Nature of Non-Qualified Plans

It is convenient to think of a nonqualified plan simply as one that offers specific -- and, often, important -- benefits to a business and its employees in ways that are prohibited in a qualified plan.  As a result of the nonqualified plan's providing of those particular benefits, it does not meet one or more of the requirements of a qualified plan.  For those reasons, it becomes a nonqualified plan.  

The plus side of nonqualified plans is that they enable the business and its owners to tailor benefits around the needs of the business and its key employees.  That means the employer can favor one employee over another by offering a benefit to one that it withholds from the other.  Or, the employer may offer both employees the same type of benefit but give one a larger benefit than the other.  Furthermore, the business -- depending on the type of nonqualified plan -- may be able to recover some or all of its costs to provide the benefit.

There is a negative side to nonqualified plans, however.  That negative side results from the fact that these plans are not qualified plans.  Since they are not qualified plans, the employer forgoes any income tax deduction resulting from its making a contribution to the plan.  (We will see, later in our discussion, that the employer does enjoy an income tax deduction for its payment of funds to an executive bonus plan.  That deduction, however, is a deduction for compensation paid rather than as a contribution to a nonqualified plan.)

The lack of an income tax deduction for a nonqualified plan contribution should not be allowed to loom inordinately large in the business owner's mind.  While a current tax deduction would appeal to virtually all business owners, the alternative may be for the business to recover some or all of its costs for the plan.  That alternative may be far more attractive once the business owner understands it.