Your company has just offered you access to a Nonqualified Deferred Compensation Plan (NQDC), but perhaps you don’t know where to begin. First, congratulations! Having access to plans like these can be greatly beneficial to your financial savings, and many employees are unable to access.
Let’s start with some of the basics on what these plans are, why they exist, and some key items to know that can help you decide if an NQDC is right for you.
In addition to the information in this article, our Kovitz Financial Advisors are happy to help you navigate the decision-making process.
What is a nonqualified deferred compensation plan?
Simply put, it’s an arrangement between an employer and employee to postpone receipt of currently earned compensation.
Chances are that you already take advantage of a qualified deferred plan that achieves a similar goal – your 401(k). The main difference here is that a nonqualified plan allows you the ability to make contributions beyond 401(k) or similar qualified plan limits.
What might these plans be called by my Employer?
You might see plan types such as: Top-hat, SERP, Excess Benefit, or 401(k) Wraparound Plan.
When is the right time to utilize a nonqualified plan vs a qualified one?
If you’re already deferring the max amount allowed in your 401(k) and would like to defer even more, a nonqualified plan is the way to achieve this goal. Or perhaps you’re expecting a higher-than-normal amount of income in a specific year and would like to lower your taxable income.
What are the advantages of nonqualified plans?
Employers like nonqualified plans as a tool to attract and retain top talent. Because nonqualified plans have limited ERISA requirements, they can benefit a select group of management and have the added benefit of limited reporting requirements. For participants, deferred compensation plans provide opportunities for additional tax-deferred savings which can reduce taxable income, resulting in lower taxes and accelerated wealth accumulation.
What are the disadvantages of nonqualified plans?
The ability to defer vast amounts of additional income is a great tool – but every tool has its limitations. An employee must make an irrevocable election to defer compensation in the year before the compensation is earned. Once the election is made, benefits may not be accelerated from the original payment dates elected. So, you won’t be able to access your money in the event of a personal financial emergency. Most importantly, most non-qualified deferred compensation plans represent a mere promise by the employer to pay the benefits at a future date. If the employer goes bankrupt, those assets will be available to the company’s creditors.
Participating in a deferred compensation plan can be a fantastic tool for building wealth. If your employer has offered this type of plan to you, there are many factors to consider in your decision-making process. While the rules and timing of these plans can be tricky and every situation is unique, your Kovitz Financial Advisor is here to support you. Contact us today to learn more.