Are you looking to reward a few highly compensated employees? Are you unwilling to take on a lot of extra benefits paperwork and administrative costs? A nonqualified retirement plan could meet the
needs of your organization and your employees.
A qualified retirement plan must meet the requirements of Internal Revenue Code Section 401(a) and the Employee Retirement Income Security Act (ERISA) for coverage, participation, funding, vesting and reporting. In return, employers and participants enjoy certain tax advantages.
Meeting these requirements takes diligence, time and paperwork. Qualified plans cannot discriminate in favor of highly compensated employees. They must cover at least 70 percent of non-highly compensated employees, and employers must generally offer them to all full-time employees on the same terms. Any time an employer makes a contribution, it must make contributions on behalf of all participants. Some plans require employers to make annual contributions whether or not the company is profitable. Qualified plans require extensive reporting and, depending on how they are structured, you might have to perform complicated nondiscrimination tests.
Despite the administrative burdens, qualified plans offer valuable tax advantages for both the employer and participating employees. Employers can take a current tax deduction for all qualified plan contributions, while employee accounts grow tax-free until the time of distribution. Qualified plans also have further protections under ERISA, the Employee Retirement Income Security Act of 1974. This federal law requires accountability of plan fiduciaries and gives participants the right to sue for benefits and breaches of fiduciary duty. Employer contributions to qualified plans are held in trust until the employee is entitled to receive them, an arrangement that helps assure employees that the money will actually be there when they retire.
Nonqualified deferred compensation (NQDC) plans are employer-sponsored retirement plans designed to benefit a select group of executive or key employees. If the plan is properly structured, the employer can include only those employees it chooses — without having to abide by the anti-discrimination, participation or vesting rules that qualified plans must follow. NQDC plans may be formal or informal, and they need not be in writing.
NQDC plans typically fall into four categories. Salary reduction arrangements allow participants to defer receipt of a portion of their salary. Bonus deferral plans resemble salary reduction arrangements, except participants can use them to defer receipt of bonuses. In both these types of plans, participants elect to defer a portion of their compensation.
Employers who want to contribute to an NQDC can select from a top-hat plan or an excess benefit plan. Also known as supplemental executive retirement plans, or SERPs, top-hat plans benefit a select group of management or highly compensated employees, while excess benefit plans provide benefits solely to employees whose benefits under the employer’s qualified plan are limited by IRC Section 415. NQDC plans maintained by governmental and tax-exempt employers, referred to as 457 plans, are subject to a special set of rules.
Although non-qualified plans are subject to fewer government regulations, they receive fewer tax benefits. Any earnings in the plan are taxable to the employer and taxable to the employee when distributed as benefits. However, the employer can take a tax deduction at the time of distribution. And since non-qualified plan contributions are not held in a separate trust, employees receive no guarantee that benefits will be there when they retire — and any assets set aside for future payouts are subject to claims by the employer’s creditors.
NQDC plans are either funded or unfunded, though most are intended to be unfunded because of the tax advantages unfunded plans afford participants. Under an unfunded arrangement, the employee has only the employer’s “mere promise to pay” the deferred compensation benefits in the future, and the promise is not secured in any way. The employer may keep track of the benefit in a bookkeeping account, or it may choose to invest in annuities, securities or insurance to help fulfill its promise to pay the employee. The employer may transfer benefit amounts to a trust; however, funds remain part of the employer’s general assets, subject to the claims of creditors if the employer becomes insolvent. If amounts are set aside from the employer’s creditors for the exclusive benefit of the employee, the employee may have currently includible compensation.
If you’d like to supplement your qualified plan with a nonqualified plan, please contact us for assistance and information.
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