A nonqualified retirement plan is one that does not meet Internal Revenue Service guidelines for special tax benefits or the rules of the Employee Retirement Income Security Act. Nonqualified plans are funded by employers and can be limited in the employees they include. They often are used to provide additional benefits to upper-level managers and usually pay benefits from annuities, which count as taxable income.
Internal Revenue Code Section 457 retirement plans for state and municipal employees and 403b programs for nonprofit organizations are nonqualified plans. They technically are deferred-compensation plans in which money is set aside from pay for retirement. The money isn't available to the employee until service with the employer ends and isn't considered taxable income until it is withdrawn. Employee contributions to 403b plans are limited to $17,500.
Many nonqualified plans are "top hat," "excess benefit" or "supplemental executive retirement" types designed to give extra benefits to high-paid or upper-level executive employees. They generally are supplements to qualified retirement plans offered to all employees. Benefits are typically paid from annuities at retirement and are fully taxable.
Nonqualified plans don't have any limit on contributions, and money put into them and the earnings they make are tax-deferred just like in a qualified plan. They're flexible, so employers can structure them in many different ways to best suit the company. They're free from government regulations and most reporting requirements. However, contributions are not protected from company creditors, and an employee who quits may forfeit her rights to benefits.
A nonqualified plan can offer benefits above those offered to all employees, but employers cannot deduct funding for nonqualified plans until the benefits are actually paid. An employee is obligated to begin paying taxes on nonqualified retirement benefits as soon as he is entitled to receive them, whether or not they are actually collected. An exception is when the employer's promise to pay is unfunded and unsecured.
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