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So you make more than $85K
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November 29, 2000: 9:14 a.m. ET
Want to put more in a 401(k) but can't? You may be offered a non-qualified plan
By Staff Writer Jeanne Sahadi
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NEW YORK (CNNfn) - If you earn $85,000 or more, you have joined the ranks of the Highly Compensated, at least as far as your company's 401(k) is concerned. In practice, that means you may not be able to contribute as high a percentage of your salary into the retirement plan as some of your lesser-paid colleagues.
Consequently, your employer may let you put some money into a non-qualified deferred compensation plan. The plan may look a lot like your 401(k) -- complete with investment options, matches and vesting schedules. And there are certainly advantages, such as the opportunity to allow more of your money to grow completely tax-deferred for a number of years.
But there are significant risks and rules associated with "non-quals" that you should be aware of before turning over any of your pay. "Deferred compensation is very good, but it comes with a lot of strings attached," said certified financial planner (CFP) Brian Orol of Raleigh, N.C.
The limits of your 401(k)
First things first. Why, you wonder, can't you put more of your money in your 401(k)? After all, say your company's plan allows employees to contribute up to 15 percent of eligible compensation so long as it does not exceed the $10,500 federal limit on contributions. If you make $100,000, you figure you can put in 10.5 percent of your salary, but then you're told you can only put in 7 percent, or just $7,000.
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 PSCA FOUND THAT NON-QUALIFIED PLANS ARE OFFERED AT:
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63.3% of companies with more than 5,000 employees
6.5% of companies with fewer than 50 employees
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That's because 401(k) plans must pass several tests and meet certain regulations, many of which can place limits on contributions from highly compensated employees. One such regulation is that a firm's more highly paid employees cannot contribute more than 2 percent more than the average salary-percentage contribution by employees making less than $85,000, Orol said. So, if the under-$85K crowd is only contributing 5 percent on average, then you can't put in more than 7 percent.
"The key is the participation rate," said CFP Virginia Gerhart of San Rafael, Calif.
Another factor, said David Wray, president of the 401(k)/Profit-Sharing Council of America (PSCA), is that the total annual contributions to a 401(k) plan, including employee contributions and employer matches, may not exceed 15 percent of the company's payroll for covered participants.
"The plan will be designed to ensure that none of these (and other) limits are violated," Wray said.
The money you defer isn't yours ... yet
So, you're glad for the higher pay but you're a little miffed you can't do more to save in a tax-advantaged way. Enter the non-qualified plan option.
Such plans come in many stripes, depending on the size of your firm and on whether your compensation is so high that you can negotiate your own arrangement with your employer.
Regardless, there are key risks you assume since a non-qualified plan, unlike a 401(k), is not regulated or protected by the Employee Retirement Income Security Act (ERISA).
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RISK NO. 1
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Should your company go belly up, its creditors can make claims on your deferred compensation because it is the company's money until it is in your pocket.
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First, the money you put in a non-qualified account is not really yours. "It's an asset of the corporation," Gerhart said.
That's because "it's not your money until it's paid to you," said Toledo, Ohio-based CFP Chris Cooper. In essence, you've agreed to defer your compensation until some later point, which means you don't report it as income for the year and you pay no tax on it whatsoever. "It's just wages in the future," Cooper said.
And a lot can happen between now and that future. Translation: should your company go belly up, its creditors can make claims on your deferred compensation because it is the company's money until it is in your pocket. That's an increasingly serious risk these days, as companies you once may have assumed would be around forever are getting themselves in deep financial trouble, Cooper said. Consider Owens Corning, he suggested. It filed for Chapter 11 in October.
Other 'risks of forfeiture'
There are other "risks of forfeiture," many of them defined by your employer. When you participate in a deferred compensation plan, you enter into a contract, which sets out certain conditions that must be met for you to get the money in full.
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TO GET THE FULL BENEFITS OF A DEFERRED COMPENSATION PLAN, YOU MAY NEED TO:
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Stay with the company for a certain number of years
Agree to a non-compete clause
Leave the firm under amicable circumstances
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For example, your employer might impose a vesting schedule, which means you have to stay at the company a certain number of years to receive the full benefits. Or you might have to agree to a non-compete clause. Or you may forfeit some or all of your account if you leave the firm under less than amicable circumstances.
Don't rollover, Beethoven
Consider, too, the short-term and long-term consequences of deferred compensation in your financial planning, Orol said.
First, whenever you leave the company, expect to begin receiving payouts and to pay taxes on them in the year they are received. You may not roll the money over into an IRA, 401(k) or even another non-qualified plan, Gerhart said.
Furthermore, if you receive payments between the ages of 62 and 65 while simultaneously receiving Social Security, you might lose some of your benefits if you exceed the earnings limits imposed on Social Security recipients younger than 65, Cooper said.
Second, your employer will probably limit your choices on how and when you receive the distributions. You may not have to take it all in one lump sum, but you might not be able to spread out the payments over a very long period, either.
In some instances, if the plan is set up under the framework of a life insurance policy, you may have more flexibility, Orol said. You may, for instance, be able to negotiate a deal where you assume ownership of the policy when you leave your company, but that may mean you first must pay back the firm for any premiums it paid on your behalf.
To sign or not to sign
Before deferring some of your pay in hopes of greater growth down the line, Orol suggested you first maximize your 401(k) contributions, fully contribute to a Roth if you are eligible, and, if you have kids, invest as much as you can for their education, since their tuition is more of a known quantity than the fate of your deferred compensation.
Lastly, he said, while weighing the pros and cons of a non-qualified plan, ask yourself not only "How much can I live without?" today but "How much do I want to put at risk?" for tomorrow. 
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