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What Is a Qualified Retirement Plan?

The Federal government has outlined what are referred to as “Qualified” plans, meaning they are earmarked for retirement. Everyone has access to a Traditional IRA, most people have access to a Roth IRA, and depending on who you work for, you may have access to a 401(k), a 403(b), or a 457. We will touch on each of those options in a future post.

But what happens if you don’t work for anyone and you feel like you’ve lost out on potential tax savings because of the low contribution limits on IRAs? After all, the contribution limit for employer-sponsored plans for most people is $18,500 annually and the contribution limit for Traditional and Roth IRAs is $5,500 annually for most people.

If you are self-employed, IRS publications outline different options for you. There are a few easy to implement and cheaper options in the form of a SEP plan and a SIMPLE plan.

We will go over the specifics of each of these plans in future updates, but here we will specifically be discussing what these plans all have in common.

These plans are all meant for retirement and are often implemented by financial institutions such as banks, insurance companies, or brokerage firms.

When Can I Draw Money Out of the Accounts?

All of the accounts have a stipulation that you cannot begin drawing money out in the form of distributions until age 59 ½. If you are to take money out early, you will incur not only normal income tax payments but also a 10% penalty on the money that is withdrawn.

Why Would I Put Money Into One of These Plans?

Qualified plans are tax-favored, meaning that the money put in is either exempt from tax when it is contributed into the plan or distributed from it, but not both. Traditional plans provide for tax savings upfront, but are tax-deferred, meaning they are taxed as ordinary income when distributed.

Roth plans are taxed upfront in the year contributed, however they allow for tax-free growth.

So Should I Save Into Roth Plans or Traditional Plans?

It may depend on what is available to you and what strategy you are pursuing. Employer-sponsored plans allow for greater contribution rates but it may be harder to find an employer that sponsors a Roth 401(k), 403(b), or 457.

Because of this, you may want to pursue a mixed strategy where you save into a Roth IRA outside of your employer and then save into a pre-tax account with your employer.

Why Would I Save Into One Plan Over the Other?

If you believe you will be in a lower tax bracket when you retire, then it will be wisest to put money into a pre-tax account where you get the tax break upfront when your tax bracket is higher.

If you think your tax bracket will be higher when you retire, you will be better off saving into Roth plans where you can get the growth of your contributions tax free when you would otherwise have to pay more on earned income.

 


This article does not constitute financial advice. For information regarding your specific situation, please consult your local financial advisor.

By Foxx Financial

We are focused on financial literacy and a want to help others grow assets, reduce and remove debt, or just understand financial concepts better.

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One reply on “What Is a Qualified Retirement Plan?”

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