Nonqualified Deferred Compensation Agreement: A Guide for Employers and Employees

A nonqualified deferred compensation agreement or NQDC is a type of retirement plan that allows employers to defer compensation for their employees to a later date. This type of plan is not subject to the same regulations as qualified retirement plans such as a 401(k), making it more flexible but also more complex. In this article, we will discuss the basics of NQDC agreements and how they work.

What is a Nonqualified Deferred Compensation Agreement?

An NQDC agreement is a contractual arrangement between an employer and an employee where the employee agrees to defer some of their compensation to a later date. This deferred compensation is not subject to income tax until it is paid out to the employee. The agreement can be structured in different ways, such as a fixed amount, a percentage of salary, or a bonus.

NQDC agreements are typically offered to high-level executives or key employees to provide additional retirement benefits beyond what is offered by traditional retirement plans. Employees can also use NQDC agreements to defer taxes and manage their income tax liability. However, it is important to note that NQDC agreements are not protected by ERISA, and the deferred compensation may not be secured.

How Does the Nonqualified Deferred Compensation Agreement Work?

When an employee enters into an NQDC agreement, they are agreeing to defer a portion of their compensation until a later date. The agreement typically outlines the amount to be deferred, the payment schedule, and any distribution options. Employers may offer various investment options for the deferred compensation, which can include mutual funds, stocks, or other securities.

The deferred compensation is not subject to income tax until it is paid out to the employee. At that time, the employee will pay income tax on the amount received, and any earnings on the deferred compensation will also be subject to income tax. Employers may also offer distribution options, such as lump-sum payments or installment payments over a specified period.

Benefits and Risks of Nonqualified Deferred Compensation Agreements

Benefits:

– Provides additional retirement benefits beyond traditional retirement plans

– Allows employees to defer taxes and manage their income tax liability

– Can be used to attract and retain high-level executives or key employees

– More flexible than qualified retirement plans

– Employers can deduct deferred compensation as a business expense

Risks:

– Deferred compensation is not protected by ERISA

– Deferred compensation may not be secured and is subject to the employer`s financial viability

– Employees may lose their deferred compensation if the employer goes bankrupt

– The employer may change the terms of the agreement or be unable to fulfill its obligations under the agreement

– Deferred compensation is subject to income tax when it is paid out, and the tax rate may be higher than when the compensation was earned

Conclusion

Nonqualified deferred compensation agreements can be a valuable tool for employers and employees to provide additional retirement benefits and manage their income tax liability. However, they are subject to more risk than qualified retirement plans and require careful consideration and planning. Employers should work with their legal and financial advisors to develop an NQDC agreement that meets the needs of their business and employees, while employees should understand the risks and benefits before entering into an agreement.