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  • Earnings on all contributions are tax deferred until withdrawn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. Professionals

    Qualified Retirement Plans

    FINRA/NASAA Series 66: Section 4 Qualified Retirement Plans. This section discusses two types of qualified retirement plans, defined benefit and defined contribution plans.
  2. 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.
  3. Professionals

    Qualified Employer-Sponsored Retirement Plans

    FINRA/NASAA Series 26 Section 4 - Qualified Employer-Sponsored Retirement Plans. In this section defined-benefit plans and defined-contribution plans (401(k) plans, 403(b) plans and profit-sharing ...
  4. Retirement

    How Does a Pension Plan Work?

    A pension plan is a savings plan maintained by an employer on behalf of its employees for their retirement.
  5. Professionals

    Qualified Employer-Sponsored Retirement Plans

    Qualified Employer-Sponsored Retirement Plans. In this section Defined Benefit vs. Defined Contribution Plan and 401(k), 403(b) and Profit-Sharing plans.
  6. Professionals

    Types and Provisions of Qualified Plans

    Types and Provisions of Qualified Plans
  7. Professionals

    Retirement Planning for the Self-Employed

    How to select a qualified retirement plan if you are self-employed and have no employees.
  8. 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 ...
  9. Entrepreneurship

    Plans The Small-Business Owner Can Establish

    Don't hesitate to adopt a smart plan for you and your employees.
  10. Professionals

    Nonqualified Retirement Plans

    NASAA Series 65: Section 14 Nonqualified Retirement Plans. In this section 457 plan and sample questions.
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. Tax-Sheltered Annuity

    A type of annuity that allows an employee to make contributions ...
  5. Unit Benefit Formula

    A method of calculating an employer's contribution to an employee's ...
  6. Plan Participant

    A plan participant either contributes into a pension plan or ...
RELATED FAQS
  1. How does a defined benefit pension plan differ from a defined contribution plan?

    Learn the differences between defined benefit plans and defined contribution plans when reviewing employer-sponsored qualified ... Read Answer >>
  2. 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 >>
  3. 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 >>
  4. 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 >>
  5. What is the difference between a 401(k) plan and a 457 plan?

    Discover how 401(k) plans are privately offered employee retirement plans, while 457 plans are typically available to public ... Read Answer >>
  6. How can an entrepreneur save for retirement?

    Learn about the retirement savings plan options for entrepreneurs and small business owners, including administration and ... Read Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center