The myStockOptions Blog: Nonqualified Deferred Compensation

Talk to your financial professional about incorporating—or improving—a deferred comp plan in your benefits program. Similarly, to meet the “in operation” requirement, an NQDC plan needs to be operated in accordance with the plan document and the 409A regulations. For example, if the plan says an executive will be paid 90 days following separation and the employer pays 10 days following separation, the executive will be subject to 409A penalties. Because these rules were designed to curb the potential for abuse by executives, Sec. 409A imposes immediate taxation, an additional 20% tax, and in some instances interest for failures to comply. These penalties are imposed on the individual executives rather than the employer.

Unlike funds in qualified retirement plans, funds in NQDC plans are not protected from creditors. Employees who defer compensation may never recoup that money if the company goes bankrupt. This is because, by law, and from the standpoint of a creditor, the money is part of the company’s general assets until it is distributed to the employee. In general, employees cannot take the money out of the plan early or take loans against the assets (although there is some limited ability to access amounts in certain financial hardship circumstances).

Navigating the Complexities of Nonqualified Deferred Compensation Plans

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• For example, if the plan says an executive will be paid 90 days following separation and the employer pays 10 days following separation, the executive will be subject to 409A penalties.
• By working with an experienced employee benefits attorney, employers can implement and maintain customized NQDC plans to meet their needs and the needs of their employees.
• On the other hand, the IRS has recently released updated field guidance to its agents on the examination and review of nonqualified deferred compensation plans under Sec. 409A.
• Does this uncertainty mean you should stop deferring compensation into your company’s NQDC plan or increase your deferrals?

This election can be changed, provided that it is made at least one year before the originally scheduled payment date and the change delays the originally scheduled payment for at least five years. Generally,
the election to defer is provided annually during open enrollment or during a
special enrollment period when you’re first eligible to participate. Your first
decision is to determine if you would like to participate and how much of your
salary and bonus you would like to defer. You’ll be asked to make this decision
in the year before you earn the income, within 30 days of initial enrollment,
or, in specified situations (such as a performance bonus), up to six months
ahead. Once you’ve made an election to defer, that election will be irrevocable for the year. Depending on
how the plan is structured, you may be asked to select the timing of when to
receive your balance (at retirement or a specified date) and the form of
payment (lump sum or installment payments).

Why use a nonqualified deferred compensation plan?

And because assets left to heirs receive a “stepped up” cost basis, it’s a very tax-friendly way to leave a legacy. Also, by drawing from both tax-deferred and taxable assets in retirement, it can help provide flexibility to manage your tax situation https://turbo-tax.org/nonqualified-deferred-compensation-plan-faqs-for/ in retirement and even harvest losses to offset gains. Its nonqualified counterpart still shares many of the core features of a 401(k). SERP plans offer savings well in excess of a 401(k), but they are inflexible in several other ways.

SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. SmartAsset does not review the ongoing performance of any RIA/IAR, participate in the management of any user’s account by an RIA/IAR or provide advice regarding specific investments. It’s a benefit that makes working for — and staying with — your company that much more valuable. To comply with Section 409A regulations, the election to defer compensation must generally be made at the close of the tax year prior to the earnings year.

Unlimited Savings and Tax Benefit

Since NQDC rules exempt plans from most ERISA and reporting requirements, no limitations on deferred amounts and no minimum distribution rules apply to these plans. Also, a NQDC plan can discriminate in favor of higher compensated employees https://turbo-tax.org/ and amongst employees in various compensation levels, which becomes problematic in a qualified retirement plan. Review the plan documents to see if deferred compensation assets may be paid out if you voluntarily leave the company.

Employers typically offer NQDC plans only to top management or other highly compensated employees and generally should not cover non-highly compensated employees. Employers typically offer NQDC plans only to top management or other highly compensated employees and generally should not cover nonhighly compensated employees. If a SERP plan does not require distributions at your RMD age, this could be a way to continue tax-deferred growth or extra income before RMDs. Your plans may change and there’s no way to tell what the tax code may be in the future. Set up a bank or brokerage account at a financial institution you don’t regularly use, and schedule automatic transfers to match pay periods.

Best Financial Advisors

As such, qualified plans such as 401(k) plans and NQDC packages such as 409A plans are both considered deferred compensation plans. So you might also want to think about how your tax bracket will change when you stop working (or whenever you elect to receive the deferred payments). You’ll benefit the most from having a NQDC plan if you wind up in a lower tax bracket since you’ll be paying income taxes on the deferred funds. A nonqualified deferred compensation plan from Principal allows you, a key employee, to save for retirement on a pre-tax basis to supplement your existing qualified employer-sponsored plan, such as a 401(k). The procedures to voluntarily correct 409A failures have been around for over a decade now, and while there’s no promise that they’ll last forever, there’s also no indication that the service plans to shut them down anytime soon.