Basics of Total Rewards

Non-Qualified Retirement Plans

Non-qualified retirement plans do not receive the same favorable tax treatment as qualified plans but have far fewer restrictions. They are unsecured and subject to seizure by creditors.

Basically, non-qualified retirement plans are a way for organizations to reward their senior staff. Due to the limitations imposed on qualified plans and changes in management compensation, companies now rely more on these plans to create attractive executive compensation packages.

Some executive staff may receive 50-80% of their total retirement income from non-qualified plans.

Non-qualified vs. qualified plans

As we discussed in the previous section, qualified benefit plans (like a pension or 401(k)) must meet U.S. tax codes. Qualified benefit plans are funded through a trust, and receive favorable tax treatment.

• Employees do not pay taxes on contributions. Instead they are taxed when they receive the benefits.
• There are annual contribution limits
• Employers get a tax deduction on contributions.

Non-qualified plans, on the other hand, have fewer restrictions.

• There is no cap on employee contributions.
• The defined benefit is not limited to a dollar amount.
• There are no discrimination testing requirements.
• It does not have to be funded. (The assets do not have to be held in a trust exclusively for paying the benefits.)
• There are no minimum age requirements, service requirements, or vesting rules.

In organizations today:

• Non-qualified plans are a way to retain talent.
• Compensation may be deferred under these plans with payments informally funded, often using life insurance as a capital accumulation device. This lets employees take advantage of the tax-free buildup of cash values, the same advantage as found in a qualified retirement plan trust.
• Rabbi trusts are being used to hold the assets of these plans. These are company-owned trusts set up to meet non-qualified benefit payments and they are not out-of-bounds to company creditors.

Advantages of non-qualified plans

Non-qualified plans are investment vehicles used by organizations for the benefit of executives allowing them to defer taxation of compensation contributed to the plan. The employee defers taxation on the benefit that is not "constructively received." These plans are extremely popular among executives who control when and how the payment is received. They are tax effective and useful for attracting and retaining management. However, with the 2004 American Jobs Creation Act also referred to as 409A, these plan designs have become more complex and less flexible in terms of when and how the deferred compensation is constructively received. For more information, see DLC Course 74: Trends in Retirement Plans.