Non-Qualified Retirement Plan: Types & Examples

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

In this lesson we will define and give examples of the four common types of non-qualified retirement plans available to corporate executives and other highly compensated employees.

Non-Qualified Retirement Plans

Many workers are familiar with the concept of retirement plans such as Roth IRAs, 401(k)s, and other forms of tax sheltered retirement accounts. For high level executives and other certain highly compensated employees, there are additional plan options available in the event they no longer qualify for typical retirement plans. Let's take a look at what exactly a non-qualified retirement plan is and review examples of different types of plans.

Definition

A non-qualified retirement plan is a retirement program that doesn't meet Employer Retirement Income Security Act (ERISA) standards. An ERISA qualified account would include a typical retirement account like a 401(k). A non-qualified plan is used to accommodate high level employees who may be excluded from other plans by law, or to provide a retirement benefit option that the company doesn't want to make available to every employee. For example, qualified plans might not allow as much money to be invested as a high income earner would need to put in to meet his retirement goals.

Types

Non-qualified retirement plans describe a class of investment strategies. There are four major types which we will review.

Deferred Compensation

In a deferred compensation plan, an employee elects to wait until a later date to receive his wages. If Bill, a corporate Chief Operations Officer earns $200,000 a year, but elects to defer $25,000, he will actually take home $175,000 before taxes. That $25,000 can then be invested in an account similar to a 401(k) where Bill can invest the money in mutual funds. When he pulls the money out many years later in retirement, he will pay income taxes on the compensation he has delayed, taking any earnings that have accrued. The benefit for Bill is lower taxes now, in his high income earning years, and that the growth of that money in the investment account is tax free.

Executive Bonus Plans

An executive bonus plan allows a company to provide additional compensation beyond regular wages to an employee. One option is for the company to pay the premiums on a cash-value life insurance plan that belongs to Bill. Bill can then access this money as he could with any other life insurance policy that can be surrendered for a cash sum. The company can even include an additional amount to make up for the taxes Bill will have to pay when he takes the money. This is one of the most common options, but executive bonuses can also include perks such as a car purchased by the company and given to Bill, or outright cash payments.

Group Carve-Out Plans

An employer can provide up to $50,000 of group life insurance for an employee without the employee having a tax burden. With a group carve-out plan, Bill's company takes out a separate, individual policy on any amount it wishes to offer Bill in excess of $50,000. This allows Bill to have company-paid life insurance without having to pay taxes on the premiums which would otherwise be considered taxable compensation.

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