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.
The Advisor Insight
A qualified retirement plan is included in Section 401(a) of the Tax Code and falls under the jurisdiction of ERISA guidelines. Employee and/or employer contributions are distinct from the employer’s balance sheet and are owned by the employee. There are more restrictions to a qualified plan, such as limited deferral amounts and employer contribution amounts. Examples of these are 401(k) and 403(b) plans.
A non-qualified plan does not fall under ERISA guidelines so they do not receive the same tax advantages. They are considered to be assets of the employer, and can be seized by creditors of the company. If the employee quits, they will likely lose the benefits of the non-qualified plan. The advantages are no contribution limits and more flexibility. Executive Bonus Plan is an example.
Thomas M. Dowling
Aegis Capital Corp
Hilton Head, SC