Today’s job market is extremely competitive, especially for Key Employees. Nonqualified Plans offer an indispensable means for employers to attract, motivate, reward, and retain key executive talent.
Unlike a “qualified” plan, such as a 401K, tax laws allow employers to establish “nonqualified plans” for a select group of highly compensated employees. Nonqualified plans allow employers to supplement key employees’ retirement and pre-retirement deferred compensation benefits under qualified plans. They also supplement the voluntary, tax-favored savings opportunities available to these employees. This allows these employees to save a percentage of their income for retirement that is more in line with other employees of the company.
Additionally, “nonqualified” plans can be established for independent contractors or directors. By rule, “qualified” plans cannot cover these important contributors. Consequently, companies often use “nonqualified” plans to boost compensation packages for key independent contractors/directors.
Nonqualified plans can serve non-tax-motivated purposes as well. Based on the terms of the plan, it can incentivize Key Employee retention, to prevent competition following termination of employment, or to provide supplemental retirement benefits.
As executive salaries and benefits packages increase, nonqualified plans have increasing importance in executive compensation planning. This is because qualified plans are subject to significant monetary restrictions. These restrictions limit a qualified plan’s ability to provide key employees with all of the deferred compensation they require to adequately prepare for retirement.
IRS Limitations on Qualified Plans
There are limits on annual contributions to “qualified” defined contribution retirement plans. These limits apply to 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan. This impacts how much money Key Employees can save for retirement through these plans. In 2020, contributions to these plans are limited to the lesser of $57,000 or 100 percent of the executive’s compensation. See 26 USC § 415(c)(1)(a); see also IRS technical guidance Notice 2019-59.
Additionally, there are also dollar limitations on the annual benefits payable from qualified defined benefit retirement plans. For 2020, this limitation, measured after 10 years of plan participation against plan benefits payable for a single life beginning at age 62, is the lesser of $230,000 or 100 percent of annual compensation for the participant’s highest paid three consecutive years of employment with the employer.
There is also a limitation on the amount of annual compensation that may be considered for all qualified plan purposes. For 2019, this limitation is $285,000, indexed for inflation in $5,000 increments. See 26 USC § 401(a)(17); see also IRS technical guidance Notice 2019-59. Moreover, there are various coverage and discrimination rules imposed on qualified plans that significantly limit their utility as it relates to compensating Key Employees. See generally 26 USC §§ 410(b), 401(a)(4), (26), 26(k), 26(m).
The bottom line is that all of these rules serve to limit a company’s ability to effectively reward Key Employees.
Benefits of a Nonqualified Plan
Instead, a nonqualified plan allows a company to provide contributions and benefits and permit deferrals without regard to the limits imposed by the Code on tax-qualified plans.
This allows your company to:
Enable Key Employees to save for their own retirement without regard to the limits of tax-qualified plans.
Make Key Employees whole for the amount the Key Employee loses and the amount the employer saves as a result of the tax-qualified plan not being able to recognize the Key Employee’s entire amount of earned compensation.
Incentivize Key Employees to remain with the company.
Provide an attractive and competitive aggregate compensation and benefits package to attract desired Key Employees.
Allow Key Employees to avoid the strict minimum distribution requirements imposed on tax-qualified plans by IRC Section 401(a)(9).
Chasen Cohan, Esq. is the founder of Cohan PLLC. Mr. Cohan is a licensed attorney who also possesses FINRA Series 7 (Registered Representative) and Series 63 (Uniform State Representative) licenses, state insurance licenses, and State Securities Registrations in Nevada, Missouri, and North Carolina. Mr. Cohan is admitted to practice law before the Nevada Bar, all Nevada State and Federal Courts, and the United States Court of Appeals for the Ninth Circuit.
Mr. Cohan’s representative clients have included: Wal-Mart Stores, Inc., Sam’s West, Inc., MGM Grand Resorts International, New York-New York Hotel & Casino, Mandalay Corp., The Treasure Island Hotel and Casino, The Cosmopolitan of Las Vegas, The Mirage Casino-Hotel, South Point Hotel & Casino, American Express, Barclays, US Bank, Wells Fargo, Citibank, and various life insurance companies and service providers.
Mr. Cohan is a Las Vegas native who graduated with honors from UCLA with a Bachelor of Arts degree in Political Science. Mr. Cohan received his Juris Doctorate from the University of Texas School of Law. During law school, Mr. Cohan served as a clerk for the Office of the Texas Attorney General and a Judicial Extern for United States District Court Judge James R. Nowlin.
Clients from global brands and middle-market companies to innovative startups and individuals trust Cohan PLLC to resolve their trickiest legal disputes. Whether that’s litigation in state or federal trial and appellate courts in Nevada; investigations and enforcement actions before government agencies; or mediation, arbitration, and regulatory agency proceedings. Cohan PLLC has litigated hundreds of millions in dollars of claims on behalf of corporate litigants. As a result of this experience, Cohan PLLC has been afforded the opportunity to selectively act as Plaintiff’s counsel on complex, personal injury matters.