NQDC Learn - Learning center

A deferred comp plan can help you:

• Save more. Deferred comp can help you save beyond the limits of qualified plans like a 401(k). And pre-tax deferrals result in tax-deferred growth, allowing compounded earnings to help you save more.
• Manage your taxes. Deferring a portion of your compensation reduces your taxable income. And you’ll have more control over how and when you pay taxes on what you saved.
• Retire on your schedule. With no age-based rules on when you receive deferred comp income, the plan could potentially help you retire early.

Prior to enrolling, ask yourself a few questions:

• Can you afford to defer a set amount of income for the entire year—with no loan or withdrawal? 
  • The amount you defer is locked in for the year and you don’t have any loan or withdrawal options. So it’s important to save what you can afford. 
  • If your needs change and you need to reschedule a distribution, you must let your employer know at least 12 months before the scheduled payout (no changes are allowed within a year of your scheduled distribution). The payout also must be delayed at least five years from the originally scheduled distribution date.
• Are you maximizing your qualified plans?
  • If not, do that first and use catch-up contributions if you’re age 50 or older.  
  • Savings in qualified plans like a 401(k) plan are yours and protected from creditors by the federal law.
  • Keep in mind that deferred comp deferrals reduce the income available to contribute to a qualified plan.  
  • Note: You can’t roll money over from a qualified to a nonqualified plan.
• Do you want to lower your tax rate?
  • If so, a nonqualified plan can help.
  • Distributions are treated as ordinary income when they’re paid out, and they’re subject to current federal and state income tax.
• Are you concerned about meeting your retirement savings goals?
  • If so, the NQDC plan can supplement your other savings plans.
  • If not, deferred comp could still help you meet other financial goals.
• Are you confident in your employer’s success?
  • Nonqualified plans have fewer government-imposed restrictions than qualified plans, but they don’t have the same government protections. 
  • Some plans place deferred compensation in a trust, which is used to hold assets and pay benefits. While your employer retains control of any deferred money until it’s paid out, the trust protects you from a change of control in company ownership. It also protects you from a later change of heart by your employer—after you’ve deferred income but before it’s laid out.
  • The only situation where your company’s promise to pay out deferred compensation could be broken is if they became insolvent or went bankrupt. Then, the bankruptcy process would determine how or if you’d get paid.

Distributions, or payouts, are how you receive money from your nonqualified deferred compensation plan.    

• The distribution is dependent on the type of account or goal you’ve set up for your plan: 
  • Retirement. A retirement account pays out once you leave your employer, regardless of age. It can help replace your income after you’ve stopped working but before you start drawing down other retirement savings. 
  • Savings. A savings account, also known as an in-service account, is designed to help meet short-term goals such as paying for a college education or second home. These accounts generally pay out while you’re still working, and you choose how and when to receive the distribution.  
• Distributions occur depending on your employer’s plan design. The money is paid out in lump sums or installments. 
  • Depending on how your employer set up the plan, installments could be paid out annually, semi-annually, quarterly, monthly, bi-weekly, or weekly. 
• Events both in your control (such as leaving for a new job or retiring) and out of it (like death or a disability) can trigger distributions. 
• Decisions made when establishing accounts during the enrollment process determine how the accounts distribute. 
• You’ll pay federal income taxes on the amount paid out, along with any applicable state taxes, the year you receive your distribution.  
• If deferred income is needed unexpectedly, circumstances like death, disability, a change in company control, or financial hardship may qualify you to receive this money outside of when it was planned to be distributed. During enrollment, you designate how to receive your money from the plan should one of these situations occur.

Compound Interest

• Thanks to compound interest, the tax-deferred advantage increases the longer you let your balance grow. The example below shows that over time, assuming the same earnings rate, you’d have a larger account value from a pre-tax investment.

Tax Brackets

• With a deferred comp plan, you can also defer your highest tax bracket income to help lower your actual tax rate.  
• Each dollar is taxed at the rate of the tax bracket it falls into. The first dollars you make are taxed at a lower rate, and the last dollars you make are taxed at the highest tax bracket you reach. These are called marginal tax rates, and there is a different rate for each tax bracket. Your average or combined tax rate is called your effective tax rate.  
• Preventing money from being taxed at the higher marginal tax rates will lower your effective tax rate, like in the example below.  

• You pay income taxes when you receive the money you’ve deferred. Depending on when you receive your payout, you could lower your annual taxable income enough to drop into a lower tax bracket in your retirement years. 
• Keep in mind that distributions from a nonqualified deferred comp plan are treated as ordinary income, and are subject to current federal and state income tax. 

• Rather than investing directly into funds, nonqualified plans use “reference” investments—a plan requirement to help preserve the tax-deferred status of the plan. 
• You can direct your deferrals toward a variety of reference investment options that align with your risk profile. 
  • Reference investments you select may or may not actually be selected by your employer.  
• A reference investment mirrors the performance of an actual investment and is used solely for the purpose of calculating earnings.  
• Any potential growth or loss is determined by the performance of the reference investment you chose.