Basic Types of Plans
There are two major categories of pension plans: qualified plans and nonqualified plans.
Qualified plans meet the requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code and qualify for four significant tax benefits.
- The income generated by the plan assets is not subject to income tax, because the income is earned and managed within the framework of a tax-exempt trust.
- An employer is entitled to a current tax deduction for contributions to the plan.
- The plan participants (the employees or their beneficiaries) do not have to pay income tax on the amounts contributed on their behalf until the year the funds are distributed to them by the employer.
- Under the right circumstances, beneficiaries of qualified plan distributions are afforded special tax treatment.
Nonqualified plans are those not meeting the ERISA guidelines and the requirement of the Internal Revenue Code. They cannot avail themselves of the preferential tax treatment. Nonqualified plans are usually designed to provide deferred compensation exclusively for one or more executives.
Retirement plans are also divisible into the following broad categories:
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