Qualified retirement plan Definition

Deeper definition

Qualified retirement plans are any plans that meet the specifications laid out in Section 401(a) of the U.S. tax code. There are several types of plans, including defined-contribution plans and defined-benefit plans.

Defined-contribution plans include 401(k) and 403(b) plans. These plans allow an employee to contribute a percentage of his wages to the plan each year, while the employer also may choose to contribute a percentage. Early withdrawals are allowed before retirement, although the employee must meet certain requirements to avoid paying a penalty.

Defined benefit plans are not as common. With these plans, the employee is promised a certain amount of money due at the time of retirement, regardless of the contributions made by the employee. These plans are usually either pension plans or annuities.

Pensions provide a certain amount of retirement money per year based on the employee’s salary, while annuities offer a fixed amount of money every year after retirement until death. Defined-benefit plans put more of a burden on the employer to be sure to contribute enough so that these benefits can be paid upon retirement.

Qualified retirement plan example

If you work for a company that offers a qualified retirement plan, especially a defined-contribution plan, you’ll likely get to choose a certain percentage of your income to contribute to the plan.

For instance, if your employer offers a 401(k) plan, you can decide how much of your income you want to contribute to that 401(k). Contributions are tax-free, and are made during each pay period.

In addition, many employers also match employee contributions up to a certain percentage. If your employer matches 3 percent of your contributions, it is in your best interest to contribute at least that much to take advantage of the full employer contribution.