Is a 401(k) a Qualified Retirement Plan?

Aa 401(k) is usually a qualified retirement plan because it meets the Internal Revenue Service's qualified retirement plan definition. So what exactly does it mean to be a qualified plan, and what does it mean for your retirement plans?

Key Takeaways

  • Yes, a 401(k) is usually a qualified retirement account.
  • Defined-benefit and defined-contribution plans are two of the most popular categories of qualified plans.
  • A 401(k) is a type of defined-contribution plan.

Qualified Retirement Plans

Qualified retirement plans must satisfy Internal Revenue Service (IRS) requirements for both setup and operations. These requirements are detailed in Internal Revenue Code Section 401(a), which was written into the Internal Revenue Code of 1954. The IRS also provides a breakdown of qualified retirement plan requirements.

Employers are responsible for maintaining assurance of qualified plan authenticity through the IRS’s determination letter program. While 401(k)s are generally set up as qualified retirement plans, they can be disqualified if an employer and any associated affiliates do not comply with qualified plan rules. Some of the main requirements include the following:

  • Minimum levels of participation
  • Non-discrimination
  • Minimum levels for vesting
  • Adherence to Required Minimum Distributions (RMDs)

The 2 Main Types of Qualified Plans

Employers take responsibility for ensuring that a retirement plan they offer meets all of the 401(a) requirements. Generally, most defined-benefit plans and defined-contribution plans set up by an employer will be considered qualified.

Defined Benefit

In a defined-benefit plan, the employer commits to providing a specific payout for employees, regardless of the performance of the employer’s business or investments.

An example of a defined-benefit plan is a pension. A defined-benefit plan puts most of the burden for generating the assets due at retirement mainly on the employer. In some defined-benefit plans, employees are not responsible for saving anything. Other plans may require some contributions from the employee. Defined-benefit plans have become increasingly rare, mainly because they are expensive and complex for the employer.

Defined-benefit plans are managed collectively by the employer, who usually appoints a board of trustees to oversee asset management. The board manages the allocations of an entire portfolio. Board members and consultants work comprehensively to determine standard parameters for ensuring that the portfolio has the funds it needs to payout according to its promised terms. Board members choose asset allocations based on the needs and risk management of the portfolio.

Defined Contribution

In a defined-contribution plan, the onus is upon the employee to contribute enough to the retirement plan to ensure sufficient assets at retirement, a much more attractive option for employers.

The most common defined-contribution plans are the 401(k) in the private sector and the 403(b) in the public sector. Most defined-contribution plans will offer matching benefits. This gives the employee additional funding in the plan if they enroll. An employer will match the employee's contributions up to a certain limit, usually a percentage of the employee’s pay.

A 401(k) is a popular type of defined-contribution plan. The employer is not responsible for managing a collective pool of assets that will be paid out to employees. However, the employer does have the authority to choose which types of investments it will allow in its plans. These investment options usually span the risk spectrum from money market investments to mutual funds, exchange-traded funds (ETFs), and more. The investment options in a 401(k) plan usually depend on the partners the employer has access to or chooses to work with.

Other Potential Types of Qualified Plans

In general, any employer-sponsored retirement plan that meets the requirements of Internal Revenue Code 401(a) can be considered a qualified plan. Some alternative types of qualified plans can include:

  • Small business retirement plans
  • The SIMPLE 401(k)
  • Some profit-sharing plans
  • Employer-sponsored Roth and individual retirement account (IRA) plans

Non-Qualified Plans

Non-qualified plans are any other type of employer-sponsored plan that meets all of the 401(a) requirements. Non-qualified plans can be easier to set up for some employers. Non-qualified plan investments are made with after-tax dollars. Therefore, these plans do not enjoy the benefit of a tax shelter. However, most non-qualified plans do have shorter liquidity terms.

Qualified Plan Considerations for the Employer

In general, employers have the greatest need for awareness regarding qualified plans. Employers are responsible for obtaining qualified plan status, setting up appropriate procedures, ensuring that operational procedures are consistently maintained, and auditing plans annually for compliance.

