What is the difference between qualified and non-qualified plans?
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.
Criteria for Qualified Plans
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.
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Qualified - before tax (or pre-tax) money, which includes, but not limited to, the following retirement plans:
- Thrift Savings Plans (TSPs);
- Simplified Employee Pensions (SEPs);
- Traditional IRAs;
- Savings Incentive Match Plans for Employees (SIMPLE) IRAs;
- Salary Reduction Simplified Employee Pensions (SARSEPs); and
- Profit sharing.
With a qualified plan, you receive an upfront tax deduction (or reduction) now but will have to pay taxes on the entire amount in the future (or when you begin withdrawing). Required Minimum Distributions (RMDs) will be due by age 70 ½ at the latest (you can begin withdrawing by age 59 ½ without incurring a 10% penalty).
Non-Qualified - after-tax money, which includes, but not limited to, the following:
- Certificates of Deposits (CDs);
- Mutual Funds;
- Money Markets; and
With a non-qualified plan, there are no deductions, but the principal is never taxed twice. Instead, the interest is taxed once withdrawn. Also, there are no RMDs on nonqualified plans.
Note: Although 457 plans are called nonqualified, they are technically tax-advantaged deferred compensation plans, which are similar to a qualified plan, such as a 401(k) or IRA.
If you have any further questions, I'd be happy to help.
Qualified = pre-tax retirement savings accounts. I.E. 401(k), IRA, 403(b), Simple IRA, SEP IRA, etc...
Non-Qualified = after tax accounts. Cash, savings, joint brokerage accounts, etc...
Qualified accounts are subject to withdrawal rules in which you will be forced to take distributions and pay income tax at that point. Non-Qualified accounts are subject to interest, dividend and capital gain taxes.
A qualified plan is a retirement plan that is included in Section 401(a) of the Tax Code and falls under the jurisdiction of the Employment Retirement Income Security Act (ERISA) guidelines. The funds contributed by the employee and/or employer are set aside and are separated from the employer’s accounts and are owned by the employee. Therefore, those funds are not accessible by the company’s creditors. The downside of this is 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 is one that does not fall under ERISA guidelines, therefore they do not receive the same tax advantages. They are considered the assets of the employer so the employee assumes risk because the assets may be seized by creditors of the company. Also, if the employee leaves the company it is likely they will lose the benefits of the non-qualified plan. The upside of a non-qualified plan is no limits on contributions and the plans can be flexible in structure. An example is an Executive Bonus Plan.
Excellent retirement plan question! Being qualified or non-qualified usually refers to the plan meeting IRS guidelines for a tax-preferred treatment. Non-qualified "plans" are usually annuity or life insurance strategies that insurers offer as an alternative or supplement to qualified plans. Qualified plans typically (traditionally) allow the participant to contribute pre-tax money to the plan, and it grows tax-deferred until it is taken out at a future date. The 401(k) Roth option is growing in popularity and it allows the participant to contribute after-tax money, but offers tax-deferral and no future taxation upon withdrawal. Of course there are a myriad of rules surrounding these plans. Most financial planners urge clients to fully utilize qualified plans before contributing to non-qualified plans. Be sure to check with your advisor about your particular situation. Good luck!
Qualified plans give you some instant tax benefits, whereas non-qualified ones do not. For example, when you make a contribution to an IRA or 401(k), you will enjoy either an up-front deduction (in case of a traditional 401(k) or IRA) or tax-exempt withdrawal in the retirement (such as Roth 401(k) or Roth IRA). An easy way to differentiate the two is to see if the account is retirement related, so you instantly recognize that any 401(k), 403b, 457 as well as SIMPLE IRA or SEP IRA are qualified. Happy learning.