Nonqualified Plan
What Is a Nonqualified Plan?
A nonqualified plan is a type of tax-deferred, employer-sponsored retirement plan that falls outside of Employee Retirement Income Security Act (ERISA) rules. Nonqualified plans are intended to meet particular retirement needs for key executives and other select employees and can act as enlistment or employee retention devices. These plans are additionally exempt from the unfair and cumbersome testing that qualified plans are subject to.
How a Nonqualified Plan Works
There are four major types of nonqualified plans:
- Deferred-compensation plans
- Executive bonus plans
- Part dollar life insurance plans
- Group carve-out plans
The contributions made to these types of plans are normally nondeductible to the employer and taxable to the employee.
Nonetheless, they permit employees to concede taxes until retirement (when they probably will be in a lower tax bracket). Nonqualified plans are frequently used to give specific forms of compensation to key executives or employees as opposed to making them partners or part owners in a company or corporation.
One of the other major objectives of a nonqualified plan is to permit profoundly compensated employees to add to another retirement plan after their qualified retirement plan contributions have been pushed to the limit, which normally happens immediately given their level of compensation.
Deferred Compensation as a Nonqualified Plan
There are two types of deferred compensation plans: true deferred compensation plans and pay continuation plans. The two plans are intended to furnish executives with supplemental retirement income. The primary difference between the two is in the funding source. With a true deferred compensation plan, the executive concedes a portion of their income, which is frequently bonus income.
With a compensation continuation plan, the employer funds the future retirement benefit for the executive's sake. The two plans take into consideration the earnings to gather tax-deferred until retirement when the Internal Revenue Service (IRS) will tax the income received as though it were ordinary income.
Different Plans
Nonqualified Plan: Executive Bonus Plan
Executive bonus plans are direct. A company issues an executive a life insurance policy with employer-paid premiums as a bonus. Premium payments are viewed as compensation and are deductible by the employer. The bonus payments are taxable to the executive. At times, the employer might pay a bonus over the premium amount to cover the executive's taxes.
Nonqualified Plan: Split-Dollar Plan
A split-dollar plan is utilized when an employer needs to give a key employee a permanent life insurance policy. Under this arrangement, an employer purchases a policy on the employee's life, and the employer and the employee partition ownership of the policy.
The employee might be responsible for paying the mortality cost, while the employer pays the balance of the premium. At death, the employee's beneficiaries receive the fundamental portion of the death benefit, while the employer receives a portion equivalent to its investment in the plan.
Nonqualified Plan: Group Carve-Out
A group carve-out plan is one more life insurance arrangement in which the employer carves out a key employee's group life insurance more than $50,000 and replaces it with an individual policy. This permits the key employee to keep away from the imputed income on group life insurance above $50,000. The employer diverts the premium it would have paid on the excess group life insurance to the individual policy owned by the employee.
Illustration of a Nonqualified Plan
Consider a high-paid executive working in the financial industry who contributes the maximum to their 401(k), and is searching for extra ways of putting something aside for retirement. Simultaneously, their employer offers nonqualified deferred compensation plans to executives. This permits the executive to concede a greater part of their compensation, alongside taxes on this money, into this plan.
Frequently, employers and executives will settle on a set period that the income will be deferred, which could be somewhere in the range of five years up until retirement. Eventually, the deferred income can develop tax-deferred until it is distributed. These deferral amounts might change from one year to another, contingent upon the agreement between the executive and employer.
Features
- They are called nonqualified on the grounds that not at all like qualified plans they don't comply with Employee Retirement Income Security Act (ERISA) rules.
- Nonqualified plans are generally used to give high-paid executives an extra retirement savings option.
- Nonqualified plans are retirement savings plans.
