Qualified Retirement Plans

Qualified plans must meet the qualified-plan requirements under the Internal Revenue Code (IRC) and receive IRS approval. They benefit from tax-deductible employer contributions, tax-deferred growth, and creditor protection under the Employee Retirement Income Security Act (ERISA). They must not discriminate in favor of highly compensated employees (nondiscrimination testing).

SEP and SIMPLE IRAs are not covered here. They are IRA-based plans with their own rules, taught in the SEP and SIMPLE IRAs lesson.

How Do Vesting Schedules Work?

Vesting schedules determine how employees earn ownership of employer contributions over time:

• Cliff vesting: 0% until a set date, then 100% (max 3 years of service for an employer match)
• Graded vesting: Vesting rises in steps, and the longest schedule a defined contribution plan (such as a 401(k)) may use is 6 years of service
• Employee's own contributions are always 100% immediately vested

The longest graded schedule for employer contributions in a defined contribution plan starts at year 2, not year 1:

A plan may vest faster than this schedule but never slower. Four years of service is 60% vested, not 0% and not 50%.

How Do Defined Benefit and Defined Contribution Plans Compare?

Think of it this way: In a defined benefit plan, the employer promises a specific monthly check at retirement; if the investments perform poorly, the employer makes up the difference. In a defined contribution plan, the employer promises a specific contribution today; whatever that money grows to (or shrinks to) is what you get.

Exam Tip: Gotchas

• Defined benefit = employer bears investment risk, PBGC insured. Defined contribution = employee bears investment risk, no PBGC. This distinction appears frequently on the exam.

How Does a Defined Benefit Plan Work?

• Employer promises a specific retirement benefit (e.g., percentage of final salary times years of service)
• Employer bears the investment risk (must fund enough to pay promised benefits)
• Actuaries determine required employer contributions each year
• Pension Benefit Guaranty Corporation (PBGC) insures defined benefit plans (employer pays premiums)
• Maximum annual benefit (2026): the lesser of $290,000 or 100% of average compensation for highest 3 consecutive years
• Benefits are typically based on: years of service, final average salary, benefit formula
• Less common today; being replaced by defined contribution plans

How Does a Defined Contribution Plan Work?

• Employer and/or employee contribute to individual accounts; retirement benefit depends on contributions + investment performance
• Employee bears the investment risk (account value fluctuates with market)
• No guaranteed benefit amount at retirement
• Maximum combined contribution (2026): the lesser of $72,000 or 100% of the participant's compensation (employer + employee, excluding catch-up); the Internal Revenue Code caps whichever of the two figures is smaller
• Includes: 401(k), 403(b), 457, profit-sharing, money purchase pension

How Does a 401(k) Plan Work?

• Most common employer-sponsored defined contribution plan
• Employee deferral limit (2026): $24,500 (under 50); catch-up contributions for 50+. The Internal Revenue Code applies this limit per person, not per plan: an employee's 401(k) and 403(b) deferrals count together against one $24,500 limit. A governmental or tax-exempt 457(b) has its own separate limit (see the 457(b) section)
• Employer match: Common but not required; often 50% or 100% of deferrals up to a percentage of salary
• Employer contributions are subject to vesting schedules; employee deferrals are always 100% vested
• A 401(k) plan may offer participant loans, but it does not have to
• For a participant's first loan, when there is no outstanding loan and there was no plan loan during the preceding year, the usual cap is the lesser of $50,000 or 50% of the vested balance. If 50% is below $10,000, the plan may adopt an optional exception allowing a loan of up to $10,000. Current or recent plan loans can reduce the amount available
• A plan loan must generally be repaid within 5 years through payments made at least quarterly, except a loan used to buy a principal residence may run longer
• Hardship withdrawals available under specific circumstances (still subject to income tax; 10% penalty may apply if under 59.5)
• Roth 401(k): After-tax contributions made to the plan with no contributor income limit; qualified distributions are tax-free
  • Roth and traditional deferrals together count against the same $24,500 (2026) employee deferral limit. The Roth label changes the tax treatment, not the limit
  • Under current law, a designated Roth account has no lifetime required minimum distributions (RMDs), the same as a Roth IRA. This is a recent change: Roth 401(k) accounts used to have RMDs
  • Employer match: By default, the employer match on Roth deferrals goes into the traditional (pre-tax) account and is taxed as ordinary income when distributed. A plan may instead offer a designated Roth match, but only if the match is fully vested when made. That is an employer plan-design choice, not an employee election
  • Inherited Roth accounts still have distribution requirements after the owner's death
• Two Internal Revenue Code exceptions to the 10% early withdrawal penalty apply to 401(k) and other employer plans but not to IRAs:
  • Separation from service at or after age 55: a distribution taken after the employee leaves the employer in or after the year they turn 55 is exempt from the 10% penalty (ordinary income tax still applies)
  • Qualified Domestic Relations Order (QDRO): a distribution paid to an alternate payee (such as a former spouse) under a QDRO is exempt from the 10% penalty

