What Is a Non-Qualified Plan?
Let me explain what a non-qualified plan is: it's a tax-deferred retirement plan sponsored by your employer that doesn't follow the Employee Retirement Income Security Act (ERISA) guidelines.
These plans are built to address specific retirement needs for key executives and select employees. You can use them as tools to recruit or retain talent, and they're free from the discriminatory and top-heavy testing that qualified plans must undergo.
Key Takeaways
Non-qualified plans function as retirement savings options. They're termed non-qualified because they skip ERISA guidelines, unlike qualified plans. Typically, you see them providing high-paid executives with extra ways to save for retirement.
How a Non-Qualified Plan Works
There are four main types of non-qualified plans: deferred compensation plans, executive bonus plans, split-dollar life insurance plans, and group carve-out plans.
Contributions to these plans are usually not deductible for the employer and are taxable for you as the employee. That said, they let you defer taxes until retirement, when you might be in a lower tax bracket.
Importantly, non-qualified plans often deliver specialized compensation to key executives or employees, avoiding the need to make them partners or owners in the company.
Another big purpose is to enable highly compensated employees like you to keep contributing to retirement savings after hitting the max on qualified plans, which happens fast with high incomes.
Deferred Compensation Plans
You'll find two types here: true deferred compensation plans and salary-continuation plans. The key difference is funding—with a true plan, you as the executive defer part of your income, often bonuses.
In a salary-continuation plan, the employer funds your future retirement benefit. Both types let earnings grow tax-deferred until retirement, when the IRS taxes the income as ordinary income.
Other Types of Non-Qualified Plans
Take the executive bonus plan: here, a company gives you a life insurance policy with premiums paid by the employer as a bonus. Those payments count as compensation, deductible for the employer but taxable to you. Sometimes, the employer adds extra to cover your taxes.
Then there's the split-dollar plan, used when an employer wants to provide you with permanent life insurance. The employer buys the policy on your life, and you both share ownership. You might pay the mortality cost, while the employer covers the rest. At death, your beneficiaries get the main death benefit, and the employer recovers its investment.
Finally, a group carve-out plan involves the employer removing your group life insurance over $50,000 and replacing it with an individual policy. This helps you avoid imputed income on the excess, with the employer redirecting premiums to your owned policy.
What Is an Example of a Non-Qualified Plan?
Picture a high-paid executive in finance who's already maxed out their 401(k) and needs more retirement savings. Their employer offers a non-qualified deferred compensation plan, letting them defer more compensation and taxes into it.
What Are Deferred Compensation Plans?
Both true deferred compensation and salary-continuation plans aim to give executives like you supplemental retirement income. The plan holds assets that aren't taxed or paid out until later.
How Much Can You Contribute to a 401(k)?
The IRS sets an annual maximum for 401(k) or Roth 401(k) contributions, adjusting it for inflation. Even with multiple plans, your total can't exceed this limit. If you're 50 or older, you can add a catch-up contribution.
The Bottom Line
Often, you and your employer agree on a deferral period, from five years to retirement. The deferred income grows tax-deferred until distribution. These amounts can vary yearly based on your agreement.
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