Types of NonQualified Plans
When it comes to retirement plans, just when you think you have the basics covered, the language can begin to get a bit tricky.
As an employer, you want to make sure that everyone working for you received some type of retirement benefits. Choosing a plan can be difficult, particularly when it comes to the language of the plan. Many, like 401(k)s are straightforward, but if you are considering offering non-qualified retirement options for your company, you may want to make sure that you understand the vocabulary of the plan and what it means for your company.
What is a NonQualified Plan?
A nonqualified retirement plan is an employer-sponsored, tax-deferred retirement plan. One of the primary differences between qualified plans and nonqualified plans are that nonqualified plans do not fall under Employee Retirement Income Security Act of 1974, or ERISA. ERISA is federal that sets standards for pension plans to protect employees.
The whole purpose of these plans is to provide key executives with bonuses, without having to make them part owners or company partners.
Nonqualified pension plans are designed for a specific purpose: to align with specific retirement needs for key employees and executives. They may not fall under the guidelines of ERISA, but they come with their own set of rules. Before considering offering this type of plan as an employer, you should make sure you thoroughly understand its guidelines.
Main Types of NonQualified Plans
Nonqualified plans come in four main types: executive bonus plans, split-dollar life insurance plans, deferred compensation plans and group carve-out plans.
– An executive bonus plan, occasionally known as a Section 162 plan, allows employers to provide supplemental bonuses to their executives. In many cases, these come in the form of whole life insurance policies with built-in cash benefits and a death benefit. The employer pays the premiums.
– Split-dollar life insurance policies are life insurance policies owned and split by both the employer and the employee. This allows an employee to obtain better life insurance at a lower cost and a portion of the premiums paid for the employee by the employer are tax-deductible.
– Deferred compensation plans are plans in which a portion of an employee’s earnings are paid out after they were earned. This allows employees to use this money to invest in retirement with tax-benefits. Occasionally, these include employee stock options.
– Group carve-out plans have as a base life insurance incentives. These nonqualified plans are group term life policies that allow executives to retain $50,000 in ordinary life insurance coverage, but also allows them to have the benefits of a universal life insurance policy.
For employers, contributions made to these plans are nondeductible. Employees, as well, have to pay taxes on these plans, but the taxes will deffer until retirement. The benefit of this deferral is that employees will be pay taxes within a lower bracket.
Why Would an Employer Offer a NonQualified Plan?
There are several reasons an employer may choose to offer this type of benefit.
In many cases, employers will want to tempt a valuable executive to remain with the company for a set amount of years or simply to provide supplementary compensation.
Nonqualified plans also allow employers to defer compensation – and taxes – for themselves.
In many cases, qualified retirement plans cannot achieve the same goals that nonqualified plans offer. This is because qualified plans have regulations in place requiring employers to provide uniform benefits to all employees.
If an employer is looking attract and retain executive talent, a nonqualified pension plan may be the best choice.
Key Definitions to Know
Nonqualified plans may seem pretty straightforward thus far and, in theory, they are. However, these kinds of plans can trip even the savviest employer or employee up with their confusing language. Here are a few key definitions to look out for:
became popular during a time when company takeovers were a barrier to key executive retention. This refers to a promise made by employers to pay executives a set amount – in addition to their compensation – of company control switches hands.
refer to an agreement between an employer and a key employee or executive that are contingent on meeting certain conditions. For example, an employer may agree to pay out certain supplemental benefits to an executive, but only if the executive remains with the company for a certain amount of years. The purpose of the golden handcuffs is to retain key employees.
In these types of plans, employers use general assets, rather than formally set-aside funds to provide deferred compensation to employees. The employees receiving the deferred compensation in these plans are a select few: typically management or highly-paid executives. There are many special rules surrounding these plans.
Compensation plans that deffer transfer amounts to a trust. These trusts defer taxation to the employee. In case of bankruptcy or unpaid depts, creditors can reach the trust funds.
Taking the time to read over the details of nonqualified plans is extremely beneficial to both employees and employers. Remember: this type of pension plan is not right for every company. Before considering a nonqualified retirement plan as a business owner, you should assess the needs of your company and your employees. Speak to a financial adviser today to find out if nonqualified pension plans are right for you!