Maximize the compensation you pay top talent with non-qualified deferred compensation plans.
Non-qualified deferred compensation (NQDC) plans are a way for an employee to postpone earned income by delaying or deferring when earnings are paid. They allow your employees to earn income in one year but receive it in another, deferring any associated tax burden along with it. It’s also a way for an employer to reduce current payroll expenses that will instead be paid in the future.
An NQDC can provide your employees a source of income in the future. Typically, when enrolling in NQDC plans the employee must select when the funds will be distributed. The distribution options are plan specific, but employees can strategize and anticipate some income needs such as college expenses or retirement when timing their deferred compensation.
NQDC plans can help maximize compensation for your top earners and ensure that they’re getting the most out of what you pay them – by leveraging tax efficiency without increasing payroll. Most important, they can serve as incentives for enticing and retaining high value professionals.
If income is deferred from a year in which an employee is in a high tax bracket and paid when they’re in a lower bracket, the employee pays less in taxes over time. Unlike a tax-deferred retirement account, there are no contribution limits and your employees don’t have to wait until they meet an age requirement to start paying lower taxes on their deferred income.
NQDC plans fall into two main categories: top-hat plans and deferred savings plans. While top-hat plans are focused on delaying the payment of top earners’ compensation and don’t contain funds, deferred savings plans are executed through salary reductions of up to 25% of base pay and 100% of bonuses.
With deferred savings plans, the employer agrees to promise a specific rate of return, and taxes are paid after the earnings are received. Because deferred savings plans have fewer restrictions, they can be offered to a wider variety of employees.
How an employee is positioned in your company may help determine what sort of NQDC plan to offer. For example, executives and other “key employees” may be subject to different ERISA limits than others. High earning executives are restricted by how much they can save in an ERISA-type plan whereas there are fewer contribution restrictions in a NQDC plan. Top hat plans might be a beneficial strategy for these executives since top hats provide unfounded deferred compensation to select executives and top management.
Your advisor can help you determine which plans may be the best fit for your managers should their status as key employees be a factor.
Making the decision to offer NQDC plans to your employees is the first major step, but what about putting them into place? Although having a conversation with your advisor is the best way to know what to do in your specific situation, it’s important to note:
Salaries aren’t the only type of income that can be deferred to a later date. You can also defer employee bonuses, commission checks and other variable income sources. This way, employees can keep the steady income they rely on now from their base pay, but also save additional compensation for a rainy day – or for when the tax burden may be lower.
Flexibility is a noteworthy benefit of NQDC plans. Each plan can be tailored specifically to an individual employee’s goals, such as putting aside equity payment and bonus incentives for meeting quotas and performance metrics.
No matter how you choose to incorporate NQDC plans into your business, your financial advisor can help you find the most efficient and beneficial strategies. Whether you’re focused on attracting new talent or retaining your existing key players, reach out to your advisor and have a conversation about how NQDC offerings can benefit both you and your employees.
Notable considerations regarding NQDC plans: