When developing for retirement is a priority, your employee benefits package is likely to be your starting speck. Having access to a tax-advantaged employer savings plan – such as a 401(k) or 403(b) – can commandeer you to build wealth for retirement while deferring taxes on your portfolio’s enlargement.
Nonqualified deferred compensation plans (NQDC) offer another way to building retirement wealth. These plans are used by private retinues to attract and retain executives and other highly compensated employees. In a 2017 Newport Grouping survey, 92% of companies polled said they offered NQDCs to their managers at some level in the organization.
These plans make it possible for appropriate employees to save more for retirement when they’ve maxed out an remaining employer savings plan. At the same time, NQDCs allow staff members to reap the benefits of deferred taxation. (For more, see Executive Deferred Comp: Awareness NQDC.)
How Nonqualified Deferred Compensation Plans Work
In a nutshell, an NQDC authorizes highly compensated employees to defer some of their compensation to a later year. You determine how much of your salary, bonuses, commissions or other compensation to way to. Essentially, your employer agrees to pay you that money down the method, which could be five or 10 years in the future, or even upon your retirement escort.
That’s different from a 401(k) and other defined-contribution plans, which grant you to contribute a percentage of your income each year, up to the annual contribution limit. Instantly you retire, you’d begin taking distributions from your plan, which wish be subject to your ordinary income tax rate. With an NQDC, you don’t pay any takings tax on the part of your compensation you’re deferring, just Social Security and Medicare encumbrances. In doing so, you’re letting that money grow tax-deferred until you clear it.
That’s a boon for higher income earners. For 2018, for instance, the crest annual contribution limit to a 401(k) is $18,500 for employees. Employers can also mark aggressive matching contributions, with total contributions topping out at $55,000 for the year.
For someone typing $1 million a year, that $18,500 contribution represents upright a fraction of their income. A nest egg to support that income plane in retirement requires considerably more savings and finding tax-advantaged courses to accomplish this can be difficult, even if the employee also maxes out an IRA and salubrity savings account (HSA). (See a detailed explanation in Why Retiring on 70% of Your Revenues Might Be Tough. Then review Why HSAs Appeal More to High-Income Earners)
An NQDC accomplishes this target, allowing employees put aside additional money beyond their business plans for their later years on a tax-advantaged basis. For some decidedly compensated employees, an NQDC may be a more attractive option than requiting taxes on all their compensation each year and supplementing their tax-advantaged representations with a taxable brokerage account.
Potential Downsides of Using an NQDC to Wherewithal Your Retirement
Deferring compensation can yield tax benefits, but there are some dislikes to consider before taking advantage of one of these plans.
First, you obligation be strategic in how much of your compensation you defer. Internal Revenue Cryptogram Section 409A states that employees must choose their deferral plebiscite in the year before it takes effect. Once you make that voting, you can’t change it once the working period begins. Under those ascendancies, it’s possible to defer too much – or not enough – of your compensation in any given year.
Another possibility downside is that you can’t roll over money from an NQDC into an IRA or another retirement intend, the way you can with a 401(k) or similar plan. That, together with the decided rules for making deferral elections, makes these plans doll-sized flexible compared to other employer retirement savings options.
A third consequence – and this is a big one – is that the assets in an NQDC are typically viewed as unsecured all-inclusive assets of the company. If your employer were to file bankruptcy or be smarted, those assets would be vulnerable to creditor claims. If you’ve deferred a sizable amount of compensation into your scheme, you’re assuming a certain degree of risk, in addition to any risk you might on oneself if your contributions were being invested in the market, the way they thinks fitting with a 401(k).
The Bottom Line
Nonqualified deferred compensation outlines may be a more appropriate choice for some employees than others. If you possess a high annual income and are consistently maxing out your 401(k) or a comparable plan, an NQDC could help you add to your savings while leveraging some tax benefits. Solely remember to weigh the potential risks of adding one of these plans to your retirement scheme against any rewards you stand to gain.