Non-Qualified Plans (W-2)

Navigating Non-Qualified Retirement Plans (W-2): A Comprehensive Guide

Understanding Non-Qualified Plans

Non-Qualified Plans listed on a W-2 form refer to a specific category of employer-sponsored, tax-deferred retirement savings plans. Distinguished by their non-qualification under the Employee Retirement Income Security Act (ERISA), these plans are exempt from the testing requirements associated with qualified retirement savings plans like the commonly known 401(k) and 403(b).

Diverse Types of Non-Qualified Plans

Several types of non-qualified plans cater to specific needs, primarily targeting key executives. These include:

1. Deferred-Compensation Plan: Enables employees to defer the receipt of wages from one year to a later year, often during retirement. It encompasses retirement, pension, stock option plans, and variations such as wraparound 401(k), excess benefit, bonus, and severance pay plans.
2. Salary-Continuation Plan: Involves an employer funding future retirement benefits for an executive, with the employer continuing to pay the employee during retirement, possibly at a reduced rate.
3. Executive Bonus Plan: Provides supplemental benefits to select executives and employees, counted as a deductible business expense for the employer. Typically involves the issuance of a life insurance policy with premium payments reported as bonus compensation.
4. Split-Dollar Life Insurance Plan: Allows the sharing of premium costs, cash value, and tax/legal benefits of a permanent life insurance plan between employer and employee. Details vary based on the specific situation and contract.
5. Group Carve-Out Plan: Replaces part of an employee’s group life insurance policy with an individual life insurance policy to mitigate excess costs.

Eligibility for Non-Qualified Plans

Non-qualified plans are primarily designed for executives and key employees, addressing their unique needs and serving as an incentive for their recruitment and retention. In certain cases, such as deferred-compensation plans, specific seasonal workers may also fall under eligibility criteria.

Tax Implications and Calculations

Taxation for non-qualified plans involves a split between when the money is earned and when it is paid out. FICA taxes, covering Medicare and Social Security, are deducted when the money is earned. However, federal income tax withholding for non-qualified plans is deferred until the payout, offering potential advantages for employees in lower tax brackets during retirement.

Key tax considerations include:

1. Plans are funded using after-tax dollars.
2. Employers usually cannot claim contributions as a tax deduction.
3. Distributions are treated as supplemental wages for income tax withholding purposes.
4. Federal tax withholding rules are applied, with rates of 25% for amounts up to $1 million and 35% for amounts exceeding $1 million.
5. Distributions from a non-qualified plan are reported in box 11 on an employee’s W-2 form.

Benefits of Non-Qualified Plans for Employers

Non-qualified plans offer several advantages for employers:

1. Flexibility: These plans provide greater flexibility than ERISA-covered plans, allowing customization for specific executives and employees.
2. No Non-Discrimination Rules: Unlike qualified plans, non-qualified plans don’t have non-discrimination rules, enabling tailored benefits for executives without proportionate equality for all employees.
3. Retention Incentive: Serving as an incentive for loyalty, employees typically forfeit non-qualified plans if they leave the company before retirement.
4. Cash Flow Improvement: Deferring a portion of earned compensation to the future enhances cash flow.
5. Cost-Efficient Setup: Non-qualified plans entail minimal setup and administration costs, devoid of special annual expenses, and do not mandate IRS filings.

Conclusion: Leveraging Non-Qualified Plans Understanding the nuances of non-qualified retirement plans is essential for both employees and employers. Navigating the diverse types, eligibility criteria, tax implications, and employer benefits ensures a strategic approach to incorporating these plans into the overall compensation and benefits strategy.