Qualified Retirement Plans

Qualified retirement plans are set up by employers to provide employees with opportunities to save for retirement. A self-employed person or small business owner can also set up some of these plans, even when there are no employees in the business.

Qualified plans are referred to as qualified because they qualify for favorable tax treatment under the Internal Revenue Code. Provided they meet the requirements for maintaining such plans, employers and self-employed individuals get to deduct their contributions to the plan. Also, employees are not immediately taxed on the contributions made on their behalf, they can often make additional contributions on a pre-tax basis, and earnings on their retirement plan funds accrue on a tax-deferred basis. This is a pretty good deal for both the employer and the employee.

If you are an employee, chances are pretty good that your employer offers a qualified retirement plan as part of your compensation package. According to data released by the Bureau of Labor Statistics, employer-provided retirement plans were a common employee benefit in the United States, available to 74 percent of all full-time workers in private industry in March 2010. Not everyone who has access to a plan participates, but the numbers are likely to increase as people realize that our troubled Social Security system is likely to provide limited benefits in the years to come.

The type of qualified plan offered by your employer affects the type of benefits you will receive at retirement. Generally speaking, a qualified retirement plan will fall under one of the following three broad categories:

• Defined contribution plans. This type of plan does not guarantee an employee a fixed level of benefits upon retirement. Instead, the employer contributes a fixed amount to an account set up for the employee. At retirement, the employee will have the amount contributed to the account before retirement, with adjustments up or down due to income, expenses, losses, etc. Under such plans, an employee can only make an educated guess as to the exact amount of assets that will be available in the account for retirement. These plans are more favored today by employers because they know their costs up front. They are favored, too, because retirement fund balances are more easily calculated and transferred as employees move from one employer to another.
• Defined benefit plans. The tax code defines this type of plan as any plan that is not a defined contribution plan. More specifically, these pension and annuity plans promise the employee a fixed or determinable monthly payment upon retirement (e.g., 25 percent of average annual compensation or $400 a month). Historically, the early benefit plans were mostly defined benefit plans. During recent decades, the trend has been toward defined contribution plans.
• Hybrid plans. A hybrid plan has the features of both a defined contribution and a defined benefit plan. These types of plans have increased in popularity as the workforce becomes more mobile.

Tip As long as you don't have to set up the plan yourself, the only things that you have to really be concerned about are making sure that you understand your employer's retirement benefits and making sure that you invest in them.

Drilling down even further, there are five general types of plans that may qualify for tax benefits. The five types of plans are:

• Pension plans. A pension plan is designed to pay definitely determinable benefits to the employee for a prescribed number of years after retirement. Although a pension plan may be structured as a defined benefit or defined contribution plan, a defined benefit plan is always a pension plan for tax purposes.
• Profit-sharing plans. An employer providing this type of plan will allow its employees to participate in the employer's profits. Contributions to the plan are made under a predetermined formula.
• Money purchase plans. Unlike profit-sharing plans, contributions to this type of plan are fixed (often a percentage of the participant's compensation) and are not based on business profits.
• Stock bonus plans. This type of plan provides benefits similar to those of a profit-sharing plan except that the employer's contributions are not necessarily dependent on profits and benefits are distributable in the form of the employer's stock. A stock bonus plan is always a defined contribution plan.
• Annuity plans. An annuity plan is a type of pension plan. Unlike other pension plans, however, annuity plans are administered by insurance companies that receive contributions and hold funds in the form of premiums.

Within the respective broad categories mentioned above, qualified retirement plans come in various flavors. To find out about the benefits they offer, take a closer look at the following most commonly used qualified plans:

• 401(k) Plans
• Keogh Plans
• SIMPLE Plans
• Tax-Sheltered Annuities or 403(b) Plans
• Government or 457 Plans

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