Know The Difference: Qualified Vs. Non-Qualified Plans
As soon as you enter the workforce, you’re told it’s important to start planning for retirement. While retirement may seem like it’s a long time coming, one of the most critical things you can do early on in your career is to start building your nest egg. However, what do you really know about your retirement plan? And do you know if it’s the best possible plan for your situation?
When analyzing potential retirement plans, it’s essential to understand the difference between qualified vs. non-qualified plans.
First, let’s start with qualified retirement plans. When people talk about qualified plans, they’re referring to a plan that specifically qualifies with the guidelines of the Employee Retirement Income Security Act (ERISA) from 1974. If your plan is a qualified one, that means it gets all of the benefits spelled out by ERISA, which include tax benefits. These plans, which include 401(k) plans, 403(b) plans, profit-sharing arrangements, and HR-10 plans, work by deducting funds from an employee’s paycheck before tax and funneling them into one of these plans. The employee will not have any tax obligations to the funds they put into these plans until they withdraw them later in life, ideally by retirement.
Next, non-qualified plans are the types of plans that do not meet ERISA guidelines, such as deferred compensation or executive bonus plans. Because those ERISA guidelines aren’t met, such as those that don’t meet requirements of participation, vesting schedules, or others, the funds that are sent to the retirement plan are taxed beforehand. This difference means employees aren’t putting as many funds away into the non-qualified plan, but it also means that when they withdraw them later in life, they aren’t subject to taxes at that point.
Which is better: qualified vs. non-qualified plans?
Both qualified and non-qualified plans have their inherent advantages and disadvantages.
For qualified plans, employers must offer them to all eligible employees at the same rate, while your money put into these qualified plans are able to grow with a greater investment due to lack of taxes upfront. Ideally, when you withdraw the funds later in life and do get hit with the taxes, you’ve spent a lifetime saving and can afford to pay those taxes. If you’re young and just starting out in the workforce or had a late start to your career, these taxes may be less affordable.
Regarding non-qualified plans, there’s no ceiling on how much you can contribute to them (compared with the less than $20,000 in funds the IRS allows you to put into qualified plans today). Further, if you’re a higher-paid employee, non-qualified plans might be available to you because they don’t have to be offered at the same rate (or at all) to all employees. The downside is that you are taxed right away on these funds and you’re not covered by the required protections of ERISA.
To find out more information about retirement plans, contact Schechner Lifson Corporation today!