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A qualified retirement plan is a sort of employer-sponsored retirement strategy that complies with particular criteria established by the Internal Revenue Service (IRS). These programs give tax advantages to both the business and the employee in an effort to encourage employees to save money for retirement.
Defining Benefit Plans and Defined Contribution Plans Defined Benefit plans are the two basic categories of qualifying retirement plans. Employees who participate in defined benefit plans, commonly referred to as pension plans, receive a particular benefit upon retirement. This benefit is determined by a formula that typically takes into account variables including years of service and income history. Employees can contribute a percentage of their pay to a retirement account under defined contribution plans like 401(k), which also often include employer contributions that are matched.
Tax advantages offered by qualified retirement plans include tax-deferred growth of contributions and tax-deductible employer contributions. These plans allow for pre-tax contributions, which can lessen an employee's taxable income and current tax liability. Also, unless they are withdrawn after retirement, contributions and earnings in the plan are not taxed.
These plans must adhere to a number of IRS criteria, including nondiscrimination testing to make sure the plan does not disproportionately benefit highly compensated employees, in order to keep their eligible status. Employers who sponsor eligible retirement plans also have fiduciary obligations to make sure the plan is run in the participants' best interests.
