Understanding Non-Qualified Retirement Plans

The Employee Retirement Income Security Acti, ERISAii, sets out the rules for determining whether a retirement account is “qualified,” or “non-qualified.” Do not be confused by the terms, as non-qualified plans also receive advantageous tax treatment. Though contributions to these plans are usually nondeductible for employers and taxable for employees, the employees can defer taxes on the assets and growth until withdrawal in retirement.

Non-qualified plansiii are mostly used for highly paid executives that often have other retirement savings plans as well. The four major types of non-qualified plans are:

  • Deferred-compensation plans
  • Executive bonus plans
  • Group carve-out plans
  • Split-dollar life insurance plans

According to the IRS, “Non-qualified plans are designed to meet specialized retirement needs for key executives and other select employees and can act as recruitment or employee retention tools. These plans are also exempt from the discriminatory and top-heavy testing that qualified plans are subject to.”

Deferred-compensation Plans

To complicate things a little more, there are two types of deferred-compensation plans. They are the true deferred-compensation plans and salary-continuation plans, with the primary difference being the plan funding source.

  • The true deferred-compensation plan is funded when the executive/employee defers part of their compensation. This is usually deferral of bonus income.
  • The salary-continuation plan is when the employer funds the account on behalf of the employee/executive.

Both plan types accumulate tax-deferred over time, with the executive paying taxes on withdrawals as ordinary income during retirement.

Executive Bonus Plans

Executive bonus plans are simple in structure. The employer issues the executive a life insurance policy as a bonus and the employer pays the premiums. The employer can deduct the premiums paid, and the executive must declare them as bonus income for taxes. Some employers also pay a bonus to the executive in addition to cover all or part of their tax liability for the premiums.

Group Carve-out Plans

A group policy is one which an employer covers an entire group of employees or executives. Should the employer want to further incentivize a particular executive, they can carve them out of the group for coverage over $50,000 and cover them with an individual policy. This allows the key employee to avoid the imputed income on group life insurance in excess of $50,000. The employer redirects the premium that would have been paid on the excess group policy to pay toward the premium of the individual policy.

Split-dollar Plans

Split-dollar plans can be used to provide a permanent life insurance policy for a key employee. This policy would achieve two goals, protection for the employer and for the family of the employee. The employer purchases the policy on the employee’s life, and they split the premium. Upon the employee’s death, their family receives the death benefit of the policy, and the employer receives a benefit equal to the employer’s investment in the plan.

Designed to meet the retirement needs of key employees as recruitment or retention tools, the non-qualified plans are exempt from the discriminatory and top-heavy tests that are part of the rules for qualified plans.

i The Employee Retirement Income Security Act from the U.S. Dept. of Labor website.

ii The Employee Retirement Income Security Act for Employees and Families; U.S. Dept. of Labor

iii Non-qualified Plan by Julia Kagan, Investopedia.com, updated Aug 4, 2019

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