Is a Non-Qualified Plan Right for Your Organization?

Retaining high-level, top-performing employees isn’t always easy. In order to establish loyalty and head off the threat of competitors attempting to lure them away, employers need to find the best way to compensate their executives. But if you’re not willing to offer them a piece of the company, you might want to consider providing a non-qualified retirement plan.

Non-Qualified plans vs. Qualified Plans

According to ERISA, plans that do not discriminate among its employees are qualified to receive certain tax advantages. Plans such as 401(k)s and 403(b)s, for example, fall under this category of qualified plans. Any plan that does not treat its employees equally is considered to be a non-qualified plan; the employer chooses who is eligible to participate and who is not. As a result, employers are often denied tax benefits for most non-qualified plans.

The Benefits of Non-Qualified Plans

At first glance, the tax factor may be unappealing to some employers. However, it might be worthwhile for those who believe losing certain executives would be detrimental to the company. When you’re unable to provide overt compensation, such as a partnership, to an employee in order to keep him on your payroll, a non-qualified plan becomes a favorable negotiating factor.

Why? Because the average 401(k) plan isn’t effective for high-income earners since there’s a $17,500 limit on the annual contributions. This means that an executive with a salary half a million dollars a year could never save enough for retirement. But with a non-qualified plan, he could save enough to make his golden years a little more golden.

Employers also have the power to design non-qualified plans to meet the specific retirement needs of each upper-level employee. This also means the plans are completely flexible and even more cost-effective than the typical qualified plan. In addition to choosing who will be allowed to participate, you can also outline what benefits will be provided and define the terms and conditions of the plan.

Non-qualified plans also serve as a way for employers to give additional benefits to high-income individuals already receiving the maximum benefits set by the IRS.

Types of Non-Qualified Plans

In deferred compensation plans, employees will defer a portion of their annual income until a specific date in the future. By participating in this plan, employees won’t have to pay income taxes on their compensation for the year in which it was earned, while being able to invest the funds now so it can potentially grow over time.

In an executive bonus plan, the employer purchases a life insurance policy for select upper-level employees and pays the premiums via a pay raise to those employees. This is particularly appealing to many employers since they are immediately tax-deductible, unlike other types of non-qualified plans. Employers are also expected to compensate these employees if their income taxes rise as a result of the bonus. Employees own the life insurance policy and can control the cash value. They can also obtain tax-free income from the policy through partial withdrawals and loans.

A split-dollar life insurance plan is also a non-qualified plan that provides certain employees with low-cost life insurance. In this plan, an employer and employee agree to share the premium, death benefit, and cash value of a permanent life insurance policy. One major perk is that participating employees are obligated to repay the employer for the advanced premiums.

And then there are group term carve out plans, which provide select employees with extra life insurance benefits, in addition to the basic group plan. Under a typical group term life insurance plan, the cost of the first $50,000 of insurance is tax-free for employees. Since anything higher than that is considered excess coverage, the carved out plan allows high earning employees to receive additional coverage that’s more proportionate to their salary. Either the employer or the employee can own the additional coverage.

If you think a non-qualified plan may be a good fit for your organization, ask your consultant for more information.

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