Highly Compensated individuals are unable to save enough pre-tax dollars in their 401(k) and Profit Sharing plans to adequately create enough retirement income. It is incumbent on them to then save more dollars to close the retirement gap.
Highly Compensated individuals typically expect to retire at 80% of their pre-retirement income; however, qualified plans are limited on what percent of compensation can be saved. The gap in retirement savings is due to lost benefits created by legislative restrictions – $19,500 maximum deferral limit into 401(k) plan (2021) plus $6,500 “catch-up” provision for participants over the age of 50.
Benefits of the Nonqualified Deferral Plan
- Allows highly compensated employees to defer pre-tax income above 401(k) limits
- Credits account balances with the same rate of return earned in the 401(k) account or a fixed rate option
- Allows employers to make up lost 401(k) contributions (match or profit-sharing)
- Tax-deferred earnings – more dollars compounding on a tax-deferred basis
Important Differences Between Qualified and Nonqualified Plans
Nonqualified plans are regulated by IRC Section 409A.
Nonqualified plan participants are unsecured creditors and subject to risk of forfeiture (bankruptcy of employer).
In nonqualified plans, the corporation defers the tax deduction on any contributions and/or deferrals until paid to the executive.
In nonqualified plans, liabilities must be accrued and plan assets remain on corporate balance sheet and any taxable investment earnings are reportable by the employer.
Nonqualified plans are not protected by ERISA and are not subject to the reporting, funding, vesting, or fiduciary responsibilities of Title I of ERISA.
Nonqualified plans must satisfy Top Hat Rules.