Is a Roth IRA a Qualified Retirement Plan?

The Roth IRA stands out among other types of retirement accounts due to its unique tax advantages and withdrawal rules. But is a Roth IRA a qualified retirement plan? While Roth IRAs offer significant benefits and are regulated by the IRS, they do not meet the technical definition of a qualified retirement plan, such as 401(k)s and traditional pensions, which adhere to specific criteria under the IRS code and ERISA guidelines. Consider working with a financial advisor if you need help understanding the tax benefits and requirements of different retirement plans.

What Is a Qualified Retirement Plan?

A qualified retirement plan is an employer-sponsored retirement savings plan that offers tax advantages to both employers and employees. These plans are designed to encourage individuals to save for their retirement while providing them with certain tax benefits.

Contributions made to qualified retirement plans are typically tax-deductible for the employer and are not taxed as income for the employee until withdrawn, allowing for tax-deferred growth of investments within the plan. 

For example, if an employee contributes $5,000 to their qualified retirement plan, that amount will not be subject to income tax in the year it is contributed, and the investment earnings will grow tax-free until the funds are withdrawn in retirement. This tax-advantaged status makes qualified retirement plans an attractive option for both employers looking to provide valuable benefits to their employees and for individuals seeking to save for their future.

To be considered qualified, a retirement plan must meet specific criteria set forth by the Internal Revenue Service (IRS):

1. The plan must be established and maintained by an employer, ensuring that it is a formal, structured savings vehicle.
2. The plan must comply with non-discrimination rules, which are designed to ensure fair treatment of all employees, regardless of their income level or position within the company.
3. The plan must adhere to specific contribution limits set by the IRS, which may vary depending on the type of plan and the employee’s age.
4. The plan must follow required minimum distribution rules, which dictate when participants must begin withdrawing funds from their accounts once they reach a certain age.

Types of Qualified Retirement Plans 

Qualified retirement plans can be broadly categorized into two main types: defined benefit plans and defined contribution plans. 

Defined benefit plans, such as traditional pensions, guarantee a predetermined retirement benefit based on a formula that considers factors like the employee’s salary and length of service. So in a company like General Motors, which historically offered a defined benefit plan, employees received a fixed monthly pension payment in retirement based on their years of service and average salary. The employer is responsible for ensuring that the plan is adequately funded to provide the promised benefits. 

In contrast, defined contribution plans allow employees and/or employers to contribute funds to individual investment accounts. A well-known example of a defined contribution plan is the 401(k) plan offered by many companies, where employees can choose to contribute a portion of their salary and invest in a selection of mutual funds or other investment options. 

The final retirement benefit in a defined contribution plan depends on the performance of the invested assets over time, with the employee bearing the investment risk. 

Defined contribution plans include: 

Roth IRAs vs. Qualified Retirement Plans

While both Roth IRAs and qualified retirement plans both help people save for retirement, they differ significantly in structure, contribution limits and tax implications. Roth IRAs, unlike qualified plans, are not sponsored by employers but are established by individuals. They offer post-tax contributions, which means the contributions are made with after-tax dollars, and withdrawals can typically be made tax-free in retirement.

Tax Treatment

The primary difference lies in the tax treatment of contributions and distributions. Qualified plans often allow for pre-tax contributions, which reduce taxable income during the years of contribution. The distributions are then taxed as ordinary income upon withdrawal. 

In contrast, Roth IRAs offer no tax break on contributions but offer tax-free growth and tax-free withdrawals in retirement, provided certain conditions are met.

Since Roth IRAs are funded with money that’s already been taxed, they are not subject to required minimum distributions (RMDs) – mandatory withdrawals that must be made from tax-deferred accounts starting at age 73 (75 for people turning 74 after Dec. 31, 2032). 

Contribution Limits

Roth IRAs and qualified retirement plans also differ in contribution limits. For 2024, Roth IRAs have a contribution limit of $7,000 per year ($8,000 if you’re age 50 or older), while qualified plans like 401(k)s have a much higher limit of $23,000 ($30,500 if you’re 50 or older).

Eligibility

Eligibility for Roth IRAs is determined by income limits, while eligibility for qualified plans is determined by the employer. This means that not everyone may have access to both options, and it’s essential to understand which plans are available based on individual circumstances.

In 2024, Roth IRA contributions are subject to the following limits: