Nonqualified Deferred Compensation Plan Basics

A nonqualified deferred compensation plan (NQDC) allows your employees to set aside income or benefits until a later time as specified in the plan.  NQDC’s are a flexible form of employee compensation that allows you to tailor the benefit amounts, payment terms, and conditions of the plan to suit both you and your employee’s needs. As a result, an NQDC plan can cover any group of employees without regard to nondiscrimination requirements, provide unlimited benefits to any employee, and can provide different benefit amounts for different employees under different terms and conditions. In addition to its flexibility, an NQDC plan can also provide your employees with significant tax benefits.

Funded Versus Unfunded Plans

NQDC plans fall into two categories, funded plans, and unfunded plans.  Unfunded plans are far more common than funded plans because they can provide the benefit of tax deferral while avoiding almost all of ERISA’s burdensome requirements.  On the other hand, funded plans must comply with ERISA, and provide only limited deferral opportunities.

In general, a plan is considered to be funded if assets have been “irrevocably and unconditionally” set aside with a third party for the payment of NQDC plan benefits. In short, if the participants in the NQDC plan are guaranteed to receive their benefits, the plan is considered to be “funded”.

In an unfunded plan, the participants are relying solely on your promise to pay benefits at a later date. Participation in unfunded pans is limited to a select group of management or highly paid executives.

Benefits of NQDC Plans

• Flexibility – Design a plan that helps meet each employee’s specific needs.  This enables you to offer a more attractive plan to each employee while giving you control over the benefits themselves.
• Valuable Benefit – NQDC plans can offer life insurance coverage for your key employees.
• Reduce Employee’s Anual lncome Tax Liability – Participation in an NQDC plan means employees won’t have to pay taxes on the deferred income until they withdraw it from the plan.
• Keep Your Employees Feeling Appreciated – Encourage your employees to stay with your company longer because the longer they contribute to the plan, the greater their benefit pool.
• Cost Effective – Once set up an NQDC plan is relatively easy to administer and maintain.  Any costs linked to the maintenance of these plans are generally tax-deductible for your business, as are any benefit payments you make to the employees.

Special  Considerations

• Notice and consent are required by all parties for employer-owned life insurance.
• Any financial vehicle used to fund the plan is subject to company creditors.
• NQDC plans may be offered only to a select group of employees of C and S Corporations.
• The business can contribute to the plan whether or not the employee actually defers salary to the plan.
• All parties should consult with their attorney and tax advisor to discuss their NQDC plan situation.