Non-Qualified Retirement Plans | Definition, Types, and Features

Definition of Non-Qualified Retirement Plans

Non-qualified retirement plans refer to employer-sponsored retirement plans that do not meet the specific requirements and regulations set forth by the Internal Revenue Service (IRS) for qualified plans, such as 401(k)s or traditional pension plans. 

The primary purpose of non-qualified retirement plans is to provide additional retirement benefits and compensation to select employees, typically executives and other highly compensated individuals. 

These plans offer a way for companies to attract, retain, and reward key employees who play a crucial role in the organization's success. 

By offering non-qualified retirement plans, high-earning employees are able to save more for retirement than they would be able to only through qualified plans, which have contribution limits set by the IRS.

Types of Non-Qualified Retirement Plans

Deferred Compensation Plans

Deferred compensation plans are arrangements in which a portion of an employee's income is set aside to be paid at a later date, typically after retirement. 

These plans are popular among highly compensated employees who wish to defer taxes on their income until they retire and potentially move into a lower tax bracket.

Executive Bonus Plans

Executive bonus plans, also known as Section 162 plans, involve the employer providing a bonus to the executive, which is used to fund a life insurance policy. 

The executive owns the policy, and the bonus is considered taxable income. However, the cash value accumulation and death benefits can offer significant tax advantages.

Supplemental Executive Retirement Plans (SERPs)

Supplemental executive retirement plans (SERPs) are non-qualified plans designed to provide additional retirement benefits for select executives. 

SERPs are often funded by the employer and may be structured as defined benefit or defined contribution plans. 

They typically offer more generous benefits than qualified plans, allowing for higher contributions and greater flexibility.

Split-Dollar Life Insurance Plans

Split-dollar life insurance plans are arrangements where the employer and employee share the costs and benefits of a permanent life insurance policy. 

The employer typically pays the premiums, and the death benefit is divided between the employer and the employee's designated beneficiary. These plans can offer both tax and financial benefits to the participating employee.

Features of Non-Qualified Retirement Plans

No Contribution Limits

One of the main features of non-qualified retirement plans is that they do not have the same contribution limits as qualified plans. This allows high-earning employees to save more for their retirement, potentially leading to a more secure financial future.

No IRS Approval Required

Non-qualified retirement plans do not require IRS approval, which allows for greater flexibility in plan design and administration. This can be particularly advantageous for employers seeking to offer unique and competitive retirement benefits to their top employees.

No Discrimination Testing Required

Qualified plans are subject to discrimination testing, which ensures that the benefits provided by the plan do not disproportionately favor highly compensated employees. 

Non-qualified plans are not subject to this testing, allowing employers to selectively offer these plans to specific employees, such as executives and key personnel.

Employer Flexibility

Employers have significant flexibility when it comes to designing and implementing non-qualified retirement plans. This allows them to tailor the plans to meet the specific needs and goals of their organization and its employees.

Advantages of Non-Qualified Retirement Plans

Higher Contribution Limits

As mentioned previously, non-qualified retirement plans do not have the same contribution limits as qualified plans, allowing high-earning employees to save more for their retirement. 

This can be particularly beneficial for those who have maxed out their contributions to qualified plans and are seeking additional retirement savings options.

No Mandatory Distributions

Unlike qualified plans, non-qualified retirement plans are not subject to required minimum distributions (RMDs) once the participant reaches a certain age. 

This allows employees to continue accumulating savings in their plans without being forced to withdraw funds, providing more flexibility in retirement planning.

Tax Benefits

While non-qualified retirement plans do not offer the same up front tax benefits as qualified plans, they can still provide significant tax advantages. 

For example, deferred compensation plans allow employees to defer taxes on their income until they retire. By taking that income during retirement, the individual may be in a lower tax bracket than during their high-earning years, potentially reducing their overall tax burden. 

Additionally, certain non-qualified plans, such as split-dollar life insurance plans, can offer tax-free death benefits to beneficiaries.

Customizable

Non-qualified retirement plans are highly customizable, allowing employers to design plans that meet the specific needs and preferences of their employees. 

This can be particularly beneficial for organizations seeking to offer unique and competitive retirement benefits to their top talent.

