An active duty servicemember doesn’t need to think much about retirement plans. There is one, and if you stick around for 20 years, you get it. If you don’t, you don’t. While the military retirement system is changing, there still isn’t much to decide on. It’s not like the Air Force has a different retirement plan than the Navy or Army. That is not the case in the civilian world and you’re going to need to understand the plans you’re offered and how they might help support your long-term goals.
In the civilian retirement universe there are two main types of plans. Non-Qualified and Qualified. You’ll want to know which type of plan an employer offers.
Non-Qualified plans are generally, but not always, offered to executives and high-earners in a company. These retirement plans provide for contribution of funds, either your wages or additional funds provided by your employer, and deferral of taxes (you don’t pay taxes on the money you put into the plan or the earnings on the money while the funds are invested, but you pay taxes when you take the money out). The reason you don’t pay taxes on the funds that go into the plan is because they are at risk.
Being at risk means that you might not ever get the funds. In some cases you need to stay with the company for a specified amount of time. In others, the funds are a considered a “loan” to the company and if the company goes bankrupt you may get nothing. Non-qualified retirement plans go by names like Deferred Compensation, Restricted Stock Units or Incentive Stock Options amongst others. Non-qualified plans are very tricky when it comes to taxes so consult with a tax professional if you are offered one.
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Conversely, qualified plans can’t be limited to a restricted group of employees. In fact that is one of the key requirements of a non-qualified plan. It can’t discriminate. Employers can’t favor highly compensated employees at the expense of the rank and file. Another key requirement of a qualified plan is that it must vest within a certain amount of time. Vesting is when the money becomes yours to keep. We’ll cover vesting in depth in a future article.
Like non-qualified retirement plans, qualified retirement plans, provide tax benefits. Just like a non-qualified retirement plan, an employer can contribute additional funds beyond your wages and you won’t owe taxes on the contributions when made. Also, you may have the right to deposit some of your wages into a qualified plan and defer paying taxes on those funds and the earnings on them until you take the money out.
Unlike non-qualified plans, some qualified plans allow you to deposit money after paying taxes and when you withdraw the funds in the future, the contributions and earnings on them will be tax free.
Retirement plans are important and have a language all their own. Next month I’ll take a stab at defining some more key terms in the qualified plan realm.
Curt Sheldon CFP®, EA is the author of the book “Well and Faithfully Discharged: Financial TTP for Military Retirement”. He is the owner and founder of C.L. Sheldon & Company a financial and tax firm specializing in serving current and former military members. Prior to starting his company, he served 27 years in the USAF.