Non-qualified Deferred Compensation Plans

A Non-qualified Deferred Compensation Plan is designed for certain executives to provide retirement and supplemental benefits. Unlike qualified plans, they do not follow specific tax or labor law requirements, which gives them more flexibility but with unique tax consequences.

How is it Utilized?

Non-qualified Deferred Compensation Plans are used when:

• The employer wants to give deferred compensation benefits to executives but finds the cost of a qualified plan too high due to non-executive employees also being covered by the plan.
• An executive needs additional benefits over and above what is provided through their employer's qualified retirement plan.
• Tax-deferred compensation is desired by key employees under different terms than those available to other employees.
• An executive wants a forced investment program using the employer's tax savings for future benefits.
• The company needs to solve its "four-R" problem (recruit, retain, reward, retire) with respect to key personnel.
• A closely held corporation desires attracting and keeping non-shareholder employees so it offers deferred compensation as an alternative to equity-based pay packages.

Advantages

There are several pros offered by Non-qualified Deferred Compensation Plans:

• Flexible: This type of plan can cover select management or highly compensated employees without nondiscrimination requirements as well as provide different benefit amounts under varying terms;
• Less Regulatory Burden: Fewer IRS, Department of Labor (DOL), and other regulatory burdens such as reporting, disclosure fiduciary standards, or funding rules apply to these programs;
• Deferral of Taxes: Employees may defer taxes on their earnings while employers also delay deductions; this can be beneficial if current year savings are invested during the period;
• Golden Handcuffs: The arrangement serves as a retention device by providing rewards that could be forfeited based on vesting schedules adopted by employers including contingencies like early termination or misconduct;
• Corporate Financing: Marginal rates often favor corporate financing over cash bonuses in case of deferred compensation arrangements.

Disadvantages

Non-qualified Deferred Compensation Plans have some downsides:

• Tax Deduction Delay: Employers can't take an immediate tax deduction; they must wait until employees report income from these plans even if it takes decades;
• Lack of Security: Executives rely on their employer’s unsecured promise to pay as there is no federal protection under ERISA (Employee Retirement Income Security Act) applicable to qualified plans;
• Disclosure Requirements: Financial statements may require disclosure thus reducing confidentiality;
• Limited Suitability: These programs aren’t suitable for every employer. S corporations, partnerships, tax-exempt, or governmental organizations face unique challenges in using Non-qualified Plans.