As a busy executive, you have a lot on your plate. In addition to juggling work and home commitments, you’ve also got to decide which aspects of your business you want to handle yourself and which you want to designate to other professionals. If you work for a larger company, you may also have to make decisions on how to handle certain types of non-traditional compensation. One question I frequently get asked regarding this subject is about non-qualified deferred compensation.
What is non-qualified deferred compensation?
Non-qualified deferred compensation is when certain parts of your compensation, such as a bonus, is not paid to you with your regular salary. Instead, that money is usually invested in company stock or into the S&P until a future designated time. The amount of time the compensation is deferred is up to you and your employer. It could be a short time in the future, such as five years, or it could be deferred until retirement. These types of plans are required by law to be in writing and the written document must include the following:
- The amount to be paid
- The payment schedule
- The trigger that will result in payment
- An election by the employee to defer his or her compensation
What are the pros of non-qualified deferred compensation?
There are many reasons why employers offer and employees accept non-qualified deferred compensation plans. They include:
- They delay the payment of a portion of taxes until a later date.
- If invested properly, the money will grow.
- The money can be used to enhance a retirement plan.
- The compensation will not be considered part of the current year’s taxable income and could lower an employee’s tax bracket.
- The plans provide a way for employers to incentivize key employees to stay with the company.
- The cost of setting up these plans is minimal to the employer.
- There are no limits to the amount of money that can be put into a plan.
What are the cons of non-qualified deferred compensation?
Of course, hardly any type of compensation plan has pluses without any minuses. The cons of this type of plan include:
- Funds must be removed on a strict schedule.
- A significant penalty—usually 20%–for any portion of the funds that are withdrawn early.
- Immediate taxation of funds that are withdrawn.
- Can reduce the amount of usable monthly or yearly income.
- The compensation cannot be used as a tax deduction for the employer until it is paid to the employee.
- The plans are not covered under ERISA (Employee Retirement Income Security Act) and therefore are not protected from creditors. If an employer files for bankruptcy or must pay back creditors, the funds in the non-deferred plans may be depleted.
How can I maximize my non-qualified deferred compensation plan?
If you have received, are receiving, or will receive a non-qualified deferred compensation plan from your employer, it’s imperative that you work with an experienced financial advisor who can help you make the most of your plan. These arrangements can be a boon to employees in the long term if they are handled correctly and if taxes are properly planned for.
Need help with your non-qualified deferred compensation plan or any other type of financial advice? Please reach out. I’d love to help.