NONQUALIFIED PLANS AS ALTERNATIVES TO 401(K)S
Qualified pensions, like 401(k)s, offer employers immediate tax benefits, while providing employees retirement income that is tax-deferred. However, these plans must comply with strict participation, contribution, and reporting requirements, which can make them costly and labor- intensive to maintain. As a supplement or alternative to these types of plans, which are also called qualified plans, many companies are now adopting nonqualified retirement plans.
Simply put, nonqualified plans include a variety of contractual arrangements that provide compensation at a future date for services performed now. This arrangement can defer the employee's tax on a gain, but it also defers the employer's tax deduction.
Despite this disadvantage for employers, certain changes enacted by the 1993 federal tax law have made nonqualified plans more attractive. With the introduction of the 36 percent and 39.6 percent tax brackets, many employees retiring in the future will be paying taxes at lower rates than they pay on salaries that they are currently earning.
The tax law also limits to $200,000 the total compensation that can be considered
when contributions are made to qualified plans, which is a severe restriction
to executives earning a high wage. Conversely, includable compensation is typically
unlimited in nonqualified plans, as is the length of time such compensation
may be deferred. Another advantage to a nonqualified plan is that it permits
employers to select specific individuals to cover. Also, companies can structure
nonqualified plans so that funds are not tied to pay for future benefits. In
this way, employers can continue to keep funds available to the company. These
nonqualified arrangements are relatively inexpensive and simple to manage since
federal reporting and administration expenses are usually minimal.