A non-qualified deferred compensation (NQDC) plan allows a service provider to earn wages, bonuses, or other compensation in one year but receive the earnings—and defer the income tax on them—in a later year. Doing this provides income in the future (often after they've left the workforce), and may reduce the tax payable on the income if the person is in a lower tax bracket when the 澳洲幸运5官方开奖结果体彩网:deferred compensation is received.

Cond🐠itions of Non-Qualified Deferred C🐼ompensation (NQDC) Plans

NQDC plans are retirement savings plans commonly known as 澳洲幸运5官方开奖结果体彩网:409A plans. They can impose certain conditions. This includes refraining from competing with the company or providing advisory services after retirement. Violating the conditions in the law triggers penalties. All of the deferred compensation becomes immediately taxable. What's more, there is a 20% penalty, plus interest, charged on this amount.

The deferred amount of an NQDC plan earns a reasonable 澳洲幸运5官方开奖结果体彩网:rate of return determined by the employer at the time that the deferral is made. This can be the rate of return on an actual asset or indicator—say, the return on the 澳洲幸运5官方开奖结果体彩网:Standard & Poor's 500 Index. When distributions are made, they include the compensation and what amounts to earnings o𝓡n that compensation (though there are no actual𒁃 earnings; it's merely a bookkeeping entry).

Keep in mind that there are several varieties of NQDC plans. The one discussed here is the most common type, which is a basic 澳洲幸运5官方开奖结果体彩网:unfunded plan for deferring part of an employee's annual compensation.

How Employers Bꦰenef෴it from Non-Qualified Deferred Compensation (NQDC) Plans

NQDC plans are not qualified, which means they aren't covered under the 澳洲幸运5官方开奖结果体彩网:Employee Retirement Income Security Act (☂ERISA). As such, they offer greater flexibility for employers and employees. Employers can 𒁏offer NQDC plans only to executives and key employees who will use and benefit from them. There are no non-discrimination rules, so deferral need not be offered to non-executives.🌠 This gives the company considerable flexibility in tailoring its plan.

The plans are also used as 澳洲幸运5官方开奖结果体彩网:golden handcuffs to keep valued staff on board, as leaving the company before 澳洲幸运5官方开奖结果体彩网:retirement can result in forfeiting deferred benefits.

An NQDC plan can be a boon to 澳洲幸运5官方开奖结果体彩网:cash flow, since currently earned compensation is not payable until the future. However, the compensation is not 澳洲幸运5官方开奖结果体彩网:tax-deductible for the company until it is paid.

The costs of setting up and administering an NQDC plan are minimal. Once initial legal and accounting fees have been paid, there are no special annual costs, and there are no required filings with the 澳洲幸运5官方开奖结果体彩网:Internal Revenue Service (IRS) or other government agencies.

Benefits of Non-Quali𝐆fied Deferred Compensation (NQDC) Plans for Employees

Unlimited Savings and Tax Benefits

The IRS imposes 澳洲幸运5官方开奖结果体彩网:strict limitations on the amount of money you contribute to a 澳洲幸运5官方开奖结果体彩网:qualified retirement plan, like a 401(k). In tax year 2024, the contribution limit for someone who is under 50 years old is $23,000. People who are age 50 or older can contribute an additional $7,500 under the 澳洲幸运5官方开奖结果体彩网:catch-up contribution rule set by the IRS.

Deferred compensation plans have no such federally mandated limits, though employers may specify a contribution limit based on your compensation. If you are a 澳洲幸运5官方开奖结果体彩网:highly compensated employee, you can maximize contributions to your 401(k) and then continue to build your rꦆetirement savings through an NQDC plan without restriction.

The ability to defer any amount of compensation also reduces your annual taxable income. This can, in turn, put you in a lower 澳洲幸运5官方开奖结果体彩网:tax bracket, further decreasing your tax liability each year.

Investment Options

Many NQDC plans offer investment options similar to 401(k) plans, such as mutual funds and 澳洲幸运5官方开奖结果体彩网:stock options. These investment options allow you to grow your wealth over time. You can also invest at a larger scale because your contributions are unlimited, increasing the potential for more significant gains.

