What Is 26 CFR 401? Qualified Plan Requirements

The U.S. Code of Federal Regulations, Title 26, Section 401, provides the rules for employer-sponsored retirement plans. For a plan to receive special tax treatment, it must be “qualified” by meeting a comprehensive set of requirements. When a plan achieves qualified status, both the employer and employees benefit.

Employers can claim a tax deduction for contributions made to the plan. For employees, contributions can be made on a pre-tax basis, lowering current taxable income, and investments within the plan grow tax-deferred. This allows the account balance to compound more rapidly until funds are withdrawn in retirement.

Core Requirements for Plan Qualification

A qualified plan must be a definite written program with its terms detailed in a formal plan document. The assets of the plan must be held in a trust or custodial account for the exclusive benefit of participants and their beneficiaries. This “exclusive benefit rule” is a fiduciary standard ensuring plan funds are not used by the employer, other than for providing benefits and paying reasonable administrative expenses.

To prevent employers from offering benefits only to select executives, plans must satisfy minimum participation and coverage rules. A defined benefit plan, for instance, must benefit at least 50 employees or 40% of all employees, whichever is less. All plans must also meet complex coverage tests, such as the ratio test, to ensure a sufficient percentage of non-highly compensated employees are covered.

The principle of nondiscrimination ensures a plan does not unfairly favor highly compensated employees (HCEs) in contributions or benefits. For example, 401(k) plans undergo annual testing, like the Actual Deferral Percentage (ADP) test, which compares the average deferral rates of HCEs and non-highly compensated employees (NHCEs). If HCEs contribute a significantly higher percentage, the plan may fail, requiring corrective actions like refunding excess contributions to HCEs.

Vesting determines when an employee gains full ownership of employer contributions. An employee’s own contributions are always 100% vested immediately. For employer contributions, a plan must follow a minimum vesting schedule. Under a “cliff” schedule, an employee is 100% vested after no more than three years of service. A “graded” schedule provides partial vesting over time, reaching 100% after six years.

Rules for Contributions and Distributions

The Internal Revenue Code imposes limits on the amounts that can be contributed to a participant’s account each year. The “annual additions limit” for defined contribution plans caps the total of all contributions for a single participant. For 2025, this limit is $71,000.

A plan’s document must state when participants can access their funds, such as upon retirement, death, disability, or separation from service. Some plans may permit in-service distributions under specific circumstances. These can include hardship withdrawals, which require demonstrating an immediate financial need, or plan loans, allowing a participant to borrow against their vested account balance.

To ensure plans are used for retirement income, Required Minimum Distributions (RMDs) are necessary. Participants must begin taking distributions by April 1 of the year after they turn age 73. The RMD amount is calculated annually based on the participant’s account balance and life expectancy.

Qualified plans must allow participants to preserve the tax-deferred status of their savings when changing jobs or retiring. Upon a distributable event, a participant must be given the option to directly roll over their vested account balance to another eligible retirement plan, such as a new employer’s plan or an Individual Retirement Account (IRA). A direct rollover avoids mandatory 20% federal income tax withholding.

Common Types of Qualified Plans

Qualified plans are broadly categorized as either defined benefit or defined contribution plans. A defined benefit (DB) plan, or traditional pension, promises a specific monthly benefit at retirement. The benefit is calculated using a formula based on salary history and years of service. In a DB plan, the employer bears the investment risk and must fund the promised benefits.

A defined contribution (DC) plan has individual accounts for each participant and does not promise a specific benefit amount. The final retirement benefit is the total amount in the account, including contributions and any investment gains or losses. With a DC plan, the investment risk shifts to the employee, whose retirement income depends on their investment performance.

Within the DC category, a profit-sharing plan allows an employer to make discretionary contributions, often based on company profits. A stock bonus plan is similar, but contributions are generally made in company stock rather than cash, giving employees an ownership stake.

A 401(k) is a feature added to a profit-sharing or stock bonus plan, not a standalone plan. This feature allows employees to contribute a portion of their salary on a pre-tax basis, known as an elective deferral. Employers often encourage participation by offering to match a portion of these employee contributions.

Maintaining a Plan’s Qualified Status

Operating a qualified plan is an ongoing responsibility. Employers must conduct annual compliance testing to verify the plan still satisfies coverage and nondiscrimination rules. Administrators perform the ADP and ACP tests for 401(k) plans and check that defined benefit plans meet minimum participation requirements. Another test is the top-heavy test, ensuring key employees do not hold more than 60% of the plan’s assets.

Transparency and reporting are also components of maintaining qualified status. Most plan sponsors must file a Form 5500, Annual Return/Report of Employee Benefit Plan, with the Department of Labor and the IRS each year. This report provides information about the plan’s financial condition, investments, and operations, helping government agencies monitor compliance.

When laws affecting retirement plans change, employers must formally update their written plan documents through a process called a plan amendment. Failing to amend the plan document by the deadlines set by the IRS can jeopardize the plan’s qualified status.

If operational errors occur, such as miscalculating contributions, the IRS established the Employee Plans Compliance Resolution System (EPCRS). This program provides a framework for plan sponsors to voluntarily identify, correct, and report failures. Following the prescribed correction methods under EPCRS allows an employer to fix the error and preserve the plan’s tax-qualified status.