Introduction to Nonqualified Deferred Compensation

Deferred compensation is a contractual arrangement between the employer and employee in which the employer generally makes an unsecured promise to pay benefits in a future tax year in exchange for services rendered currently. Nonqualified plans can also be set up for outside directors and other independent contractors. In general, the same tax rules that apply in employer-employee plans apply to plans that cover independent contractors. One distinction with respect to plans covering only independent contractors is that ERISA does not apply.

A nonqualified deferred compensation plan (NQDC) is a deferred compensation plan that does not meet the tax and labor law requirements applicable to qualified plans.

There are two major types of nonqualified deferred compensation plans:

  • Salary continuation plans (also known as “Supplemental Executive Retirement Plans” [SERPs]); and
  • Salary deferral plans (also called “salary reduction” plans).

SERPs are used to provide retirement benefits to a select group of executives (or other key employees), or to provide that select group with supplemental benefits over and above those provided by the employer’s qualified plan. This is a nonelective form of deferred compensation; the employer provides it in addition to the key employee’s salary and other compensation and the plan is funded solely by employer contributions.

Salary deferral plans are those under which a select group of key employees voluntarily choose to defer a portion of their future salary (or bonus) as a means of tax deferred savings. These types of plans are funded solely by employee contributions.

There are also combination NQDC plans (e.g., a 401(k) Overlay/Mirror plan), which are funded by a combination of employer and employee contributions. A 401(k) Overlay plan is generally stacked on top of an existing 401(k) plan and enables select key executives to defer additional salary above and beyond what they can defer into the 401(k) plan. The employer will generally provide an employer match, which may be similar to that of the underlying 401(k) plan.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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