Say you’re planning to retire, and you’re probably looking for options to fund your expenses. While there are many ways to do this, one of the most common methods is to get a retirement plan.
However, there are several types of retirement plans you can choose from, so it might be tricky.
Today, we’ll be discussing what you need to know about one of the most common types of retirement plans, which are qualified retirement plans.
Whether you’re an employee or an employer, this article will help.
If you want to learn more about qualified retirement plans and find out if they’re what you need, read on!
Understanding Qualified Retirement Plans
In simple words, a qualified retirement plan is an IRS-recognized retirement plan in which your investment income is tax-free. Additionally, these are retirement plans that meet Section 401(a) of the US tax code.
There are two main types of qualified retirement plans: defined contribution and defined benefit. However, there are also other plans which are combinations of the two.
Employers typically lay-out qualified retirement plans on behalf of their employees. Through these plans, employers can increase employee retention and attract employees.
Types of Qualified Retirement Plans
This section will discuss the features and the differences the types of qualified retirement plans have.
1. Defined Benefit Plans
Defined benefit plans are plans that enable employees to receive a guaranteed payout. Typically, the amount employees receive is computed depending on several factors, including employment length.
However, these plans put the employers at risk because they’re required to pay the plan liabilities.
If your company is nonprofit, defined benefit plans include 401(k) and 403(b). Typically, you can get these plans tax-deferred, which means that contributions are pre-tax.
Moreover, the money you earn from defined benefit plans grows tax-free.
2. Defined Contribution Plans
Defined contribution plans work the same as defined benefit plans. The main difference is that the formula used to compute the amount employees receive depends on different factors.
Also, defined contribution plans are, unlike defined benefit plans, uncommon. Generally, these plans specify that a certain amount should be given to the account holder once they retire.
Also, these plans don’t consider employer or employee contributions.
Under a defined contribution plan, the amount depends on how well employees save and earn through their investment.
How Qualified Retirement Plans Work
Like we’ve said, there are requirements a retirement plan has to meet to be a qualified one. These plans have to meet specifications under the Internal Revenue Code that pertain to participation and contribution limits, among others.
If you’ve retired and you’re looking to get a qualified retirement plan, here are the plan requirements you have to know about:
Generally, qualified retirement plans should be available to employees once they reach 21. These plans should also be made available once employees finish 12 months of service with the employer.
There are different documents an employer has to prepare for qualified retirement plans. These include a detailed document stating which plans employees participate in.
The document should also include the contribution types and benefits that employees can receive. The plan employees enroll in has to work how it says it would in the document.
3. Compensation Limits
Typically, the maximum compensation an employee can take into account ranges from $285,000 to $290,000.
4. Elective Deferral Limits
If your retirement plan allows elective deferrals, you must know that elective deferrals must not be more than $19,5000. It should not exceed $26,000 if you’re 50 or older.
5. Total Contribution Limits
The maximum allowable contribution an employee can make to defined contribution plans is the lesser of $58,000 or the full compensation. However, if you’re 50 or older, you pay the lesser of $64,500 or 100% of your salary.
Qualified vs. Non-qualified Retirement Plans
Generally, employers create retirement plans to benefit their employees. To do this, employers provide their employees with retirement plan options, including qualified and non-qualified retirement plans.
Now, you might be asking, how are the two different from each other?
The simple answer is this: qualified retirement plans meet the Employee Retirement Income Security Act (ERISA) guidelines, while non-qualified ones don’t. However, more things make the two different, including tax implications.
Qualified Retirement Plans
Like we’ve mentioned, qualified retirement plans meet the guidelines provided by ERISA. Because of this, qualified retirement plans have tax benefits, in addition to those that employees receive from regular retirement plans.
In some instances, employers take away a portion of pretax dollars from the employee’s compensation as a form of investment in the qualified plan.
Under qualified retirement plans, employee earnings and contributions are tax-deferred until they decide to withdraw them.
