Unqualified Retirement Plan – Definition, Benefits and Examples

 

Millions of employees save for retirement by suspending part of their compensation in a tax-deferred savings plan sponsored by the employer. Most of these are known plans and fall under the jurisdiction of ERISA guidelines, which means that they are subject to certain restrictive requirements.

These requirements may, for example, relate to the type and number of employees participating, as well as the amount of money placed in the plan by rank-and-file employees compared to executives and owners.

However, there are times when a qualified plan does not meet the goals of an employer. For example, a company wants to defer a higher amount for retirement than is permitted under a qualified plan, or reward itself or a key employee with additional benefits and compensation that is not offered to the majority of employees. In such cases, non-qualified plans are used to achieve specialized objectives.

Characteristics of non-qualified plans

 

Because of their flexibility, non-qualified plans have very few established criteria that they must meet. These plans are usually tailor-made on a case-by-case basis and come in all shapes and sizes.

They can be relatively simple or fairly complex, depending on various factors, such as the objectives of the employer and the number of employees included. In addition, the funds that are placed in it are growing tax-deferred as long as certain conditions are met.

Present value of life insurance

Unqualified plans are usually funded with life insurance policies at present value. Also known as “permanent” insurance, cash value policies accumulate cash within the policy of some of the premiums paid. This type of policy is “fully paid up” once a certain amount of premium has been paid. Premium payments are currently being stopped and the policy remains in force until the death of the insured.

Money can also be withdrawn from the present value of the policy in the form of a tax-free loan that does not have to be repaid. However, the policy will charge interest on the loan and the death benefit paid by the policy will be reduced by the amount of outstanding loans.

The policy can also expire if too much money is earmarked. But cash-based life insurance policies are an ideal vehicle for non-qualified plans for a few important reasons:

  1. There are no premium limits for life insurance.
  2. Its present value can be withdrawn and used as pension income with no tax consequences in most cases.

Plan structure

Because non-qualified plans do not fall under the ERISA regulations, such as their qualified cousins, they do not enjoy the same tax benefits. To ensure that fund investments are postponed for tax purposes, the IRS has mandated that the money in these plans must usually meet two conditions:

  1. Plan assets must be separated from the rest of the employer’s assets.
  2. Plan assets must run a significant risk of loss. This means that in the event of bankruptcy they can be seized by creditors.

To achieve this, the assets in an unqualified plan are usually placed in an irrevocable trust, which is a type of legal instrument that is funded by a grantor (in this case the employer) for the benefit of the employee beneficiary (who may be a person or a group of people).

In most cases, two types of irrevocable trusts are used:

  1. Rabbi Trust . A rabbi’s trust is a trust that irrevocably secures fund investments for the benefit of employees, but still gives creditors access to the funds if the employer becomes insolvent. All assets placed in this type of trust are tax-deferred until they are paid to the beneficiary.
  2. Secular Trust . Equivalent to rabbi confidence, except that all assets placed in this trust are unconditionally exempt from seizure by creditors. However, the assets placed in these trusts are subject to tax.

The rules regarding these plans present a dilemma, because both employers and their employees generally require that fund investments be safe for creditors while maintaining their tax deferral status. That is why many plans have chosen to use a rabbicular trust.

A rabbicular trust is a hybrid that acts as a rabbi’s confidence for the duration of the plan, unless the employer encounters financial difficulties or goes bankrupt. Then this trust relationship will be automatically converted into a secular trust relationship, resulting in immediate taxation of fund investments, but also protecting assets against creditors. If this happens, fund investments are usually immediately distributed among the participants.

