Retirement plans are really nothing more that formal contracts to provide retirement benefits. Some plans you can set up by yourself. Others plans may be sponsored by your employer.

A "qualified" retirement plan is one that complies with applicable law so that taxes are deferred on contributions and earnings thereon until withdrawn. The federal law that governs such plans is the Employee Retirement Income Security Act (ERISA). ERISA establishes non-discrimination rules and other safeguards to protect employee benefits.

While not legally obligated to do so, employers may establish retirement plans to attract prospective employees and to keep current employees. Employers have an incentive to set up "qualified" plans because they get tax benefits in the process. They are also protected from some lawsuits. ERISA-covered plans are not subject to state regulation.

It is also possible to set up "non-qualified" plans, which means that they do not qualify for the same tax benefits. When employers establish such plans, they are usually for highly compensated executives.

ERISA Requirements

In order for a pension plan to be considered as an ERISA pension plan, the plan must either:

• Provide retirement income or
• Result in a deferral of income to termination of covered employment or beyond

Other requirements include:

• The plan must be established or maintained by an employer, an employee organization, or by both
• The plan must include at least one common-law employee
• The plan be established or maintained by an employer or an employee organization which is involved in interstate commerce

ERISA also covers welfare plans, such as health care, severance pay and life insurance. However, welfare plans are different from pension plans because they provide different kinds of benefits.

Examples of "Qualified" Retirement Plans

Popular "qualified" plans include:

401(k) Plans
A 401(k) plan is a type of deferred compensation plan. You may annually contribute roughly $15,500 of your earnings if you are age 49 and below and $20,500 if you are age 50 and above. Your employer may match a percentage of what you contribute. You are not taxed on contributions until you receive distributions. There can be stiff penalties for withdrawals before age of 59-1/2. A great incentive to participate is that contributions can grow and accumulate until withdrawal, all on a pre-tax basis.

Profit Sharing Plans
A profit sharing plan allows an employer to supplement other retirement benefits by letting employees share in profits. Contributions are at the discretion of the employer. If contributions are made, however, they must be on a non-discriminatory basis. Usually, an employer makes contributions based on a percentage of total annual pay roll.

IRA
An individual retirement account (IRA) is basically a savings or investment account for the employee. Contributions are made pre-tax and contributions and subsequent earnings are not taxed until they are withdrawn. IRAs that are provided in connection with another plan, such as a Roth 401k or a Simplified Employee Pension plan, are covered by ERISA. IRAs are not considered ERISA pension plans where:

• No contributions are made by the employer or employee organization
• Participation in the program is completely voluntary
• The sole functions of the employer or employee organization is, without endorsing the program, to permit the sponsor to publicize its plan to employees or members and collect contributions though payroll deductions or dues check-offs, and
• The employer or employee organization receives no compensation other than expense reimbursement for its payroll deductions or dues check offs

Pension Plans

The two basic qualified pension plans are:

• Defined benefit plans, which provide retirement benefits where the employer promises retirees a pension in a specific amount, with the benefit set by a formula based on years of service X final average salary X a percentage figure.
• The employer must contribute to the plan on a regular basis so that sufficient funds are available to pay required benefits to all retired employees as they come due. The employer bears the risk of having sufficient funds to pay the pensions.
• Defined contribution plans, which require employer to contribute specific amounts to their plans. Employees are also typically required to make contributions. Each employee has an account, and has available at retirement the amount of money that is then in this account. The employee bears the investment risk.

Examples of "Non-Qualified" Retirement Plans

The types of non-qualified plans are unlimited. They can be as simple as making a contract with yourself to contribute to a savings account each month, or they can be as complicated as deferred compensation arrangements that are funded by insurance.

A deferred compensation plan funded by insurance is probably the most popular "non-qualified" plan. It involves an employer's agreement to pay compensation to a key employee in the future if certain conditions are met (for example, working continuously for the company until retirement). The goal is for the employee not to be taxed on the compensation until it is paid. A common approach is to fund the plan with insurance benefits, the premiums for which may or may not be tax deductible to the employer.

Questions for Your Attorney

• What incentives does my employer have to provide an ERISA pension plan?
• What is a 401(k) plan?
• What kinds of IRAs are covered by ERISA?

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Web Resources

- Department of Labor - ERISA