Non-Qualified Plan
What is a non-qualified plan?
A non-qualified plan is an employer-sponsored, tax-deferred retirement or compensation arrangement that falls outside of ERISA (Employee Retirement Income Security Act) rules. These plans are typically used to provide additional retirement savings or deferred compensation for key executives and other select employees. Because they are not subject to ERISA’s nondiscrimination and top‑heavy testing, employers can design benefits that favor specific employees.
Key points
* Designed for select employees (often executives) rather than the broad workforce.
* Outside ERISA, so plan assets are generally not held in a protected trust and remain subject to employer creditors.
* Allow deferral of income tax for employees until distributions are made (typically at retirement or another agreed date).
* Employer tax treatment varies by plan type and timing; in many cases the employer’s deduction occurs when the employee recognizes income.
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How non‑qualified plans work
Non‑qualified plans let an employee defer receipt of compensation (salary, bonus, or other benefits) so income tax is postponed until distribution. Employers and employees negotiate the deferral amount, timing, and distribution schedule. Because these plans are often unfunded promises by the employer, plan participants face the risk that benefits may be reduced or lost if the employer becomes insolvent.
Major types of non‑qualified plans
- Deferred compensation plans
- True deferred compensation: The employee elects to defer a portion of current pay (often bonuses). The deferred amounts grow tax-deferred and are taxed as ordinary income when paid to the employee.
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Salary‑continuation plan: The employer funds future benefits on the employee’s behalf; payouts and tax treatment occur when distributions are made. Both varieties provide supplemental retirement income beyond qualified plan limits.
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Executive bonus plans
- The employer pays premiums on a life insurance policy owned by the executive as a form of bonus.
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Premiums are treated as compensation to the executive (taxable to the employee); employers typically can deduct these amounts as a business expense.
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Split‑dollar life insurance plans
- The employer and employee share ownership and benefits of a permanent life insurance policy.
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The employer may pay part of the premium while the employee pays other costs (for example, mortality costs). Upon death, benefits are allocated between the employee’s beneficiaries and the employer, often in proportion to employer contributions.
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Group carve‑out plans
- An employer replaces group life insurance coverage in excess of $50,000 with an individual policy for a key employee.
- The employer redirects the excess premium to the individual policy, which can avoid imputed income under the group plan and provide a tailored benefit to the executive.
Example
A high‑paid executive who has already maxed out 401(k) contributions may use a non‑qualified deferred compensation plan to defer additional income and tax liability until retirement. This lets the executive continue saving on a tax‑deferred basis beyond qualified plan limits.
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Tax and other considerations
- Employees generally pay ordinary income tax on distributions when amounts are received.
- Employer tax deduction timing depends on the plan structure and typically occurs when the employee recognizes income.
- Because non‑qualified plans are usually unfunded, plan assets remain part of the employer’s general assets and are subject to creditors if the employer becomes insolvent.
- Non‑qualified plans are exempt from ERISA’s participation and funding rules but are often governed by other tax and regulatory requirements agreed between employer and employee.
How they complement qualified plans
Non‑qualified plans are commonly used to supplement qualified retirement plans (like 401(k) plans). Executives who reach the contribution caps of qualified plans can defer additional compensation into non‑qualified arrangements to increase retirement savings or receive other tailored benefits.
Bottom line
Non‑qualified plans provide flexible, employer‑sponsored ways to defer compensation and create executive‑level benefits beyond qualified plans. They permit targeted rewards and retention incentives but carry different tax timing, lack ERISA protections, and expose participants to employer credit risk. Agreement terms between employer and employee determine funding, distribution timing, and tax outcomes.