Objectives of non-qualified plans

Non-qualified plans can achieve different objectives for employers that cannot be achieved with qualified plans such as:

  • Offer extra compensation for an important employee without losing control of the company. This is valuable because it allows an employer to financially reward an employee without having to make that person a partner or co-owner of the company. For example, a computer company owned by a very smart businessman may hire a key programmer or designer who is indispensable to the company but is not qualified to make competent business decisions. The owner could therefore prepare a non-qualified plan for this person that offers him or her discriminatory compensation.
  • Recruit top talent and encourage them to stay with the company until retirement. Many unqualified plans have “golden handcuffs” arrangements that stipulate that plan participants leaving the company or going to work for a competitor lose their rights to plan benefits.
  • Offering additional compensation for a director who is terminated in the event of a takeover or takeover. This is usually referred to as a “golden parachute plan or clause”.

 

Advantages disadvantages

Advantages disadvantages

Benefits of non-qualified plans

Non-qualified plans have several advantages over their qualified counterparts, including:

  1. No limits on contributions . Hundreds of thousands of dollars can be placed in these plans in a single year at the employer’s discretion.
  2. Tax dependence . As long as the segregation and expiration requirements are met, all the money that is placed in these plans is tax deferred as it would in an IRA or other qualified plan.
  3. Insurance benefits . Unqualified plans can pay large Dad death benefits. Moreover, modern policies can offer different types of protection in a single policy with the use of riders who pay benefits for disability, critical illness and long-term care in addition to death. This type of policy effectively offers the employee a package of benefits that he or she can count on as long as the conditions of the plan are met.
  4. Freedom from ERISA requirements . These rules prohibit discrimination among employees and require top-heavy tests for qualified retirement plans.
  5. Aanbig Daddyy flexibility . Non-qualified plans can be structured in different ways according to the needs of the participants.
  6. Additional benefits . These plans require minimal reporting and submission, and are usually cheaper to establish and maintain than qualified plans.

Disadvantages of non-qualified plans

Some of the limitations of non-qualified plans include:

  1. Great Daddyijk risk of loss . Unlike money in qualified plans, funds that are placed in non-qualified plans are usually subject to attachment by creditors. If this risk does not exist, the plan may become invalid and all assets currently covered by the plan become immediately taxable for the employee. The IRS also stipulates that money in these plans that becomes unconditionally available to employees will be considered as taxable income.
  2. “Golden Handcuff” provisions . Employees who do not complete their duties at the company or who do not meet other requirements specified in the plan generally lose their entitlement to the benefits that would otherwise have been paid.

 

The 4 types of non-qualified plans

 

The 4 types of non-qualified plans

There are four basic types of unqualified plans: deferred compensation plans, plans for executive bonuses, collective carve-out plans and plan for life insurance with a split dollar.

As mentioned earlier, they are usually funded with cash-based life insurance, but annuity contracts can also be used in some cases, such as for deferred compensation plans designed to make cash payments to participants when they retire.

1. Deferred compensation plans

This is probably Daddyijk’s most common type of non-qualified plan and is usually offered to senior executives or key employees of small businesses as an additional form of compensation. One of the main objectives of deferred compensation plans is to reduce the amount of tax paid by the employee. This is achieved by postponing it until the moment of retirement when he or she is hopefully in a lower tax bracket. These plans often also contain a ‘golden handcuff’ provision.

Deferred remuneration plans come in two forms: deferred savings plans and SERPs (supplementary pension plans). These two types are similar in many respects, but deferred savings plans are funded by employee contributions, while SERPs are fully funded by the employer. Deferred savings plans usually reflect their qualified cousins ​​with fixed contributions, such as 401k plans, where the employee can set aside a certain percentage of the profit to grow in investment funds or at a fixed interest rate guaranteed by the employer.

SERPs, on the other hand, are generally structured as a private form of defined benefit plans and are funded by a type of zinc fund or a collective life insurance contract (COLI). Plan benefits can also be paid directly from the company’s cash, according to an agreement.

2. Executive bonus plans

Section 162 of the Internal Revenue Code considers bonuses of up to $ 1 million to executives as a reasonable remuneration. Many companies pay these bonuses in cash, but some employers choose to pay them in the form of additional benefits instead. These plans are therefore known as executive bonus plans and they are perhaps the most versatile type of non-qualified plan used today.

