One of the foundational concepts in the institutional retirement plan industry (employer plans) is the difference between a qualified and non-qualified plan. When pulling together my thoughts to prepare for this post, I had my personal understanding and how I had planned on articulating this topic but wanted to see what else was out there and how others were talking about it...so I went out and read a few things.
What I found interesting is that the few sites I visited explained this distinction solely or at least primarily by speaking to the tax deferred (pre-tax) aspect of qualified plans contrasting that with non-qualified plans being after-tax. While the tax status is certainly accurate and one of, if not, the most talked about benefit of a qualified plan, that didn’t actually cross my mind first. I also want to point out that there can be tax advantaged non-qualified plans so even though a defining characteristic of a qualified plan relates to tax, that isn’t to say it’s the differentiating characteristic in every case.
You see, the way I look at a qualified plan and why it’s such a benefit is that it’s protected by ERISA (Employee Retirement Income Security Act) which does in fact afford those participating in the plan with said tax deferment, however, the overarching theme in much of the education I’ve received is that it really revolves around the security of ERISA protecting those individuals as well as their beneficiaries.
In order to be qualified, there are standards in place, outlined as part of ERISA and as long as those requirements are met, all of those tax benefits are able to be taken advantage of by the plan sponsor and participants. The call out I'd like to make (and why my contention is that qualified really means protected by ERISA) is that all of these requirements, which anyone in the industry will attest are tedious, are in place to ensure participants are being treated fairly, the plan is designed to assist in protecting those benefits, and there is a responsible party (i.e. the fiduciary) who is constantly acting in the best interest of all plan participants and their beneficiaries.
While each individual plan sponsor should consult with a professional on their individual plan and the specific requirements, some of the major actions that need to be taken in order to maintain a qualified status include:
Nondiscrimination testing (ACP/ADP Testing)
Providing appropriate disclosures timely and handling appropriate IRS reporting
Operating the plan in alignment with plan documents (also assuming the plan docs align with the IRC)
Top heavy requirements
Minimum vesting requirements
While I’d love to go into detail on any of these specific requirements (or on the total list of requirements), that is out of scope for this post as an introduction to a “qualified plan.”
Some of the benefits of being part of a qualified plan as either the plan sponsor (employer) or the participant (employee) of the plan include:
Plan sponsor (as an individual person) has a place he/she can put their money for their own individual retirement so he/she is able to reap benefits by being a participant as well
Plan sponsors get some deductions for their business/organization based on the amount of assets that are actually in the retirement plan for that taxable year
Plan sponsors also get some tax exemptions on gains that accrue in their retirement plan
Participants get tax deferment (pre-tax) contributions going into their plan, making their taxable income each year less and allowing them to pay taxes when they transition to retirement (the thought process there is that individuals will be in a lower tax bracket so even if they are being taxed at distribution, it would be a lesser amount than today)
Well…this is a lot to absorb so I’ll leave it at this. Some great articles and books; some of which I’ve used and browsed over the last few days and some for years include:
The Pension Answer Book by Stephen Krass
http://scholarship.law.georgetown.edu/legal/50 “A Timeline of the Evolution of Retirement in the United States”
“History of 401(k) Plans: An Update” published by the Employee Benefit Research Institute (a little outdated since it was printed in 2005 before the PPA, however still a great read on 401(k) history
IRS.gov (while very dry since it’s literally the IRC, it definitely has the most up to date requirements and information on what’s required)