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. 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. And employers usually allow employees to change the amount of salary deferred into the plan as the employees' circumstances change. Also, employees are often permitted to make their own investment decisions, and are frequently given access to their retirement funds through loans or hardship withdrawals.

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.

The most onerous restriction is 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.

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