What is a Qualified Retirement Plan? - Rules & Options

Instructor: Noel Ransom

Noel has taught college Accounting and a host of other related topics and has a dual Master's Degree in Accounting/Finance. She is currently working on her Doctoral Degree.

This lesson includes an overview of qualified retirement plans, including explanations of the two types (defined benefit plan and defined contribution plan), rules, and options regarding withdrawals, and penalties.

Qualified Retirement Plan

Susan starts a new job next week and her human resources office needs her to review the retirement benefits her company offers to new employees. Susan is super excited because she is eager to begin saving for retirement. She learns that her plan has certain rules about how and when she can withdraw money. Because Susan wants to ensure she makes the right choices, she researches how managing this qualified retirement plan will impact her savings strategy.

A qualified retirement plan (QRP) is a type of retirement plan established by a company for employees. When a company establishes a QRP, the company receives tax deductions for their own contributions made on behalf of their employees. Companies offer qualified retirement plans as part of an employee's comprehensive benefits package, which helps attract new employees. The employee benefits because they can make tax-deferred contributions into the retirement plan, which lowers their taxable income.

Types of Qualified Retirement Plans

There are two types of qualified retirement plans, a defined benefit plan and a defined contribution plan.

  • A defined benefit plan is a retirement plan sponsored by the employer where the employee benefits are calculated based on a formula. The defined benefit formula considers an employee's base salary or length of service to the company. It offers a guaranteed retirement payout to the employee. With this type of plan, the employer takes on the risk of the investment and management of the plan. An example of the defined benefit plan is a pension plan.

Say Daniel has been working at a manufacturing firm for over 25 years. He makes $150,000 a year. His company offers a defined benefit plan where they contribute a specific percentage to his plan each month based on a formula calculation. The calculation includes factors such as how long Daniel works at the firm, his age and salary. The longer Daniel works at the firm the higher the contribution amount.

This year Daniel's company contributes 7% to his defined benefit plan, or $10,500. Daniel's company contributes money directly to his plan, and Daniel does not make contributions from his salary. Once Daniel retires, he will receive a statement from his firm stating the guaranteed monthly amount of retirement benefits he will receive for the rest of his life.

  • The second type is the defined contribution plan, where the employee contributes a specific percentage of their income to the plan. An employer can offer an option to match the employee's contributions to the defined contribution plan. The employee is responsible for the investment selections and management of the defined contribution plan. An example of a defined contribution plan is a 401(k) plan.

Say Elisa got a job with a craft retail outlet. She makes $10/hr and works 40 hours a week. Therefore, every month she earns $1600 (before taxes). Her company offers a defined contribution plan, where 3% of that income is taken out before taxes and put into an account. 3% or $48.00 is taken out of her paycheck and put into this account, and the company also puts $48.00 into the account. Then Elisa is only taxed on the remaining $1552 and has $96 in her retirement account.

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