A qualified retirement plan is a program implemented and maintained by an employer or individual for the primary purpose of providing retirement benefits and which meets specific rules spelled out in the Internal Revenue Code. For an employer-sponsored qualified retirement plan, these rules include:
- The plan must be established by the employer for the exclusive benefit of the employees and their beneficiaries, the plan must be in writing and it must be communicated to all company employees.
- Plan assets cannot be used for purposes other than the exclusive benefit of the employees or their beneficiaries until the plan is terminated and all obligations to employees and their beneficiaries have been satisfied.
- Plan contributions or benefits cannot exceed specified amounts.
- The plan benefits and/or contributions cannot discriminate in favor of highly-compensated employees.
- The plan must meet certain eligibility, coverage, vesting and/or minimum funding standards.
- The plan must provide for distributions that meet specified distribution requirements.
- The plan must prohibit the assignment or alienation of plan benefits.
- Death benefits may be included in the plan, but only to the extent that they are “incidental,” as defined by law.
|Question||Why do employers comply with these requirements and establish qualified retirement plans?|
|Answer||To benefit from the tax advantages offered by qualified retirement plans.|
Qualified Retirement Plan Tax Advantages:
In order to encourage saving for retirement, qualified retirement plans offer a variety of tax advantages to businesses and their employees. The most significant tax breaks offered by all qualified retirement plans are:
- Contributions by an employer to a qualified retirement plan are immediately tax deductible as a business expense, up to specified maximum amounts.
- Employer contributions are not taxed to the employee until actually distributed.
- Investment earnings and gains on qualified retirement plan contributions grow on a tax-deferred basis, meaning that they are not taxed until distributed from the plan.
Depending on the type of qualified retirement plan used, other tax incentives may also be available:
- Certain types of qualified retirement plans allow employees to defer a portion of their compensation, which the employer then contributes to the qualified retirement plan. Unless the Roth 401(k) option is selected, these elective employee deferrals are not included in the employee’s taxable income, meaning that they are made with before-tax dollars (see page 13 for information on the Roth 401(k) option).
- Qualified retirement plan distributions may qualify for special tax treatment.
- Depending on the type of qualified retirement plan, employees age 50 and over may be able to make additional “catch-up” contributions.
- Low- and moderate-income employees who make contributions to certain qualified retirement plans may be eligible for a tax credit.
- Small employers may be able to claim a tax credit for part of the costs in establishing certain types of qualified retirement plans.
The bottomline is that the primary qualified retirement plan tax advantages – before-tax contributions and tax-deferred growth – provide the opportunity to accumulate substantially more money for retirement, when compared to saving with after-tax contributions, the earnings on which are taxed each year