Nonqualified Deferred Compensation

You may want to offer this plan if you are interested in rewarding highly compensated employees (sometimes referred to as the Top Hat Group). For example, an employee may not have accrued the maximum benefit permitted under the qualified plan and may wish to contribute more. Another example, perhaps a key employee changes jobs and forfeits a variety of benefits under the plan of the past employer. You can compensate the new employee through a Nonqualified Deferred Compensation plan.

Nonqualified Deferred Compensation plans involve an agreement by you to make payments to employees at a future date as compensation for their services.

These plans are generally funded with employee deferrals and there are no contribution limits other than the amount of an employee’s compensation. However, you may make a contribution as well. Contributions, including salary deferrals, grow tax deferred and employees pay income taxes only when payments are received under the plan.

The assets in a Nonqualified Deferred Compensation plan are the general assets of the employer and each participant is an unsecured creditor of the employer. That means there is always the risk that the employer will not pay benefits to employees due to financial or non-financial reasons. To address these risks, employers sometimes establish funding vehicles such as a Rabbi Trust to set aside these funds to meet future obligations.

Key Benefits:

Bypasses the discrimination testing and contribution limits associated with qualified retirement plans
Not subject to laws that restrict benefits available to highly compensated employees under qualified plans.
You have complete discretion in determining eligibility
Triggering events may be written into the agreement
Reduces employee’s current tax bill

Possible Drawbacks:

Subject to changes in tax law
Setup is complicated
You receive a deduction only when the deferred amount becomes taxable income