What are non-qualified retirement plans?
Nonqualified retirement plans are retirement plans to which employees can contribute, but which are not subject to the limitations that apply to qualified retirement plans.
Nonqualified retirement plans include individual retirement accounts (IRAs), simplified employee pension (SEP) plans, money purchase pension plans (MPPs), and profit-sharing plans.
These retirement plans are subject to the same requirements that apply to all retirement plans, namely, that the contributions be elective, and that the employer and employee must both be eligible to make contributions.
What Are the Types of Non-Qualified Plans?
The types of non-qualified plans include:
- Deferred-compensation plan: This allows an employee to earn wages during one year, but receive the wages in a later year (most often during retirement). Deferred compensation can include retirement, pension, and stock option plans. Deferred compensation plans also include wraparound 401(k), excess benefit, bonus, and severance pay plans. Sometimes this sort of plan is referred to as a 457(b) plan or a 457(f) plan.
- Salary-continuation plan: Funds for the future retirement benefit of an executive or top-tier employee come from the employer. In other words, the employer continues to pay the employee even during retirement, although it may be at a reduced rate.
- Executive bonus plan: Provides supplemental benefits to choice executives and employees while being counted as a deductible business expense for the employer. Basically, an employer issues a life insurance policy and pays for the premiums, reporting them as bonus compensation.
- Split-dollar life insurance plan: Permits the premium costs, cash value, and tax/legal benefits of a permanent life insurance plan to be shared between an employer and employee. This sort of arrangement is not highly regulated, so the details can differ based on the specific situation and contract.
- Group carve-out plan: Replaces part of an employee’s group life insurance policy with an individual life insurance policy to avoid excess costs.
Why are nonqualified retirement plans necessary?
Because they provide a way for employees to save for retirement without having to meet the qualifications of a traditional retirement plan.
Nonqualified plans also allow employers to offer a retirement savings benefit to a wider range of employees, including those who are not eligible for a traditional retirement plan.
They don’t have any non-discrimination rules, so the plans can be tailored to meet the needs of executives and key employees and don’t have to be proportionately equal for all employees. One reason for this is to prevent excessive weighting that tends to favor employees who are earning more.