Qualified vs. Non-Qualified Plans
Before looking at specific plan types, you need to understand the fundamental distinction in retirement planning: whether a plan is qualified or non-qualified under the Internal Revenue Code.
Qualified Plans
A qualified plan meets the requirements of the Internal Revenue Code (IRC) and the Employee Retirement Income Security Act (ERISA) to receive favorable tax treatment:
- Employer contributions are tax-deductible to the employer when made
- Employee contributions grow tax-deferred until distribution
- Must be established for the exclusive benefit of employees and their beneficiaries
- Subject to IRC Section 415 limits on benefits and contributions
- Must be non-discriminatory: cannot favor highly compensated employees over rank-and-file workers
- Plan assets are held in a trust, separate from the employer's general assets
- IRS approval is required
Non-Qualified Plans
A non-qualified plan does not meet IRC/ERISA requirements and operates under a different set of rules:
- Employer contributions are not tax-deductible until the employee receives and reports the income
- May discriminate: can be offered selectively to executives or highly compensated employees
- Assets are typically part of the employer's general assets (subject to creditors in bankruptcy)
- No IRS approval required
- No contribution limits (unlike qualified plans)
Exam Tip: Gotchas
Non-qualified plans can discriminate. This is intentional: they exist specifically to provide extra benefits to key employees. Do not confuse "non-qualified" with "illegal" or "inferior." It simply means the plan does not meet IRC/ERISA requirements for broad-based tax advantages.
Side-by-Side Comparison
| Feature | Qualified | Non-Qualified |
|---|---|---|
| IRS approval required | Yes | No |
| Tax-deductible employer contributions | Yes (when made) | No (until distributed) |
| Tax-deferred growth | Yes | Varies |
| ERISA coverage | Yes (private sector) | Generally no |
| Must be non-discriminatory | Yes | No |
| Creditor protection | Yes (ERISA shield) | No (general creditor claims) |
| Contribution limits | Yes (IRC Section 415) | No |
Exam Tip: Gotchas
- Non-qualified plan assets sit in the employer's general account and are exposed to the employer's creditors. If the company goes bankrupt, participants may lose their deferred compensation. Qualified plan assets are held in trust and protected. This creditor protection distinction is a favorite exam topic.
- "Qualified" does not mean "better for the employee" in all cases. It means the plan meets IRS requirements for tax advantages.
- Employer contributions to non-qualified plans are NOT deductible when made; they become deductible only when the employee receives the income.