Define: Nonqualified Deferred-Compensation Plan

A nonqualified deferred-compensation plan is an agreement between an employer and an employee to defer a portion of the employee’s compensation to a future date, typically after retirement. Unlike qualified plans, such as 401(k) plans, nonqualified plans do not meet certain IRS requirements and do not offer the same tax advantages.

Under a nonqualified deferred-compensation plan, an employee agrees to defer a portion of their salary or bonus to a future date. The deferred amount is typically invested and grows tax-deferred until it is paid out to the employee. The employer may also contribute to the plan, subject to certain limitations.

Yes, nonqualified deferred-compensation plans are legal as long as they comply with applicable tax laws and regulations. However, they are subject to specific rules and restrictions, and employers must ensure they meet the requirements to avoid penalties or adverse tax consequences.

Unlike qualified plans, nonqualified deferred-compensation plans do not offer immediate tax advantages. The deferred amounts are subject to income tax when they are paid out to the employee. However, the plan may still provide tax advantages if the employee is in a lower tax bracket during retirement.

Nonqualified deferred-compensation plans are typically offered to key executives or highly compensated employees. Employers have the discretion to determine eligibility criteria and may exclude certain employees from participating.

In most cases, employees cannot withdraw funds from a nonqualified deferred-compensation plan before the agreed-upon payout date. However, some plans may allow for limited withdrawals or hardship distributions under certain circumstances.

In the event of an employer’s bankruptcy, the funds in a nonqualified deferred-compensation plan may be at risk. Employees may become unsecured creditors and may not receive the full amount owed to them. It is important to carefully consider the financial stability of the employer before participating in such a plan.

In some cases, a nonqualified deferred-compensation plan may be transferable to a new employer if both employers agree to the transfer. However, there may be restrictions and tax implications associated with such transfers, and it is advisable to consult with legal and tax professionals before making any decisions.

Yes, there are limits on the amount that can be deferred under a nonqualified deferred-compensation plan. The IRS imposes annual limits on the total amount of compensation that can be deferred, as well as limits on the total benefits that can be paid out to an employee.

In the event of an employee’s death, the nonqualified deferred-compensation plan may provide for a beneficiary to receive the remaining funds. The specific terms and conditions regarding death benefits should be outlined in the plan document. It is important to review and update beneficiary designations regularly to ensure the intended recipients receive the benefits.