What is an unqualified plan?
An ineligible plan is a type of employer-sponsored deferred tax pension plan that does not meet the guidelines of the Employee Retirement Income Security Act (ERISA). Unqualified plans are designed to meet the specialized retirement needs of key executives and other selected employees and can act as a recruitment or retention tool for employees. These plans are also exempt from the discriminatory and demanding tests to which qualified plans are subjected.
Key points to remember
- Unqualified plans are retirement savings plans.
- They are called unqualified because they do not meet the guidelines of the Employee Retirement Income Security Act (ERISA) as for a qualified plan.
- Unqualified plans are generally used to provide well-paid executives with an additional retirement savings option.
Operation of an unqualified plan
There are four main types of ineligible plans: deferred compensation plans, executive bonus plans, group exemption plans and two-penny life insurance plans. Contributions to these types of plans are generally not deductible for the employer and taxable for the employee.
However, they allow employees to defer their taxes until retirement (when they are likely in a lower tax bracket). Unskilled plans are often used to provide specialized forms of compensation to key executives or employees rather than making them partners or co-owners of the business or company.
Deferred compensation as an ineligible plan
There are two types of deferred compensation plans: real deferred compensation plans and salary continuation plans. Both plans are designed to provide executives with additional retirement income. The main difference between the two is the source of funding. With a real deferred compensation plan, the manager defers part of his income, which is often bonus income.
With a salary maintenance plan, the employer finances the future retirement benefit on behalf of the manager. Both plans accumulate tax deferred earnings, while the Internal Revenue Service (IRS) will tax income earned at retirement as if it were ordinary income.
Unqualified plan: bonus plans for executives
Executive bonus plans are simple. A company issues to a manager a life insurance policy with premiums paid by the employer as a bonus. The payment of premiums is considered as compensation and is deductible for the employer. Premiums are taxable for the executive. In some cases, the employer may pay a premium greater than the amount of the premium to cover the manager’s taxes.
Split-Dollar plan: another unqualified plan
A two-penny 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 for the employee’s life, and the employer and the employee share ownership of the policy. The employee may be responsible for paying the cost of mortality, while the employer pays the balance of the premium. On death, the employee’s beneficiaries receive the main part of the death benefit, while the employer receives a part equal to his investment in the plan.
Ineligible plan: group exclusion
A group exemption plan is another life insurance agreement in which the employer purchases group life insurance for a key employee in excess of $ 50,000 and replaces it with an individual policy. This allows the key employee to avoid income charged to group life insurance of more than $ 50,000. The employer redirects the premium he would have paid on excess group life insurance to the individual policy held by the employee.