Non-qualified plans on a W-2 refer to a kind of retirement savings plan tax-deferred and sponsored by an employer. These retirement plans fall outside the Employee Retirement Income Security Act(ERISA) guidelines, which is why they are non-qualified. They are also exempt from regulations, discrimination, and testing that qualified retirement plans need.
Non-qualified plans are additional retirement savings options created to meet high-paid employees' and critical executives' specialized retirement requirements. These plans are also offered as a benefit to top executives for recruitment and retention in the organization.
Please note that 401(k) and 403(b) are qualified retirement savings plans, and the information for the non-qualified retirement plan does not apply to the mentioned popular retirement plans.
How Do Non-Qualified Plans Work?
The employer funds the non-qualified plans using after-tax dollars. Although the compensations are taxable for the employees, they can defer their taxes until after retirement to benefit from low tax payments.
Moreover, the contributions have no limit and allow employers and employees to contribute as much as they like.
What are the Major Non-Qualified Plans?
There are four major non-qualified plans briefly discussed in this part.
1. Deferred-Compensation Plans: Two types of deferred compensation plans include true deferred compensation and salary-continuation plans. Both of the plans’ goal is to supplement executives with retirement income. But the primary variation lies in the funding source.
In true deferred compensation plans, employees receive a portion of their salary upon retirement(or a year later) as a pension, bonus income, or stock option plan. It’s also sometimes called the 457(b) plan or 457(f) plan. This plan includes excess benefits, severance pay plans, and wraparound 401(k).
On the other hand, in a salary-continuation retirement plan, an employee receives a reduced monthly salary from the company after retirement.
2. Executive Bonus Plan: Executive bonus plans are simple. In this plan, the employer supplements the selected executives and employees with a life insurance policy with annual employer-paid premiums as a deductible bonus. The employers may treat the compensation as tax-deductible to cover the executives’ taxes.
3. Group Carve-Out Plan: This plan is another life insurance coverage arrangement where the employer replaces the group life insurance policy above $50,000 with an individual policy arrangement. It helps the employee avoid any additional costs.
4. Split-Dollar Life Insurance Plan: Employers offer this plan when they want to provide their essential executives with a permanent life insurance policy. In this plan, the employer buys the life insurance policy and shares the premium costs, cash value, and legal benefits with the employee. Such retirement plans are not highly regulated and differ based on the contract and circumstances.
Who Are Eligible Employees for a Non-Qualified Plan?
Employers fund the non-qualified plans with after-tax dollars, and so it is offered to only key executives and select senior employees.
Employers provide their key company members with such incentives to allow them to contribute to another retirement plan because their qualified retirement plans get maxed out due to well-compensated salaries. It also benefits the organization by keeping the key employee working.
There is an exception in the deferred-compensation plan for teachers, but it doesn’t go through their retirement plan. Instead, the teachers can defer a portion of their annual salary at any point in the school year. It helps them keep earning at a flat rate even in the summer when they are not working.
How Do Employers Benefit from Non-Qualified Plans?
Employers also benefit from non-qualified plans along with select employees. Let’s look at ways non-qualified plans benefit employers.
Unlike ERISA's qualified plans, employers control selecting eligible employees for the non-qualified plans.
No non-discrimination rules make the plans flexible to meet the requirements of the individual employees and key executives. As the plans do not have to be proportional for all the employees, the company can prevent excessive weighting favoring the higher-paid employees.
Employers can hold onto key employees by offering non-qualified plans. It works as an incentive for being part of the company; if the employee leaves, they also have to forfeit the plans.
Improvement of cash flow for the employer as a portion of the employee’s income defers for the future incentive plan.
Non-qualified plans have two separate taxes; one is when money is earned, and the other is when the money is paid to you.
When an employee receives their paycheck, monthly FICA taxes, which include Social Security tax(6.2%) and Medicare(1.45%), are deducted, and the remaining sum of money is paid to the employee. This is the tax deduction when money is earned.
However, non-qualified plans benefit the employee by withholding the majority of the federal income tax withholding until the money is paid during retirement. Predictions for these tax calculations are not actually possible as they will be paid far in the future, depending on future tax rates.
Non-qualified plans benefit the employees as they have a lower tax bracket after retirement than during their working days in the company.
Additional Information on Tax of Non-Qualified Plans
All information is essential regarding taxes, and an employer should know the additional tax details of non-qualified plans.
Bonuses or supplemental wages are actually the distributions of the non-qualified plans. They are called so for income tax withholding purposes.
Employers must report non-qualified plans’ distributions in box 11 of an employee’s W-2 form.
Employers must apply federal tax withholdings rules to bonus incomes up to $1 million at a rate of 25%, which increases to 35% when it’s more than $1 million.