Employer-sponsored retirement-savings plans, including 401(k)s and 403(bs), are critical for helping businesses attract and retain skilled employees. However, due to government regulations and annual contribution limits, these qualified plans restrict highly compensated employees’ savings opportunities and their ability to build enough wealth to maintain their standard of living in retirement. To bridge this savings shortfall and help key executives put more of their hard-earned money in tax-advantaged retirement accounts, many businesses are looking into non-qualified deferred compensation (NQDC) plans that avoid rigid restrictions and testing requirements.
Traditional workplace retirement plans come with a long list of regulatory compliance requirements to ensure they provide equal benefits to all employees regardless of job title or salary. For example, in 2025, the maximum an individual may contribute to a 401(k), 403(b) or certain 457 plans is $23,500, or $31,000 for those age 50 and older. Contributions via salary deferral can be made with pre-tax dollars, meaning they reduce plan participants’ taxable income in the year of contribution. Earnings on those contributions grow tax-deferred, meaning the employee pays no tax on the dividends, interest or capital gains during the accumulation period. Any distributions from these accounts before age 59½ are subject to a 10% early withdrawal penalty. Once account owners reach age 73, they must begin taking annual required minimum distributions (RMDs) and paying the related income tax liabilities on those amounts.
By contrast, there are no limits on the amount of salary, bonuses, or other forms of compensation employees may elect to defer to NQDC plans on a pre-tax basis, making them particularly useful for high-earning employees who already max out their annual savings in qualified 401(k) plans. The more compensation an employee defers to an NQCD in a particular year, the more likely they will fall under a lower marginal income tax bracket during the years of contribution. The employer holds these contributions in trust and promises to distribute the deferred compensation plus associated earnings to plan participants at predetermined future dates. At that point, plan participants are responsible for paying income taxes on distributed amounts. Employees are not penalized for taking withdrawals before age 59½ and are not required to take minimum distributions at age 73. This gives employees significant flexibility in timing their distributions and resulting tax liabilities to meet their unique savings and spending needs and goals.
For example, employees may elect to defer a portion of their annual salaries to accumulate retirement savings and a portion of their annual bonuses to save for their children’s college education, a second home, a new boat or all three. Under these circumstances, the employees could elect to receive taxable distributions for their children’s education over four years while they are still working and defer additional distributions until retirement, when they may have a lower effective tax rate. Despite all this flexibility and customization offered by NQDCs, also referred to as Top Hat plans, employees need to recognize that although the funds held in trust provide some protections to plan participants, they are also considered company assets subject to creditors’ claims. In addition, there are no guarantees that the benefits promised today will be available in the future should the employer go out of business or suffer significant financial difficulties.
For employers, NQDC plans are easy to administer because they do not demand all the paperwork and compliance procedures required of qualified plans governed by the Employee Retirement Income Security Act (ERISA). Instead, the company can set the plan’s eligibility requirements and salary deferral limits, the option of an employer match, the investment options and the vesting schedule. Deferred compensation contributions are made to a trust and reported on the company’s balance sheet. Moreover, plan sponsors have a one-time filing notice responsibility with the Department of Labor (DOL) after establishing the plan rather than having to file annual reports with the DOL and IRS.
About the Author: Sean Deviney is a CFP®* professional, a retirement plan advisor and a director with Provenance Wealth Advisors (PWA), an Independent Registered Investment Advisor affiliated with Berkowitz Pollack Brant Advisors + CPAs and a registered representative with PWA Securities, LLC. He can be reached at the firm’s Fort Lauderdale, Fla., office at (954) 712-8888 or info@provwealth.com.
Provenance Wealth Advisors (PWA), 200 E. Las Olas Blvd., 19th Floor, Ft. Lauderdale, FL 33301 (954) 712-8888.
Sean Deviney, CFP®*, is a registered representative of and offers securities through PWA Securities, LLC, Member FINRA/SIPC.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
Any opinions are those of the advisors of PWA and not necessarily those of PWA Securities, LLC. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of PWAS, we are not qualified to render advice on tax or legal matters. You should discuss any tax or legal matters with the appropriate professional. Prior to making any investment decision, please consult with your financial advisor about your individual situation.
* Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and federally registered CFP (with flame design) in the U.S., which it awards to individuals who successfully complete the CFP Board’s initial and ongoing certification requirements.
Posted on December 23, 2024