Qualified vs. Non-Qualified Retirement Plans
As you read about different types of retirement plans, you’re going to run across various terms that have important implications for things like taxation. Two important phrases to look for are “qualified” and “non-qualified” retirement plans. While the two might have similarities, it’s important to understand how their differences impact the investor’s wallet.
What Is a Qualified Retirement Plan?
Qualified retirement plans are governed by a set of federal laws that come from the Employee Retirement Income Security Act (ERISA).
As Susie Roberts, Bank of Labor Vice President & Trust Officer, notes, “These types of plans benefit employers because they receive a tax break for the contributions they make on behalf of employees.”
A business might contribute a certain percentage of an employee’s income to a 401(k) as part of their benefits package. One of the reasons it does this is for the business tax break it receives.
When an employee contributes to a qualified retirement plan, their employer makes the deposit on their behalf before any taxes are taken out if the employees selects a pre-tax contribution. Alternatively, the employee may select to have deposits made post-tax. Depending how the accountholder selected pre or post tax will determine if they will be taxed on the withdrawals made after retirement.
If an employer offers a qualified retirement plan, it must be offered equally to every employee. In other words, the employer can’t offer matching at higher levels to certain employees. Also, you can’t hold certain types of investments in this type of plan.
Common Types of Qualified Retirement Plans
Most employer-sponsored retirement plans are considered qualified plans. But each is going to have its own requirements, rules, and contribution limits. Some of the most common types of qualified retirement plans include the following.
- 401(k) plan
- Employee stock ownership plan (ESOP)
- Pension or other defined benefit plan
- KEOGH plan or H.R. 10 plan
What Is a Non-Qualified Retirement Plan?
Non-qualified retirement plans can help employees save for retirement. However, they have different rules than qualified retirement plans. These plans are not subject to the rules of ERISA.
If you are an employer, there are no tax deductions with these plans, but the good news for employees is that they can defer taxes until after retirement. Since experts advise putting about 15% of your pre-tax income into retirement savings each year, this can be challenging for high-income workers to achieve with a qualified plan alone. Likewise, some self-employed people don’t have access to qualified plans.
Non-qualified plans can fill the gap left by qualified plans. This is because they don’t have annual contribution limits. Employees and self-employed people can contribute as much as they like to one of these plans to save for retirement.
Common Types of Non-Qualified Retirement Plans
Non-qualified plans are available from a variety of sources, including employers, banks, and brokerage firms. Roberts cautions that just because you can get a retirement plan through your employer, it doesn’t necessarily mean it is a qualified plan. You’ll want to ask the question.
Many self-employed people access these plans, as well as those who want to supplement their qualified retirement plans with something more.
Some examples of non-qualified retirement plans include the following.
- Non-qualified deferred compensation plan (NQDC plan)
- Executive bonus plans
- Split-dollar life insurance plans
- Group carve-out plans
Critical Differences Between Qualified and Non-Qualified Retirement Plans
It’s essential to understand the differences between qualified and non-qualified retirement plans because the IRS is involved in your retirement savings in one way or another. Depending on the plan you choose, eligibility and tax treatment will differ. Here are the key differences between these two types of plans.
- Qualified Plan — Must be equally available to all employees as defined by the plan.
- Non-Qualified Plan — Can be made available to only certain employees.
- Qualified Plan — Distribution is generally not permitted before age 59½, but exceptions exist.
- Non-Qualified Plan — There are several options available, but once you choose an option, it can’t be changed.
- Qualified Plan — The plan requires that distributions begin at age 70½.
- Non-Qualified Plan — There are no IRS rules, but plan-specific rules may apply.
Asset Protection from Company Creditors
- Qualified Plan — This is available.
- Non-Qualified Plan — This is not available.
Availability of Loans
- Qualified Plan — Loans are permitted.
- Non-Qualified Plan — Loans are not permitted.
Rollover to IRA Upon Job Loss
- Qualified Plan — This is permitted under the terms of the plan
- Non-Qualified Plan — This is not permitted.
Participant and Company Tax Deduction on Deferrals
- Qualified Plan — This is permitted in the year of the deferral only.
- Non-Qualified Plan — This is only permitted upon distribution.
Qualified retirement plans allow you to build up retirement savings by having your employer invest some of your pre-tax income. The U.S. tax code defines what constitutes a “qualified plan,” like a 401(k).
Non-qualified retirement plans might be available whether you have access to a qualified retirement plan through your employer. However, the money invested is with after-tax dollars.
As an employee or business owner, it’s vital to understand the differences between these two types of plans so that you are optimizing retirement savings and adhering to the law.
Consult a tax advisor for retirement planning.
To learn more about business retirement plans or get answers to other investment or banking-related questions, contact Bank of Labor at 913.321.4242.