The 401(k) has become the cornerstone of retirement savings for millions of American workers, offering a powerful way to build wealth through tax-deferred growth. Bolstered by recent legislation like SECURE 2.0, which introduced incentives such as tax credits for small businesses launching plans, the 401(k) remains the go-to choice for employers. Yet, beyond this familiar option, a range of qualified and non-qualified retirement plans can unlock unique benefits, particularly for companies aiming to attract and retain top talent. Let’s explore how these plans work and why they matter.
Qualified vs. Non-Qualified Plans: A Clear Distinction
Qualified retirement plans, sponsored by employers, adhere to the Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA). These plans offer compelling advantages: contributions—whether from the employer or employee—are tax-deductible, and investment gains grow tax-deferred until withdrawal. They also typically shield assets from creditors, providing a layer of security. Qualified plans fall into two categories: defined-benefit plans, like pensions, which promise a fixed payout, and defined-contribution plans, like 401(k)s, where the payout depends on contributions and investment performance.
Non-qualified plans, by contrast, operate outside IRC and ERISA requirements. While they can still defer taxes on investment gains, they lack the same regulatory protections and are generally not shielded from creditors, though protections vary by plan type and state law. Often designed for highly compensated employees (HCEs), employer-sponsored non-qualified plans provide additional tax deferral when 401(k) limits are maxed out. These include deferred compensation plans, executive bonus plans, split-dollar life insurance plans, and group carve-out plans—each tailored to specific needs.
Unpacking Non-Qualified Plans
Non-qualified plans shine as tools to reward and retain key employees. Here’s how they work:
Deferred Compensation Plans are the most prevalent, allowing HCEs to defer income—often bonuses—beyond 401(k) limits. This deferred amount grows tax-free until retirement, when it’s taxed as ordinary income (with FICA taxes applied at vesting). They come in two forms: employee-driven deferrals or employer-funded future benefits, ideal for those expecting a lower tax bracket later.
Executive Bonus Plans involve the employer purchasing a life insurance policy for a key employee, with premiums treated as a taxable bonus. The employer deducts these payments, and in some cases, adds extra to cover the employee’s taxes, making it a compelling retention tool.
Split-Dollar Plans use life insurance to split benefits between employer and employee. The employer typically covers most of the premium, while the employee pays the insurance cost. At the employee’s passing, their beneficiaries receive a portion of the death benefit, as defined by the agreement, and the employer recoups its investment.
Group Carve-Out Plans replace group life insurance above $50,000 for key employees with individual policies. This sidesteps imputed income taxes on excess coverage, with the employer redirecting premiums to the employee-owned policy—a tax-efficient perk.
While non-qualified plans don’t carry the full protections of qualified plans, their flexibility makes them invaluable for targeting benefits to high-value employees, aligning with strategic business goals.
Why Consider Both?
The 401(k)’s popularity stems from its broad appeal and tax advantages, amplified by SECURE 2.0’s push for wider adoption. Yet, for companies with HCEs, non-qualified plans offer a way to go beyond standard limits, creating tailored incentives without the constraints of ERISA compliance. For example, a cash balance plan—a qualified defined-benefit option—can allow significant contributions (potentially hundreds of thousands annually for older HCEs), complementing a 401(k). Costs vary, with setup fees ranging from a few thousand dollars to tens of thousands and annual administration between $20,000 and $70,000 for larger plans, often absorbed by the plan itself, though companies bear the risk of underperformance. The choice hinges on fit—qualified plans like 401(k)s suit broad employee bases, while non-qualified plans target key players. Both require careful design to maximize tax benefits and align with long-term objectives, whether it’s fostering retirement readiness or securing executive loyalty.
Your Next Step
At Rothschild Retirement Planning Services, we specialize in crafting retirement strategies that match your company’s vision. Whether you’re exploring a 401(k), a cash balance plan, or a non-qualified option for your leadership team, our advisors are ready to provide tailored guidance. Contact us to start shaping your plan today.
The information presented is general in nature, is not and should not be construed as a recommendation to purchase or sell any particular security or strategy. This material is for informational purposes only and is not intended to provide investment, legal, tax recommendations or advice.
