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Retirement Plan FAQ
by Nolo.com
From the Nolo.com Retirement & Elder Care Center
Quick answers to common questions about retirement plans.
What's Below:
What is a qualified retirement plan?
A qualified plan is simply one that is described in Section
401(a) of the Tax Code. The most common types of qualified plans are
profit sharing plans (including 401(k) plans), defined benefit plans
and money purchase pension plans. In general, your contributions are
not taxed until you withdraw money from the plan. In addition, and
any qualified contributions made on your behalf by your employer are
tax deductible. Most retirement plans that you obtain through your
job are qualified plans.
Why are 401(k) plans so popular?
401(k) plans are popular with employers because they are less
expensive than other types of retirement plans. Contributions
constitute the biggest expense for an employer. But in the case of a
401(k) plan, the bulk of the contribution is typically made by the
employee -- through salary reductions. The employee diverts into the
plan a portion of the salary he or she would otherwise receive in
cash.
401(k) plans are popular with employees because the plan allows
them to save for retirement while simultaneously reducing their
current income tax bill. Employees don't pay income tax on salary
deferrals until the money comes out of the 401(k) plan, some time in
the future. Also, employers usually allow employees to change the
amount of salary deferred into the plan as the employees'
circumstances change. Furthermore, employees are often permitted to
make their own investment decisions, and are frequently given access
to their retirement funds through loans or hardship
withdrawals.
For more information about how 401(k) plans work, see Types of
Retirement Plans.
What is a Keogh plan?
A Keogh plan is a qualified plan for self-employed individuals.
The term Keogh is not a tax term, and you won't find any reference
to it in the Tax Code. It's just a bit of retirement planning jargon
that refers to the special restrictions placed on qualified plans
when they are established by self-employed individuals. Two of the
most onerous restrictions are the following:
- Contributions to retirement plans are often determined by
taking a percentage of compensation, but compensation for
self-employed individuals is defined differently than it is for
employees of corporations. The revised definition often produces a
lower contribution limit for a Keogh.
- A self-employed individual can never borrow from a Keogh,
whereas it is common for employees to borrow from their corporate
retirement plans.
What does it mean to be "vested" in my retirement plan?
If you are vested in your retirement plan, you can take it with
you when you leave the company. If you are 50% vested, you can take
50% of it with you when you go. In the case of a 401(k) plan, you
are always 100% vested in the salary you defer into the plan.
Is an IRA a retirement plan?
An IRA or Individual Retirement Account is indeed a retirement
plan. However, it's not a qualified plan. Instead, IRAs are
described in Section 408 of the Tax Code and have their own set of
rules. One significant difference between qualified plans and IRAs
is that qualified plans are established by businesses while certain
types of IRAs -- traditional or Roth IRAs -- are established by
individuals. For this reason, you can always have a traditional or
Roth IRA even if you are covered by a qualified plan.
Other types of IRAs, known as SEPs and SIMPLE IRAs, are for
businesses and must be established by an employer. For example, the
employer might be a corporation, a sole proprietor or a partnership.
SEPs and SIMPLE IRAs permit larger tax deductions than do
traditional or Roth IRAs.
I work for a company and also have a small business of my own.
Can I set up a retirement plan for my business even if I'm covered
by a plan at work?
Generally, yes. The restrictions on contributions you can make to
a retirement plan are applied to each employer separately. If you
work for a company, the company is an employer. If you are
self-employed, you are a separate employer, and can have a separate
retirement plan for your business. But be careful. If both you and
your employer establish some type of salary reduction plan, you
might run up against an overall limit on contributions.
The most common types of salary reduction plans are 401(k) plans,
tax-deferred annuity or 403(b) plans (these generally cover
university professors and public school teachers), and 457 plans
(sponsored by state and local governments and other tax-exempt
organizations). A SIMPLE IRA is also a salary reduction plan.
Although the amount of your salary or compensation you can defer
into each of these plans is limited, the law also puts a limit on
the total amount you can defer into all such plans, if you happen to
be covered by more than one. The overall limit depends on the type
of plan you participate in.
Is my retirement plan protected from creditors?
Most employer plans are safe from creditors, thanks to the
Employee Retirement Income Security Act of 1974, commonly known as
ERISA. ERISA requires all plans under its purview (generally,
qualified plans) to include provisions that prohibit the assignment
of plan assets to a creditor. The U.S. Supreme Court has also ruled
that ERISA plans are even protected from creditors when you are in
bankruptcy.
Unfortunately, Keogh plans that cover only you -- or you and your
partners, but not employees -- are not governed or protected by
ERISA. Neither are IRAs, whether traditional, Roth, SEP or
SIMPLE.
But even though IRAs are not automatically protected from
creditors under federal law, many states have put safeguards in
place that specifically protect IRA assets from creditors' claims,
whether or not you are in bankruptcy. Also, some state laws contain
protective language that is broad enough to protect
single-participant Keoghs, as well.
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