When it comes to recruitment, there are many creative methods your business can use to attract good executive leadership. For example, you can offer any combination of fringe benefits you wish – from gym memberships all the way up to a company jet.
Within the field of recruiting, Culver has seen a trend where high-powered executives demand customizable and flexible retirement packages. Nonqualified deferred compensation plans (NQDC) have become a popular retirement plan option for the C-suite. Importantly, these custom benefit plans are not forced to operate under the constraints of normal 401(k) programs.
For high-earning executives, a major selling point on nonqualified deferred compensation programs is the fact that there is no limit on contributions. Therefore, these individuals can save large sums of money beyond the limitations of standard 401(k) plans.
At CulverCareers, we have decades of experience in recruiting executive leaders. With this expansive background, we have spoken with high-caliber talent at length concerning benefits.
When negotiating for a new job, one of the most important elements of fringe benefits is that of retirement packages. All things considered, we strongly recommend that you think about NQDC plans to attract and retain executive leadership.
What is a Nonqualified Deferred Compensation Plan?
The process of learning about deferred compensation plans and retirement savings can be quite daunting. Yet, to properly follow the rules and regulations set forth by the IRS, you must have a working knowledge of retirement plan basics. To help you on your way in this process, we wanted to briefly break down the concept of deferred compensation plans.
It might be difficult to wrap your brain around, but the term “deferred compensation plan” actually refers to both qualified and non-qualified plans. Therefore, the term “deferred compensation plan” can be used to describe any employee/employer savings plan where the employee defers income to a later date. As such, qualified plans such as 401(k) plans and NQDC packages such as 409A plans are both considered deferred compensation plans.
Qualified deferred compensation plans and NQDC plans differ concerning their relationship to the Employee Retirement Income Security Act of 1974 (ERISA). According to the U.S. Department of Labor website, the ERISA act “protects the interests of employee benefit plan participants and their beneficiaries … It establishes enforcement provisions to ensure that plan funds are protected and that qualifying participants receive their benefits, even if a company goes bankrupt.”
For the sake of employees, qualified deferred compensation plans (such as 401(k) plans) are protected under the auspices of ERISA and the U.S. Department of Labor. As such, qualified retirement savings are held in secure trust funds that are at least partially insured by the government. Conversely, NQDC plans do not meet the minimum standards of ERISA and are not protected by the U.S. Department of Labor. NQDC plans offer more flexibility for high-earning executives, but come with far more risk than qualified plans like 401(k) programs.
How do Nonqualified Deferred Compensation Programs Work?
While the basic structure for all NQDC plans is the same, the individual packages can take on almost endless forms. At the most basic level, NQDC plans are any deferred savings plans that are not protected by ERISA law. Their overall functionality is largely defined by both flexibility and risk.
NQDC plans work when an employee and employer agree to defer a certain amount of wages each year into a custom savings program. There are no specific rules on where the employee’s deferred income must be held. However, their savings are entwined with business funds and at the mercy of the company’s overall performance. In the event that the company goes bankrupt, all of the NQDC funds can be lost.
Perks of NQDC Plans
There are a good number of reasons why executives are attracted to NQDC plans:
- Plans have flexibility for use outside of retirement.
- Plans are customizable for single employees, such as executives.
- Plans have no contribution limits.
- Ability to postpone withdrawals to get tax breaks.
Drawbacks of NQDC Plans
There are also some serious drawbacks to using an NQDC plan when compared to something safer like a 401(k):
- The funds are uninsured and tied to the performance of the business.
- The plans cannot be “rolled-over” into a new NQDC or IRA.
- Executives might lose their NQDC savings if they leave their position early.
- Employees can’t use the NQDC funds as collateral for a loan.
Please Contact Us to learn more about NQDC plans.
Who can Participate in a Nonqualified Deferred Compensation Program?
Plainly speaking, your company can offer a NQDC plan to any employee you wish. However, due to the fact that NQDC plans are entirely custom, it often doesn’t make sense to use them on a company-wide basis. It would be very labor-intensive for your Human Resources department to craft individual retirement plans for each employee.
Generally speaking, it makes the most sense to use 401(k) plans for a vast majority of your employee team and keep NQDC options available for executive leadership. A primary motivation for this being, executives earn far more money than most employees, so giving them more options for retirement allows them to save a larger percentage of their overall income.
If you decide to offer NQDC plans for your executive team, we recommend you thoroughly educate them on the risks involved. As NQDC plans are hinged on the success of your business, things could get messy if your company gets in trouble and your executives’ retirement savings are lost. Therefore, it is best to explain these possibilities before engaging in an NQDC program.
What is a Section 409A Nonqualified Deferred Compensation Program?
It goes without saying, retirement plan benefits can get quite confusing when you start comparing qualified and non-qualified programs. Yet, these two distinct categories are just the “tip of the iceberg” when discussing the ins-and-outs of retirement benefits.
Due to the fact that NQDC plans are custom-made for individual executives, it can be quite challenging to understand how these plans actually function. To limit people’s ability to manipulate NQDC programs for their own ends, the IRS launched Revenue Code Section 409A in 2005.
Revenue Code Section 409A was designed to regulate NQDC plans in the wake of the Enron scandal. In this high-profile case, Enron executives “moved $32 million out of deferred compensation accounts and into limited partnerships they had created for their families.” In doing so, they were able to protect their retirement funds when the business went bankrupt.
In post-Enron society, all NQDC plans are considered to be 409A nonqualified deferred compensation programs. In order for an NQDC plan to be legal, the 409A law states that an employee must state “well in advance” exactly when they will cash out on their NQDC plan. This restriction keeps executives from being able to pull their funds out of a business based on insider knowledge of bankruptcy.
How is a NQDC Plan Taxed?
Concerning taxes, all deferred compensation plans work the same on the most basic level. Whether it be a 401(k) or 409A plan, the plan works as an employee defers income throughout the year. Due to the fact that the deferred income is not accessed during that specific tax year, they do not have to pay income tax on it. For example, if an executive at your company earns $150,000 per year and defers $50,000 into an NQDC, they will only pay taxes on the $100,000 they did not defer.
Once your executive reaches retirement, they will draw down the deferred compensation. With all deferred compensation plans, the date when the draw is made is when income taxes must be paid. Generally, this date coincides with retirement.
For taxes, NQDC plans are beneficial to employees in several ways:
- There are no contribution limits for NQDC plans, allowing executives to pay less annual income taxes through larger deferments.
- Large annual contributions will keep high earners in lower tax brackets.
- Employees can hold their NQDC funds in stocks and cash them out well after retirement.
Other considerations to make concerning taxes and NQDC plans have to do with social security and Medicare. As seen with other deferred compensation plans like 401(k) plans, income taxes on both social security and Medicare are due when the money is earned. As such, even if an employee defers income with an NQDC, they must still pay taxes on a few key items when the money is initially earned.
For tax purposes, the primary selling point for NQDC plans is that they do not have contribution limits. With this setup, senior executives have the ability to defer as much money as they want each year. In doing so, they can avoid paying income taxes until after retirement when they are in a lower tax bracket.
Contact CulverCareers to Discuss Retirement Packages
Culver understands well how difficult it can be to find the right executive talent. In conducting executive searches, we have worked with countless clients in crafting attractive retirement plans.
Contact Us today to learn more about NQDC plans and C-suite recruitment.