What Does "Non-Qualified Retirement Plan" Mean?

If your workplace retirement plan is qualified under sections 401(a) or 403(a) of the Internal Revenue Code, you can invest money in the plan tax-free until you take it out in retirement. Non-qualified plans get the same result but have to use different methods. For example, the plan may let you defer collecting your salary -- and paying tax on it -- until you leave the company.


When your employer offers a qualified retirement plan, everyone on staff usually has an equal right to participate, regardless of how much they make or how important they are. If your company wants to reward the top execs alone, it needs a non-qualified plan. Non-qualified plans are often called "top hat" plans because of their exclusivity. To meet the law, the plan must only apply to a "select group of employees"--although what constitutes a select group is a little vague.


Your 401(k) and other qualified plans come with limits on how much you can contribute. Top-hat plans don't have that problem: most of them have no restriction on how much the employee can save tax-free. Postponing some of her salary enables an employee in the top tax bracket to lower her tax bill until she's retired and gone down a bracket or two. The decision to defer your income has to be made at the start of the year. If you realize in July that you want to defer income and cut your taxes, too bad.


Federal law gives qualified plans a lot of protection: corporate creditors can't touch the money in your 401(k), for instance, even if the company goes belly up. Non-qualified plans don't have that option -- you've postponed getting paid so the money isn't legally yours yet. If your employer files for bankruptcy, the money in your plan may go to pay creditors, because it's part of the company's assets. You could end up with nothing to show for your work.


If the government raises taxes on top incomes in the future, deferred compensation plans aren't such a great deal. Instead of paying lower taxes, you may actually have to give the IRS more money when you collect your pay. Another consideration is that if the plan isn't structured to meet federal requirements, the government could decide your deferred pay is taxable after all. Assess your individual situation and decide if a non-qualified plan fits your financial goals.

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