A. General Requirements
An employer-sponsored qualified retirement planis approved by the IRS, which then gives both the employer and employee benefits such as deductible contributions and tax-deferred growth.
Qualified plans have the following characteristics:
- Designed for the exclusive benefit of the employees and their beneficiaries;
- Are formally written and communicated to the employees;
- Use a benefit or contribution formula that does not discriminate in favor of the prohibited group— officers, stockholders, or highly paid employees;
- Are not geared exclusively to the prohibited group;
- Are permanent;
- Are approved by the IRS; and
- Have a vesting requirement.
In contrast, nonqualified plans are not subject to the requirements regarding participation, discrimination, and vesting as qualified plans. Nonqualified plans require no government approval and are used as a means for an employer to discriminate in favor of a valuable employee with regard to employee benefits. Nonqualified plans accept after-tax contributions.
The table below highlights the differences between qualified and nonqualified retirement plans.
QUALIFIED
|
NONQUALIFIED
|
| Contributions currently TAX DEDUCTIBLE | Contributions NOT currently TAX DEDUCTIBLE |
| Plan APPROVED by the IRS | Plan DOES NOT NEED IRS APPROVAL |
| Plan CANNOT DISCRIMINATE | Plan CAN DISCRIMINATE |
| Earnings grow TAX DEFERRED | Earnings grow TAX DEFERRED |
| ALL WITHDRAWALS are TAXED | EXCESS over cost basis is TAXED |
B. Plan Types, Characteristics and Purchasers
1. Individual Qualified Plans - IRA and Roth IRA
The 2 most common qualified individual retirement plans are Traditional IRAs and Roth IRAs. Anybody with earned income can contribute to either plan.
A Traditional Individual Retirement Account(IRA) allows individuals to make tax deductible contributions until the age of 70 ½. Plan participants are allowed to contribute up to a specified dollar limit each year, or 100% of their salary if less than the maximum allowable amount. Individuals who are age 50 or older are entitled to make additional catch-upcontributions. A married couple could contribute a specified amount that is double the individual amount, even if only one person had earned income. Each spouse is required to maintain a separate account not exceeding the individual limit. In traditional IRAs, withdrawals may begin at age 59 ½, but no later than age 70 ½.
The Roth IRA is a form of an individual retirement account funded with after-tax contributions. An individual can contribute 100% of earned income up to an IRS-specified maximum, as with traditional IRAs (the dollar amounts change every year). In contrast with a traditional IRA, Roth contributions can continue beyond age 70½ and distributions do not have to begin at age 70½. Roth IRAs grow tax free as long as the account is open for at least 5 years.
In addition to individual plans, different types of qualified plans are available and have been designed for use by small and large employers.