What is the difference between qualified and non-qualified plans?

By Investopedia Staff AAA
A:

Qualified and non-qualified retirement plans are created by employers with the intent of benefiting employees. The Employee Retirement Income Security Act (ERISA), enacted in 1974, defines qualified and non-qualified plans.

Qualified plans are designed to offer individuals added tax benefits on top of their regular retirement plans, such as IRAs. Employers deduct an allowable portion of pretax wages from the employees, and the contributions and the earnings then grow tax-deferred until withdrawal.

Non-qualified plans are those that are not eligible for tax-deferral benefits. Consequently, deducted contributions for non-qualified plans are taxed when income is recognized. This generally refers to when employees must pay income taxes on benefits associated with their employment.

The main difference between the two plans is the tax treatment of deductions by employers, but there are other differences. A plan must meet several criteria to be considered qualified, including:

  • Disclosure - Documents pertaining to the plan's framework and investments must be available to participants upon request.
  • Coverage - A specified portion of employees, but not all, must be covered.
  • Participation - Employees who meet eligibility requirements must be permitted to participate.
  • Vesting - After a specified duration of employment, a participant's rights to pensions are non-forfeitable benefits.
  • Nondiscrimination - Benefits must be proportionately equal in assignment to all participants in order to prevent excessive weighting in favor of higher paid employees.

Learn more by checking out our retirement tutorial section.

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