Non-Qualified Deferred Compensation (NQDC)

Non-Qualified Deferred Compensation (NQDC) plans are a type of compensation arrangement that allows employees to defer a portion of their income to a future date. Unlike qualified retirement plans (such as 401(k)s or IRAs), which may offer certain tax advantages and are subject to various legal requirements, NQDC plans are typically designed for higher-level executives or key employees.

Here are some key points about Non-Qualified Deferred Compensation plans:

  1. Purpose: NQDC plans are often used by employers to attract and retain top talent, especially in situations where standard compensation packages might not be enough. These plans allow employees to defer a portion of their current compensation to a later date, usually retirement, when they expect to be in a lower tax bracket.
  2. Timing of Benefits: With NQDC plans, participants typically choose the timing of when they will receive the deferred compensation, which is often at retirement. They may receive a lump sum or choose a schedule of payments, such as monthly or annually.
  3. Risks: NQDC plans carry some risks. Since the deferred compensation is not protected under ERISA (Employee Retirement Income Security Act), participants are at risk if their employer faces financial difficulties or bankruptcy. If the company is unable to fulfill its obligation to pay the deferred compensation, employees might not receive the benefits they were promised.
  4. 409A Regulations: NQDC plans must comply with Internal Revenue Code Section 409A, which imposes strict rules to prevent abuse and tax avoidance. These regulations govern the timing of deferral elections, distribution events, and other plan features to ensure that deferred compensation is taxed appropriately.
  5. Limits on Contributions: Unlike qualified plans, which have annual contribution limits set by the IRS, NQDC plans do not have specific contribution limits. However, the total amount that can be deferred is usually subject to a cap, often a percentage of the employee's total compensation.
  6. Distribution Restrictions: NQDC plans usually have restrictions on when distributions can occur. Distributions are typically triggered by specific events, such as retirement, separation from service, disability, or a predetermined date. Early withdrawals or distributions outside of the defined triggers can result in penalties and taxes.
  7. Employee Benefits: Beyond retirement savings, NQDC plans might offer additional benefits, such as supplemental retirement income, and the ability to time income to coincide with lower tax years.

It is important to note that NQDC plans can be complex, and their specifics can vary based on the employer's plan.  Before making any decisions related to a Non-Qualified Deferred Compensation Plan, you should consult with a CERTIFIED FINANCIAL PLANNER™ professional to understand the tax implications, and make an informed decision which may significantly impact your personal financial situation.