QRPs are an integral part of retirement savings. Employers receive tax breaks for contributions they make for their employees, and in some cases, employees can defer part of their salaries to make contributions, which reduces their taxable income as well.
According to Investopedia, a qualified retirement plan meets the requirements of Internal Revenue Code Section 401(a) of the Internal Revenue Service (IRS) and is thus eligible to receive certain tax benefits. An employer establishes such a retirement plan on behalf of and for the benefit of the company’s employees. It is one tool that can help employers attract and retain good employees.
Tax considerations are important. Employees usually earn higher incomes before they retire. Tax rates are also lower when they retire and begin taking withdrawals, so their contributions are taxed in a lower bracket.
Withdrawals begin at retirement age, if an employee becomes disabled or when the plan is terminated. Taking contributions out of a retirement plan before retirement age can often result in tax penalties.
Now let’s go in-depth and learn a bit more about QRPs and how they can benefit you!
Understanding Qualified Retirement Plans
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There are 2 types of QRP: defined benefit and defined contribution.
Defined benefit plans
It gives employees a guaranteed payout and places the risk on the employer to save and invest properly to meet plan liabilities.
In simpler terms, a defined benefit plan is funded and managed by a company for its employees. Employees receive a guaranteed payout when they retire or begin taking withdrawals. Pensions are a good example, although fewer and fewer firms are offering them.
Defined contribution plans
These are more prevalent today. They are funded by a portion of the employee salaries, and many employers match these contributions. Payouts depend on the investment performance, but again, employee contributions reduce taxable income.
Under defined contribution plans, the amount employees receive in retirement depends on how well they save and earn through investment on their behalf during their working years. The employee bears all the investment and longevity risks and is expected to be a financially savvy saver. A 401(k) is the most popular example of a defined contribution plan.
Investing with Qualified Retirement Plans
Qualified plans only allow certain types of investments, which vary by plan but typically include:
- Publicly traded securities
- Real Estate
- Mutual funds
- Money market funds
Increasingly, alternative investments like hedge funds and private equity are being considered for defined contribution plans. Some are already available, packaged into target-date funds.
Retirement plans also specify when distributions can be made, typically when the employee reaches the plan’s defined retirement age, when the employee becomes disabled, when the plan is terminated and not replaced by another qualified plan, or when the employee dies (in which case the beneficiary receives the distributions).
QRPs and Taxes
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Qualified retirement plans give employers a tax break for the contributions they make for their employees. Those plans that allow employees to defer a portion of their salaries into the plan can also reduce employees’ present income-tax liability by reducing taxable income.
Workers may take distributions from qualified plans before retirement age or before one of the other triggering events occurs, but the distributions will be subject to taxes and penalties that often make it unwise to take an early distribution.
Some plans also allow employees to borrow from the plan under strict rules about how the loan is repaid. For example, plan rules may require that the loan be repaid within a certain number of years, that the worker pays interest (which goes back into the plan) on the loan, and that the loan is repaid immediately if the employee leaves the job to which the qualified retirement plan is tied.
The Bottom Line
QRPs are a great alternative to Self-Directed IRAs and 401(k)s, given that some of the most powerful tax strategies exist within the aforementioned section of the tax code, which covers many types of tax-sheltered QRP plans.
For those that qualify, a QRP offers significant benefits above the self-directed IRA, some of them are:
- You don’t need a custodian from a financial institution for a QRP like a self-directed IRA does.
- You can take personal loans from the plan, of up to $50,000 – to be used for any purpose.
- Prohibited transactions do not disqualify a QRP.- It has its consequences, of course, but they’re not nearly as harsh as what you might get from a self-directed IRA.
It’s important to note that A QRP can only be sponsored or created by an employer for the exclusive benefit of his employees or by a self-employed individual, otherwise, it won’t provide any tax benefits.
There are some caveats of course. A QRP — especially one that’s required to cover non-owner employees of a business — is very complex and costly to run. The IRS and DOL compliance requirements are incredibly elaborate, and if those rules are not followed it gets 10x more costly.
For that reason, our friends over at eQRP Co have written the QRP Book that can help you learn to navigate the nuances of the tax code and also protect your investments. The QRP Book will also help you get full control of your 401(k) & IRA money and avoid the IRA Tax on Real Estate Investments like multifamily and residential assisted living properties!
Order a FREE copy of the QRP book by clicking here
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