If you offer a 401(k) to your employees but it isn’t meeting all their retirement planning needs, a nonqualified deferred compensation plan (NQDC) may be the solution. NQDC plans give key employees the ability to defer more of their salary and bonuses on a pretax basis.
There are no formal funding vehicles required for these type plans, but for the example below we’ll assume corporate-owned life insurance (COLI) is the funding vehicle because of the tax advantages it can offer.
The business purchases life insurance policies on each key employee, and the employee defers money into the plan. The employee chooses how the funds in the plan are invested from a menu of investment options, and the gains in the account grow tax deferred until they are withdrawn from the plan.
The employer can make additional contributions into the account but is not required to do so. The employee is immediately 100% vested in his or her own contributions and earnings, but the employer may make company contributions subject to a vesting schedule to add a “golden handcuffs” element to the plan.
Potential employer benefits
Serves as both a recruiting and retention tool for valued employees
Requires less administration and fewer funding requirements than qualified plans
Enables the business to select who receives benefits, when they receive them and how much they receive, unlike qualified plans
The death benefit from the insurance funding can allow the business to recover costs
Provides a tax deduction when employee receives compensation from the plan
Potential employee benefits
Recognition of key employees’ contributions to your business
Tax deferral of earnings until employee receives compensation under terms of the plan
Source of supplemental retirement income
Unlimited employer and employee deferrals, plan permitting