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Difference Between Tax Qualified vs Non Tax Qualified Retirement Plan
Reading about various kinds of retirement plans, you’re bound to come across terms such as “non tax qualified” and “tax qualified.” These terms have far-reaching implications on the manner in which such plans operate as well as on their present as well as future taxations. As an employee, it is very important that you know how the structure of your retirement plan will influence investments in the future as well as have an idea about tax qualified vs non tax qualified retirement plans.
What Is a Qualified Retirement Plan?
The Employee Retirement Income Security Act (ERISA) regulates qualified plans.
Advantages of Qualified Retirement Plans
Employers prefer qualified plans since they offer advantageous tax benefits to the employer as well as individual employees. Some advantages include:
- Pre-tax contributions: Contributions to qualified plans are taken directly from an employee’s salary and done on an pre-tax basis.
- Tax-deferred growth: Earnings on a tax-deferred basis accumulate, with no tax payments being made until you withdraw money from the account.
Disadvantages of Qualified Retirement Plans
There also exist some disadvantages to qualified plans that one should know about, including:
- Restrictions: Various requirements and restrictions for these plans include limited investment, filing requirements, nondiscrimination, and other provisions which render them quite costly to maintain.
- Penalties and taxes: In case there are distributions from the account for an unqualified expense before an employee has reached an agreed-upon age, there will be penalties and taxes. This specified age is 59 and a half at present.
Examples of Qualified Retirement Plans
Examples of tax qualified retirement plans include retirement plans, such as:
- Keogh plans
- 401(k) plans
- 403(b) plans
- Pension plans
- Profit-sharing plans
- Simplified employee pension plans (SEPs)
What Are Nonqualified Retirement Plans?
Nonqualified plans are retirement plans offered by employers that ERISA does not govern.
Pros of Nonqualified Retirement Plans
There are a few advantages of nonqualified retirement plans that may appeal to you, such as:
- Designed for executives: Since these plans are exempt from the discriminatory and top-heavy testing in qualified plans, they are often designed for executives whose needs are not entirely met by qualified plans.
- Defer taxation: Nonqualified retirement plans may sometimes allow the employee to defer taxation until retirement when they access the funds in their plan.
- Tax-deferred growth: The amount invested into a nonqualified plan can grow tax-deferred until it is accessed in retirement.
Cons of Nonqualified Retirement Plans
There are also some disadvantages of nonqualified retirement plans that you may want to consider, such as:
- Lack of tax benefits for the employer: While a qualified retirement plan may offer tax advantages to both the employee and the employer, nonqualified retirement plans aren’t deductible for employers.
- Taxable contributions: In some cases, employees may need to pay taxes right away on their contributions to a nonqualified retirement plan.
- Limited eligibility and availability: Nonqualified retirement plans are often available only to certain employees, particularly executives and highly compensated employees.
Examples of Nonqualified Retirement Plans
Unlike qualified retirement plans, a nonqualified retirement plan doesn’t have set features that you are required to include. There are some broad categories of nonqualified agreements, however, such as:
- Bonus deferral plan: This type of nonqualified retirement plan enables employees to delay bonus receipts.
- Excess benefit plan: This type of nonqualified retirement plan provides benefits to employees limited by IRS restrictions regarding retirement plan benefits and contributions. An excess benefit plan is sometimes referred to as a Section 415 nonqualified plan because its limitations come from Section 415 of the IRC.
- Salary reduction arrangement: This type of nonqualified retirement plan lets an employee delay receipt of income.
- Supplemental executive retirement plan (SERP): This type of nonqualified retirement plan is also referred to as a top-hat plan. This plan is intended to benefit a specific group of employees. Typically, this group of employees is management or executives.
Examples of nonqualified plans within these broad categories include:
- Group carve-out plans
- Executive bonus plans
- Deferred compensation plans
- Split-dollar life insurance plans
- Individual retirement accounts (IRAs) with the exception of SEPs
FAQs
1: Is a 401(k) Plan Qualified or Nonqualified?
401(k) plan is considered a qualified retirement plan. If your company offers employees a 401(k), you may get a tax break by contributing a percentage on your employees’ behalf.
2: Is a Traditional IRA Qualified or Nonqualified?
Traditional individual retirement accounts (IRAs) are considered nonqualified retirement plans. This is because these plans are not created by employers. The exception to this rule is if you offer your employees a SEP IRA option.
3: Is a Roth IRA Qualified or Nonqualified?
Similar to a traditional IRA, a Roth IRA is a nonqualified retirement plan, as employers do not offer it to employees. For many taxpayers, however, an IRA can offer similar tax benefits to a qualified plan.
4: Are Pensions Considered Qualified or Nonqualified?
Most pension plans are considered qualified retirement plans, including SEP plans and salary reduction simplified employee pension (SARSEP) plans.
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