If you have heard the acronym NQDC, when discussing retirement plans, you may be wondering what is a NQDC and should you have one. It stands for Nonqualified Deferred Compensation plan, and it is one type of employer-sponsored retirement plan. As with other types of retirement plans, a NQDC has its own advantages.
What makes this compensation plan different?
The Nonqualified Deferred Compensation plan is established and governed by Section 409A of the Internal Revenue Code, which applies to compensation that employees earn in one year, but that is paid in a future year. This is why it is referred to as deferred compensation. However, it is different from deferred compensation in the form of elective deferrals to qualified plans, like a 401(k) plan.
What are the benefits of a Nonqualified Deferred Compensation plan?
You may be hoping that the money you have saved through your employer’s qualified retirement plan will be sufficient to sustain your standard of living when you retire. However, even with an IRA and Social Security, that may provide only a fraction of what you will need to retire comfortably.
A Nonqualified Deferred Compensation plan can provide a strategy to diversify your retirement investment options. One benefit, is that a NQDC plan will allow employees to accumulate pretax dollars beyond the contribution limits of qualified plans. This way, participants in the plan may be able to fill the gaps in their retirement income.
Contributions and Taxation
Unlike the various 401(k) options, a NQDC plan does not have the annual contribution limits imposed by the IRS. There may be limits imposed by the plan itself. Also, employees have the option of deferring the receipt of their income in order to reduce their current income tax burden. This will help provide more flexible, long-term tax planning. Although investments made in NQDC plans are subject to market risk, and may possibly lose value, they do provide tax-deferred growth. All distributions from a NQDC plan are subject to income tax.
Why are Nonqualified Deferred Compensation plans so popular?
A NQDC is essentially a contract, between the employer and employee, to defer the receipt of presently earned compensation, in order to defer the taxes on that income to future years. Changes to the tax law in this area have made alternatives to NQDC plans more expensive, more restrictive and often troublesome. That has made the NQDC more attractive to employers, as well as employees.
Employers often prefer the NQDC plan because it is very flexible, allowing the employer almost complete control over the design of the plan. The employer can choose who will be covered, the level of benefits that will be provided, and which terms and conditions will be imposed. In fact, the employer can create different plans for different employees.
If you have questions regarding Nonqualified Deferred Compensation plans, or any other retirement planning needs, please contact Sexton, Bailey Attorneys, PA online or by calling us at (479) 443-0062.