What is a Qualified Retirement Plan?

When planning for retirement, choosing only one or two retirement plans can be a challenge. There are so many options available, and it’s not always obvious which is best for you. It’s important to be aware of the different plans, the categories they fall into, and what this means for your future. This will help you to make the best decision for your personal situation.

Qualified retirement plans are some of the most popular options available. But what exactly are they? And how do you know whether they’re right for you? This article will discuss everything you need to know.

Qualified Retirement Plans: A Definition

A qualified retirement plan is one of several retirement plans that meet guidelines set by ERISA (or the Employee Retirement Income Security Act of 1974). These plans are often referred to as tax-advantaged plans, as you don’t pay any income tax on your contributions; only the money you withdraw.

The most popular qualified retirement plan is the 401(k) plan. Other qualified retirement plans include 403(b) plans, Keogh (HR-10) plans, and profit-sharing plans. 

The most important notable feature of a qualified retirement plan is that it is eligible for certain tax benefits. Typically, your employer will establish this retirement plan for you when you start a job. 

Defined Benefit Plans & Defined Contribution Plans

There are two common types of qualified retirement plan: defined benefit plans and defined contribution plans. 

A defined benefit plan offers you, the employee, a guaranteed payout when you retire. Your employer deals with the risk of investing and saving to ensure they meet the liabilities of the plan. If you have an annuity-type pension, this is classed as a defined benefit plan. 

Defined contribution plans, on the other hand, put more pressure on you. The money you receive when you retire is dependent on your savings and earnings throughout your years at work. With a defined contribution plan, it’s you who bears 100% of the longevity and investment risk, so it’s important that you’re financially savvy if you choose this option. Still, this option is very popular. For instance, a 401(k) is an example of a defined contribution plan.  

Qualified Vs Non-Qualified Retirement Plans

When you’re deciding between a qualified and a non-qualified retirement plan, it’s worth knowing their key differences. 

The most obvious difference is non-qualified plans aren’t eligible to receive tax-deferred benefits based on ERISA’s guidelines, while qualified plans meet the ERISA guidelines and are therefore entitled to additional tax benefits – on top of the existing retirement plan’s benefits.  

Something else to note is that for a qualified plan, your contributions are tax-deferred. Your employer can also contribute to the plan and claim for tax deduction. A non-qualified plan, on the other hand, is usually funded by after-tax dollars. Typically, your employer won’t be able to deduct their contributions to this type of plan. 

It’s unlikely that a non-qualified retirement plan will be suitable for you, unless you’re a key executive or have a similar job role. This type of plan is only really suitable if you need a plan that can be tailored to meet your specific requirements. 

Qualified Retirement Plans, Taxes & Investing

Qualified retirement plans offer tax benefits to both you and your employer. 

Your employer will get a tax break from any contributions they make to your qualified plan. If you choose an option that lets you put some of your salary into your plan, this will also reduce your taxable income. 

If you’re interested in varying your retirement investments, however, keep in mind that a qualified retirement plan may not allow for certain types of investments. 

The plan you opt for will determine the investments that you can make. Typically, these include investments in mutual funds, publicly traded securities, real estate, and money market funds. Several alternative investments that are rapidly gaining popularity, including hedge funds and private equity, may also be investment options within your retirement plan. 

Another thing to keep in mind is that you typically won’t have as much freedom to access your funds as you would if you opted for an alternative means of investing. Most retirement accounts have strict distribution rules, and will only release your funds when you reach retirement age or if you become disabled, or terminate your plan without replacing it with another qualified retirement plan. Your family would receive your funds from the beneficiary if you were to die.

On some occasions, you may be able to withdraw from your plan, though you may be subject to penalties and taxes that will likely put you off the decision. Similarly, some plans allow you to borrow money, but rules about repaying the loan can be very strict. You may have to pay interest on the loan or pay it back within a relatively short amount of time. 

Is a Qualified Retirement Plan For Me?

Qualified retirement planning tends to be the most available and popular option for people in the US. Your investments can grow tax-free, and you can even lower your annual taxable income from making contributions to this plan. 

However, qualified retirement plans aren’t the only option when it comes to making tax-free contributions. You may also want to consider health savings accounts (HSAs) or flexible spending accounts (FSAs).

Trying to decide on a retirement plan – or whether you need a retirement plan at all – is difficult. You want to save enough for retirement, but you’re unsure about the best method to achieve this.

With 50 years of investment experience, the financial advisors at Koinonia Financial can guide you to make sound decisions for your future. Call us to discuss your requirements with a qualified member of our team today.