If you like the tax advantages that come with traditional workplace savings plans, you might love a nonqualified deferred compensation plan—if such a plan is available to you.
NQDC plans are typically offered by an employer to company officers and other highly compensated employees, allowing them to save more in a tax-advantaged account than is allowed under 401(k) plans. Most companies provide NQDC plans as an executive retirement benefit because 401(k) plans often are inadequate for high earners.
The advantages of participating in a NQDC plan
- The primary advantage of deferring income in a NQDC plan is tax deferral. From a tax perspective it's like contributing pretax to a 401(k)—but on a much larger scale.
- NQDC plans allow executives to defer a portion of their compensation, and to defer taxes on the money until the deferral is paid.
- There's no limit specified by the IRS on how much compensation a participant can defer into a NQDC plan each year (although plan provisions may limit the level of contributions, usually expressed as a percentage of compensation).
- Many plans allow you to schedule distributions during the course of your career, not just when you retire, so you can defer compensation to cover shorter-term goals.
Considerations of participating in a NQDC plan
- A NQDC plan represents a potential credit risk, as it's an unsecured promise by a company to pay out a participant's account balance in the future. It's not covered by the Employee Retirement Income Security Act (ERISA), which protects qualified employer retirement plan participants if the plan sponsor runs into financial trouble. Nonqualified plan participants could potentially lose some or all of their NQDC assets if the company falls into insolvency.
- In a NQDC plan there is no ability to borrow against one's account balance. Nor can it be rolled over into an IRA or another company's retirement plan.
- NQDC plans lack flexibility as distribution elections must be made when deferrals are made. Some employers may require payments as a lump-sum distribution per plan rules, while others require you to defer compensation until a specified date, which could be during retirement.
- NQDC money is generally not accessible until the distribution date or another allowable event such as termination. Unlike a 401(k) plan, a NQDC generally does not allow early distributions.
NQDC plans have the potential for tax-deferred growth, but they also come with substantial risks, including the risk of complete loss of the assets in your NQDC plan. Before you enroll, it’s important to understand exactly how such plans work and how one might fit into your overall financial plan.
Your dedicated Fidelity Executive ServicesSM team can help you determine if participating in a NQDC plan is right for you, and can answer key questions regarding the plan going forward.