Using non qualified deferred compensation plans: Frequently, business owners and executives are looking for ways to save more money for retirement than they’re allowed to sock away in their 401(k) plan. For 2017, the annual elective deferral contribution limit for a 401(k) is just $18,000, or $24,000 if you’re 50 years of age or older.
This represents a significantly lower percentage of the typical owner-employee’s or executive’s salary than the percentage of the average employee’s salary. Therefore, it can be difficult for these highly compensated employees to save enough money to maintain their current lifestyle in retirement. That’s where a nonqualified deferred compensation (NQDC) plan can be helpful.
NQDC plans allow owner-employees, executives and other highly paid key employees to significantly boost their retirement savings without running afoul of the nondiscrimination rules under the Employee Retirement Income Security Act of 1974 (ERISA). These rules apply to qualified plans, such as 401(k)s, and prevent highly compensated employees from benefiting disproportionately in comparison to rank-and-file employees.
NQDC plans are basically agreements that the business will pay out currently earned compensation in the future, such as at retirement. Not only do such plans not have to comply with ERISA nondiscrimination rules, but they aren’t subject to the IRS contribution limits and distribution rules that apply to qualified retirement plans. So businesses can tailor benefit amounts, payment terms and conditions to the participants’ specific needs.
Types of Nonqualified Deferred Compensation Plans
There are several types of NQDC plans. Among the most common are:
- Excess benefit plans,
- Wraparound 401(k) plans,
- Supplemental executive retirement plans (SERPs),
- Section 162 executive bonus plans, and
- Salary-reduction plans.
The key to an NQDC plan: Because the promised compensation hasn’t been transferred to the participants, it’s not yet counted as earned income — and therefore it isn’t currently taxed. This allows the compensation to grow tax-deferred.
Naturally, there are challenges to consider. NQDC plans are subject to strict rules under Internal Revenue Code Sections 409A and 451, and plan loans generally aren’t allowed. But attracting and retaining top executive talent is a business imperative, and an NQDC plan can help you win the talent race with a powerful benefits package.
For additional information on NQDC plans or wealth management questions please contact John Csargo, CPA, MBT,CFP at 952.854.4244 or email@example.com.
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This material is being provided for informational purposes only with the understanding that neither HKFS nor ProEquities is rendering tax, legal or accounting advice. Please consult with your CPA or other appropriate advisors on all matters pertaining to legal, accounting or tax obligations and requirements.