Qualified vs. Non-Qualified Retirement Plans: What is the Difference?

Retirement planning is a vast concept that entails picking the right investment and savings instruments, setting an achievable goal, and planning with a reasonable time frame in mind. There are many options that allow good returns for your savings and investments, which is why the decision to choose a suitable product can sometimes be difficult. Retirement accounts can broadly be classified into a qualified or a non-qualified retirement plan. Both these types can offer you great benefits and at the same time, come with a fixed set of rules for withdrawals and contributions.

Here are some important things to know about qualified and non-qualified retirement plans:

Qualified retirement plan

Qualified retirement plans come under the gamut of the Employee Retirement Income Security Act, also known as ERISA. This is a preferred choice for most employers as qualified retirement plans offer them better tax advantages for the contributions made by them. Employers are obliged to offer qualified retirement plans to all the employees of their organization. In the case of qualified plans, a portion of the employee’s income is contributed to the plan as a benefit by the employer.

One of the most commonly offered qualified plans is the 401(k) account. The 403(b) plan is another example. There are some rules that all companies offering such qualified plans must follow. For instance, the employee must be working with the company for at least one year. The type of employment must be full-time. In addition to this, the company must fix the same percentage for matching contributions for all employees without any bias. So, if the matching contribution for a low-level employee is 1.5%, it must be the same for high-level executives as well.

The withdrawals from qualified accounts cannot be taken out until the employee turns 59.5 years. If the funds are withdrawn before this age, a 10% penalty is levied to the employee. You must also follow the rules for required minimum withdrawals starting from the age of 70.5 years. The yearly limit for contributions and catch up contributions is revised by the Internal Revenue Services (IRS) every year for these plans.

Non-qualified retirement plan

Non-qualified retirement plans do not fall under ERISA, which is why the rules for such plans are comparatively more relaxed. Taxes on these accounts are paid by the employee before contributing, and the employer cannot claim the contributions as tax deductions. There is no limit for contributions in non-qualified plans, and both the employee and the employer can contribute anything they want. This is one of the reasons why highly paid employees prefer these plans as it allows them to contribute more than qualified plans. Non-qualified plans must abide by two rules as mandated by the IRS:

• The funds from non-qualified plans have to be separate from any other employer asset.
• In the case of bankruptcy, a non-qualified account can be seized by a creditor just like any other asset.

Some common types of non-qualified retirement plans include executive bonus plans, deferred-compensation plans, and split-dollar life insurance plans.

Qualified vs non-qualified retirement plans:

Major differences Here are some points of distinction between qualified and non-qualified retirement plans:

1. Contribution limit
   There is no limit or restriction on a non-qualified retirement plan as directed by the IRS. The employee and the employer can contribute as per their preferences and needs. On the other hand, a qualified retirement plan has a fixed limit as decided by the IRS for each year. For instance, the revised limit for a 401 (k) account for 2020 is set at $19,500. The catch-up contribution limit for employees over the age of 50 is $6,500. In 2019, the same was set at $19,000 and $6,000 respectively.
2. Eligibility
   An employer must offer a qualified plan to all employers of the company as long as they have been hired for a full-time role and have been working at the organization for at least a year. However, a non-qualified retirement plan can be offered to a limited number of employees as per the discretion of the employer.
3. Required minimum distributions
   In the case of qualified retirement accounts, an employee must make the withdrawals starting at the age of 70.5 years. Any delay in taking out funds beyond this age would result in a penalty. The rules for a non-qualified plan may differ as per each unique account. The IRS does not require any required minimum distributions for non-qualified accounts./li>
4. Risk
   A qualified plan can be protected from creditors in the case of bankruptcy. But a non-qualified plan can be seized by a creditor if the situation demands.
5. Loan facility
   The employee can take a loan against a qualified retirement account if they need urgent funds. The same option is not available to non-qualified account holders.
6. Minimum age for withdrawals
   For most qualified accounts, the employee cannot take out funds before the age of 59.5 years. In case of an early withdraw a penalty is charged to the account holder. However, there can be certain exceptions for a limited number of reasons as per the rules of the account. Non-qualified retirement accounts offer numerous options for withdrawal. But as per section 409A, once a method is selected, the account holder cannot alter it.
7. Rollover to IRA
   In case of loss of a job, a qualified retirement account can be rolled over to an individual retirement account (IRA). The same is not allowed for a non-qualified retirement plan.
8. Taxes
   Qualified retirement plans fall under ERISA and section 401(a) of the Tax Code. A non-qualified retirement plan does not fall under ERISA as a result of which such plans are not eligible for any tax advantages.

To sum it up

Both types come with their fair share of benefits and restrictions and can be beneficial to different people. While non-qualified retirement plans are seen as a good option for people with high salaries, qualified retirement plans may offer more security as they cannot be seized by creditors.

To know more about qualified and non-qualified retirement plans, you can reach out to a Financial Advisor.