Nonqualified Deferred Compensation (NQDC) Plans Valued by Key Personnel

NQDC plans have long been a part of competitive benefits packages for executives, management teams, and highly compensated employees. Participants appreciate nonqualified plans because they help them save for retirement above qualified plan limits, manage their taxes, and obtain additional employer contributions in some cases. As a result, NQDC plans can be especially helpful in attracting and retaining key personnel. While the number of total employees participating in NQDC plans remains relatively small, these plans are growing in popularity.

6.1% of total employees were eligible to participate in NQDC plans in 2020; slightly more than the 5.2% of employees who were eligible to participate in NQDC plans in 2018[1]

66.1% of eligible employees participated in NQDC plans in 2020; up from the 53.4% of eligible employees who participated in NQDC plans in 2018[1]

What You Should Know

Unfunded NQDC plans are exempt from most ERISA requirements and thus provide employers flexibility in determining eligibility, funding, vesting on employer contributions, and plan distributions.

NQDC plans typically fall into one of four categories:

  1. Salary Reduction Arrangements allow the participant to defer receipt of a portion of their salary.
  2. Bonus Deferral Plans are similar to salary reduction arrangements, except they enable participants to defer receipt of bonuses.
  3. Top-Hat Plans (aka Supplemental Executive Retirement Plans or SERPs) are NQDC plans maintained primarily for a select group of management or highly compensated employees.
  4. Excess Benefit Plans provide benefits solely to employees whose benefits under the employer’s qualified plan are limited by IRC Section 415.
NQDC plans can be funded or unfunded. A plan will generally be considered funded if assets are segregated or set aside so that they are identified as a source to which participants can look for the payment of their benefits. Funded plans result in taxation to the participant in the year that contributions are made, and subject to ERISA. Therefore, many employers choose to establish unfunded plans. An unfunded arrangement is one where the employee has only the employer’s unsecured promise to pay the deferred compensation benefits in the future. However, to make the plan more appealing to employees, the employer may set aside funds in a nonqualified trust (often called a “Rabbi Trust”) to pay NQDC benefits, as long as the funds remain subject to the claims of the employer’s general creditors. Corporate-owned life insurance is another informal funding vehicle for unfunded plans.

Under a nonqualified plan, employers generally may only deduct employee and employer contributions to the plan and any earnings on those contributions when those amounts are distributed (or become taxable) to employees. In contrast, under a qualified plan, employers are entitled to deduct expenses in the year contributions are made even though employees will not recognize income until the later years upon receipt of distributions.

NQDC plans must be in writing. Many plans are defined in extensive detail, although some are referenced by a few provisions in an employment contract.

A common problem with NQDC plans is lack of participation by eligible employees. Employers should consider providing educational and communications resources to help eligible employees understand the advantages of participation, and to help those who are participating understand plan details.

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