Nonqualified Retirement Plans

Lesson

Nonqualified retirement plans are employer-sponsored retirement plans that do not meet the requirements set forth by the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC) for tax-favored status. These plans are typically offered to highly compensated employees and executives to provide additional retirement benefits beyond those provided by qualified retirement plans.

Practice Question #1

Which of the following is a characteristic of a nonqualified retirement plan?

A) Meets the requirements for tax-favored status under ERISA and the IRC

B) Offered to all employees of a company

C) Provides additional retirement benefits beyond those provided by qualified retirement plans

D) Subject to the same contribution limits as a 401(k) plan

Select an option above to see an explanation here.

A) Nonqualified retirement plans do not meet the requirements for tax-favored status under ERISA and the IRC. B) Nonqualified retirement plans are typically offered to highly compensated employees and executives, not all employees. C) Nonqualified retirement plans provide additional benefits beyond those provided by qualified retirement plans. D) Nonqualified retirement plans are not subject to the same contribution limits as a 401(k) plan.

Terms

Nonqualified retirement plan:: A retirement plan that does not meet the requirements for tax-favored status under ERISA and the IRC.
Deferred compensation:: Compensation earned but not received until a later date, typically upon retirement or termination of employment.
Top-heavy plan:: A retirement plan in which key employees hold more than 60% of the plan's assets.
Key employee:: An employee who is an officer, a 5% owner, or a 1% owner with annual compensation greater than $150,000.
Highly compensated employee:: An employee who owns more than 5% of the company or has compensation exceeding a specified threshold.
SERP:: Supplemental Executive Retirement Plan, a nonqualified retirement plan for executives.
Excess benefit plan:: A nonqualified retirement plan designed to provide benefits over the limits imposed by qualified retirement plans.
Golden parachute:: A provision in an executive's employment contract that provides significant benefits in the event of a change in company control.

Practice Question #2

Which of the following is an example of a nonqualified retirement plan?

A) 401(k) plan

B) Defined benefit plan

C) Supplemental Executive Retirement Plan (SERP)

D) Individual Retirement Account (IRA)

Select an option above to see an explanation here.

A) A 401(k) plan is a qualified retirement plan. B) A defined benefit plan is a type of qualified retirement plan. C) A Supplemental Executive Retirement Plan (SERP) is a nonqualified retirement plan for executives. D) An Individual Retirement Account (IRA) is a qualified retirement plan.

Do Not Confuse With

Qualified retirement plan:: A retirement plan that meets the requirements for tax-favored status under ERISA and the IRC.
401(k) plan:: A type of qualified retirement plan that allows employees to make pre-tax contributions to a retirement account.
Defined benefit plan:: A qualified retirement plan that provides a specified benefit at retirement based on factors such as salary and years of service.
Defined contribution plan:: A qualified retirement plan in which the employee and employer contribute to an individual account, with the retirement benefit based on the account balance.

Practice Question #3

Which of the following is a key characteristic of nonqualified retirement plans?

A) They are subject to ERISA guidelines

B) They are available to all employees

C) They offer tax-deferred growth

D) They require mandatory contributions from employees

Select an option above to see an explanation here.

A) Nonqualified retirement plans are not subject to ERISA guidelines. B) Nonqualified retirement plans are typically offered to a select group of employees, such as executives. C) Nonqualified retirement plans offer tax-deferred growth, which is a key characteristic of these plans. D) Nonqualified retirement plans do not require mandatory contributions from employees.

Historical Example

In the 1980s, many companies began offering nonqualified retirement plans to their executives to provide additional retirement benefits beyond those provided by qualified retirement plans. This trend was partly driven by changes in tax laws that limited the amount of compensation that could be deferred under qualified plans.

Practice Question #4

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Example Series 65 Example Practice Question

Real-World Example

A large corporation offers its CEO a nonqualified deferred compensation plan and a 401(k) plan. The CEO can defer a portion of her salary and bonus into the nonqualified plan, which will be paid out upon her retirement or termination of employment. This allows her to save for retirement on a tax-deferred basis while also providing additional benefits beyond the limits of the 401(k) plan.