The rules governing qualified retirement plans have several significant consequences for both employers and employees. Here are some examples:
- Tax Benefits and Penalties:
- Tax Deductibility: Contributions to qualified retirement plans are tax-deductible for employers, which can reduce their taxable income.
- Tax Deferral for Employees: Employees are not taxed on contributions to the plan until distributions are made, allowing the funds to grow tax-free within the trust.
- Early Distribution Penalty: If a taxpayer receives an amount from a qualified retirement plan before reaching age 59½, a 10% additional tax is imposed on the distribution unless an exception applies (e.g., distributions made after separation from service after age 55, or for certain medical expenses).
- Plan Qualification Requirements:
- Exclusive Benefit Rule: A trust forming part of a stock bonus, pension, or profit-sharing plan must be for the exclusive benefit of employees or their beneficiaries to be considered a qualified trust.
- Joint and Survivor Annuity Requirements: For certain plans, benefits must be provided in the form of a qualified joint and survivor annuity or a qualified preretirement survivor annuity to the surviving spouse, unless specific exceptions apply.
- Plan Disqualification:
- Consequences of Disqualification: If a plan fails to meet qualification requirements, it can result in substantial tax deficiencies, penalties, and interest for the employer, plan participants, and the trust. The IRS has established the Employee Plans Compliance Resolution System (EPCRS) to allow plan sponsors to correct defects and avoid disqualification.
- Transfers and Rollovers:
- Non-Taxable Transfers: Transfers between defined contribution plans and defined benefit plans, or rollovers to IRAs, are generally not taxable events. These transfers do not result in constructive receipt or additional taxes under sections 72(t), 401(k), or 402.
- Rollover Contributions: Contributions rolled over from one qualified plan to another or to an IRA are not included in gross income and can continue to grow tax-deferred.
- Special Rules for Certain Plans:
- Top-Heavy Plans: Plans that are top-heavy must meet additional requirements under section 416 to remain qualified.
- Employee Stock Ownership Plans (ESOPs): Certain benefits under ESOPs are exempt from the joint and survivor annuity requirements, provided specific conditions are met.
- Mandatory Contributions:
- Pick-Up Contributions: Mandatory employee contributions to a plan that are picked up by the employer are treated as employer contributions and are not included in the employee's gross income until distributed.
- Exceptions to Early Distribution Penalty:
- Qualified Birth or Adoption Distributions (QBA): Distributions following the birth or adoption of a child are exempt from the 10% early distribution penalty, subject to certain conditions and limits.
These rules and their consequences are designed to encourage retirement savings, ensure the proper administration of retirement plans, and provide tax benefits while imposing penalties to discourage early withdrawals and non-compliance.
Sources:
Qualified Plan Disqualification and IRA Prohibited Transactions
Birth or Adoption Exception to the Early Retirement Distribution Penalty
PLR 202304001
PLR 201349029
PLR 201527041
§ 72. Annuities; certain proceeds of endowment and life insurance contracts
§ 401. Qualified pension, profit-sharing, and stock bonus plans
