used to denote the change in a financial instrument. The basis point is commonly ...
  6. Sharing Economy

    An economic model in which individuals are able to borrow or rent assets owned by someone else.
Trading Center