What Is a Non-Qualified Savings Plan?

A "qualified" plan is an employer-sponsored retirement savings plan that meets the criteria for special treatment under the federal tax code, so employee contributions aren't subject to income tax, employers can take a tax deduction for contributions they make on behalf of employees, and employees pay no taxes until they withdraw money from their account. Traditional pensions, 401(k) and 403(b) plans, SIMPLE IRA plans and most other retirement plans offered by employers are qualified plans.

Qualified plans are supposed to be geared toward a company's rank-and-file workers, rather than its top management. The tax code gives these plans special treatment to make it easier for average Joes and Janes to save for their own retirement, not to give well-paid executives in top hats a tax shelter for their fortunes. To that end, the tax code divides the world into haves and have-nots -- or, rather, "highly compensated employees" and "non-highly compensated employees." A highly compensated employee, or "HCE" in human-resources lingo, is anyone who gets paid more than a certain amount or who owns at least 5 percent of the company. The salary threshold rises with inflation; as of 2012, it was $115,000 a year. Everyone else is a non-HCE.

Buried within the tax code is a paragraph, Section 401(a)(4), that can cause all sorts of trouble for employer-sponsored retirement savings plans. This paragraph says that to be qualified, a plan cannot "discriminate in favor of highly compensated employees." How the law defines "discrimination" is complicated and not terribly compelling reading -- unless the phrase "401(a)(4) general test" excites you -- but it boils down to this: The benefits that HCEs receive from the plan shouldn't be out of line from what non-HCEs are getting. Problem is, since the plans are geared toward lower-level workers, they have little to offer top executives. As of 2012, for example, employees under age 50 couldn't contribute more than $17,000 a year to a 401(k). If you were making $50,000 a year, that limit probably wasn't a concern. If you were making $800,000, though, it may well have been. Even if you and your fellow HCEs do participate in the plan and contribute the maximum, the plan may still fail the non-discrimination test if other workers contribute only a small fraction of that.

Employers deal with the discrimination question by setting up non-qualified plans for their highly compensated employees. A favorite among the HCE set is the deferred compensation plan. Under these plans, the company doesn't contribute money to a retirement plan on your behalf. Rather, it says (wink, wink) that it will defer a portion of your salary until a later date -- say, after you retire or leave the company. You don't have to pay taxes on the money until you actually get it, at which point the company can deduct the money as an expense, just like it would with any other employee pay. Other non-qualified plans include "executive bonus" arrangements, in which the company pays for such things as annuities and securities that generate income. The company writes off the cost, and the employee pays taxes on the proceeds.