How to choose between qualified and nonqualified deferred compensation plans

As a business owner, you are constantly trying to find ways to attract and retain high-quality employees. Qualified plans, like profit-sharing or 401(k) plans, and nonqualified deferred compensation (NQDC) plans are popular and offer successful means of achieving this goal. While both types of plans give employees added incentives to join or remain at your business, they are quite distinct. Because of their differences, one of these options may fit your business or your desired objectives better than the other.

A qualified plan generally covers all or most employees. It gives you, as the employer, an immediate tax deduction for the money contributed to the plan for a particular year. And employees don’t have to pay income tax on amounts contributed to the plan until those amounts are distributed from the plan. For employees to receive this beneficial tax treatment, however, a qualified plan must comply with strict and highly complex ERISA and IRS rules. In addition, qualified plans are subject to limitations on contributions and benefits. These limitations have a particularly harsh effect on highly paid executives.

An employer will generally make NQDC plans available only to select executives and other key employees in order to avoid ERISA’s requirements and adverse tax consequences. Additionally, no dollar limits apply to NQDC plan benefits (although compensation must generally meet the IRS’s definition of reasonable compensation to be deductible). While tax consequences depend on the NQDC plan’s specific design and funding provisions, you generally won’t be allowed to take a tax deduction for amounts contributed to the plan until funds are actually distributed from the plan and received as taxable income by participating employees.

Similar to qualified plan participants, employees participating in NQDC plans usually don’t recognize the deferred compensation as current income (when it is earned) for tax purposes. Rather, they recognize the income when they receive payment from the NQDC plan.

Many employers use qualified plans and/or NQDC plans to attract and retain employees. But you need to understand how these options differ so that you can choose the most suitable employee incentives. As your trusted financial professional, we will work with you to understand your business’s needs, so we can help you select the most valuable employee incentives for your situation.

Commonwealth Financial Network® does not offer tax or legal advice. You should consult a tax or legal professional regarding your individual situation.

Attracting and retaining qualified employees can be challenging. The right compensation package can make all the difference. Contact MaPP to learn more at (330) 339-6308 or submit a form.