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What does the term "qualified plan" mean?

A qualified plan is an employer-sponsored retirement plan that qualifies for special tax treatment under Section 401(a) of the Internal Revenue Code.

There are many different types of qualified plans, but they all fall into two categories. A defined benefit plan (e.g., a traditional pension plan) is funded solely by employer contributions and provides you with a specified level of retirement benefits. A defined contribution plan (e.g., a profit-sharing or 401(k) plan) is funded by employer and/or employee contributions. The benefits you receive from the plan depend on investment performance.

The annual contribution limits and other rules vary among specific types of plans. However, most qualified plans share certain key features, including:

• Pretax contributions: Contributions to a qualified plan (both employer and employee) are made on a pretax basis (in 2006, employers can also allow employees to make after-tax "Roth" contributions to a 401(k) plan). You don't pay income tax on amounts contributed until you withdraw money from the plan.
• Tax-deferred growth: Investment earnings (e.g., dividends and interest) on all contributions grow tax deferred. Again, you don't pay income tax on those earnings until you withdraw money from the plan.
• Vesting: If the plan provides for employer contributions, those amounts (and related investment earnings) must vest before you're entitled to them. Check with your employer to find out when this happens.
• Creditor protection: In most cases, your creditors cannot reach your qualified retirement plan funds to satisfy your debts.

If you have access to a qualified retirement plan, strongly consider taking advantage of it. Over time, these plans can provide you with substantial retirement savings.

Copyright © 2006 Forefield Inc. All rights reserved.

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