Qualified vs. Non-qualified Retirement Plans: What's the Difference?

Employers create qualified and non-qualified retirement plans with the intent of benefiting employees. The Employee Retirement Income Security Act (ERISA), enacted in 1974, was intended to protect workers' retirement income and provide a measure of information and transparency.

In simplest terms, a qualified retirement plan is one that meets ERISA guidelines, while a non-qualified plan falls outside of ERISA guidelines. 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.

The tax implications for the two plan types are also different. Except for a simplified employee pension (SEP), individual retirement accounts (IRAs) plans are not created by an employer and are not qualified plans.

Qualified plans are designed to meet ERISA guidelines and, as such, qualify for added tax benefits on top of those received by regular retirement plans, such as 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 withdrawal.

A qualified plan may have a defined contribution or a defined benefit structure. In a defined contribution plan, employees select investments, and the retirement amount will depend on the decisions they made. With a defined benefit structure there is a guaranteed payout amount and risk of investing transfers to the employer.

To qualify as an ERISA plan, plan sponsors must meet several guidelines regarding participation, vesting, benefit accrual, funding, and plan information.

Many employers will offer primary employees non-qualified plans as part of a benefit or executive package. Non-qualified plans are those that are not eligible for tax-deferral benefits under ERISA. Consequently, deducted contributions for non-qualified plans are taxed when the income is recognized. In other words, the employee will pay taxes on the funds before they are contributed to the plan.

In most cases, the employer may not deduct any contributions made to non-qualified plans.

The main difference between the two plans is the tax treatment of deductions by employers, but there are other differences. Qualified plans have tax-deferred contributions from the employee, and the employer may deduct amounts they contribute to the plan. Non-qualified plans use after-tax dollars to fund the plan and, in most cases, the employer cannot claim their contributions as a tax deduction.

A plan must meet several criteria to be considered qualified, including:

• Disclosure – Documents about the plan's framework and investments must be available to participants upon request.
• Coverage – A specified portion of employees, but not all, must be covered.
• Participation – Employees who meet eligibility requirements must be permitted to participate.
• Vesting – After a specified 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 in favor of higher paid employees.

Non-qualified plans are often offered to key executives and other select employees. They can be designed to meet the specific needs of these employees when qualified plans cannot meet those needs.