Workplace retirement plans can be either qualified or non-qualified. A plan is considered qualified when it meets requirements under the Employee Retirement Income Security Act (ERISA), a federal law discussed below. ERISA generally governs qualified plans offered by non-governmental (private) organizations. Qualified plans are eligible for substantial tax benefits for both the employer and the employee.
Most qualified retirement plans allow pre-tax contributions. Normally, every dollar you earn at work is taxable, and higher income generally means higher taxes. Pre-tax contributions reduce the income you report for tax purposes.
For example, assume you earn $100,000 and that income is subject to taxes. If you contribute $5,000 to your employer’s qualified retirement plan, you’re taxed on $95,000 of income for the year. Many qualified plans also allow payroll deductions to be deposited directly into the retirement account before taxes are applied*. The more you contribute pre-tax, the less taxable income you report. However, those retirement plan assets are generally taxable when they’re distributed later in retirement.
*Not all qualified plans offer pre-tax contributions. Roth 401(k)s are a good example. We’ll learn more about these accounts later in this unit.
Qualified plans are popular because of their tax benefits. Employers often offer them to stay competitive when attracting and retaining employees. To offer a qualified plan, an organization must follow specific rules - most importantly, it must comply with ERISA. ERISA is designed to protect employee retirement assets from employer misconduct or mismanagement. Qualified plans must meet ERISA standards, including the following:
Minimum participation/non-discrimination
Must offer the plan to all full-time employees
Cannot offer the plan to executives only (this would be discrimination)
To be considered full-time, an employee must be:
Age 21 or older
Working 1,000 hours+ annually
Reporting and disclosure
Details of retirement plan available in writing
Employees provided annual updates
Funding
Defined benefit plans (discussed below) must be funded appropriately
Vesting
Employees must earn employer-provided benefits in a reasonable amount of time
Typically five years or less
For example, employer-matched contributions*
Employee contributions are always 100% vested
*Some employers match employee contributions as a workplace benefit. For example, a company offers to match 100% of employee contributions, up to 5% of their salary. If an employee saves 5% of their salary, the employer matches the contribution (allowing the employee to effectively save 10% of their salary). Employers usually apply vesting periods of five years or less, which means an employee quitting their position within the vesting period loses part or all of the employer match.
Every qualified plan is governed by a plan document, which must be created before the plan is offered to employees. The plan document spells out the plan’s rules, including:
If you’re interested, here’s a link to a boilerplate plan document. Knowing the minor details of a plan document is unnecessary, but viewing an example may help build real world context.
A fiduciary administers the qualified plan according to the rules in the plan document. The Internal Revenue Service (IRS) defines a fiduciary as:
“A person who owes a duty of care and trust to another and must act primarily for the benefit of the other in a particular activity.”
The fiduciary’s role is to make sure the plan operates as the plan document describes. The fiduciary’s primary responsibility is to the plan participants (employees who have access to the plan), and the fiduciary must put participants’ interests ahead of the employer’s interests. Several entities can serve as the fiduciary, including employees of the organization (often an executive or board member) or unaffiliated third parties.
After the plan document is created and a fiduciary is appointed, the organization must submit the plan documents in writing to the IRS for approval. Once approved, the qualified plan may be offered to employees.
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