Non-Qualified Deferred Compensation

In today’s highly competitive work environment, top-performing executives are hard to recruit and retain. The usual employee benefits aren’t enough. As a result of changes in the tax laws designed to benefit rank-and-file employees, higher-paid executives often find that the benefits from qualified pension, profit-sharing and 401(k) plans are, in many cases, significantly reduced and insufficient.

For example, if a company’s 401(k) plan has low participation rates by rank-and-file employees, the ability of key executives to make pre-tax contributions could be significantly reduced. Highly paid executives also are surprised to learn that their qualified retirement plan benefits may be insufficient, at retirement, to meet the lifestyle they are accustomed to.   As a result, many businesses need to seek alternative arrangements to retain their most talented executives. Businesses also need to prevent competitors from hiring their best talent away with more attractive benefit programs.

Non-Qualified Deferred Compensation is one way to recruit and retain one of the biggest assets the business has which is its key executives.

Non-qualified deferred compensation (“NQDC”) arrangements are one of the most common and attractive plans for businesses seeking to reward and retain their top performers because they are flexible and customizable to the executive.

NQDC plans come in two basic forms. The first is often referred to as a “Supplemental Executive Retirement Plan” or SERP. As the name implies, a SERP is a plan that provides retirement benefits in excess of those available under the business’ qualified plan. A SERP is an agreement where the business promises to supplement the executive’s income at retirement. This arrangement is negotiated and can be customized for each key executive. It is also funded entirely by the business and documented by a contract between the business and the executive. When the executive retires, the payments made to the executive by the business are taxable to the employee but deductible by the business.

The second form of NQDC plan is commonly referred to as a “Salary Reduction/Deferral Plan.” As the name implies, the executive defers his or her own salary to fund the plan. The salary amounts deferred are not currently taxable to the executive, but will be at retirement and then deductible by the business. A common variation of a Salary Reduction Plan mirrors the company’s 401(k) plan and provides matching contributions.

Advantages on a Non-Qualified Deferred Compensation Plan

To the Company:

  • Flexibility to decide who is allowed to participate
  • Ability to attract new talent and retain current executives
  • Coordinates with existing qualified plans and can be individually tailored to complement other benefit programs
  • Benefits are tax deductible to the business when paid at retirement
  • Policy cash surrender value subject to business control
  • Tax-deferred accumulation and high early cash value can offset hit to earnings charges
  • Two options for cost recovering benefit payments

To the Executive:

  • No current income taxation and ability to reduce taxable income
  • Tax-deferred growth on the account balance
  • Increased retirement income
  • Pre-retirement death benefit for designated beneficiaries
  • Retirement income shortfall can be reduced or eliminated