Drawbacks oꦆf Non-Qualified Deferred Co🐬mpensation (NQDC) Plans for Employees

Strict Distribution Schedule

Unlike a 401(k), you must schedule distributions from an NQDC plan in advance. Rather than being able to withdraw funds at will after retirement, you must choose a distribution date at some time in the future. You must take distributions on the designated date, regardless of whether you need the funds or how the market is doing. This means your taxable income for the year is increased, and the timing of the distribution may mean that the assets in your investment portfolio are 澳洲幸运5官方开奖结果体彩网:liquidated at a loss.

The NQDC plan can allow for a subsequent deferral or a change in election only under certain conditions, such as receiving deferred compensation at age 70 rather than at age 65. This requires that the subsequent election be made at least 12 months before the date that payment was originally scheduled to begin, that the subsequent election change delays the payment date for at least five years, and that the election is not effective until at least 12 months after it is made.

No Early Withdrawal Provision

Though it is discouraged, employees who contribute to 401(k)s or other qualified plans are legally allowed to withdraw funds at any time. While distributions taken before age 59½ result in a 10% early withdrawal tax penalty, nothing is preventing you from accessing funds in an emergency. In addition, most plans provide for several 澳洲幸运5官方开奖结果体彩网:penalty-free early withdrawals if you can prove financial hardship.

Conversely, NQDC plans have no such provisions. You must withdraw funds according to the distribution schedule—and no earlier. Funds contributed to an NQDC plan are not accessible before the designated distribution date, even if you have an emergency financial need that you cannot meet by other means.

No ERISA Protections

Because NQDC plans are not covered under ERISA, they are not afforded the same protections from creditors as other retirement plans. In fact, as a plan participant, you don't own an account of any kind, because your employer reduces your compensation by the deferral amount rather than depositing funds into an account held with a financial institution. An employee deferral represents a 澳洲幸运5官方开奖结果体彩网:liability on the employer's 澳洲幸运5官方开奖结果体彩网:balance sheet, essentially making the NQDC plan an 澳洲幸运5官方开奖结果体彩网:unsecured loan between the lending employee and th𒁏e borrowing employer.

If the plan is unfunded, you must rely on the employer's promise to pay in the future according to the distribution schedule. If the employer falls on hard times and must pay off debts, the funds that might have been used to pay your employee distributions can be claimed by 澳洲幸运5官方开奖结果体彩网:creditors. Funded NQDC plans offer more protection for employee contributions, but deferrals are generally taxable in the year they were earned, nullifying the 澳洲幸运5官方开奖结果体彩网:tax benefit that unfunded plans provide.

There's another financial risk: the rate of return paid on the deferred compensation. An employee may be able to earn a greater rate of return on the after-tax amount without deferral than what is paid under the deferred compensation plan.

Examples of NQDC Plans

NQDC plans can be 澳洲幸运5官方开奖结果体彩网:supplemental executiᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚve retirement plans (SERPs), voluntary deferral plans, wraparound 401(k) plans, excess benefit plans, equity arrangements, bonus plans, and 澳洲幸运5官方开奖结果体彩网:severance pay plans.

Teachers' salaries are non-qualified compensation plans that meet the requirements of 澳洲幸运5官方开奖结果体彩网:Internal Revenue Code (IRC) Section 409A. Say a teacher earns $54,000 a y🐻ear and works from Aug. 1, 2024, to May 31, 2025. They earn $5,400 a month. If the teacher is paid for only the months they worked, they are paid $5,400 a month for 10 months. If, however, they are paid over 12 months, they earn $4,500 a month.

In the example dates above, with a 10-month salary, the teacher earns $27,000 in 2024 and $27,000 in 2025. With a 12-month salary, they earn $22,500 in 2024 and $31,500 in 2025. Based on the hours worked, if they are paid a 12-month salary, $4,500 worth of work conducted in 2024 is paid out in 2024. Under IRC Section 409A, the $4,500 from 2024 is considered non-qualifying deferred compensation that meets the requirements of the code.

The Bottom Line

A non-qualified deferred compensation plan can supplement or supplant a qualified 澳洲幸运5官方开奖结果体彩网:retirement plan to create retirement savings on a 澳洲幸运5官方开奖结果体彩网:tax-advantaged basis. It is non-qualified because it is not covered by the ERISA. It can be used for employees, independent contractors, corporate directors, and other non-staffers༒. However, the intended tax benefits are realized onl🍨y if the plan conforms to tax law requirements.