Is an IRA a qualified plan?

An IRA is a retirement plan that individuals use to make tax-deferred contributions for their retirement. It lets you pick your preferred investment options from a wide pool comprising stocks, bonds, mutual funds, certificates of deposits, etc. to create a well-diversified portfolio. The IRS sets certain guidelines for retirement plans that classify them into qualified and non-qualified plans.

An IRA is not a qualified plan, but it offers similar tax benefits to those offered by qualified retirement plans. A qualified plan is offered by an employer, and it must meet certain requirements set by the Internal Revenue Code as well as requirements established by the Employee Retirement Income Security Act (ERISA). Therefore, IRAs such as traditional IRA and Roth IRA are not ERISA compliant.

What is a qualified plan?

The IRS provides that a qualified retirement plan must meet Internal Revenue Code guidelines. Section 401(a) of the IRC contains the guidelines that qualified plans must meet. Employers are required to update the plan documents to ensure that plans are operated per the set rules and that plan participants receive the required retirement benefits.

Qualified retirement plans must also satisfy the minimum requirements set by the Employment Retirement Income Security Act of 1974 (ERISA). ERISA covers employer-sponsored plans, and it protects plan participants and their retirement plans. ERISA sets accountability standards for fiduciaries who manage retirement assets; plan sponsors or fiduciaries who do not meet these requirements could face lawsuits or financial implications. Plan sponsors must meet the minimum standards regarding plan participation, funding, vesting, and information transparency to qualify the retirement plans under ERISA.  

Types of Qualified Retirement Plans

Qualified retirement plans fall into two broad categories i.e. defined benefit plans and defined contribution plans.

Defined benefits plans are primarily offered by employers, and they guarantee a fixed stream of income in retirement. These plans are primarily funded by the employer, but some plans may require employees to contribute to the plan. Once an employee retires, they become eligible to receive retirement benefits. The employer uses a formula to determine the employee benefits based on several factors such as age, salary, and years of service, rather than what the employee contributed. Examples of defined benefits plans include pension plans and annuities.

Defined contribution plans are funded through elective salary deferrals. Employers may also make matching contributions, either partially or dollar-for-dollar, but it is not mandatory. The contributions are then allocated to various investments such as stocks, mutual funds, and bonds to earn a return. Examples of defined contribution plans may include 401(k) and Solo 401(k). The amount that an employee receives in retirement depends on their contributions and the performance of their investments.

What is a non-qualified retirement plan?

A non-qualified plan refers to a retirement plan that falls outside the ERISA guidelines, and therefore, is not subject to the discriminatory testing that qualified plans require. Non-qualified retirement plans are designed to meet specialized retirement needs for certain key employees and can be used as an employee retention tool.

Employers may offer non-qualified retirement plans to the top executives to allow them to contribute to another retirement plan after maxing out their qualified retirement plan. They allow highly compensated employees to contribute more than other employees, but they are subject to annual contribution limits to ensure eligible employees do not contribute too much to the disadvantage of the average employee.

Is a traditional IRA a qualified plan?

A traditional IRA plan is not a qualified retirement plan, since it is opened and managed by an individual, and not their employer. However, a traditional IRA offers similar tax advantages to qualified retirement plans like 401(k) and 403(b). You contribute pre-tax dollars to the IRA, and you will only pay taxes when you withdraw money from the account. If you withdraw funds before 59 ½, you could owe income taxes and a 10% penalty tax unless you qualify for an early withdrawal penalty exemption. 

Is a Roth IRA a qualified retirement plan?

A Roth IRA is not a qualified retirement plan and is, therefore, not subject to the requirements of the ERISA rule. A Roth IRA is established by an individual, not an employer, and you can open and manage the account on your own even if your employer offers a qualified retirement plan at work. It provides individuals with an opportunity to contribute post-tax dollars to the account, and make qualified withdrawals tax-free.

IRAs that are ERISA Qualified

Although traditional IRAs and Roth IRAs are not qualified retirement plans, certain IRAs are considered qualified retirement plans.

SEP IRA and SIMPLE IRA are established by employers for the benefit of employees, and they are both ERISA qualified. SEP IRAs are offered by small to mid-sized companies, and they allow employers to contribute to every employee's IRA account as well as the employer’s own IRA account. It is also available to self-employed individuals. Once the employer makes tax-deductible contributions on behalf of the employee, they lose vesting privileges; the contributions vest fully immediately.

On the other hand, a SIMPLE IRA is a retirement plan that businesses with 100 or fewer employees use. This plan allows employers to contribute to employees' IRAs while allowing employees to also contribute to their IRA accounts. The employer's involvement in opening and managing the employee accounts makes SIMPLE IRAs ERISA-qualified.