Is an IRA a Qualified Retirement Plan?

While both Individual Retirement Arrangements (IRAs) and qualified retirement plans are tax-advantaged accounts for retirement savings, an IRA is not a qualified retirement plan. The term “qualified retirement plan” refers to a specific category of employer-sponsored plans that operate under a different set of rules. Their governing regulations, sponsorship, and operational rules create a clear distinction that is important for financial planning.

Defining a Qualified Retirement Plan

A qualified retirement plan is established by an employer for the exclusive benefit of its employees. To be “qualified,” the plan must adhere to requirements in the Internal Revenue Code (IRC) Section 401. These plans are also governed by the Employee Retirement Income Security Act of 1974 (ERISA), a federal law that protects the retirement assets of employees.

ERISA establishes minimum standards for these plans, covering participation, vesting, funding, and fiduciary duties. For example, it sets rules on how long an employee must work to earn a nonforfeitable right to employer contributions, a process known as vesting. It also requires that plan assets be held in a trust separate from the employer’s business assets to safeguard them from company creditors. Common examples of qualified retirement plans include 401(k)s, defined benefit pension plans, and profit-sharing plans.

Understanding Individual Retirement Arrangements (IRAs)

An Individual Retirement Arrangement (IRA) is a personal savings plan that an individual establishes, separate from any employer. These accounts are governed by Internal Revenue Code Section 408. An individual can open an IRA with a bank, brokerage firm, or other financial institution.

The most common types are Traditional and Roth IRAs. Contributions to a Traditional IRA may be tax-deductible, and the investments grow tax-deferred until retirement, at which point withdrawals are taxed as income. Roth IRA contributions are made with after-tax dollars, meaning there is no upfront deduction, but qualified withdrawals in retirement are tax-free.

While most IRAs are set up by individuals, some employer-related plans like Simplified Employee Pension (SEP) IRAs and Savings Incentive Match Plan for Employees (SIMPLE) IRAs exist. These plans are used by small businesses and self-employed individuals. Despite an employer’s role, they are not considered qualified retirement plans because they are governed by IRA rules.

Key Distinctions and Their Implications

Sponsorship and Contribution Limits

Qualified plans are sponsored by employers, who can make contributions for their employees in addition to the employee’s own salary deferrals. This structure allows for much higher total contribution limits. The total amount that can be contributed to a 401(k) from both employee and employer sources is substantially higher than the annual limit for an IRA, which is set by the IRS and adjusted periodically.

Rollover Rules

It is a common practice for individuals to roll over funds from an employer’s qualified plan, like a 401(k), into an IRA when they change jobs or retire. This process is straightforward. Moving funds in the opposite direction, from an IRA into a qualified plan, can be more restrictive. Many employer plans do not accept rollovers from IRAs, or they may only accept rollovers of funds that originated in another qualified plan.

Creditor Protection

A significant distinction lies in creditor protection. Funds held in a qualified plan, such as a 401(k), receive robust protection from creditors under federal ERISA law. This protection is uniform across the country and shields retirement assets from claims in lawsuits and bankruptcy, with limited exceptions. IRAs, however, are not covered by ERISA. Their protection is determined by a combination of federal bankruptcy law and state statutes, which can vary significantly. While federal law provides a substantial bankruptcy exemption for IRAs, protection against general creditors outside of bankruptcy depends on state law.

Loan Provisions

Many qualified plans, particularly 401(k)s, allow participants to borrow against their account balance, subject to certain limits and repayment rules. This can provide a source of liquidity. Taking a loan from an IRA, however, is a “prohibited transaction.” This action results in the entire IRA being treated as distributed, triggering immediate income taxes and potential penalties on the full balance.