Your workers, especially those holding senior positions, are the most critical hires in your organization. For this reason, it is essential that you find ways to attract more quality talent and retain the best you have. Nonqualified deferred compensation (NQDC) plans are among the benefits employers use to retain top talent, and if you are wondering what they are, this article clarifies everything. In addition, you will understand the benefits and risks of implementing NQDC plans so that you can put them to the best use for your business. 

What is a Non-Qualified Deferred Compensation Plan?

A non-qualified deferred compensation (NQDC) plan is whereby an employer reaches an agreement with an employee to pay them sometime in the future. It is mainly applied to executive staff benefits, whereby employees get to postpone their income taxes on their earnings. NQDCs are also known as 409A plans, and they allow employers to come up with compensation packages aligned with their business values. This means that executive deferred compensation plans can be customized to suit each staff. Additionally, NQDC comes in various forms, including bonuses, company stocks, etc.

What is the Difference Between a Qualified and Non-Qualified Deferred Compensation Plan?

To give you a better understanding of the non-qualified deferred compensation plan, it’s essential to understand all types of deferred compensation plans. Besides the 409A deferred compensation, there is also the qualified deferred compensation plan such as the 401(k)s. Simply put, these plans differ based on how the law and people use them. 

A qualified deferred compensation plan is regulated by the rules under the Employee Retirement Income Security Act (ERISA). This doesnt mean that the NQDC doesn’t abide by ERISA laws. However, the guidelines NQDC plans are subjected to are not as stringent as those imposed on the qualified deferred compensation. 

In addition, qualified deferred compensation plans come with income caps, whereby contributions to the program are limited annually. This makes the non-qualified deferred comp a preferred choice by many since it can benefit even the high-income earners willing to contribute more than they couldn’t on the qualified compensation plan. 

Although NQDCs are mere agreements and do not have to be in writing, it is crucial to consider the specifics, including payment schedule, date, amount, the reason for payment, etc. 

What are the Types of Nonqualified Deferred Compensation Plans?

Non-qualified deferred compensation comes in two forms, and understanding them will help you decide the one that works best for your business. As a result, you will choose a plan that will effectively supplement your executive staffs’ retirement income. Note that with both plans, tax accumulates, and the IRS will deduct employees during retirement as if they were ordinary income. 

1. True-Deferred Compensation Plans:

This type of non-qualified deferred compensation plan is funded by the employer. The executive staff receives portions of their earned salaries during retirement or later as agreed between both parties. Employees will also receive tax benefits as specified under section 409A. 

2. Salary Continuation Plans:

This NQDC plan is funded by the employees. An employer deducts a specific amount of money from the employees’ salaries to fund their retirement. As a result, employees continue to receive lower salaries, especially after retiring. 

What are nonqualified deferred compensation examples?

Non-qualified deferred compensation plan comes in different forms, and it is not as strict as other ordinary retirement plans. It could be voluntary deferral plans, bonus plans, excess benefits plans, equity arrangements, severance pay plans, and supplemental executive retirement plans. 

For example, an executive staff is earning $750,000 annually. However, with a 401(k) maximum contribution of $22,500, representing 3% of his annual income, it is challenging to save enough for his retirement. In this regard, deferring some of his earnings to the NQDC plan could help him postpone paying income taxes until later in the future. As a result, the employee can save more than what is allowed on the 401(k) plan. 

Note that the NQDC plan is flexible and allows your savings to be deferred for more than ten years or until you retire. However, as mentioned earlier, this plan is not protected by ERISA. This means that in case your employer’s business goes bust or is sued, you will not be protected from the business’s creditors. Furthermore, your tax burden can be much more since the tax you pay while claiming your NQDC is more than what you would have paid before saving. Simply put, this savings vehicle is suitable for individuals earning a substantial amount of money and have no other savings option. 

Conclusion

Non-qualified compensation plans are more complicated because of the different purposes they serve. In this regard, it is crucial that you fully understand how they work before participating in one. For example, consider your financial circumstances, such as the amount of tax deducted when claiming it. If you believe that your plan will end up in a lower tax bracket, then go for it. In addition, consider investment options in both the 401(k) and the 409A deferred compensation. Settle for the 401(k) if they are similar since it is protected under ERISA, making it safer. All in all, it is best to seek the services of a financial advisor for more insight into the NQDC plan before diving right in.