Most pension plans in the United States are qualified plans. A qualified plan is a retirement plan that meets certain standards set by the Internal Revenue Service (IRS).
To be a qualified plan, a pension must:
- be established by an employer for the exclusive benefit of its employees
- have a written document that sets forth the plan’s provisions
- not discriminate in favor of highly compensated employees
- provide for contributions that are deductible by the employer and/or tax-deferred to the employees
- provide for vesting of benefits
- meet certain minimum coverage and participation requirements
- meet certain funding rules
If a pension plan meets all of the above requirements, it is said to be “qualified” under the Internal Revenue Code and is entitled to certain tax benefits.
The most common type of qualified pension plan is a defined benefit plan. In a defined benefit plan, the employer agrees to provide a certain level of benefits to employees upon retirement. The amount of the benefit is usually based on the employee’s salary and years of service.
Another type of qualified pension plan is a defined contribution plan. In a defined contribution plan, the employer (and sometimes the employee) makes contributions to the plan on behalf of the employees. The employees’ benefits in retirement depend on the investment performance of the contributions made to their individual accounts.
The IRS has set forth certain rules that must be followed in order for a pension plan to qualify for favorable tax treatment. These rules are designed to ensure that pension plans are fair to employees and to prevent abuse by employers.
If a pension plan does not meet the requirements of the Internal Revenue Code, it is said to be “non-qualified.” Non-qualified pension plans do not receive the same tax benefits as qualified plans.
If you are not sure whether your pension plan is qualified, you should check with your employer or the plan administrator.