There are countless decisions to make when you’re a business owner. Understanding how to drive revenue and increase profitability involves many factors, like strong marketing, sales, and customer service. You also need to make sure you’re hiring and retaining great talent. Learning the difference between qualified vs. non-qualified retirement plans is worth your time if you are trying to build and maintain a great team.
In this article, we’ll define both a qualified and a non-qualified retirement plan. we’ll also help you figure out which type of plan is the right fit for your company to offer employees.
Why offer a retirement plan to your employees?
As a business owner who cares about your team’s well-being and success, both at the office and in their personal lives, offering an employee retirement plan is an excellent idea. It gives your staff the ability to save money and accumulate wealth in a tax-efficient way, so they’ll be one step closer to being able to enjoy the benefits of their hard work.
From a recruitment perspective, offering an employee retirement plan gives your company a competitive advantage against others in your industry who may not provide such a valuable perk. These plans can be relatively inexpensive, easy to administer and save you and your employees taxes. There are a range of options that will allow you the opportunity to manage your costs and limit your contributions. This can vary significantly depending on the type of plan you choose.
Qualified Vs. Non-Qualified Retirement Plans, Explained
When you offer a qualified retirement plan, you are bound to the rules of the Employee Retirement Income Security Act (ERISA). This law, which dates back to 1974, sets the standards for retirement plans to protect employees. Some of the requirements you must adhere to under ERISA are:
- including all your staff in the plan, rather than excluding anyone based on age (however, you can make employees wait a year or certain number of hours to enroll)
- having a third party administer the plan and test it on an annual basis
- filing a 5500 tax return, which reports on the plan’s financial condition and more
There are several different types of qualified plans you can choose from. They vary from simple plans designed for small businesses that have few or no employees, to 401k profit sharing plans for larger companies with multiple employees, to defined benefit plans that provide fixed benefits for your employees’ lives.
In contrast, a non-qualified retirement plan is not governed by ERISA. This means you, as the employer, can be more flexible with how you structure the plan. These plans are typically geared toward highly paid executives and offer deferred compensation. Although they are not governed by ERISA, there are specific guidelines defined by the IRS that you must follow in order for these plans to work.
Similarities And Differences Between Qualified Vs. Non-Qualified Plans
Both qualified and non-qualified retirement plans are designed to defer taxes on contributions made to these plans, enabling your staff to minimize their tax bill and maximize their wealth. For example, with a 401(k) plan or a qualified plan, an employee who contributes to a plan on a pre-tax basis gets a tax deduction for this amount and the money they’ve put in grows tax-deferred until they withdraw the funds.
However, the way these two types of plans are taxed is different. With a qualified plan, if you choose to contribute to it as the employer, you’ll receive a tax deduction, too. If a staff member puts $10,000 into their plan and you match $4,000, you could get a tax break of $1,000, which makes this approach an attractive option. With a non-qualified retirement plan, the employee’s money grows tax free, but you can’t get a tax deduction until the funds are eventually paid out to the employee.
Qualified and non-qualified retirement plans are both designed to defer taxes on contributions, but they are taxed differently.
Another major difference between qualified vs. non-qualified retirement plans is that non-qualified plans may have an added layer of risk for employees since these plans are typically not funded by the employer.
For example, if one of your staff members defers $100,000 of their salary or bonus in a particular year and leaves it in the plan, that money is subject to your company’s creditors. If the company goes bankrupt, the money could disappear. In contrast, when an employee or employer makes a contribution to a qualified plan the funds go into a trust and are held separately from the employer assets. There also may be insurance in place to provide an added layer of protection.
In addition to the risk mentioned above, there are different withdrawal requirements for non-qualified plans that will typically mandate distributions to be made and taxes to be paid upon severing ties with the company.
As financial advisors, we often have conversations with our clients who are employees about how long they want to leave their money in their non-qualified plan and how the assets will fit into their overall financial plan. It is important that employees understand all of their options and future needs before electing to participate in these plans. As an employer, it’s helpful for you to understand how to structure these plans in order to reward your key employees and incentivise them to stick around for the long-term.
Which kind of retirement plan should you offer?
You should always consider starting with a qualified plan. There are simple options you can set up if you have a small number of employees, which is true for many small business owners. These retirement plans help you maximize your contributions at a low cost. If you don’t have any staff, you can set up a self-employed plan or individual 401(k) plan. As your company grows, you can consider an employee 401(k) plan or a profit sharing plan. Just keep in mind that these plans involve a greater level of coordination and higher costs.
| Pro Tip: Remember that when you set up a qualified retirement plan, you must send an annual cost disclosure to your staff, which outlines the fees they’re being charged. You also need to let them know whether you’ll be contributing to the plan. |
If you have a team of around 50 employees or more, you may have employees who receive higher compensation, and it might make sense for you to offer them a non-qualified retirement plan. This can be a good recruitment tool because it allows these individuals to put their money away and let it grow tax-deferred.
In the case of a non-qualified plan, you should make sure your Is are dotted and Ts are crossed. These plans can be complicated and expensive to set up and maintain. You will want to make sure you provide the appropriate level of education for eligible employees and encourage them to seek guidance from their professional advisors. The restrictions placed on access to the money and the tax consequences upon withdrawal should be evaluated to make sure their participation makes sense for their personal situation.
How To Get Started With Offering A Retirement Plan
If you want to set up a qualified retirement plan, your financial advisor can walk you through the process, or connect you to a plan consultant or third party administrator. Keep in mind that most of these plans must be set up by the end of the year for employees to be eligible to make contributions and for employers to take a tax deduction. It is important to start the process early in the year.
If you’re considering a non-qualified plan, make sure you have a good reason to put this type of plan in place before you embark on the journey. The process isn’t easy, quick, or cheap, and the plan needs to be the right fit for your company and your employees. Deferred compensation plans involve a lot of legalities that require documentation to be drafted. This can take at least two months to sort out.
We’re On Your Team
At Curio Wealth, we understand the challenges of running a company. Setting up a qualified or non-qualified retirement plan is a big decision, but you don’t have to navigate it alone. Our firm works closely with small business retirement plans and 401(k) plans, and we can help you put these plans into action as your third-party investment provider and consultant. Schedule a call with us today to learn more.
