Qualified Retirement Plans: Everything You Need to Know

Shawn Plummer

CEO, The Annuity Expert

If you’re saving for retirement, it’s time to start thinking about your options for a qualified retirement plan. Many different types of plans are available, and deciding which is the best for you can be challenging. This guide 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, this guide has everything you need to know whether you’re just starting to think about retirement or already enrolled in a plan!

What Is A Qualified Retirement Plan?

Qualified retirement plans provide plan sponsors and participants with tax advantages because they fulfill the requirements of the law. The term qualified plan refers to a retirement plan that meets the requirements of Internal Revenue Code 401 and is, therefore, tax-favored. In addition, the phrase “qualified plan” is broadened to include 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 equal to the amount required to fund the promised retirement benefit fully. The plan sponsor invests in 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.
  • The plan sponsor’s required annual payment will decrease if plan assets have increased dramatically due to enhanced investment performance.

Defined Contribution Plans  

A qualified plan uses a defined contribution method to fund its benefits. Unlike defined benefit plans, which pool assets, defined contribution plans are individual account arrangements in which plan sponsors provide contributions based on 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 their account value.

Under a defined contribution plan, participants bear the investment risk rather than the plan sponsors.

A plan participant’s gain is determined by 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

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 year bulletin summarizing 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 also decide to invest all or part of their deferred funds in a qualified deferred annuity contract.

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. They are also known as a tax-sheltered annuity.

457 Plan

State and local governments, as well as top-level non-profit 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 non-profits.

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 sponsored by employers, in which much greater contributions are permitted.

The employer may contribute in any year and forgo one 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 qualified tax-free 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 various investments, including qualified deferred annuities and other instruments.

Traditional IRAs

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 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.

Roth IRA

Contributions to a Roth IRA are not tax-deductible, but qualified distributions are 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

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.

Distributions

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 has been bought to fund a tax-qualified retirement plan. Such arrangements include pension and profit-sharing plans, simplified employee pensions (SEPs), SIMPLEs, tax-sheltered annuities (TSAs), and IRAs.

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)

Nonqualified Annuity401(k)IRARoth
Maximum ContributionNo Limits$20,500$6,000$6,000
Catch-Up ContributionN/A$6,500$1,000$1,000
Tax-DeductibleNoYesYesNo
How Are Savings TaxedTax-DeferredTax-DeferredTax-DeferredTax-Deferred
How Is Spending TaxedGains-Only TaxedFully TaxableFully TaxableTax-Free
Distribution Before 59 1/210% Penalty On Gains Withdrawn10% Penalty – All Withdrawals10% Penalty – All Withdrawals10% Penalty – All Withdrawals
RMDsNoneAge 72Age 72None

Next Steps

Now that you understand the different types of qualified retirement plans and how they work, it’s time to decide which is right for you. If you’re still unsure, don’t worry! Our team can help you find the perfect plan and set it up so you can start enjoying the benefits right away. Contact us today for a free quote, and let us help you take the first step towards a secure retirement. Thanks for reading!

What Is A Qualified Retirement Plan, And How Does It Work?

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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