Contributed by: Kali Hassinger
A Non-Qualified Deferred Compensation plan (NQDC) is a benefit plan offered by some employers to their higher earning and/or ranking employees. Some of you may have heard of these plans referred to as “Golden Handcuffs” because they often require that an employee stay with their current employer, or at least not move to a competing firm, in order to receive the compensation. This nickname provides both a negative and positive connotation, but, when appropriate, NQDC plans can offer employees greater control over their income, taxes, and financial future.
NQDC plans, unlike your typical 401(k), are not subject to limitations or non-discrimination rules. That means that the employer can offer this benefit to specific employees and there is no restriction on the dollar amount deferred. This is advantageous to an employee who is expecting to be in a high tax bracket, is already fully funding their retirement savings plan(s), has a surplus in cash flow, and may foresee a time when their taxable income will be reduced. With this strategy, the employee and employer agree upon a date in the future to pay the employee his/her earned income. Both parties agree to when the funds will be received in the future, and it isn’t taxable income until it is actually received by the employee.
In most cases, these plans are considered “unfunded” by the employer, which means that the money isn’t explicitly set aside for the employee. This scenario creates a certain level of risk for the employee because the funds would be subject to any future bankruptcy or creditor claims. There are some strategies that the employer can utilize to mitigate the risk (involving trusts and insurance), but they need to uphold the NQDC status. Otherwise, the deferred compensation amount will become fully taxable to the employee along with a 20% penalty. Funded NQDC plans exist as well, and these plans set the deferred compensation assets aside exclusively for the benefit for the employee. Funded plans, however, open themselves back up to ERISA requirements, making them far less popular.
When an employer and employee enter in a NQDC agreement, it can be a win for both parties. Employers are securing that valued employees will remain loyal, while employees are able to reduce their taxable income now.
Kali Hassinger, CFP® is an Associate Financial Planner at Center for Financial Planning, Inc.®
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of Kali Hassinger and are not necessarily those of RJFS or Raymond James. Raymond James Financial Services, Inc. and its advisors do not provide advice on tax issues, these matters should be discussed with the appropriate professional.