Investopedia’s recent article on this subject asks “Qualified vs. Non-qualified Retirement Plans: What's the Difference?” 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. Note that the tax implications for the two kinds of plans are also different. Except for a simplified employee pension (SEP), individual retirement accounts (IRAs) plans not created by an employer are not qualified plans.
Qualified plans are designed to meet ERISA guidelines. They qualify for added tax benefits, in addition to those received by regular retirement plans, like IRAs. Employers deduct an allowable portion of pretax dollars from the employee's wages for investment in the qualified plan. The contributions and earnings then grow tax-deferred, until they are withdrawn. A qualified plan may also have a defined contribution structure. With this, employees choose investments, and the retirement amount will depend on the decisions they make. With a defined benefit structure, there’s a guaranteed payout amount and the risk of investing moves to the employer.
To qualify as an ERISA plan, the plan sponsors must satisfy guidelines on participation, vesting, benefit accrual, funding and plan information.
Many employers offer employees non-qualified plans as part of a benefit or executive package. These plans are those that aren’t eligible for tax-deferral benefits under ERISA. Deducted contributions for non-qualified plans are taxed, when the income is recognized. Therefore, the employee must pay taxes on the funds before they’re contributed to the plan. Usually, the employer is not able to deduct any contributions made to non-qualified plans.
The big difference between the two plans is the tax treatment of deductions by employers. However, there are some other differences. Qualified plans have tax-deferred contributions from the employee, and the employer can deduct amounts they contribute to the plan. Non-qualified plans use after-tax dollars to fund the plan and, in most instances, the employer can’t claim their contributions as a tax deduction.
A plan must meet several criteria to be considered qualified, including the following:
- Disclosure–information about the plan's framework and investments must be available upon a participant’s request.
- Coverage–A specified portion of employees—but not all—must be covered.
- Participation–Employees who meet eligibility requirements must be allowed to participate.
- Vesting–After a certain 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 for higher paid employees.
Top executives and select employees are usually the ones who are offered these non-qualified retirement plans. One advantage of a non-qualified plan is that they can be designed to meet specific employee needs, when the qualified plans may not be suited for them.
Reference: Investopedia (July 15, 2019) “Qualified vs. Non-qualified Retirement Plans: What's the Difference?”