Unlike deferred compensation plans, executive bonus plans are funded in the employee’s name and are often transferable. These plans usually consist of payments in a cash value life insurance policy or a combination policy that offers a package of benefits, such as life, critical illness, disability and long-term care coverage.

In most cases, the employer pays the premiums on behalf of the employee and reports this to the employee as additional taxable compensation on the W-2 tax form. The costs of the policy are then deductible as operating costs for the employer. The employer continues to pay the premiums of the policy until the employee leaves the company, retires or the policy is fully paid up. The employee can then gain access to the present value in the policy as an additional source of pension income.

Some employers will also give the employee an additional amount of money to pay tax on the original bonus through a “double bonus” scheme. It should be noted that the bonus for employees can in fact take the form of cars or other benefits rather than money or insurance, although the latter two are the most common.

 

3. Group Carve-Out Plans

This type of non-qualified plan is always layered on top of a group-level life insurance plan. Lifelong group plans enable employees to receive up to $ 50,000 in term life insurance without this being counted as additional taxable compensation. With this plan the employees are ‘selected’ who have been selected to receive extra cash insurance coverage on top of the group plan. The employer pays the premiums for the cash value policies directly to the insurance company or bonuses the money to the employee, who then pays the premiums.

Any type of monetary value policy can be used for this, including entire life, universal life or variable universal life. Group carve-out plans may also be eligible for simplified acceptance by insurance companies, providing cover to valued or otherwise uninsurable participants.

Some types of plans require the employer to pay the death benefit directly to the beneficiary from the company fund. In this case, the benefit is taxable as income for the beneficiary. There are many factors to consider when comparing the costs and benefits of this type of plan with an executive bonus or a split dollar plan, including the tax brackets of the employer and employees, the amount of benefits that must be be paid and the premium costs. In many cases, however, group carve-out plans can be the most economical type of non-qualified plan.

A cousin of the collective breakdown plan is the Section 79 Plan, a program that is suitable for small, closely-owned companies that register as C-companies or preferred C-corp treatments as LLCs. This type of plan allows employers to apply a deduction for the payment of life insurance premiums for employees who exceed the level of the standard group plan, while employees generally have to declare as income only about two thirds of this premium. The rules regarding who can participate in a plan of Paragraph 79 are quite complex and employers must ensure that these rules are followed closely to prevent tax penalties.

4. Split-dollar life insurance

As the name implies, a plan for a split dollar is a partnership between two parties (employer and employee) who both have a part of a single cash-worth life insurance policy. The employer retains a percentage of the ownership of the death benefit equal to the premium costs paid by the employer, while the employee receives the remainder. Employees are generally taxed on the amount of insurance premiums that the IRS regards as “economic benefit” for the employee, known as the PS 58 charges.

Plans with a split in dollars can be classified according to one of two forms of ownership: endorsement and collateral assignment. The former method is the employer as the owner, who subscribes the correct percentage of the present value and death benefit to the employee, who either owns no shares in the company or, at most, a minority of shares.

In the collateral allocation method, the owner of a majority stock is the owner of the policy. The employee assigns the correct percentage of ownership of the present value and death benefit to the employer as collateral in exchange for the premium payment by the employer. In most cases, the death benefit received by the employee’s beneficiaries is tax-free.

Last word

Non-qualified plans can be structured and used in different ways to achieve the different specialized objectives of employers and employees. Although their lack of regulation offers a lot of freedom compared to qualified plans, non-qualified plans do not have the same tax benefits as their qualified cousins.

Although there are general guidelines on how these plans are taxed, the specific rules may vary considerably depending on various factors and must be analyzed and monitored individually and regularly.

Since non-qualified plans usually contain large amounts of money, it is vital to ensure that tax rules and other rules regarding financing and benefits are followed to prevent direct taxation of benefits and fines for employees.

For more information about non-qualified plans, dowBig Daddyoad IRS Publication 575 on pension and annuity benefits, or consult your financial advisor.

 

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