Definition
The term qualified plan is often used to describe employer sponsored retirement plans that meet the Internal Revenue's requirements in terms of both plan structure and operation. These requirements must be met in order for the plan to qualify for favorable tax treatment.
Explanation
Qualified plans must meet the requirements of both the IRS as well as the Employee Retirement Income Security Act of 1974 (ERISA). These qualifications were put in place to ensure the employees participating in the plan actually receive the pension benefits promised by their employer. Examples of qualified retirement plans include SIMPLE IRAs, 401k plans, Keoghs and SEP IRAs. Nonqualified plans include 457f and Supplemental Executive Retirement Plans.
Qualified plans must maintain sufficient funds, offer single and joint and survivor annuities, and once vested, the retirement benefit cannot be lost. Qualified plans typically fall into one of two categories:
Defined Contribution Plans: Employees and employers are permitted to contribute funds into a defined contribution plan. Employer contributions are usually formula based, meaning employers will guarantee contributions to an employee's retirement fund.
Defined Benefits Plans: provides employees with a predetermined benefit in retirement. That benefit is normally calculated using a combination of the employee's salary and years of service. This type of calculation is commonly used, and is known as a final average pay (FAP) plan.
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