Is a Pension a Qualified Retirement Plan?

Is a Pension a Qualified Retirement Plan?

Posted by Colton Hoisager on Feb 24, 2021


When retirement plans are mentioned, a pension is usually at the top of the list. Pensions were at the height of popularity during the 20th century until the rise of defined-contribution plans in the early 1980s.

To make pensions more secure due to failed pension commitments, the U.S. government enacted the Employee Retirement Income Security Act (ERISA) in 1974 to establish accountability, legal protection, and disclosure requirements. Employer-sponsored plans that are covered under ERISA are referred to as qualified retirement plans. 

We’ll go over pension plans and how they are qualified retirement plans under ERISA requirements. 

What is a Pension Plan?

A traditional pension plan is also considered to be a defined-benefit plan. It’s an employer-sponsored retirement plan funded by the employer where contributions are made to an investment portfolio, managed by a professional, on behalf of the employee while they work for the company. Private pensions are usually available through companies, while public pensions are provided to those working in state and local governments. 

Upon retirement, employees receive regular payments from their pension plan in the form of annuity payments or a lump-sum. Some plans may allow employees to contribute part of their wages, and employers may also match these contributions up to a certain percentage or dollar amount. 

Because employees do not have any control over the investment decisions regarding the funds in their pension plan, they assume no market risk. The sponsor provides an established monthly income upon retirement until death. This amount is based on the total contributions and the number of years the employee worked for the company. 

What if a portfolio doesn’t perform well or the company faces bankruptcy? In these cases, benefits are at risk of being reduced, although all private pensions are protected and insured by the Pension Benefit Guaranty Corporation (PBGC).

What About Taxes?

According to the IRS, all or some of the income received from your pension plan may be taxable. The majority of pensions are funded with pre-tax income, and the annual pension income will be on your tax return as taxable income. Taxes can also be directly withheld. Contributions made of after-tax dollars are partially taxable. 

If you make withdrawals from your pension before the age of 59½, you may be subject to an additional 10% tax on these distributions unless it qualifies for early withdrawal. 

ERISA Qualified Retirement Plan Requirements

To be eligible for qualified plan status under ERISA, plan sponsors must meet requirements regarding finding, vesting, participation, and the growth of benefits under IRS Section 401(a).

ERISA covers both defined-benefit and defined-contribution plans that are offered by employers. The IRS has a lengthy guide on common qualified plan requirements.

As long as the sponsor is following the ERISA guidelines, a pension is considered a qualified retirement plan. If you’re curious as to the level of security offered by your pension plan, companies have two options when it comes to pension plan termination. These options are:

  • Standard termination:The company can terminate the pension, with the approval of the PBGC, if the plan has enough money to pay all benefits to participants. The plan purchases an annuity from an insurance company or issues one lump-sum payment. 
  • Distress termination: If the company is under financial distress and if the pension plan is not fully funded, the company can terminate the pension plan. PBGC takes over as trustee to pay benefits up to legal limits using plan assets and guarantee funds. 

For advice regarding your employer-sponsored pension plan, a retirement advisor can help you qualify and prioritize your retirement goals and develop a plan for you to reach them.

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