One of the most important requirements for a qualified plan is non-discrimination. This means a qualified plan must be offered to all employees equally, regardless of their status within the company.

Employers have several advantages for the company if they offer a qualified plan. Any contributions to a qualified plan are tax-deductible. Businesses with 100 or fewer employees can get a tax credit. Lastly, qualified plans are an important benefit that helps companies attract talent to their organization.

Withdrawals from a qualified retirement plan before you are 59½ generally incur a 10% early withdrawal penalty and are subject to income tax at the current annual rate.

Qualified Plan Considerations for the Employee

Employees don’t necessarily have any special obligations when it comes to qualified plans. Some employees may not know the difference between a qualified and a non-qualified plan. However, there are several distinctions that an employee will need to be aware of for their own sake.

Qualified plans are considered to be a tax shelter. This means employees contribute to the plan with pre-tax dollars that are not taxed immediately but sheltered until they are withdrawn. Pre-tax payroll contributions lower the amount of take-home pay an employee receives in each paycheck, which also results in a lower amount of tax withheld. Some employers may allow for short-term loans from a 401(k) with regular payments and low interest paid back to the account, which can be an efficient way to borrow.

Investment Restrictions

Investors in a 401(k) or another type of qualified plan can choose to invest in any of the investment products the plan offers. Funds in a qualified account cannot be withdrawn penalty-free until age 59½. Any funds withdrawn prior to 59½ are subject to income tax and a 10% penalty unless exceptions apply. For example, if you make a withdrawal to help make payments for the birth or adoption of a child, it is an exception.

After age 59½, account investors can withdraw funds at their annual tax rate without penalty. However, if you have a qualified retirement plan, you must take required minimum distributions (RMDs) from the account at 73. Account holders are penalized if RMDs are not made.

The IRS has annual contribution limits for both qualified and non-qualified plans. In 2023, the following contribution limits apply for a 401(k):

  • Contributions cannot be made after the annual compensation threshold of $330,000 in 2023.
  • The maximum employee contribution is $22,500.
  • An extra $7,500 in catch-up contributions is allowed for individuals 50 or over, for a total contribution limit of $30,000.
  • There is a total defined contribution limit for employees and employers combined of $66,000 in 2023.

Is a 401(k) Considered a Retirement Plan for Tax Purposes?

Yes. Your contributions can be tax-deferred or taxed, depending on the type of 401(k) you choose. For example, if you contribute to a Roth 401(k), your contributions are taxed at your current income tax level.

What Counts as a Qualified Retirement Plan?

Qualified retirement plans are defined benefit or defined contribution plans. They include pension plans, 401(k)s, and other profit-sharing plans.

What Is Considered a Non-Qualified Retirement Plan?

Non-qualified plans are usually employer-sponsored and tax-deferred and are generally used for key or select employees for retention or recruiting purposes.

The Bottom Line

Qualified retirement plans must meet specific IRS requirements, such as defined contributions and defined benefits. Small business plans and SIMPLE 401(k)s are also qualified plans. Regular 401(k) plans are qualified plans and generally work to reduce the overall tax burdens of employees. They reduce taxes because contributions are made tax-deferred, with taxes paid when withdrawals are made later in life—hopefully at a lower income tax rate.

Article Sources
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  2. Internal Revenue Service. "A Guide to Common Qualified Plan Requirements," Select "11. Minimum Distribution Requirements."

  3. Internal Revenue Service. "401(k) Plan Qualification Requirements."

  4. Internal Revenue Service. "Defined Benefit Plan."

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  8. Financial Industry Regulatory Authority. "Investing in Your 401(k)."

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  12. Internal Revenue Service. "401(k) Plan Overview."

  13. Internal Revenue Service. "Retirement Plans Startup Costs Tax Credit."

  14. Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions."

  15. Internal Revenue Service. "Considering a Loan From Your 401(k) Plan?"

  16. Internal Revenue Service. "Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other Than IRAs."

  17. Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs."

  18. Internal Revenue Service. "Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits."

  19. Internal Revenue Service. "Nonqualified Deferred Compensation Audit Technique Guide," Pages 3-4.

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