Non-Qualified Retirement Plan Tax Risks the Corporate Professional Should Avoid

Without proper financial planning, you may be paying more taxes on your non-qualified retirement plan than necessary. If you have a retirement savings plan with the words ‘Excess Compensation’, ‘Excess Benefit’, ‘Benefits Restoration’, or something similar in the title, you may have a non-qualified retirement plan.

What is a Non-Qualified Retirement Plan?

Employers establish non-qualified retirement plans to circumvent the IRC Section 415 limitations so that their high-income earning employees can save more for retirement. The IRS rule limits both you and your employer’s contribution to your 401(k) based on the first $290,000 of income for 2021. This means that you and your employer can only make contributions to your 401(k) based on the first $290,000 that you earn. When your income exceeds the $290,000 limit, neither you nor your employer can contribute any more money to your 401(k).

Large corporations often want to continue their matching benefit for employees who have income that exceeds this limitation. They do so by establishing a non-qualified retirement plan and depositing the excess matching contributions there. These funds can be invested and grow until the employee’s retirement or departure from the company.

Plan Payouts Can Be Taxable Income the Year You Retire

If the employee makes no elections, these plans are often paid out as a lump sum very soon after retirement. Receiving all of the proceeds from the non-qualified plan in the year of retirement can cause a substantial portion of this payment be taxed at the highest marginal income tax rate. Without proper planning, you may be paying more taxes than necessary.

For example, if a client receives a $400,000 lump sum non-qualified payout instead of annuitizing it over a period of 10 years, they will be in the  higher marginal income tax brackets, assuming $100k of other income, either a pension, investments, etc. If annuitizing, they could be in the 22% marginal income tax bracket.

What Should You Do When Managing Your Non-Qualified Retirement Plan?

Different companies have different rules regarding payout elections for their non-qualified plans. For example, our Shell clients were required to have made their elections prior to 2009 in order to annuitize the payout of their Benefit Restoration plan. We work with those of our clients that did not make their elections to time their retirement decision so we can strategically manage and disperse their various payouts and minimize their overall tax burden.

We find that other companies, such as BP, allow their employees to make the election for a payout of their non-qualified retirement benefits at the beginning of each year. We proactively assess this payout decision with these clients to create a planthat manages cash flow needs in retirement and minimizes their tax impact.

With proper planning, these plans can be a very useful tool to help provide income in the first few years after retirement. If you have one of these plans, we recommend you speak with a professional advisor, like Willis Johnson & Associates, who specializes in helping corporate executives and professionals minimize taxes and maximize their company benefits



Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Corporate benefits may change at any point in time. Be sure to consult with human resources and review Summary Plan Description(s) before implementing any strategy discussed herein. Willis Johnson & Associates is not a CPA firm.