Nonqualified plans can offer additional employer-sponsored incentives for high-ranking personnel and key executives that supplement the employer’s tax-qualified retirement plans, such as a 401(k) plan.
Almost all types of retirement plans share the same goal: to make it easier for everyone to save enough to have a safe and fulfilling retirement. But today, there are numerous options that function in different ways, so it’s easy to get confused. Among others, there are individual retirement plans, like IRAs, and employer-sponsored plans. Most large companies offer tax-qualified retirement plans. They are often 401(k)s, but there are other types of qualified plans as well.
Nonqualified employer-sponsored plans are normally reserved for the highest paid employees at large companies. They can have value for other companies as well, even small businesses, to help attract and retain important employees.
Usually, nonqualified retirement plans are offered as additional benefits or incentives to a company’s most important employees. They are a way to keep the company’s compensation competitive.
The following highlights some of the key distinctions between qualified and nonqualified retirement plans, including who typically benefits, and how they fit into an overall compensation strategy.
Qualified plans, such as 401(k) plans, are designed so that all employees can save for retirement more easily. Most large employers already provide qualified plans for their employees. The employees can contribute to a 401(k) or a similar plan, and they may get some matching from their employer to help them save for retirement. These contributions, and any earnings, are tax-deferred until the time of distribution (or may grow tax free if the plan offers and the employee utilizes a Roth account).
However, qualified plans must comply with tax rules, which among other things include:
Nonqualified plans, on the other hand, also provide for tax deferral, but are not subject to the IRS limits on contributions and compensation. They also do not need to comply with some of the rules applicable to qualified plans, such as participation requirements and non-discrimination testing.
However, unlike qualified plans, nonqualified benefits are not protected from the employer’s creditors, and distributions from nonqualified plans are not eligible for rollover to an IRA or another eligible plan upon distribution.
The four main categories of non-qualified plans are generally described below, but the details of each plan will usually be negotiated on a case-by-case basis.
You can think of deferred-compensation plans as a type of bonus the company pays at a later date, since these plans allow key executives to defer their compensation to a later date. They can help large companies offer better compensation packages, since qualified retirement plans like 401(k)s have contribution limits. They can also help smaller businesses retain talent during slimmer growth years by promising supplemental income for key employees at a later date. These plans must be unfunded, but many employers “informally” fund them, for example, by purchasing corporate owned life insurance.
This is when an employer pays the premium on a life insurance policy for an employee. Usually, it’s set up so the employee gets complete control and can later have access to the policy’s cash value if needed. Or the employee can name a beneficiary and carry it as a normal life insurance policy. The premium payments the company makes are considered compensation to the employee for tax purposes.
A split-dollar plan is an agreement between two or more parties such as an employer and employee to share the ownership, costs, and benefits of a permanent life insurance policy. New rules were enacted in 2003 that changed the way taxes are treated in these agreements, and that has made them less desirable as part of a compensation package. They are still used, but not as widely as they once were.
This is yet another type of arrangement using life insurance. Many companies have group life insurance, but it is often capped at a certain amount for every employee. If a company wants to offer a higher life insurance amount to a key executive, it might take that employee out of the group pool and offer them an individual policy.
It doesn’t matter whether you’re an executive, a small-business owner, or a regular employee. You deserve a comfortable retirement. In today’s world, that takes a smart plan. But you don’t have to tackle it on your own. Our agents are knowledgeable on a wide range of products, including annuities, life insurance, and more. They can help you build a well-rounded strategy that can put you on a path toward achieving your retirement dreams and protecting your legacy.
Our agents are waiting to help you understand all of your savings options.
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Application of ERISA and Section 409A of the Internal Revenue Code
Even non-qualified plans, including retirement and welfare plans, may be subject to ERISA, a federal law that sets rules for employee benefit plans. However, a properly designed top-hat plan for select executives or highly paid employees is exempt from many ERISA requirements, like eligibility, vesting, and funding. These plans may also be subject to Section 409A of the tax code, which has specific tax rules. If these rules aren’t met, employees could face unexpected tax penalties. Employers should seek legal and tax advice before setting up a non-qualified plan.
This article is provided for your general informational purposes only. Neither New York Life Insurance Company nor its agents, employees or affiliates provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.