Deferred Compensation Plan (Individual)
Deferred compensation plans are agreements in which a portion of an employee’s wages is paid out later than when it was earned.
Commonly referred to as non-qualified deferred compensation plan, NQDC plan and supplemental executive retirement plan.
Do I Qualify for the Deferred Compensation Plan (Individual)?
If you and your employer agree to a deferred compensation plan, a portion of your wages will be deferred until a future date, allowing you to reduce your taxable income.
2022 Deferred Compensation Plan (Individual) Details
A non-qualified deferred compensation (NQDC) plan is an agreement between you and your employer to pay some portion of your compensation in the future. NQDC plans provide employers and employees with different tax benefits than qualified plans, such as 401(k)s and defined contribution plans. Under a non-qualified plan, your employer agrees to pay you some type of compensation at a future time. It may be dependent on you completing certain requirements — such as years of service or honoring the terms of a non-competition agreement — or it may simply be an agreement to pay some of your current salary at a future time.
The advantage to you is that you are not taxed on the income until you actually receive it. The disadvantage is that you will have a very low priority behind most of your employer’s creditors in the event your employer cannot pay its debts.
Types of deferred compensation plans
NQDC plans typically fall into four categories:
• Salary Reduction Arrangements allow you to defer receipt of some portion of your salary that would otherwise be included in your current compensation.
• Bonus Deferral Plans resemble salary reduction arrangements, except they apply specifically to deferring receipt of bonuses.
• Top-Hat Plans (aka Supplemental Executive Retirement Plans or SERPs) are NQDC plans maintained primarily for a select group of management or highly compensated employees. These plans are usually some form of additional compensation that your employer agrees to pay you in the future, not a deferral of salary that the employer would otherwise pay you in the current year.
• Excess Benefit Plans provide benefits solely to employees whose benefits under the employer's qualified plan are limited by the tax law.
NQDC plans may be formal or informal, but they must be in writing. While many plans are very detailed, some are mentioned only in a few provisions of an employment contract.
What is an unfunded NQDC plan?
NQDC plans can be either funded or unfunded, but most are unfunded in order to gain the tax advantages they offer employees.
An unfunded arrangement is one where you get only an unsecured promise from your employer to pay the deferred compensation benefits in the future. Your employer may:
• Keep track of the benefit in a bookkeeping account.
• Voluntarily choose to invest amounts intended to help fulfill its promise to pay you.
• Transfer amounts to a trust that remains a part of its general assets, with the intention of using those assets to fund the future payments owed to you.
These arrangements are still considered “unfunded” because your employer isn't required by law to hold that money for your benefit, and the assets would be subject to the claims of your employer's creditors in the event they cannot pay their debts.
For you to get the benefit of income tax deferral, it is important that the amounts are not set aside from the employer's creditors for your exclusive benefit. If they are, you may have currently includible compensation, meaning you may have to pay taxes on the assets after all.
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• Reduce your taxable income in the current year.
• Receive taxable income in later years when you may be in a lower tax bracket.
• Benefits aren't protected from creditors in the event your employer can't pay its debts.
• No guarantee you'll be in a lower tax bracket when the amounts are paid out.
Assumptions When Taking the Deferred Compensation Plan (Individual)
• None noted.
• None noted.
Requirements to Claim the Deferred Compensation Plan (Individual)
• Your employer must have a written plan.
• Any assets held by your employer with the intention of funding the future payments to you can't be protected for your exclusive benefit.
Business Entities That Can Claim the Deferred Compensation Plan (Individual)
The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.