A qualified retirement plan is an investment plan offered by an employer that qualifies for tax breaks under the Internal Revenue Service (IRS) and ERISA guidelines. Because an individual retirement account (IRA) is not offered by employers, a traditional or Roth IRA is not considered a qualified plan, although they feature many of the same tax benefits for retirement savers.
Two exceptions that may be offered by an employer are SEP IRAs and SIMPLE IRAs. Companies may also offer non-qualified plans to employees that might include deferred compensation plans and executive bonus plans. Because these are not ERISA-compliant, they do not enjoy the tax benefits of qualified plans.
Key Takeaways
- Qualified retirement plans are tax-advantaged retirement accounts offered by employers and must meet IRS requirements.
- Common examples of qualified retirement plans include 401(k)s, 403(b)s, SEPs, and SIMPLE IRAs.
- Traditional IRAs share many of the tax advantages of plans like 401(k)s but are not offered by employers and are not qualified plans.
- IRAs are self-managed, meaning the individual selects the financial institution to house the retirement account and chooses from a range of investment options.
Traditional IRAs
Traditional IRAs are savings plans that allow you the benefit of tax-advantaged growth as investors are commonly allowed a tax write-off, though limited or not permitted, depending on your income and whether you have a qualified retirement plan at work.
Taxes must be paid on distributions, which you are required to start taking at age 73, even if you haven't retired yet. These are called required minimum distributions (RMDs) and the amount is determined by an IRS formula involving your age and your account balance. Beginning in 2033, with the passage of the SECURE Act 2.0, the RMD age increases to 75.
If you withdraw any funds before you turn 59½, you will be subject to a 10% early withdrawal penalty in addition to the usual requirement of paying income tax on the amount you take.
The SECURE Act 2.0 of 2022 expands access to retirement savings beginning in 2024. Participants can access up to $1,000 annually from retirement savings for emergency personal or family expenses without paying the 10% early withdrawal penalties.
There are also limits to how much you can contribute to an IRA each year. In 2024, this limit is increased to $7,000 or $8,000 if you are 50 and older and qualify for the additional catch-up contribution.
IRA plan providers allow holders to designate beneficiaries, and some plan holders allow beneficiaries for multiple generations. Because traditional IRAs allow individuals to invest on a tax-deferred basis, they are suitable for people who are in a high tax bracket but anticipate being in a lower one at retirement.
Roth IRAs
Roth IRAs require that investors pay tax first on contributions and do not allow for a tax write-off. However, the advantage comes when you retire and no tax is assessed on distributions. You are not taxed on any of the money that your income earns over the years it sits in your Roth account. What's more, if you need to take money out of the account, you are not taxed if you take out just the contributions you originally made.
401(k) plans have significantly higher contribution limits than IRAs.
Roth IRAs do not have RMDs or a requirement that you start taking distributions. If you can afford to hold the funds, they can continue to grow tax-free and can be passed to your heirs. The heirs will be required to take distributions, however.
As Roth IRAs allow individuals to invest on a tax-free basis, they are suitable for individuals who are in a low tax bracket but anticipate being in a higher one at retirement. There are income limitations on who is permitted to contribute to a Roth IRA.
Those with higher incomes can only open one by rolling over traditional IRA or 401(k) money, a process called opening a backdoor Roth IRA. If you do this, you will have to pay taxes on deductible contributions and all earnings. One exception: Those who have a Roth 401(k) can roll it over into a Roth IRA without the tax requirement.
Qualified Retirement Plans
Some employers offer defined-contribution or defined-benefit-qualified retirement plans. Defined-contribution plans, such as 401(k)s, have largely replaced defined-benefit plans or pensions as the preferred model.
Employers receive incentives from the U.S. government to create these plans under ERISA rules. Beginning in 2025, the SECURE Act 2.0 requires employers to automatically enroll eligible employees in new 401(k) or 403(b) plans with a participation amount of at least 3% but no more than 10%. The contribution increases to the rate of 1% per year, up to a minimum of 10% and a maximum of 15%.
What Are the Contribution Limits for an IRA?
The annual contribution limit for both a traditional IRA and a Roth IRA in 2024 is $7,000 (or $8,000 for those 50 or older).
What Are the Contribution Limits for a 401(k) Plan?
For 2024, $23,000. If you are 50 or older, you can make a catch-up contribution of $7,500. Beginning after Dec. 31, 2024, the SECURE Act 2.0 substantially increases catch-up limits for 401(k) plan participants aged 60 to 63 to the greater of $10,000 or 150% of the “standard” catch-up amount for that year.
What Is the Difference Between a Qualified and Non-Qualified Retirement Plan?
Qualified retirement plans are offered by employers to their employees and offer tax breaks. Non-qualified retirement plans also offer tax breaks but are not offered to all employees, and do not adhere to the Employee Retirement Income Security Act (ERISA) while qualified retirement plans do.
The Bottom Line
A qualified retirement plan is a retirement plan that is only offered by an employer and qualifies for tax breaks. By its definition, an IRA is not a qualified retirement plan as it is not offered by employers, unlike 401(k)s, which are, making them qualified retirement plans. IRAs, however, do share many of the same features and benefits as qualified retirement plans that individuals can use to save for retirement, either together with qualified retirement plans or on their own.
