If you’re saving for retirement, it’s time to start thinking about your options for a qualified retirement plan. There are many different types of plans available, and it can be difficult to decide which is the best for you. In this guide, we will discuss the different types of retirement plans and help you decide which one is right for you. We’ll also provide information on how to set up a retirement plan and what tax benefits you can expect. So, whether you’re just starting to think about retirement or you’re already enrolled in a plan, this guide has everything you need to know!
- What Is A Qualified Retirement Plan?
- Defined Benefit Plans
- Defined Contribution Plans
- 401(k) Plans
- What Is A 403(B) Plan?
- 457 Plan
- Simplified Employee Pensions
- Individual Retirement Arrangements (IRA)
- Traditional IRAs
- Roth IRA
- Qualified Deferred Annuities
- Qualified Retirement Plans At A glance (2022)
- Related Reading
What Is A Qualified Retirement Plan?
Qualified retirement plans are those retirement plans that, because they fulfill the requirements of the law, provide plan sponsors and participants with tax advantages. The term qualified plan refers to a retirement plan that meets the requirements of Internal Revenue Code 401 and is therefore tax-favored. The phrase “qualified plan” is broadened to include both individual retirement arrangements (IRAs) and other tax-advantaged plans not administered by employers.
Defined Benefit Plans
A defined benefit plan is a qualified retirement plan in which a plan sponsor guarantees a certain payout at retirement and is often known as a traditional pension plan. A defined benefit plan’s guaranteed retirement benefit may be any of the following:
- an amount determined by a specified percentage of the plan participant’s income.
- an amount determined by a specified percentage and number of years of service to the plan participant’s income
- a fixed benefit amount under which each plan participant receives a retirement benefit equal to some specified amount.
Pooled plans with a defined benefit are funded by an employer’s annual contribution that is equal to the amount required to fully fund the promised retirement benefit. The plan sponsor invests the plan contributions and bears the investment risk.
- Plan assets may fall if the plan’s investment performance is poor, and larger contributions to the plan in future years might be required to make up for losses.
- If plan assets have increased dramatically as a result of enhanced investment performance, the plan sponsor’s required annual payment will decrease.
Defined Contribution Plans
A qualified plan is one that uses a defined contribution method for the funding of its benefits. Unlike defined benefit plans, which pool assets, defined contribution plans are individual account arrangements in which plan sponsors provide contributions on the basis of participant compensation.
Participation in a defined contribution plan is usually optional, and the amount of money that may be contributed to one’s account is predetermined. Plan sponsors may or may not be required to contribute, as well as participants’ contributions.
At retirement, a plan participant’s benefit is calculated based on the account value of their individual account at retirement.
Under a defined contribution plan, participants bear the investment risk rather than plan sponsors.
A plan participant’s gain is determined by how much and how often the employer makes contributions, how long the employee participates in the plan, and the plan’s performance.
Defined contribution plans, which include a variety of qualified plans, such as the following:
- 401(k) plans
- Tax-Sheltered Annuities (TSA)
- SEP IRAs
- Money purchase pension plans
- Profit-sharing plans
- Target benefit plans
The 401(k) plans are qualified profit-sharing or stock bonus plans that give participants the option of receiving company contributions in cash or having them contribute to the plan on their behalf.
401(k) plans, also known as cash or deferred arrangements (CODAs), allow participants to postpone compensation (and the taxes on it) until a later date.
The Internal Revenue Service (IRS) releases a bulletin each year that summarizes the maximum amount that can be deferred. Participants in 401(k) plans may defer current income taxation on funds contributed to the plan.
Participants may invest part or all of their 401(k) plan contributions on an after-tax basis in a designated Roth account. Contributions to a designated Roth account are made with after-tax funds, but qualified withdrawals from the account are tax-free.
Participants in a plan decide how their deferred savings are invested, such as stock shares, bonds, and money market accounts. A participant may decide to invest all or part of their deferred funds in a qualified deferred annuity contract too.
What Is A 403(B) Plan?
