Qualified vs. Nonqualified Retirement Plans

fortpitt in Retirement Planning 9 September, 2021

When you read about different types of retirement plans, you are sure to run across the words “nonqualified” and “qualified.” These words have numerous implications on the way that these plans are run and both current and future taxation. As an employee, it is crucial that you understand how your retirement plan’s structure will affect your investments in the future.

What Are Qualified Retirement Plans?

The Employee Retirement Income Security Act governs qualified plans, commonly referred to as ERISA. There are numerous restrictions and requirements for these plans, such as limited investments, filing requirements, nondiscrimination, and other measures making them somewhat expensive to maintain. These plans include retirement plans such as 401(k) ‘s, 403(b) ‘s, IRAs, and pension plans, among other investments.

Employers often favor qualified plans as they provide beneficial tax breaks to the employer as well as the individual employees. For example, contributions to qualified plans are made directly from an employee’s paycheck and are made pre-tax. In addition, earnings accumulate on a tax-deferred basis, meaning that no taxes are paid until you begin to withdraw funds from the account. However, if distributions are made from the account for a nonqualified expense prior to the employee reaching a specified age (currently 59½), there are taxes and penalties.

What Are Nonqualified Plans?

Nonqualified plans are retirement plans offered by employers that ERISA does not govern. Since these plans are exempt from the discriminatory and top-heavy testing in qualified plans, they are often designed for executives whose needs are not entirely met by qualified plans. Nonqualified plans include group carve-out plans, deferred compensation plans, and others. Although it is not always the case, some types of nonqualified plans may allow the employee to defer taxation until retirement when they access the funds in their plan. In either case, the amount invested into a nonqualified plan is able to grow tax-deferred until it is accessed in retirement.

Speak With a Financial Advisor

Suppose you are interested in discussing the best option for your qualified or nonqualified retirement plan. In that case, financial advisors can help provide clarity and enable you to make the most beneficial decision based on your own goals and needs.

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