Yes, a 401(k) is a qualified retirement plan. So what exactly does that mean? Qualified retirement plans must satisfy Internal Revenue Service (IRS) requirements for both setup and operations. They fall into two categories: defined-benefit plans and defined-contribution plans.
- Yes, a 401(k) is a qualified retirement account, of which there are two kinds: defined-benefit plans and defined-contribution plans.
- A defined-benefit plan requires an employer to create retirement assets for an employee.
- A defined-contribution plan makes the employee responsible for generating retirement income.
The Two Types of Qualified Plans
In a defined-benefit plan, your employer commits to providing you with a specific payout, regardless of the performance of your employer’s business or investments. An example of a defined-benefit plan is a pension. A defined-benefit plan puts the burden of generating the assets due you at retirement firmly upon your employer. These kinds of plans have gotten rarer and rarer, largely because they are expensive.
In a defined-contribution plan, the onus is upon you 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), 403(b), and individual retirement account (IRA).
Withdrawals from a qualified retirement plan before you are 59½ generally incur a 10% early-withdrawal penalty and are subject to income tax.
Rules and Restrictions
Regardless of the type of defined-contribution account, there are a number of restrictions placed upon it. These restrictions include the type of investments that may be made, with mutual funds and money market accounts being the most common. Other restrictions concern when the funds can be released without penalty.
Generally speaking, any withdrawals of funds prior to age 59½ must meet strict IRS requirements and can be subject to a penalty of 10% on top of income tax, with some exceptions, such as an exception to withdraw $5,000 for the birth or adoption of a child.
Some employers allow for short-term loans from a 401(k), with regular payments and interest paid back to the account, but employers are not required to permit this type of loan. As the account holder, you must begin required minimum distributions (RMDs) from your account after you reach the age of 72, as of 2020.