Overview: The single most important dividing line in retirement planning is whether a plan is "qualified" — meaning it meets IRS and ERISA requirements — or "non-qualified." This distinction determines who can participate, how contributions are taxed, and how much protection participants receive.

A qualified plan is one that satisfies the requirements of both the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA). The reward for meeting these standards is a powerful set of tax advantages: employer contributions are immediately tax-deductible, employees defer taxes on contributions and investment growth until distribution, and plan assets are held in a protected trust beyond the reach of the employer's creditors. Common examples include 401(k) plans, 403(b) plans, and traditional pension plans.

A non-qualified plan skips most of those requirements in exchange for flexibility. Non-qualified plans are typically used to recruit and retain senior executives or highly compensated employees — groups whose retirement savings are constrained by the contribution limits and nondiscrimination rules that apply to qualified plans. The most common structures are Supplemental Executive Retirement Plans (SERPs) and deferred compensation arrangements. Because non-qualified plans must be structured as "top-hat" plans for key management or highly compensated employees only, they cannot be offered to rank-and-file workers without losing their exempt status under ERISA.

The tax differences are significant. With a qualified plan, the employer deducts contributions in the year they are made, employees contribute pre-tax (or post-tax in a Roth), and assets grow tax-deferred until distribution. With a non-qualified plan, the employer cannot take a deduction until the employee actually receives and reports the benefit as income. Under IRC Section 409A, the rules governing when non-qualified deferred compensation is paid are strict — a violation triggers immediate taxation plus a 20% penalty on top of regular income tax. Because non-qualified plan assets remain part of the employer's general assets (often held in a "rabbi trust"), they are exposed to employer creditors in the event of bankruptcy, providing participants far less security.

ERISA requirements apply fully to qualified plans. These include mandatory participation rules (employees must be eligible once they reach age 21 and complete one year of service with at least 1,000 hours), vesting schedules that limit how long employees must wait before owning employer contributions, annual nondiscrimination testing to prevent the plan from favoring highly compensated employees (HCEs) over rank-and-file workers, fiduciary duties requiring those who manage plan assets to act solely in participants' interests, and comprehensive reporting and disclosure obligations including annual Form 5500 filings. Non-qualified plans structured as top-hat plans are exempt from most of these requirements; instead of filing Form 5500, an employer need only submit a one-time registration statement with the Department of Labor.

Vesting Schedules

Overview: Vesting determines when employer contributions legally belong to the employee — and it is frequently tested on the exam.

Employees are always 100% immediately vested in their own salary deferrals. The vesting question applies only to employer contributions such as matching funds or profit-sharing.

ERISA mandates that employer contributions vest on one of two schedules. Under cliff vesting, the employee goes from 0% to 100% ownership at a single point — the "cliff." For defined contribution plans like 401(k)s, the maximum cliff is three years (meaning no vesting before year three, then full vesting). Under graded vesting, ownership increases incrementally each year. The maximum graded schedule for defined contribution plans requires the plan to vest at least 20% per year starting in year two, reaching 100% by year six.

Year of Service	Cliff (max 3-yr)	Graded (max 6-yr)
1	0%	0%
2	0%	20%
3	100%	40%
4	—	60%
5	—	80%
6	—	100%

One critical exception: SEP-IRAs and SIMPLE IRAs require immediate 100% vesting of all employer contributions. Safe Harbor 401(k) plans also require immediate vesting on safe harbor contributions.

FAQ

Does ERISA apply to government or church plans?
No. ERISA generally applies to private-sector employers. State and local government plans and most church plans are exempt from ERISA, though they may be subject to similar state laws.

Can a non-qualified plan be offered to all employees?
No. To retain its ERISA exemption, a non-qualified plan must be maintained exclusively for a "select group of management or highly compensated employees." Offering it to rank-and-file employees destroys its top-hat status and triggers full ERISA compliance.

What happens when an employee leaves before fully vesting?
The unvested portion of employer contributions is forfeited back to the plan. Forfeitures can be used to reduce future employer contributions or reallocated among remaining participants, depending on plan design.