Qualified vs. Non-qualified Retirement Plans: Overview

Employers create qualified and non-qualified retirement plans with the intent of benefiting employees. The Employee Retirement Income Security Act (ERISA), enacted in 1974, was intended to protect workers' retirement income and provide a measure of information and transparency.

In simple terms, a qualified retirement plan is one that meets ERISA guidelines, while a non-qualified plan falls outside of ERISA guidelines. Some examples:

  • Qualified plans include 401(k), profit-sharing plans, 403(b), and Keogh (HR-10) plans.
  • Non-qualified plans include deferred-compensation, split-dollar life insurance, and executive bonus plans.

The tax implications for the two plan types are also different. Except for a simplified employee pension (SEP), individual retirement accounts (IRAs) plans are not created by an employer and are not qualified plans.

Key Takeaways

  • A qualified retirement plan meets the guidelines set out by ERISA.
  • Qualified plans qualify for certain tax benefits and government protection.
  • Non-qualified plans do not meet all ERISA stipulations.
  • Non-qualified plans are generally offered to executives and other key personnel whose needs cannot be met by an ERISA-qualified plan.

Qualified Plans

Qualified plans are designed to meet ERISA guidelines and, as such, qualify for tax benefits on top of those received by regular retirement plans, such as IRAs.

Employers deduct an allowable portion of pre-tax dollars from the employee's wages for investment in the qualified plan. The contributions and earnings then grow tax-deferred until withdrawal.

A qualified plan may have a defined contribution or a defined benefit structure. In a defined contribution plan, employees select investments, and the retirement amount will depend on the decisions they made. With a defined benefit structure, there is a guaranteed payout amount and risk of investing transfers to the employer.

To qualify as an ERISA plan, plan sponsors must meet a number of guidelines regarding participation, vesting, benefit accrual, funding, and plan information.

Non-Qualified Plans

Many employers offer primary employees non-qualified plans as part of a benefit or executive package.

Non-qualified plans are those that are not eligible for tax-deferral benefits under ERISA. Consequently, deducted contributions for non-qualified plans are taxed when the income is recognized. In other words, the employee will pay taxes on the funds before they are contributed to the plan.

In most cases, the employer may not deduct any contributions made to non-qualified plans.

Special Considerations

The main difference between the two plans is the tax treatment of deductions by employers, but there are other differences.

Qualified plans have tax-deferred contributions from the employee, and the employer may deduct amounts they contribute to the plan. Non-qualified plans use after-tax dollars to fund the plan and, in most cases, the employer cannot claim their contributions as a tax deduction.

A plan must meet several criteria to be considered qualified, including:

  • Disclosure – Documents about 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 to prevent excessive weighting in favor of higher-paid employees.

Non-qualified plans are often offered to key executives and other select employees. They can be designed to meet the specific needs of these employees when qualified plans cannot meet those needs.

Advisor Insight

Thomas M. Dowling, CFA, CFP®, CIMA®
Aegis Capital Corp, Hilton Head, SC

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.