When to Consider a Nonqualified Deferred Compensation Plan?

Jun 25, 2019

By Edward “Ed” V. O’Neal, Vice President and Manager, Retirement Plans

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As an employer, it’s important to have enthusiastic and engaged employees, and one way to impact that is by offering competitive employer-sponsored benefits (i.e.  retirement plans, medical benefits, etc.).  For employers particularly interested in approaches for attracting and retaining key employees and executives, a Nonqualified Deferred Compensation (NQDC) Plan can provide an effective and flexible solution.

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 until some later agreed upon date.  Properly structured, NQDC plans can have benefits to both the sponsoring employer and participating employees.

From the employer perspective, NQDC plans provide great flexibility in terms of:

  • Employee Eligibility – permitting 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 Funding – with common funding methods including corporate owned life insurance, mutual funds or other investments (i.e. equities, etc.).

NQDC plans can help employers retain their top talent.  Employees participating in these plans aren’t allowed to access their assets in these plans for some period, and they risk forfeiture of the assets if they fail to meet specific provisions within the plan (i.e. length of service, sales goals, 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.

Typically, 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 for helping employers attract new and retain existing key employees. Additionally, these plans 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.