Nonqualified Deferred Compensation Plan
A Nonqualified Deferred Compensation (NQDC) Plan allows employees to defer compensation and bonus, pre-tax, to a later year, primarily retirement. Although it sounds similar to a 401(k) or 403(b) or even a Qualified Deferred Compensation Plan (pension), it isn’t.
Here are five important factors that help distinguish a NQDC from other retirement saving options. Be sure you understand the differences before you enroll and consider maximizing other retirement savings options, like a 401(k), Traditional IRA, or Roth IRA, first.
1) The employee makes an irrevocable election to defer compensation before the year in which the compensation is earned.
This means you make an election during your annual benefit enrollment process and commit to deferring a set amount during the following year. You CANNOT make changes to the contribution amount during the year.
2) As a plan participant, you don’t own an account of any kind.
Your employer reduces your compensation by the deferral amount rather than depositing funds into an account held with a financial institution. Essentially, a NQDC plan creates an unsecured loan between the lending employee and the borrowing employer.
3) NQDC plans are not covered under ERISA and are not provided the same protections from creditors as other retirement plans.
If the plan is “unfunded”, you are an unsecured creditor of the employer. If the employer is insolvent, secured creditors have the right to payment before unsecured creditors; which means you may receive nothing.
4) The Plan Document specifies the amount to be paid, the payment schedule and the triggering event that results in payment.
The employer dictates when you will receive this money.
5) You may not have any right to dictate the investment strategy.
Remember, you don’t own the account. This may lead to an investment strategy that does not align with your risk tolerance and the rate of return paid on the deferred compensation may be less than your other investments.