A nonqualified deferred compensation (NQDC) plan can be a tax-efficient way to save for specific goals, particularly retirement. But like any financial tool, an NQDC plan takes proper planning—often decades in advance—to be effective.
Deferred comp and you
Explore our 3-part series on making the most of nonqualified deferred compensation plans.
Two of the most important decisions to be made are how to fund your NQDC plan and how to invest the money within it. You first need to determine whether to defer a portion of your salary, bonuses, or other forms of compensation. Then you need to implement an investing strategy that complements your other assets, including existing retirement accounts, and also works within the unique limitations imposed by NQDC investing rules.
Making deferral elections
When you are first offered an NQDC plan, you typically have just 30 days to enroll. Depending on plan rules, you may be able to defer part of your salary, bonuses, and cash payments under long-term incentive plans or grants of restricted stock units. If your plan allows preretirement distributions, you also must specify on the enrollment form when you wish to receive the money. (We discuss options for your distribution strategy in detail in Part 3 of this series on NQDC plans.)
Adding to the pressure, you have to decide how much income to defer the year before you receive it—and you generally can't change your mind midyear if your circumstances change. So when making a deferral election, it's essential to first examine the following factors:
Investing your deferred compensation
Bear in mind that the money in an NQDC plan is not really invested; rather, your employer promises—not guarantees—to pay you the compensation you defer at a later date, along with the earnings you would have received if your assets had matched the return of a particular investment or index. In actuality, you make notional investment selections, which are simply for accounting purposes.
Your plan might offer you several options for the benchmark—often, major stock and bond indexes, the 10-year US Treasury note, the company's stock price, or the mutual fund choices in the company 401(k) plan. Consider the following factors to ensure that your NQDC investment strategy complements your overall financial plan:
2017 tax law changes
The Tax Cuts and Jobs Act of December 2017 (the Act) established new income tax rates, corporate tax rates, and modifications to many deductions. It also impacted nonqualified plans in several ways. The Act included a new deferral provision for certain types of broad-based employee equity, which may apply to certain private companies.
The Act also expanded the group of covered employees that are subject to the $1 million cap on deductible compensation to include the CFO as well as the CEO, and repealed the exception from this rule for performance-based compensation. Lastly, the Act grandfathered compensation vested prior to 2017 under existing contracts.
A final note on investing deferred compensation: IRS rules limit the control employees can have over the assets, and your company is likely to have its own restrictions on changing investment elections. So while you can make changes to the investments in your NQDC plan, don't think of it as an account to tinker with continually.
Your investment strategies, and how you plan for them, are an essential part of your decision-making process when it comes to NQDC plans—all the more reason to think carefully and strategically about your deferral and investing strategy before you enroll.
Next steps to consider
See how an advisor can help you grow and protect your wealth.
Learn ways to invest your money and create a plan of action.
Learn more about wealth planning strategies and related topics.