Employers who offer a qualified retirement plan already know that this benefit helps attract employees while helping workers build retirement savings.
Employers have another valuable tool in their human resources tool belt that many do not know about—a nonqualified deferred compensation (NQDC) plan. This type of retirement plan is an excellent tool for attracting, retaining, and rewarding company executives and/or other highly compensated employees (HCEs).
NQDC plans reward leadership, performance, and expertise with an ownership-like experience for the employee, and additional incentives and benefits not available through traditional retirement plans.
NQDC basics
With nonqualified deferred compensation plans, employers can offer bonuses, stock options, supplemental executive retirement plans and wraparound 401(k) plans, equity arrangements, and voluntary deferrals as supplementary income. These benefits are paid out at a future agreed-upon date—so the employee earns the compensation in one year but receives the earnings later upon a specific triggering event.
Employers who offer a qualified retirement plan already know that this benefit helps attract employees while helping workers build retirement savings.
Employers have another valuable tool in their human resources tool belt that many do not know about—a nonqualified deferred compensation (NQDC) plan. This type of retirement plan is an excellent tool for attracting, retaining, and rewarding company executives and/or other highly compensated employees (HCEs).
NQDC plans reward leadership, performance, and expertise with an ownership-like experience for the employee, and additional incentives and benefits not available through traditional retirement plans.
The plan must be in writing and the plan document must specify the amount to be paid, the payment schedule, and the triggering event that will result in payment. The employee is required to make an irrevocable election to defer compensation before the year in which the compensation is earned.
Nonqualified vs. qualified plans: what are the differences?
Nonqualified deferred compensation plans differ from qualified plans in several ways. Some advantageous differences for employers are:
1 – NQDC programs are exempt from the nondiscrimination and top-heavy testing required of qualified retirement plans.
2 – NQDC plans are not covered under ERISA, so employers can offer them to certain employees rather than to “all who qualify” for a 401(k); instead, NQDC plans can be offered exclusively to executives and key employees at the employer’s discretion.
3 – There are no federally mandated contribution limits, although the employer may set those limits based on compensation.
4 – NQDC plans generally enable broader investment options than qualified plans.
5 – Because of the deferred compensation, NQDC plans can help retain strong employees with a long-term commitment. (The deferred benefits are subject to forfeiture unless certain conditions are met.)
6 – They boost cash flow since earned compensation is paid in the future.
7 – Setup costs and administration costs are minimal, as there are no required IRS filings. However, accurate recordkeeping is of paramount importance as with any employer-sponsored retirement plan
Employee advantages
This additional compensation is usually awarded after retirement and the benefits in an NQDC plan can allow key employees to retire with total pay replacement. Additionally, by postponing the benefits payment, taxes owed are deferred as well (and the employee is likely to be in a lower tax bracket than when he/she was working).
NQDC plans are good solutions for key employees and executives who have maxed out their qualified retirement plans (such as a 401(k) plan). There are no federally mandated contribution limits on a nonqualified deferred compensation plan, so if the additional compensation is offered through a retirement plan, the employee can maximize his or her 401(k) contributions and keep building retirement savings through an NQDC plan.
Potential downsides for employees
- These are more complicated agreements than a qualified retirement plan and require careful tax planning.
- No early withdrawals are permitted since the additional compensation is to be delivered at a specific later date.
- Distributions must be scheduled in advance (so employees should prepare for higher taxable income in that set year). Therefore, the employee is strongly advised to discuss this with a trusted tax planning professional to an unanticipated tax event.
- Unlike qualified plans, NQDC plans are not protected by ERISA, so there may be a higher element of risk.
Ideal plan sponsors for NQDC
Nonqualified deferred compensation plans may be offered by startups or enterprises. They offer plan sponsors the ability to:
- create a performance-driven environment or a transition plan for successors
- provide key employees with more lucrative rewards without creating an immediate tax burden; NQDC allows employees to defer taxes until retirement (at which time they would be—ideally—in a lower tax bracket).
- offer future benefits without the legal requirement to fund those benefits (as would be the case in defined benefit plan)
Intac FuturePlan can help
Intac FuturePlan’s client service team will walk you, the plan sponsor, through different scenarios to determine if offering a NQDC is the right choice for your organization. As part of the nationwide FuturePlan network, our team can support plan sponsors and business owners with a customized nonqualified deferred compensation plan, plan document creation and implementation, risk and mitigation support, and provide required legislative documentation. Contact your Intac FuturePlan plan consultant to explore this option further.