This Module provides a general overview of Nonqualified Plans.  Links to other modules covering specific plans can be found above, while links to pages within this module are shown at the left.  

In the employer-employee relationship, nothing says "I love you" more than compensation. A pat on the back or some token of appreciation are nice, but let's face it: The essence of the employer-employee relationship is based on an exchange of the employee's services for the employer's money or similar form of tangible compensation. Usually, the higher the value of an employee is, the more compensation the employee gets from the employer.

Compensation, of course, can take many forms. In addition to regular wages, employers often offer their employees compensation packages that may include a mixture of such benefits as health insurance, paid time off, tuition reimbursement and qualified plans that help to save for retirement. When it comes to qualified retirement plans, the rules generally require that an employer's basic compensation package be equally available to all employees in order to get the associated tax benefits (though the benefits employees receive can be provided in proportion to their wages).

If an employer really and truly loves an employee, however, the employer will compensate the employee above and beyond the basic compensation package provided to rank-and-file employees. This is where nonqualified deferred compensation plans come in. An employer can use a nonqualified plan to provide added incentives to attract and retain key executives and employees.

Nonqualified Plans

A nonqualified plan is an employer-sponsored retirement or other deferred compensation plan that does not meet the tax-qualification requirements under Internal Revenue Code Sec. 401 (i.e. qualified plan requirements). A nonqualified plan also does not refer to a tax-sheltered annuity (TSA), a simplified employee pension (SEP) plan, a savings incentive match plan for employees (SIMPLE) account, or a 457 governmental plan. Retirement plans like TSAs, SEPs, and SIMPLEs are governed by their own rules.

A nonqualified plan allows an employee to defer the receipt of taxable wages or bonuses until some future year when (hopefully) the employee is in a lower tax bracket, thereby paying less in taxes when the compensation is received. Although nonqualified plans are easier to set up than qualified plans, there are specific rules that must be followed to achieve the objective of deferring an employee's taxable compensation. All nonqualified plans must satisfy the following three requirements:

The deferred compensation arrangement between the employer and the employee must be entered into before the compensation is earned by the employee.
The deferred compensation cannot be available to the employee until a previously agreed upon future date or event.
The amount of the deferred compensation cannot be secured (i.e. it must remain available to the employer's creditors).

Review Questions Module 1