A 403(b) qualified retirement plan is available to non-profit workers, public school employees, and other organizations. Participants in this sort of retirement account may defer taxes on their contributions until they are withdrawn. Also known as a tax-sheltered annuity.
State and local governments, as well as top-level nonprofit workers, are eligible for the 457 plan. There are two types of these tax-advantaged retirement plans: a 457(b) for state and local government employees, and a 457(f) for C-level executives of nonprofits.
Simplified Employee Pensions
Simplified employee pension plans (SEPs) are defined contribution retirement accounts in which specially defined contribution conditions apply. These are conventional IRA programs that are sponsored by employers and in which much greater contributions are permitted.
The employer may choose to make a contribution in any year and forgo one in the following year under a SEP. However, under a SEP qualified plan, employees may not contribute more than the overall annual limit on contributions.
A plan participant may also allocate contributions to a qualified deferred annuity.
Individual Retirement Arrangements (IRA)
IRAs are labeled a “qualified plan,” but are not employer-sponsored retirement plans. Traditional IRAs and Roth IRAs are two types of individual retirement accounts (IRAs).
Traditional IRAs offer owners tax deferral of gain and contributions can be tax-deductible. Roth IRA contributions are funded with funds that have been taxed and will receive tax-free qualified distributions during retirement.
The amount that can be contributed each year is limited to the lesser of:
- $6,000 plus a catch-up contribution available to age 50+ individuals of up to $1,000
- the individual’s compensation
IRAs may be funded with a wide range of investments, including qualified deferred annuities and other instruments.
A traditional IRA is open to everyone who receives a paycheck in a given year for which an IRA contribution is made. A contributor to a traditional IRA may deduct the amount contributed from taxable income, provided that the taxpayer’s adjusted gross income for the year does not exceed specific limits.
Taxes On Contributions and Distributions
Active participants with higher incomes than those permitted under the AGI limit may still make contributions to a conventional IRA, but they won’t be tax-deductible.
When an individual withdraws earnings or deductible contributions from a traditional IRA, they are completely taxable as ordinary income when received and, if received before the individual becomes Age 59 1/2, may be subject to a premature distribution tax of 10% of the amount of the distribution that is taxable.
Required minimum distribution (RMD) in traditional IRAs must be distributed by April 1 of the year following the year in which an individual reaches age 72.
Contributions made to a Roth IRA are not tax-deductible, but qualified distributions are entirely tax-free. Individual taxpayers who meet the following requirements may establish a Roth IRA:
- Receives a compensation
- If your adjusted gross income (AGI) is less than a certain amount.
Contributions made to a Roth IRA are not tax-deductible. However, Roth IRA contributions may be made regardless of age, and are not subject to required minimum distributions (RMD) starting at age 72.
Qualified distributions are entirely tax-free. A qualified distribution from a Roth IRA is any distribution made after the required five-year period and that is:
- withdrawn when the individual attains age 59½
- passed on to a beneficiary after the Roth IRA owner’s death
- the owner becomes disabled
- a distribution made for qualified first-time homebuyer purchase
Qualified Deferred Annuities
A qualified annuity is one that has been bought to fund a tax-qualified retirement plan. Pension and profit-sharing plans, simplified employee pensions (SEPs), SIMPLEs, tax-sheltered annuities (TSAs), and IRAs are examples of such arrangements.
Qualified annuities are purchased to liquidate funds accumulated in a qualified retirement plan or both accumulation funds (saving) and liquidating (spending).
Qualified Retirement Plans At A glance (2022)
|Maximum Contribution||No Limits||$20,500||$6,000||$6,000|
|How Are Savings Taxed||Tax-Deferred||Tax-Deferred||Tax-Deferred||Tax-Deferred|
|How Is Spending Taxed||Gains-Only Taxed||Fully Taxable||Fully Taxable||Tax-Free|
|Distribution Before 59 1/2||10% Penalty On Gains Withdrawn||10% Penalty – All Withdrawals||10% Penalty – All Withdrawals||10% Penalty – All Withdrawals|
|RMDs||None||Age 72||Age 72||None|