Is a 401K a 'Qualified' Retirement Plan?

August 19th 2022

“Unsuccessful people make decisions based on their current situation; successful people make decisions based on where they want to be.”

Have you been in a conversation about retirement and phrases such as qualified or non-qualified sent you into a spiral of confusion? Or have tax code terms such as 401 K and IRA made you feel uncomfortable to ask a question? 

Let’s face it, we’ve all been there in some way or another.  The fact is there are so many retirement plan types, rules, and regulations that it is hard to keep up.  Let’s start with what is typically the largest retirement asset a person holds during their career, the 401 K.

Qualified vs Non-Qualified

Types of Retirement Plans

Before jumping into the specifics of what a 401 K is or how it works, it is important to understand
the difference between qualified and non-qualified plans. 

For the purposes of this post, a qualified account can be commonly referenced as a retirement account.  There are tax advantages and rules that define and specify what constitutes a qualified account.  

A Few Examples

  • deductions from taxable income
  • tax deferral of contributions
  • employer provided matches (specific to the 401 K)

Non-Qualified accounts have fewer guidelines and conveniently provide flexibility when it comes to contribution limits and  investment options.

But keep in mind, the tax treatment of these plans are different than qualified retirement plans.

To make the topic slightly more complex, high income earners may have several types of non-qualified retirement plans available.

Now to the traditional 401 K.

What is a 401 K?

A 401(k) plan is a retirement savings plan offered by many American employers that has tax advantages for the saver. It is named after a section of the U.S. Internal Revenue Code.

The employee who signs up for a 401(k) agrees to have a portion of their paycheck contributed into a retirement investment account. The employer may match part or all of that contribution. The employee gets to choose among a number of investment options, usually mutual funds and occasionally ETFs (Exchange Traded Funds).

Benefits of a 401 K are:

  • Tax Deferral of Contributions and Investment Growth – Until Money is Withdrawn
  • Contribution Limit for Employees – $20,500 annually
  • Catch-up Contributions – Age 50 or older $6500 annually
  • Distribution Without Penalty – Age 59 ½ or older (other options available)
  • Required Minimum Distributions – Age 72 (IRS wants their money)
  • Creditor Protection – Provide by the Employee Retirement Income Security Act of 1974

Depending on the plan, contributions will be invested into stocks, bonds or mutual fund options. The fund lineup is provided by the plan and the employee has the responsibility of choosing their investments. Typically, the option for advice or service is provided by the employer or plan administrator. They can dictate eligibility requirements for individual participants and vesting rules on employer contributions. 

Additional features including loan options, roth 401 K options, and after-tax contributions are also factors to be considered in the structure of a 401 K plan.

In the event you leave your employer, there are options to rollover your account to a new employer plan or an individual retirement account (IRA).  Keep in mind, a traditional 401 K is one of many qualified retirement plans that can be offered by employers.

Other tax qualified 401 k options examples are simple, safe harbor, and profit sharing 401 K plans. Even self-employed individuals have access to qualified retirement plans such as Simple IRA’s or SEP IRA’s, but these are out of the scope of this specific discussion on 401 K plans.

Individual Qualified Retirement Plans

     There is also much to be said about the importance of individual qualified retirement plans. IRA and Roth IRA accounts are the most common retirement opportunities individuals use outside of workplace retirement savings options. Many of the same IRS rules apply with several exceptions. 

Contributions limits per individual are $6,000 annually with an extra $1,000 catch up contribution if age 50 or older. Roth assets are contributed with funds already taxed and get the huge benefit of no taxation on future growth (certain rules apply). These plans can be opened at
any brokerage firm, or better yet, with your financial planner.

     You are probably thinking “Wow, there is so much to learn about qualified retirement plans.” I’d love to say you’ve now learned everything you need to discuss the intricacies of each plan, but we’ve only scratched the surface. The good news is that you can now confidently jump into that conversation. Dive in and share all that you now know about qualified retirement plans and 401K opportunities. 

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