Also, there are two types of qualified retirement plans, like we’ve discussed earlier.
Moreover, sponsors must meet specific guidelines about participation, compensation limits, and other factors for their plan to qualify under ERISA.
Non-qualified Retirement Plans
Like qualified retirement plans, nonqualified retirement plans are also offered by employers. Typically, non-qualified retirement plans are provided as part of a benefits or executive package.
Like we’ve said, these retirement plans are plans that don’t meet the ERISA guidelines. Thus, non-qualified retirement plans are not tax-deferred.
Also, the contributions employees make for nonqualified plans are taxed once the income becomes recognized.
In simple words, you will pay taxes on the funds before you contribute to the plan when you get a non-qualified retirement plan.
Benefits of Qualified Retirement Plans
Of course, qualified retirement plans have benefits. However, what you might not know is that these plans benefit both employers and employees.
Like we’ve said, qualified retirement plans benefit employers. If you’re one and planning to make a qualified retirement plan, here are some of the benefits you can enjoy.
1. The qualified retirement plan contributions an employer makes on behalf of their employees are tax-deductible.
If you’re a sole proprietor, you’re allowed to subtract the amount you contribute for yourself. However, this depends on the type of qualified plan.
Generally, employers can subtract up to 25% of what they pay their eligible employees. However, making these deductions require hiring an actuary to make the calculations.
2. Employer assets in the plan are tax-free.
Generally, employers aren’t responsible for paying for the taxes imposed on contributions. If you own a small business, qualified retirement plans will enable you to make significant investments.
This means you can earn what you’ve invested in your retirement without paying taxes during your employment.
3. There are special tax credits and other incentives that businesses and employees can get from starting a qualified retirement plan.
Now, this benefit generally applies if you’re an employer with 100 or fewer employees who have earned at least $5,000.
If you are, you’re qualified to claim a tax credit amounting to up to half your company’s costs. These costs generally include setting up, running, and informing your employees about the qualified retirement plan.
With this benefit, you can claim up to $500 a year.
4. Qualified retirement plans attract more employees and increase employee retention.
Like we’ve mentioned earlier, qualified retirement plans help employers attract more employees and retain them.
This is because qualified retirement plans are an employee’s future investment. Thus, these plans play an essential role when it comes to employee recruitment and retention.
Now that we’ve talked about the benefits employers can get from qualified plans; we’ll now be discussing the plan’s employee benefits.
Below are some of the benefits you, as an employee, can receive when you get a qualified retirement plan.
1. Qualified plans are convenient.
If you have a qualified retirement plan, manually scheduling your contributions isn’t needed.
Typically, you can make contributions automatically by allowing your employer to deduct them from your paycheck.
2. You can get a tax break immediately.
Until you retire and receive the funds, your employee contributions are generally tax-deferred.
This means that you can save up to hundreds or thousands of dollars on your annual tax bill if you make contributions using pre-tax dollars.
3. Employee assets are tax-deferred.
Generally, the contributions you make to a qualified retirement plan will continuously grow tax-free until you withdraw them. This also applied to your subsequent earnings.
Also, the funds you’ll get at the time of your withdrawal will be taxed at your income tax rate.
4. You can get matching contributions from the plan.
If you have a qualified retirement plan and your employer matches employee contributions, getting a qualified plan should be easy.
This means that your employer contributes a certain amount equal to what you contribute. Through this, you can receive “free money” every payday.
5. You can get investment options.
With a qualified retirement plan, there are several investment options you can choose from. Also, many qualified retirement plans provide you with low-cost options that you can access with professional advice and help.
6. Creditors provide you with protection.
Generally, assets in qualified retirement plans are safe from creditor actions under the ERISA.
Investing in your future is crucial, especially if you’re planning to retire soon.
While qualified retirement plans are an easy way to fund your retirement, they might not work for you for several reasons. With this, you must assess your options and choose the best one suited to your needs.
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