A nonqualified plan is an employer-sponsored retirement savings plan that does not qualify for special tax treatment on the federal level. Nonqualified plans are sometimes referred to as deferred compensation plans. It is a type of plan designed to supplement pension plans and other qualified retirement accounts.

Nonqualified plans provide a way for employers to provide their key employees with additional retirement savings options. It allows high-paid executives, who are already maxed out on contributions to other retirement savings plans, to save more for retirement. The funds in a nonqualified plan are typically set aside from an employee’s regular salary, so that the income is taxed at a later date. The plan is usually funded through a life insurance policy or an annuity, so that funds are available when the employee retires.

The most common type of nonqualified plan is a deferred compensation plan or a 409A plan. These plans offer a tax-deferred savings arrangement, meaning that the contributions are made with funds that have not yet been taxed. When the employee retires or leaves the company, the funds are distributed and are then subject to taxation.

Unlike qualified plans, nonqualified plans are not regulated by the Internal Revenue Service (IRS) or the Department of Labor (DOL). As a result, they offer more flexibility in terms of contribution limits, vesting periods, and distribution options. For example, employer contributions can be adjusted each year, whereas in qualified plans the amount of contributions is limited by the IRS. Additionally, some nonqualified plans allow for early withdrawals or loan provisions.

Nonqualified plans can be a great way for companies to incentivize key employees and reward them for their hard work. They are also a useful tool that can help high earners save for retirement. However, as with any retirement savings plan, there are pros and cons to consider. It may be wise to consult a financial advisor to make sure a nonqualified plan is the right fit for a particular retirement savings strategy.