Recruit and Retain the Best

When you need to recruit the very best executives, offering a nonqualified deferred compensation package can help separate you from your competitors.

Nonqualified Defined

The IRS defines a nonqualified deferred compensation (NQDC) plan as an elective or non-elective plan, agreement, method or arrangement between an employer and an employee that pays compensation in the future. In comparison to qualified plans, NQDC plans do not typically provide the tax benefits associated with qualified plans.

Types of NQDC Plans

Companies may structure NQDC plans in a variety of ways. They might defer a portion of an executive’s salary, pushing it into the future where it can help supplement retirement income, while reducing current taxable income. Executive bonus plans operate on the same premise, deferring bonus income to the future. These plans may defer nonqualified contributions from employers and employees above what qualified plans, such as a 401(k), allow.

Employer Points

Even without the tax advantages of qualified plans, NQDC plans benefit employers because an unfunded arrangement frees up working capital. One efficient way for an employer to prefund the plan is to purchase life insurance on the employee to pay benefits upon retirement. When employers prefund an NQDC plan, the amount also may be tax-deductible. Consult your tax professional.

Two more advantages: NQDC plans generally enjoy less red tape than their qualified cousins do, and employers can require vesting to encourage employees to stay with the company.

Employee Points

Executives like NQDC plans because they don't have a contribution limit. They may negotiate an agreement that annually defers much more money than allowed by qualified plans. Unlike qualified plans, NQDC plans normally don't require minimum distribution.

However, a company's bankruptcy can expose NQDC money to be claims of creditors and there are no guarantees any company won't go out of business, which can put the employee's deferred compensation at risk. Those with unfunded NQDC benefits must also rely on their companies' financial strength. Early distribution, loans and rollovers of plan funds are not allowed and FICA taxes may apply upon distribution. And if employees leave before a contractually agreed-upon term, they can forfeit all or a portion of benefits.