Deferred compensation strategies allow you to set aside a portion of your business’s profits in exchange for a deferral on the corresponding income taxes. Our unique deferred compensation strategies maximize tax efficiency even beyond those typically offered by qualified or non-qualified deferred compensation plans. As one client recently described these, “deferred compensation on steroids.”
What are Qualified Deferred Compensation Plans?
Qualified deferred compensation plans are pension plans governed by the Employee Retirement Income Security Act including 401(k) plans, 403(b) plans and 457 plans. A company that has such a plan in place must offer it to all employees, which is why these tend to be less attractive to business owners. Qualified deferred compensation is set off for the sole benefit of its recipients, meaning that creditors cannot access the funds if the company fails to pay its debts. Contributions to these plans are capped by law.
What are Non-Qualified Deferred Compensation Plans?
Non-qualified deferred compensation plan reduce a portion of an employee’s taxable income in the current year and is paid out at a date after which the income is actually earned. If funded with life insurance, the death benefit proceeds to the owner’s beneficiary are generally taxable in the event of the employee’s death.
What is 409A?
409A applies to compensation that workers earn in one year but that is paid in a future year. This is referred to as non-qualified deferred compensation. This is different from deferred compensation in the form of elective deferrals to qualified plans (such as a 401(k) plan) or to a 403(b) or 457(b) plan.
How does coverage under 409A affect an employee’s taxes?
If deferred compensation meets the requirements of 409A, then the employee is not currently taxed on such deferred wages. The compensation is taxed when withdrawn from the deferred compensation plan if it is covered by 409A. If the arrangement does not meet the requirements of 409A, the compensation is subject to certain additional taxes, including a 20% additional income tax, as well as the employee being taxed on the funds deferred currently. 409A does not reduce FICA (Social Security) and Medicare taxes.
NQDC Benefit to the Business
A Non-Qualified Deferred Compensation Plan provides many benefits to businesses, most notably the following:
- Helps retain, recruit and reward key executives.
- Can be used to provide extra benefits solely for key executives because plans are not covered by non-discriminatory compliance rules of ERISA for qualified plans.
- Provides an income-tax deduction as a business expense when benefits are paid out to executives in the future.
- Provides “golden handcuffs” that require an executive to meet terms favorable to the business in order to receive the deferred income.