What are Non-qualified Deferred Compensation (NQDC) Plans?

Non-qualified deferred compensation (NQDC) describes an arrangement made between individuals and companies, organizations, or other entities, which allows earned compensation to be reported at a future date. If the arrangement or plan meets specific requirements as outlined by the Internal Revenue Service (IRS), it is considered a qualified deferred compensation plan and income tax benefits are provided. When the plan does not meet the IRS criteria, it is considered a non-qualified deferred compensation plan. The NQDC does not provide the same income tax benefits.

To limit possible problems, Internal Revenue Code Section 409A was created to provide regulation for the non-qualified plans. This section of the law explains the timing requirements of deferrals and distributions. It has been put into place to deter questionable activity. Businesses offering NQDC plans must also report deferred compensation annually to the IRS, even if the amounts are not included as taxable income. Penalties are incurred if 409A rules are not followed.

Generally, NQDC plans are established by a business and offered as a benefit to employees. Qualified deferred compensation is limited by non-discrimination rules, but non-qualified plans are offered at the discretion of the employer. The business can elect to offer the plan to a particular employee; specific employees with higher salaries; those in specific departments; employees who have been with the company for a defined period of time; or to all employees. These plans can also be offered to non-employees, such as self-employed independent contractors.

There are two types of NQDC: elective and non-elective. If the elective option is included in the NQDC, an employee can choose to receive less current compensation than what has been earned and defer receiving the compensation until a different tax period. The non-elective option is more of a benefit to the employee. In this situation, the employee does not reduce current compensation because the employer funds the plan. Compensation is still deferred, but it does not come out of the employees’ pocket.

NQDC plans are usually part of a retirement package. They can be viewed as compensation tucked away in a safe place to be used as income upon retirement.

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