What is the most important tax difference between a qualified retirement plan and a nonqualified deferred compensation arrangement?

1. A.Nonqualified plans must satisfy stricter coverage and nondiscrimination rules than qualified plans in order to earn a deduction
2. B.Employer contributions to a qualified plan are currently deductible, while nonqualified plan deductions are generally postponed Correct answer
3. C.Earnings in a qualified plan are taxed to the employee each year, while nonqualified plan earnings grow tax deferred
4. D.Benefits from a qualified plan are received income tax free, while nonqualified plan benefits are taxed as ordinary income

Explanation

A qualified plan earns the employer an immediate deduction because the arrangement satisfies IRS participation and nondiscrimination standards, whereas a nonqualified plan usually delays the employer's deduction until the benefit is actually included in the employee's income. Nonqualified plans are attractive precisely because they may discriminate in favor of selected executives, so the option about stricter rules is reversed. Earnings in both plan types grow tax deferred, and qualified plan distributions are taxed as ordinary income rather than received tax free.