What is a 'Non-Qualified Plan'
A non-qualified plan is a type of tax-deferred, employer-sponsored retirement plan that falls outside of employee retirement income security act (ERISA) guidelines. Non-qualified plans are designed to meet specialized retirement needs for key executives and other select employees. These plans also are exempt from the discriminatory and top-heavy testing that qualified plans are subject to.
BREAKING DOWN 'Non-Qualified Plan'There are four major types of non-qualified plans: 1) Deferred compensation plans, 2) Executive bonus plans, 3) Group carve-out plans and 4) Split-dollar life insurance plans. The contributions made to these plans are usually nondeductible to the employer, and are usually taxable to the employee as well. However, they allow employees to defer taxes until retirement when they are presumably in a lower tax bracket. Non-qualified plans are often used to provide specialized forms of compensation to key executives or employees in lieu of making them partners or part owners in the company or corporation.
There are two types of deferred compensation plans: True deferred compensation plans and salary continuation plans. Both plans are designed to provide executives with supplemental retirement income. The primary difference between the two is in the funding source. With a true deferred compensation plan, the executive defers a portion of his income, which is often bonus income. With a salary continuation plan, the employer funds the future retirement benefit on behalf of the executive. Both plans allow for the earnings to accumulate tax deferred with the income received at retirement taxed as ordinary income.
Executive Bonus Plans
Executive bonus plans are straightforward. An executive is issued a life insurance policy with premiums paid by the employer as a bonus to the executive. Premium payments are considered compensation and are deductible to the employer. The bonus payments are taxable to the executive. In some cases, the employer may pay a bonus in excess of the premium amount to cover the executive’s taxes.
A split dollar plan is used when an employer wants to provide a key employee with a permanent life insurance policy. Under this arrangement, a policy is purchased on the life of the employee and ownership of the policy is divided between the employer and the employee. The employee may be responsible for paying the mortality cost, while the employer pays the balance of the premium. At death, the main portion of the death benefit is paid to the employee’s beneficiaries, while the employer receives a portion equal to its investment in the plan.
Group Carve Out
A group carve out plan is another life insurance arrangement in which the employer carves out a key employee’s group life insurance in excess of $50,000 and replaces it 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 it would have paid on the excess group life insurance to the individual policy owned by the employee.