Is a 401(k) a Qualified Retirement Plan?

Yes, a 401(k) plan is a type of qualified retirement plan. This designation signifies that the plan adheres to a specific set of federal rules established by the Internal Revenue Service (IRS) and the Department of Labor. By complying with these government standards, the plan and its participants receive substantial tax advantages. This formal status separates these plans from other non-qualified arrangements.

What is a Qualified Retirement Plan?

A qualified retirement plan is an employer-sponsored plan that meets the requirements of the Internal Revenue Code Section 401(a). These plans are also governed by the Employee Retirement Income Security Act of 1974 (ERISA), a federal law designed to protect the interests of participants in employee benefit plans.

By meeting these government standards, the plan receives favorable tax treatment. Employers can claim a tax deduction for the contributions they make to the plan on behalf of their employees. Personal contributions, employer contributions, and all investment earnings within the account are shielded from annual taxation, a concept known as tax deferral.

Core Rules for 401(k) Qualification

To maintain its qualified status, a 401(k) plan must follow several operational rules. The plan cannot unreasonably exclude employees from participating. Generally, an employee who has reached age 21 and completed one year of service must be allowed to participate.

A plan must also satisfy nondiscrimination testing annually. These tests confirm the plan does not disproportionately benefit highly compensated employees (HCEs) over non-highly compensated employees. For 2025, the IRS defines an HCE as an individual who either owned more than 5% of the business in the current or preceding year or received compensation over $160,000 in the preceding year.

The plan must also adhere to specific vesting schedules, which determine an employee’s ownership of employer contributions. While an employee’s own salary deferrals are always 100% owned by them, employer matching or profit-sharing contributions may be subject to a vesting period. Common schedules include a three-year “cliff” vesting, where an employee becomes 100% vested after three years of service, or a graded schedule that incrementally vests over a period of up to six years.

Finally, the IRS imposes annual limits on contributions. For 2025, an employee can contribute up to $23,500 from their salary. The total combined contributions from both the employee and the employer cannot exceed $70,000 for the year. Individuals age 50 and over are also permitted to make additional “catch-up” contributions. For 2025, the standard limit is $7,500; however, a higher catch-up contribution of up to $11,250 is available for individuals aged 60 to 63.

Tax Impact for Employees

When an employee contributes to a traditional 401(k), those contributions are made on a pre-tax basis. This means the amount is deducted from their pay before federal and most state income taxes are calculated, which lowers their current taxable income for the year.

Inside the 401(k) account, any earnings generated from investments, such as dividends, interest, or capital gains, grow tax-deferred. This allows the account balance to compound over time without being reduced by annual tax payments on the investment growth.

Taxes are eventually paid when funds are withdrawn from the traditional 401(k), during retirement. These distributions are taxed as ordinary income at the individual’s tax rate in the year of withdrawal. This structure is based on the principle of paying taxes later, potentially at a lower tax rate in retirement than during peak earning years.

Many plans also offer a Roth 401(k) option, which reverses the tax treatment. Contributions to a Roth 401(k) are made with after-tax dollars, meaning there is no upfront tax deduction. However, if specific conditions are met, all qualified withdrawals of both contributions and earnings in retirement are completely tax-free.