What is the Difference Between Quaified and Non-Quliafied Pension Plans?

Pension plans and retirement benefits can be some of the most difficult matters to sort through during a divorce. To ensure each spouse in the divorce receives his or her full benefits under New Jersey law, there are several steps that need to be taken by a family law attorney depending on whether the retirement plan is a “qualified” or “non-qualified” pension plan. These next two blog posts will feature the differences and similarities between qualified and non-qualified pension plans, and how they may affect a divorce proceeding.

Qualified Pension Plans

The IRS designates certain pension and retirement plans as “qualified” and “non-qualified.” Qualified pensions and retirement funds are much more popular in America and include popular retirement and pension plans including 401(k)s and 403(b)s. A retirement or pension fund is “qualified” if it meets the federal standards promulgated by the Employee Retirement Income Security (ERISA).

Here is a list of the most popular qualified funds:

●       401(k)

●       403(b)s

●       Thrift Savings Plans

●       Savings Incentive Match Plans for Employees (SIMPLE) IRAs

●       Salary Reduction Simplified Employee Pensions (SARSEPs)

Tax Treatment

In a qualified retirement or pension plan, the taxpayer may deduct the contributions made to the fund each year. Similarly, gains from a qualified account are not taxable income. Keeping these contributions in a qualified account allows the taxpayer to delay paying taxes on the income until he or she retires, and the fund begins distributing the income.

This is typically advantageous for many taxpayers because their income will be lower during retirement and therefore, the effective tax rate on the money will be lower. For this reason, most retirement plans and pension funds are qualified plans. In exchange for its advantageous tax treatment, the Internal Revenue Service (IRS) does have several rules that limit the rights of taxpayers to utilize the money in qualified funds.

Contribution Limits

Qualified plans limit the deduction on contributions to a qualified plan each year. The exact contribution limit depends on several factors, including age and the type of qualified plan. For taxpayers under the age of 50, the maximum contribution that can be deducted for all qualified plans is $18,500 for 2018. Americans over the age of 50 can contribute more income each year. In 2018, the IRS will allow these older taxpayers to deduct a maximum of $24,500 per year.

Penalty for Early Withdrawal

While the IRS allows taxpayers to withdraw from a qualified fund at any time, it does impose a hefty fine for any withdrawals before the taxpayer reaches the age of 59.5. Called “early distributions” by the IRS, any distribution before this age cutoff will incur a 10% penalty. In addition to this penalty, the taxpayer will still be required to pay federal income tax on the distribution.

There are, however, several notable exceptions that can allow a taxpayer to dodge the 10% penalty. The penalty will not apply if:

●       The taxpayer is permanently disabled.

●       The taxpayer is a member of the military serving active duty for at least six months.

●       The taxpayer has incurred medical expenses that constitute more 10% of his or her taxable income that year.

●       The taxpayer has passed away before 59.5, the beneficiaries of the fund will not be taxed on the early distribution.

Required Mandatory Distributions

When a taxpayer reaches the age of 70.5, then he or she must begin receiving distributions from a qualified fund. The exact amount depends on the type of fund and the amount of money in the fund.