Deferred Compensation Plan vs 401(k): What’s the Difference?
The best business owners know that there is no replacing quality talent. To attract the best employee team possible, you must do your homework on such important factors as health benefits and retirement plans. Especially when you start looking at c-suite positions, the best candidates have very specific ideas of what they are looking for in retirement plans.
As leading recruitment specialists, CulverCareers finds great value in educating our clients on retirement plan packages. As such, we are offering this guide into the complex world of deferred compensation plans. By focusing on such challenging topics as 401(k), 457, and NQDC packages, we hope to give employers the confidence to use these plans for attracting top talent.
Before we dive any further into the specifics of deferred compensation plans vs 401(k) plans, we wanted to clarify a key point. Namely, 401(k) plans are considered deferred compensation plans, they are just unique in their overall functionality. As we will see later in this guide, 401(k) plans differ from such plans as 457 and NQDC plans, yet they are all classified the same.
In studying the fine nuances of retirement plans, you will develop the knowledge needed to attract top executive talent. In the end, by speaking confidently about your company’s retirement offerings, you will paint the best picture possible for these hard-to-find candidates. Even more, you will reduce turnover costs, maximize team productivity, and prevent poaching by competitors.
Is a Deferred Compensation Plan a Retirement Plan?
Is a deferred compensation plan a retirement plan? This answer to this question is a bit complicated, but certainly digestible. According to Investopedia, “A deferred compensation plan withholds a portion of an employee’s pay until a specified date, usually retirement. The lump-sum owed to an employee in this type of plan is paid out on that date. Examples of deferred compensation plans include pensions, retirement plans, and employee stock options.”
To put it simply, deferred compensation packages almost always function as retirement plans. However, they are not necessarily the same thing as retirement plans. The defining characteristic of deferred compensation plans is the fact they withhold “a portion of an employee’s pay until a specified date.” As such, in theory, a deferred compensation package could be used between an employer and employee for reasons other than retirement – such as purchasing a house. However, these sorts of scenarios rarely play out in the business world.
Please Contact CulverCareers with any questions about employee retirement plans.
What is the Difference Between a 401(k), 457, and NQDC plans?
As stated at the beginning of this guide, 401(k), 457, and NQDC plans are all considered deferred compensation plans. The major differences between these plans have to do with who is eligible to utilize them, as well as government protections.
The primary distinction between 401(k) plans and 457 plans is the fact that 401(k) plans are used by private businesses, while 457 plans can only be utilized by government entities and certain non-profits. Furthermore, 401(k) plans and 457 plans differ in their relationship to the Employee Income Retirement Security Act (ERISA) of 1974. Specifically, this legislation draws a clear distinction between qualified and non-qualified deferred compensation packages.
Besides who can utilize them, the most defining distinction between 401(k) and 475 plans lies in the fact that 401(k) plans are considered qualified through ERISA, while 457 plans are designated as non-qualified. This stark difference in designation sets the stage for variances between 401(k) and other non-qualified deferred compensation packages (NQDC).
NQDC plans are non-qualified deferred compensation plans that can be utilized by private businesses. They are highly customizable and often offered to high-level executives as an added perk on top of standard 401(k) plans.
401(k) plans are by far the most popular deferred compensation packages in use by organizations today. Businesses enjoy 401(k) plans because they can be implemented fairly easily on a company-wide basis. In like fashion, employees are attracted to 401(k) plans because they are secure and predictable.
401(k) plans are considered qualified deferred compensation plans. Again, this designation is in accordance with ERISA law. According to the U.S. Department of Labor: “(ERISA) is a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans.”
In essence, qualified deferred compensation packages such as 401(k) plans are backed by the federal government in the interest of protecting employees. This protection goes as far as guaranteeing “payment of certain benefits through a federally chartered corporation” in the event something happens to 401(k) funds.
Non-Qualified (NQDC) Plans
NQDC plans are much rarer in the business world than 401(k) plans. Generally speaking, NQDC plans are utilized by companies to craft custom retirement plans for high-level executives. Employees enjoy NQDC plans because they are customizable, flexible, and less regulated than 401(k) plans.
