Qualified retirement plans may be familiar but elusive concepts. Most individuals and business owners want to leverage their benefits, but the tax rules can pose significant challenges. This guide will help you learn about qualified retirement plans and the various types. We will also consider the requirements, benefits and best practices for optimizing savings.
A qualified retirement plan is an employer-sponsored retirement savings plan that meets specific requirements for favorable tax treatment. These plans help employees save for retirement and offer tax advantages to employees and employers. They also provide customizable investment options based on your risk tolerance and retirement goals.
Qualified retirement plans are regulated by federal legislation, primarily the Internal Revenue Service (IRS) Code and the Employee Retirement Income Security Act (ERISA). Employers and employees must comply with these laws to avoid adverse legal implications.
There are two main types of qualified retirement plans. These are:
These plans provide a guaranteed monthly income to employees in retirement based on a specific formula. Income is typically calculated using factors such as the employee’s history, years of service and predetermined benefit multiplier. Defined benefit plans are often referred to as pension plans.
In contrast with defined benefit plans, defined contribution plans provide no guaranteed benefit. Instead, the retirement income depends on the contributions made and investment performance of the account over time. Examples include the following:
Accounts are usually designated as traditional or Roth. Contributions to traditional accounts are tax-deferred, but Roth contributions are made with after-tax dollars.
Tax-qualified pension plans and other retirement plans must adhere to specific requirements to maintain their tax-advantaged status. Here is an overview:
The IRS Code determines the minimum requirements to participate in a qualified retirement plan. For example, section 410(a)(1) establishes the minimum service and age requirements, whereas section 410(a)(4) provides the plan entry dates, which is when an eligible employee must start participation.
Employers must provide eligible employees with the same benefits regardless of position. This rule prevents 401(k) plans from disproportionately benefiting highly compensated employees (HCEs). Employers must employ two main tests:
Retirement plans must pass these tests to remain qualified.
The IRS sets annual contribution limits for various types of qualified retirement plans. For example, in 2025, employees participating in 401(k), 403(b) and 457 plans can only contribute up to $23,500. Individuals aged 50 or older can make an additional $7,000 catch-up contributions to these retirement accounts.
Also, withdrawal or distribution rules govern how and when participants can access their retirement savings. Generally, participants can make qualified withdrawals after turning 59 ½, while they will incur a 10% penalty plus taxes on early withdrawals. Further, participants or beneficiaries of certain plans must make required minimum distributions (RMDs) in specific situations.
Qualified retirement plans must comply with specific reporting and disclosure requirements. A classic example is filing Form 5500 annually with the IRS, which provides information about the plan’s financial condition, investments and operations. The plans must also contain a summary plan description (SPD) to inform participants about the plan’s benefits and features.
Qualified retirement plans provide several benefits, such as:
Employer contributions to qualified retirement plans are typically tax-deductible, which can reduce their taxable income. Contributions to tax-deferred plans also allow savings and investments to grow rapidly. The employee only pays taxes when they withdraw during retirement.
Qualified retirement plans provide income in retirement, which enhances financial stability. Employer matching contributions can significantly increase employees’ retirement savings and incentivize them to participate in the plan. This long-term savings strategy can provide a safety net in their later years.
Many qualified retirement plans provide investment options like bonds, stocks and mutual funds. This feature can allow participants to increase growth. Some plans also offer professional asset management that helps account holders make informed decisions without needing extensive investment knowledge.
ERISA protects some qualified retirement plans from creditors. The law shields the funds in these plans against seizure in the event of bankruptcy or legal judgments. Qualified retirement plans also have protection from the IRS against liens and levies. This feature allows employees to retain their retirement savings.
The following best practices can help you maximize retirement savings:
Spreading investments across various asset classes can reduce risks. Since different assets perform differently under varying market conditions, gains in some areas may offset losses in others. In addition to investment diversification, periodically review your asset allocation. Rebalancing your portfolio can help maintain your desired level of risk and ensure no single investment dominates.
Remember the tax implications of early withdrawals and comply strictly. Also, develop a tax and estate planning strategy based on your financial situation. For example, you may use trusts or gifts to reduce estate taxes if you have substantial retirement savings. It is important to research or consult with a professional before making decisions.
Tax-loss harvesting involves converting investment losses into tax savings. For instance, you may claim a capital loss when you sell securities held in a taxable account for less than the original cost. Then, you can use the loss to offset capital gains in other parts of your portfolio. This strategy can reduce your overall tax liability for the year.
Most investors reinvest the proceeds after realizing losses. When adopting this strategy, be mindful of the wash sale rule, which disallows a tax deduction if you repurchase the same or substantially identical security stock or securities within 30 days.
Consider whether contributing to traditional or Roth accounts makes sense for your situation. Traditional plans are ideal for those who expect to be in the same or lower tax bracket during retirement. If you anticipate being in a higher tax bracket during retirement, you may want to consider a Roth plan.
Partner with a tax professional who can help you develop a retirement strategy tailored to your goals and risk tolerance. They can provide insights into investment options, tax implications and withdrawal strategies.
The tax rules surrounding qualified retirement plans are complex, but Polston Tax is ready to help. With years of experience and a knowledgeable team, we assist individuals and businesses in optimizing these plans. We provide tax planning and advisory services to simplify requirements and develop tailored solutions. Contact us today to learn more!
