Qualified and Non-Qualified Retirement Plans
In simple terms, a qualified retirement plan is an employer provided retirement plan that meets ERISA guidelines, while a non-qualified retirement plan falls outside of ERISA guidelines. Some examples:
- Qualified plans include
- 401(k) plans,
- 403(b) plans,
- IRAs (both Traditional and Roth),
- Keogh (HR-10) plans. (for unincorporated businesses)
- Defined benefit plans (pensions), and
- Defined contribution plans.
- Non-qualified plans include (covered in another chapter)
- deferred-compensation plans,
- salary continuation plans, and
- split-dollar life insurance plans.
MR. WATSON: There are many advantages with these plans. Know them!
- The employer receives a tax deduction from their contributions to the employees' plan.
- The employee DOES NOT have to claim that contribution as income.
- The employee gets to tax-deduct what they put into the plan (except for the Roth IRA).
- The money earns interest and is NOT taxed while it grows, but is taxed at retirement when they take the money out.
- The employer can not discriminate if favor of the highly paid workers.
MR. WATSON: When you contribute money to a 401k plan at work, do you get to tax-deduct it?
STUDENTS: Yes.
MR. WATSON: When your employer matches your 401(k), does he get to deduct it?
STUDENTS: Yes.
MR. WATSON: Do you have to claim it as income the year he puts it in there?
STUDENTS: No.
MR. WATSON: Does it earn interest and grow?
STUDENTS: Yes.
MR. WATSON: Do you pay taxes while it's growing?
STUDENTS: No.
MR. WATSON: But you pay taxes when?
STUDENTS: When you take it out.
MR. WATSON: All of the retirement plans we’ll talk about in this chapter are qualified plans, and most of them work like the 401k. We just use the 401k for the example because most people have had one at their job and are familiar with it.
Qualified employer retirement plans
MR. WATSON: Qualified employer retirement plans. The basic concepts can be tied to something called the Employee Retirement Income Security Act. (E.R.I.S.A.). The purpose of ERISA is to protect the rights of employees covered under an employer sponsored retirement plan. ERISA imposes requirements (hoops) that these plans must follow or else lose their tax-favored status.
MR. WATSON: Now these plans, are they for individuals?
STUDENT: No, they are set up by the employer.
MR. WATSON: Very good. So it wouldn't be individuals setting them up, would it?
STUDENTS: No, the employer.
MR. WATSON: Now, ERISA sets participation standards . What's the purpose of participation requirements? To make sure the employer does not try to prevent the employees from participating in the retirement plan.
MR. WATSON: ERISA has coverage requirements to make sure that we are not discriminating against the rank and file.
MR. WATSON: Next, vesting. Important.
MR. WATSON: "Vesting means the right each employee has to the retirement account." You, the employee, are always 100 percent vested in your own contributions. But there are vesting schedules that apply to the money put in by the employer. You have to work there a certain amount of time before you can take the employers' contribution with you, should you leave.
MR. WATSON: Funding standards. There's federal minimum funding requirements; they're enacted to make sure that the money that was promised you for your pension plan will be sufficient whenever you retire.