Non-Qualified Plan: Definition, How It Works, and 4 Major Types

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

Marguerita is a Certified Financial Planner (CFP), Chartered Retirement Planning Counselor (CRPC), Retirement Income Certified Professional (RICP), and a Chartered Socially Responsible Investing Counselor (CSRIC). She has been working in the financial planning industry for over 20 years and spends her days helping her clients gain clarity, confidence, and control over their financial lives.

What Is a Non-Qualified Plan?

A non-qualified plan is a type of tax-deferred, employer-sponsored retirement plan that falls outside of Employee Retirement Income Security Act (ERISA) guidelines.

Non-qualified plans are designed to meet specialized retirement needs for key executives and other select employees. They can act as recruitment and/or employee retention tools. These plans are also exempt from the discriminatory and top-heavy testing that qualified plans are subject to.

Key Takeaways

• Non-qualified plans are retirement savings plans.
• They are called non-qualified because, unlike qualified plans, they do not adhere to Employee Retirement Income Security Act (ERISA) guidelines.
• Non-qualified plans are generally used to provide high-paid executives with an additional retirement savings option.

How a Non-Qualified Plan Works

There are four major types of non-qualified plans:

• Deferred compensation plans
• Executive bonus plans
• Split-dollar life insurance plans
• Group carve-out plans

The contributions made to these types of plans are usually nondeductible for the employer and taxable for the employee.

However, they allow employees to defer taxes until retirement, when they presumably will be in a lower tax bracket.

Non-qualified plans are often used to provide specialized forms of compensation to key executives or employees instead of making them partners or part owners in a company or corporation.

One of the other major goals of a non-qualified plan is to allow highly compensated employees to contribute to another retirement plan after their qualified retirement plan contributions have been maxed out, which usually happens quickly, given their level of compensation.

Deferred Compensation Plans

There are two types of deferred compensation plans: true deferred compensation plans and salary-continuation plans. The primary difference between the two is in the funding source. With a true deferred compensation plan, the executive defers a portion of their income, which is often bonus income.

With a salary-continuation plan, the employer funds the future retirement benefit on the executive's behalf. Both plans allow for the earnings to accumulate tax-deferred until retirement, when the Internal Revenue Service (IRS) will tax the income received as if it were ordinary income.

Other Plans

Non-Qualified Plan: Executive Bonus Plan

With an executive bonus plan, a company issues an executive a life insurance policy with employer-paid premiums as a bonus. Premium payments are considered compensation and are deductible by the employer. The bonus payments are taxable to the executive. In some cases, the employer may pay a bonus over the premium amount to cover the executive’s taxes.

Non-Qualified Plan: Split-Dollar Plan

A split-dollar plan is used when an employer wants to provide a key employee with a permanent life insurance policy. Under this arrangement, an employer purchases a policy on the employee's life, and the employer and the employee divide ownership of the policy.

The employee may be responsible for paying the mortality cost, while the employer pays the balance of the premium. At death, the employee’s beneficiaries receive the main portion of the death benefit, while the employer receives a portion equal to its investment in the plan.

Non-Qualified Plan: Group Carve-Out

A group carve-out plan is another life insurance arrangement in which the employer carves out a key employee’s group life insurance over $50,000 and replaces it with an individual policy. This allows the key employee to avoid the imputed income on group life insurance above $50,000. The employer redirects the premium it would have paid on the excess group life insurance to the individual policy owned by the employee.

What Is an Example of a Non-Qualified Plan?

Consider a high-paid executive working in the financial industry who has contributed the maximum to their 401(k), and is looking for additional ways to save for retirement.

At the same time, their employer offers non-qualified deferred compensation plans to executives. This allows the executive to defer a greater part of their compensation, along with taxes on this money, into this plan.

What Are Deferred Compensation Plans?

Both types of deferred compensation plans—true deferred compensation plans and salary-continuation plans—are designed to provide executives with supplemental retirement income. The plan holds assets that are not taxed or paid out as income until some point in the future.

What Is the Maximum You Can Contribute to a 401(k)?

The most you can contribute to a 401(k) in 2024 is $23,000 if you're under age 50. If you're age 50 or older, you have the option to make a catch-up contribution of up to $7,500. For 2023, you can contribute up to $22,500 if you're under age 50. The catch-up contribution limit is still $7,500.

The Bottom Line

Often, employers and executives will agree on a set period that the income will be deferred, which could be anywhere from five years up until retirement. Ultimately, the deferred income has the ability to grow tax-deferred until it is distributed. These deferral amounts may change from year to year, depending on the agreement between the executive and employer.

1. Internal Revenue Service. "401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000."

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The thrift savings plan (TSP) is a retirement investment program open only to federal employees and members of the uniformed services.

The CSRS provided the retirement, disability, and survivor benefits for most U.S. civilian service employees working for the federal government.

The life expectancy method calculates IRA payments by dividing the balance of a retirement account by the policyholder’s anticipated length of life.

An after-tax contribution is a deposit into a retirement account of money that has been taxed in the year in which it was paid into the account.

Rule 72(t), issued by the Internal Revenue Service (IRS), allows for penalty-free withdrawals from an IRA account and other certain tax-advantaged accounts.

In cliff vesting, employees receive full benefits from their retirement plan account at a certain date, versus becoming vested gradually over time.

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