What Is a Qualified Retirement Plan?

Qualified retirement plans may offer increased contribution and deduction limits.

Qualified retirement plans are a feature of the United States Internal Revenue Code created under The Employee Retirement Income Security Act of 1974 (ERISA). These plans offer tax incentives for both employers and employees to save for retirement and often offer increased contribution and deduction limits. There are also significant penalties if plan guidelines are not met.

General

Qualified retirement plans are formal plans established by a business, which allow for the deduction of the cost of employer contributions for the owner and for qualified employees. The deductions for qualified retirement plans are tax deductible to the business when funded and are not taxable until distributed. Qualified retirement plans must conform to many plan rules and guidelines. Failing to adhere to these rules can result in the loss of the entire tax deduction for contributions.

General Qualification Rules

Qualified retirement plan guidelines stipulate that the plans with vesting requirements confirm to rules established under ERISA. Plans must not discriminate or provide excess benefits to officers or highly-compensated individuals. In addition, benefits once earned under the plan may not be forfeited, and distribution of the benefits must begin at retirement age. Finally, the plans must adhere to certain investment guidelines, including offering participants the option of a joint-and-survivor annuity.

Profit-Sharing Plans

A profit-sharing plan is one of several basic types of qualified retirement plans. A profit-sharing plan is a defined-contribution plan, which means the level of retirement benefits are largely determined by the initial contributions and investment returns. Profit-sharing plans allow for discretionary employer contributions, though any contributions must strictly follow the allocation formula defined in the plan.

Money-Purchase Pension Plans

Money-purchase pension plans are another form of defined-contribution plan. Benefit contributions to a money-purchase pension plan are pre-established and are not linked to a company's income. A money-purchase pension plan requires a business to make contributions whenever any qualified earnings or compensation occur during a year. This may even include years in which the company suffered a loss.

Defined-Benefit Plans

Defined-benefit plans are plans where participants are guaranteed a set benefit at retirement age. Contributions to a defined-benefit plan must be of a certain value set to meet IRS approved actuarial calculations. Typically, deductible contributions to defined-benefit plans can be larger than those allowed under other plans. Defined-benefit plans, owing to their cost and complexity, are one of the least common plans in number. They have historically been used by some larger employers.

References

• Internal Revenue Service: Publication 560: Retirement Plans for Small Business
• RMS Accounting: Qualified Retirement Plans