Disadvantages of Non-Qualified Retirement Plans

Tax Consequences for Employees

While non-qualified retirement plans can offer tax benefits, they may also have tax consequences for employees. For example, contributions to these plans are generally not tax-deductible, and the growth of investments within the plan may be subject to taxation.

No ERISA Protection

Non-qualified retirement plans are not subject to the Employee Retirement Income Security Act (ERISA), which means they do not offer the same protections and regulations as qualified plans. 

This lack of protection can make these plans riskier for employees, particularly in the event of employer bankruptcy or financial instability.

Credit Risk

Employees participating in non-qualified retirement plans may be exposed to credit risk, as the funds in these plans are often considered general assets of the employer. 

In the event of employer bankruptcy, participants in non-qualified plans may lose some or all of their retirement savings.

Not Portable

Non-qualified retirement plans are typically not portable, meaning employees cannot take them with them if they leave the company.

This makes sense given non-qualified plans are typically used to attract and retain top talent; however, this can be a significant disadvantage for employees who change jobs or employers throughout their careers.

Considerations for Implementing Non-Qualified Retirement Plans

Cost

Implementing a non-qualified retirement plan can be costly for employers, particularly when considering administrative expenses and potential tax implications. Executive compensation can be custom-tailored to the executive, rather than a one-size-fits all plan.

Employers should carefully weigh the costs and benefits of offering these plans to ensure they are a financially viable option.

Employee Eligibility

Employers must decide which employees will be eligible to participate in the non-qualified retirement plan.

Generally, these plans are designed to benefit executives and other highly compensated employees, so it is essential to consider the impact of offering the plan to a broader employee base.

Plan Design

The design of a non-qualified retirement plan is crucial, as it will determine the plan's effectiveness in meeting the financial goals of both the employer and the participating employees. 

In some cases, these plans are tied to the performance of the executive, their department, or the overall company. 

Employers should work closely with financial and legal advisors to develop a plan that is tailored to the organization's specific needs and objectives.

Tax Implications

Non-qualified retirement plans can have complex tax implications for both employers and employees since both the employer and employee will be contributing to the plan using after-tax dollars.

It is important for employers to understand the potential tax consequences of offering these plans and to work with tax professionals to ensure compliance with applicable regulations.

Conclusion

Non-qualified retirement plans offer a way for companies to provide additional retirement benefits and compensation to select employees, typically executives and other highly compensated individuals. 

These plans are an essential tool for companies to attract, retain, and reward key employees who play a crucial role in the organization's success. 

Non-qualified retirement plans come in various forms, such as deferred compensation plans, executive bonus plans, supplemental executive retirement plans, and split-dollar life insurance plans. 

The features of such plans include; no contribution limits, no IRS approval required, no discrimination testing required, and employer flexibility. 

The advantages of non-qualified retirement plans include higher contribution limits, no mandatory distributions, tax benefits, and are customizable. On the other hand, the disadvantages include tax consequences for employees, no ERISA protection, credit risk, and are not portable. 

Employers need to consider several factors when implementing non-qualified retirement plans, such as cost, employee eligibility, plan design, and tax implications. 

They can make informed decisions about offering non-qualified retirement plans to their top talent by understanding the potential advantages and disadvantages of such plans.

FAQs

What are Non-Qualified retirement plans?

Non-qualified retirement plans are employer-sponsored retirement plans that don't meet IRS requirements for tax advantages and contribution limits.

Who is eligible for Non-Qualified retirement plans?

Non-qualified plans are typically offered to select employees, such as executives, high earners, or key personnel within an organization.

How are Non-Qualified plans different from Qualified plans?

Non-qualified plans have no contribution limits, are not subject to discrimination testing, and offer more flexibility to employers compared to qualified plans like 401(k)s or IRAs.

What are the tax implications of Non-Qualified retirement plans?

Contributions to non-qualified plans aren't tax-deductible for employees, but depending on the plan, funds grow tax-deferred until withdrawal, when they are subject to income tax.

Are Non-Qualified retirement plans portable?

Non-qualified plans are generally non-portable, meaning they cannot be transferred or rolled over to another employer's retirement plan.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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