How Does a 403(b) Plan Work?

• Available to employees of public schools, 501(c)(3) tax-exempt organizations, and religious organizations
• The elective deferral limit is the same dollar amount as the 401(k) limit: $24,500 (2026); same catch-up rules apply
• A person's 403(b) and 401(k) deferrals are combined under that one limit. A 457(b) is not part of that combined limit
• Investments typically limited to mutual funds and annuity contracts
• May have an additional 15-year service catch-up if the plan permits it. The annual amount is the least of $3,000, the unused portion of the $15,000 lifetime allowance, or $5,000 times years of service minus the employee's prior elective deferrals to the organization's plans

Exam Tip: Gotchas

• 403(b) may have a 15-year service catch-up that 401(k) does not. The plan must permit it, and $3,000 is the annual ceiling rather than a guaranteed amount. The least-of calculation also considers the unused $15,000 lifetime allowance and the employee's prior deferrals. This is separate from age-based catch-ups.

How Does a 457(b) Plan Work?

• Available to employees of state and local governments and certain tax-exempt organizations
• Contribution limit (2026): $24,500, the same dollar amount as the 401(k)/403(b) limit but a separate limit. 457(b) deferrals do not count against the 401(k)/403(b) limit, and 401(k)/403(b) deferrals do not reduce the 457(b) limit
• An employee with both a 403(b) and a 457(b), such as a public school teacher, can defer up to $24,500 into each in 2026 (up to $49,000 in total before catch-ups), subject to each plan's terms
• Eligible governmental 457(b) distributions generally avoid the 10% early withdrawal penalty, regardless of age, with one exception: amounts attributable to rollovers from plans or IRAs that were subject to the additional tax may remain subject to it
• Governmental 457(b) plans allow rollovers to IRAs and other qualified plans
• Special 3-year catch-up: In the 3 years before normal retirement age, employees may defer up to double the annual limit ($49,000 in 2026); cannot combine with age 50+ catch-up
• Non-governmental 457(b) assets are NOT protected from employer's creditors (unfunded promise to pay)

Exam Tip: Gotchas

• Same dollar amount is not one shared cap. The 401(k) and 403(b) limit is combined per person. The 457(b) limit is separate, so a 403(b) plus 457(b) participant is not limited to one $24,500 total.
• Eligible governmental 457(b) distributions generally avoid the 10% early withdrawal penalty at any age (income tax still applies). This is different from 401(k) and 403(b), which impose the 10% penalty before age 59.5. Watch for the exception: amounts attributable to rollovers from plans or IRAs that were subject to the additional tax may remain subject to it.

What Should You Check on Exam Day?

• Defined benefit: employer bears investment risk, actuarially determined contributions, PBGC-insured, max annual benefit (2026) the lesser of $290,000 or 100% of the highest 3-year average pay
• Defined contribution: employee bears investment risk, combined max contribution (2026) the lesser of $72,000 or 100% of compensation, excluding catch-up, no PBGC insurance
• Cliff vesting maxes at 3 years; graded vesting maxes at 6 years (0% before year 2, 20% at year 2, then 20 more points a year); the employee's own contributions are always 100% vested
• 401(k) and 403(b) deferrals count together against one $24,500 (2026) limit; a 457(b) has its own separate $24,500 limit; only a 403(b) may permit a 15-year service catch-up, capped at $3,000 a year
• Eligible governmental 457(b) distributions generally avoid the 10% early withdrawal penalty regardless of age, unlike 401(k) and 403(b), except for amounts attributable to rollovers that were subject to the additional tax