You may have been told that there are advantages to a qualified versus non-qualified 401(k) Plan. However, you may never have researched what the difference was? It is actually a very important distinction to 401(k) Plans and was created by the Employee Retirement Income Security Act (ERISA). This Act was enacted in 1974 to provide protection to workers’ benefits including their retirement accounts. Certain plans are deemed to be “qualified” such as 401(k) and 403(b) plans. Other plans such as deferred compensation plans are deemed to be non-qualified.
What’s the difference and why is this important?
Qualified plans must meet specific ERISA requirements. Requirements in the areas of:
- Benefit accrual,
- Funding and providing plan information to participants is all covered under the ERISA guidelines.
The Plans that are qualified, allow participants to defer compensation into these plans with the taxes on that income deferred. Also, the income that the investments held by the participants of the Plan also accrue tax-free until the amounts are withdrawn by the participant. This allows the accounts to grow more quickly and allow for participants to accumulate enough in their overall account to help with their retirement expenses when it is anticipated their tax load will be smaller. In addition, any contributions made by the employer into a qualified plan can be deducted from their tax returns.
What makes a plan qualified?
- There are specified disclosure requirements that all qualified plans must follow.
- A specified portion of the employee base must be covered by the Plan.
- All employees that meet the eligibility requirements of the Plan must be allowed to participate. Employees may choose not to participate but they must be given the option.
- Benefits under the Plan must be proportionately equal in assignments to all participants. This is designed to prevent the Plan from benefiting higher-paid employees more than others.
- After a specified period of employment, a participants’ right to full benefits must be non-forfeitable. This means that they are entitled to the full benefit once they have worked the specified period of time. This is true even if the employee terminates employment after the vesting date is reached.
- Participant accounts under these arrangements are owned by the employee. They are separate and distinct from employer accounts. The employer is not allowed to include them in their financial statements or claim ownership of the amounts in participant accounts for any financial purpose.
Note that qualified plans have tax restrictions and other regulations that must be followed to remain qualified. We recommend you consult with your tax advisor, 401(k) service provider, or Plan auditor for more information on these specific requirements.
At Summit CPA we specialize in retirement plan audits. If you would like to discuss our audit process in more detail or need an audit contact our office at (866) 497-9761 to schedule an appointment. We can help you navigate the world of the 401(k) audit as proficiently as possible. We also offer off-site assistance and flat-fee pricing so there are no surprises when the job is complete.