The challenges of attracting and retaining employees has become increasingly difficult in the current employment market for many employers. And for employers looking to reward and retain their key executive management employees, who are often critical to the employer’s success, finding an effective incentive-based solution can be a frustrating exercise.
Creating an environment to entice the “right” employees is an important step for any employer, and offering a competitive and comprehensive benefits program is a key element in that process. However, qualified retirement plans, such as 401(k) plans, have strict limits on the level of contributions for plan participants. This can present challenges for employers attempting to provide “extra” benefits and incentives to their often highly compensated key and executive management employees. A nonqualified deferred compensation (NQDC) plan could offer an effective and flexible solution for this common employer dilemma.
A NQDC plan is an arrangement made between an employer and select/key employees that permits an employee to defer receiving some of their compensation, including salary, bonuses and other kinds of income, until some later agreed upon date. Since the compensation is deferred until a later date, taxes owed on the income is deferred as well. NQDC plans don’t have contribution limits or restrictions, like 401(k)s, so they can be particularly beneficial for highly compensated employees who may already be maxing out their 401(k) plan and would like to contribute more. Properly structured, NQDC plans can have benefits to both the sponsoring employer and the participating key/executive management employees.
From the employer perspective, NQDC plans provide some key advantages:
- Employee Eligibility – Limiting participation to only key and select management employees to be included in the plan.
- Plan Design & Structure – Allowing the plan to be designed as a salary reduction arrangement, bonus deferral plan or employer funded arrangement.
- Plan Contributions & Funding – No federally mandated contribution limits or restrictions for eligible employees. Common funding methods include corporate owned life insurance, mutual funds or other investments (i.e. equities, etc.).
From the employee perspective, NQDC plans can provide some unique benefits:
- Employees can defer income beyond the contribution limits of typical employer-sponsored retirement plans (i.e. 401(k), SIMPLE, 403(b), etc.). This could be particularly appealing to highly compensated key management and executives.
- Depending on the structure of the NQDC plan, income deferred by an employee will not be considered taxable income until eventually distributed.
Employees participating in these plans aren’t typically permitted to access assets until they satisfy specific requirements outlined in the plan (i.e. length of service, performance goals, etc.). Failure to meet the requirements could result in forfeiture of those assets. Other unique provisions of NQDC plans include that employer contributions are not immediately tax deductible, distributions from NQDC plans are not rollable to IRAs for continued tax deferral, and NQDC assets are considered part of the general assets of the sponsoring employer and can be subject to creditors of the sponsoring employer.
Ultimately, NQDC plans can be an effective tool in helping employers attract, reward and retain their key executives and top talent. These programs can offer benefits and flexibility to both employers and employees, but due to their unique design and tax treatment, should be carefully reviewed with legal and tax advisors before implemented.
IMPORTANT DISCLOSURES: The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards is not engaged in rendering legal, accounting or tax preparation services. Specific questions on taxes or legal matters as they relate to your individual situation should be directed to your tax or legal professional.