Legal Definitions - nonqualified pension plan

A nonqualified pension plan is a type of employer-sponsored retirement savings arrangement that does not meet the strict requirements set by federal law, such as the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code, for "qualified" plans. Because it doesn't adhere to these specific rules, it does not receive the same immediate tax advantages for the employer or the employee that qualified plans like 401(k)s or traditional pension plans do. These plans are often designed to provide additional retirement benefits to executives or highly compensated employees, beyond what is allowed in qualified plans, and the employer's promise to pay benefits is typically an unsecured promise.

• Example 1: Executive Retention Bonus

  Imagine "Apex Solutions Inc." wants to attract and retain a highly sought-after Chief Technology Officer (CTO), Sarah. To sweeten her compensation package beyond her salary and standard 401(k) contributions, the company offers her a supplemental retirement plan. Under this plan, Apex Solutions promises to pay Sarah an additional $50,000 per year for 15 years after she retires, provided she stays with the company for at least 10 years. This arrangement is a direct agreement between Sarah and Apex Solutions, and it is not subject to the same strict government regulations or contribution limits as the company's standard 401(k) plan.

  How this illustrates the term: This is a nonqualified pension plan because it's a special retirement benefit offered to a specific, highly compensated employee (Sarah) that goes beyond the limits and rules of standard, government-regulated (qualified) retirement plans. The company's promise to pay is a direct agreement with Sarah, rather than contributions to a separate, tax-advantaged trust fund governed by ERISA, meaning the benefit is an unsecured promise from the company.

• Example 2: Deferred Compensation for Senior Management

  "Global Manufacturing Co." has several long-serving senior managers whose salaries are so high that they quickly reach the maximum contribution limits for their company's 401(k) plan. To ensure these valuable employees can still save a significant portion of their income for retirement and to encourage their continued loyalty, Global Manufacturing establishes a deferred compensation arrangement. Under this arrangement, these managers can elect to defer a portion of their annual bonus, which the company will hold and invest on their behalf, paying it out upon their retirement. The funds remain part of the company's general assets until distributed, rather than being placed in a separate, protected trust.

  How this illustrates the term: This deferred compensation arrangement is a nonqualified pension plan because it allows highly compensated employees to save more for retirement than allowed in qualified plans, and the funds are not held in a separate, protected trust. Instead, they remain assets of the company, meaning the employees are essentially unsecured creditors of Global Manufacturing until the benefits are paid out, which is a hallmark of nonqualified plans.