Importantly, NQDC plans are not protected under ERISA law, so they are considered more risky than qualified plans such as 401(k) plans. According to Investopedia, “non-qualified plans don’t have contribution limits and can be targeted just to certain employees, such as top executives. The employer may keep the deferred money as part of the business’ funds, meaning that the money is at risk in the event of bankruptcy.”
While NQDC plans can be attractive to certain high-level executives, they are overall too risky for your average employees. Largely because they lack the security of qualified deferred payment plans that are backed by the federal government.
What are the Advantages of a 401(k) Plan?
They are several advantages to offering 401(k) plans for your employee team. A majority of these perks have to do with the fact that 401(k) plans are qualified and secured by ERISA law. The primary advantages of such plans are as follows:
- Employee’s deferred funds are securely held in a trust account.
- Plans are on-discriminatory and offered equally to all employees.
- Employees have full-access to the status of their retirement plans.
- Funds are protected if the company goes bankrupt.
Generally speaking, people are attracted to 401(k) deferred compensation packages because of their security. Yet, this security also comes with increased rules and regulations, as well as less flexibility than seen with other plans.
What are the Advantages of a NQDC Plan?
There is also a good deal of advantages to offering employees NQDC plans. In the opposite vein of 401(k) plans, these advantages come largely from the fact that NQDC plans are not qualified and secured by ERISA law. Companies enjoy these plans for the following reasons:
- There are no contribution limits under NQDC plans.
- Flexibility in planning allows for deferred income for things other than retirement.
- Plans can be offered to select employees, such as executives.
- Offer more tax breaks than 401(k) plans.
As can be seen, non-qualified NQDC plans offer a good deal of flexibility for executive-level employees. However, they also pose more risk, as funds are tied up in the overall performance of the business.
How Does a Deferred Compensation Plan Affect Your Taxes?
When it comes to income taxes, all deferred compensation packages function the same way at their most basic level. As an employee defers income throughout the year into retirement savings, this income is not taxable at the time. To illustrate, if you make $60,000 per year and defer $15,000 into a 401(k) savings plan, you will only pay taxes on the remaining $45,000.
Once an employee reaches retirement, they can cash out on their deferred income. It is at this point in time that they will have to pay income tax on the money. However, they can also choose to receive the savings in installments to avoid getting bumped into a higher tax bracket.
For tax purposes, the primary distinction between 401(k) plans and NQDC plans is limits on contributions. Most notably, there are no limits on contributions for NQDC plans. This is the primary selling point for such plans concerning executive leadership. Namely because, they can defer large sums of income without paying taxes until a later date. This stands in contradiction to your average 401(k) contributions, which limits contributions to $19,500 annually.
The Importance of Retirement Plans in Attracting Top Talent
Perhaps more than anyone, recruiters understand how important the right employee team can be to the success of a company. When it comes to negotiating with high-level executives, the bargaining process can become extremely nuanced – including a heavy emphasis on the fine details of retirement.
As staffing experts, CulverCareers has witnessed far too many instances where great candidates are lost in the final phases of offer negotiations. Oftentimes, this unfortunate occurrence happens after months screening, vetting, and interviewing. Therefore, why not do anything you can to eliminate the risk of losing a good candidate during the final phases of negotiation?
When it comes to attracting the best executive leadership, CulverCareers strongly recommends employer do their homework on deferred compensation plans. According to a study conducted by Glassdoor, “57% of job candidates report benefits and perks are among their top considerations before accepting a job.” The same report also tells us the well-crafted retirement plans have a direct influence on your brand’s image in the job market.
If you take the time to develop well-crafted retirement options, you will show candidates that you are vested in their overall wellbeing. Even more, you will reassure them that their families will be safe and secure in the future. Whether you are dealing with 401(k) or NQDC plans, giving employees a clear understanding of investment options will help strengthen your overall company.
Contact CulverCareers to Discuss Retirement Planning
The staffing experts at CulverCareers understand the challenges of attracting top talent, especially for executive-level candidates. We are here to help you devise the best retirement plans possible, so you can always hire the very best candidates.
Feel free to Contact Us at any point to discuss the best retirement savings plan for your employees.