What Is a Non-Qualified Deferred Compensation (NQDC) Plan?
NQDC plans allow employers to offer a benefit to high-income earners and other key employees through a contractual arrangement. These plans can be used to support retirement goals and serve as a tool to recruit, reward, and retain top talent.
When used for retirement, key employees are able to defer income above and beyond what they are able to contribute via other qualified plans, like 401(k)s. Even if highly compensated employees (HCEs) defer the maximum allowed each year in their qualified plan, it may not be enough income replacement in retirement. NQDC plans can offer a solution by allowing HCEs the ability to defer large portions of their compensation to avoid income taxes. Similar to qualified plans, these accounts grow on a tax-deferred basis.
Furthermore, NQDC plans are a way for employers to attract top talent and reward them by offering additional compensation that may be tied to specific goals or criteria. Incorporating an NQDC into the benefits package ensures top talent has an incentive to remain committed to their firm instead of joining the competition.
There are a variety of options available, and these plans may be referred to by different names based on their plan design. You may hear them referred to as top hat plans, supplemental executive retirement plans (SERPs), or 401(k) mirror plans, just to name a few. What they all have in common is their tax code, as they are often referred to as 409A plans.
Why Consider NQDC as an Option?
Employers want effective ways to recruit and keep the best employees. Key employees want to work for companies that care about their future. To retain key employees, employers can offer valued and competitive benefits through an NQDC as a way to differentiate themselves from competitors.
One of the primary reasons employers adopt an NQDC plan is to address the retirement gap that exists for HCEs. The more income an employee makes, the more they need to replace in retirement. Even though HCEs receive larger dollar amounts from qualified plans compared to other employees, these benefits are actually smaller when expressed as a percentage of pre-retirement income. NQDC plans allow the employer a means to restore qualified plan contributions that have been returned or restricted due to nondiscrimination testing failures.
What Are the Benefits for Employers and Plan Participants?
- Allows employer to recruit, reward, and retain key employees
- Avoids certain characteristics seen in qualified plans:
- Code Section 415 contribution and benefit limits
- ADP/ACP testing limits
- Nondiscrimination requirements
- Reporting requirements
- Unlimited plan and vesting designs
- Tax deductions taken when plan participants take distributions
- Pre-tax savings and growth
- Personalized investment strategy to replace income in retirement
- Employee deferrals are unlimited
- Employer contributions are unlimited
- No age 59½ withdrawal penalties
- Pre-retirement distributions can be earmarked for expenses like college savings, retirement, or a vacation home
- Required minimum distributions (RMDs) are not required
While there are various benefits that make an NQDC plan appealing, these plans can be complex, and there are some very important considerations to keep in mind:
- NQDC plans may not be attractive to participants if the employer is not financially solid, since these assets sit on the company’s balance sheet and are not protected by creditors.
- Participant distributions from the plan are not eligible for rollover.
- Employer tax deductions are not available until plan participants take distributions.
- 409A regulations must be followed very carefully to maintain non-ERISA status.
- Participant contribution elections are made in advance of the plan year and are irrevocable.
- Depending on the plan design, distributions may be taken throughout the career of the participant, and this may require further tax guidance.
An NQDC plan can set your company apart from others in regard to attracting, rewarding, and retaining top talent. These plans can be complex, and are not suitable for every organization. Before opening an NQDC, reach out to your Stifel Financial Advisor to carefully review the risks and rewards. We can help determine appropriate providers to administer this type of plan to align with your goals.
Stifel does not provide legal or tax advice. You should consult with your legal and tax advisors regarding your particular situation.