Qualified Retirement Plans
A qualified retirement plan is simply a plan that meets the requirements set out in Section 401(a) of the U.S. tax code. This does not mean that other types of plans are not available to build your nest egg, but the majority of retirement savings programs offered by employers are qualified plans since contributions are tax-deductible. There are several types of qualified plans, though some are more common than others.
Types of Qualified Retirement Plans Include:
401(k) – Maximum flexibility in employer contribution A 401(k) Plan allows employees to defer pretax dollars for their own retirement savings. These plans can be set up with or without an employer match and, in addition to a match, can allow a discretionary employer contribution each year.
Profit Sharing – Maximum flexibility in employer contribution A profit sharing plan allows an employer (at the employers’ discretion) to contribute and deduct from 0% to 25% of covered payroll each year.
Defined Benefit – Highest tax-deductible contribution The contributions for Defined Benefit Plans are calculated based on the employees’ ages and compensation. The older the employee and the more compensation (up to IRS compensation limits) the larger the contribution required for the employee.
Cash Balance – One of the highest tax-deductible contributions The contributions for Cash Balance Plans are based on the employees’ ages, compensation and employee classes. In general, the older owners or key employees are put into classes and receive a much larger contribution than other employees. This is the case even if the other employees are close in age to the owners.
Cross-Tested – Allows varying contribution levels among classes of employees The contributions for Cross-Tested Plans are based on the employees’ ages, compensation, employee classes and the percent of contribution decided by the employer.
Money Purchase – Fixed contribution A Money Purchase Plan allows an employer to contribute and deduct up to 25% of covered payroll per a fixed formula contained in the plan document.
Target Benefit –Favors participants close to retirement The contributions for Target Benefit Plans are calculated based on the employees’ ages and compensation. The older the employee and the more compensation (up to IRS compensation limits) the larger the contribution required for the employee.
Qualified retirement plans must meet the requirements of Section 401(a) of the U.S. tax code, which means that contributions are tax-deductible.
A defined-contribution plan, which is the most common type of qualified plan, is based on employer and employee contributions that accrue in value over time.
A common type of defined-contribution plan is a 401(k)—or a 403(b) if the employer is a non-profit—but there are also profit-sharing plans.
Today there are fewer defined-benefit plans (typically pensions or annuities), which provide workers with a fixed amount upon retirement, regardless of employer/employee contributions.
Under defined contribution plans, the amount employees receive in retirement depends on how well they save and earn through investment on their own behalf during their working years. The employee bears all the investment and longevity risk and is expected to be a financially savvy saver. A 401(k) is the most popular example of a defined contribution plan. Other examples of qualified plans include the following: