GREAT IDEA . . . LOUSY NAME
GREAT IDEA . . . LOUSY NAME
Obviously, nobody asked the marketing guys before coming up with
this one. Who in the world thought up the name "non-qualified
deferred compensation?" Oh, it's descriptive alright. But who
wants anything "non-qualified?" Do you want a "non-qualified"
doctor, lawyer, or accountant? What's worse is deferring
compensation. How many people want to work today and get paid in
five years? The problem is, non-qualified deferred compensation
is a great idea; it just has a lousy name.
Non-qualified deferred compensation (NQDC) is a powerful
retirement planning tool, particularly for owners of closely
held corporations (for purposes of this article, I'm only going
to deal with "C" corporations). NQDC plans are not qualified for
two things; some of the income tax benefits afforded qualified
retirement plans and the employee protection provisions of the
Employee Retirement Income Security Act (ERISA). What NQDC plans
do offer is flexibility. Great gobs of flexibility. Flexibility
is something qualified plans, after decades of Congressional
tinkering, lack. The loss of some tax benefits and ERISA
provisions may seem a very small price to pay when you consider
the many benefits of NQDC plans.
A NQDC plan is a written contract between the corporate employer
and the employee. The contract covers employment and
compensation that will be provided in the future. The NQDC
agreement gives to the employee the employer's unsecured promise
to pay some future benefit in exchange for services today. The
promised future benefit may be in one of three general forms.
Some NQDC plans resemble defined benefit plans in that they
promise to pay the employee a fixed dollar amount or fixed
percentage of salary for a period of time after retirement.
Another type of NQDC resembles a defined contribution plan. A
fixed amount goes into the employee's "account" each year,
sometimes through voluntary salary deferrals, and the employee
is entitled to the balance of the account at retirement. The
final type of NQDC plan provides a death benefit to the
employee's designated beneficiary.
The key benefit with NQDC is flexibility. With NQDC plans, the
employer can discriminate freely. The employer can pick and
choose from among employees, including him/herself, and benefit
only a select few. The employer can treat those chosen
differently. The benefit promised need not follow any of the
rules associated with qualified plans (e.g. the $44,000 for
2006) annual limit on contributions to defined contribution
plans). The vesting schedule can be whatever the employer would
like it to be. By using life insurance products, the tax
deferral feature of qualified plans can be simulated. Properly
drafted, NQDC plans do not result in taxable income to the
employee until payments are made.
To obtain this flexibility both the employer and employee must
give something up. The employer loses the up-front tax deduction
for the contribution to the plan. However, the employer will get
a deduction when benefits are paid. The employee loses the
security provided under ERISA. However, frequently the employee
involved is the business owner which mitigates this concern.
Also there are techniques available to provide the non-owner
employee with a measure of security. By the way, the marketing
guys have gotten hold of NQDC plans, so you'll see them called
Supplemental Executive Retirement Plans or Excess Benefit Plans
among other names.