Nonqualified savings plans help eligible employees

As seasoned industry veterans continue on successful careers, they may begin wondering about alternatives for building bigger nest eggs. Over time, they may have accumulated a sizable amount of money through a company-sponsored 401(k) plan, but at their current income, they may qualify for another savings vehicle, called a nonqualified deferred compensation, or NQDC, plan.

These savings plans allow individuals to defer their salaries beyond the contribution limits of qualified retirement plans, such as a 401(k), if they receive this benefit from their employer.

For starters, it’s important to remember that the nonqualified deferred compensation plan isn’t for everyone. Unlike 401(k) plans that allow most employees at an organization to participate regardless of their income levels, individuals must be part of a select group of key management or among highly compensated employees – defined by the Internal Revenue Service as earning $100,000 or more annually – to qualify for an NQDC plan.

If individuals receive this benefit from their employers, and they’re qualified to participate, they must sign the plan’s written agreement between themselves and the employer. Keep in mind that an NQDC plan must be prepared by outside legal counsel in compliance with IRS Code Section 509A. In this agreement, the employer would make an unsecured promise to defer part of the employee’s current compensation into an investment account. Note that this unsecured promise means that all contributions to the plan are considered assets of the employer, and they could be subject to the employer’s creditors.

After the written agreement has been signed, the employee would begin to defer a portion of their salary into the investments chosen by the employer on a pretax basis. In addition to salary deferrals by the employee, the employer also can make discretionary contributions for employees, and those are not subject to current income taxes.

It’s important to note that the employees would not be subject to tax on income and realized capital gains generated by employer-owned NQDC plan assets, but their salary deferrals are subject to FICA and Medicare taxes.

NQDC plans can offer many advantages. First, unlike traditional 401(k) plans, there is no cap on contributions until the employee reaches 100 percent of earned income.

With NQDC plans, there also are no mandatory minimum withdrawal requirements at the age of 70 1/2, and there are no penalties for distributions taken prior to age 59 1/2.

While the distributions from an NQDC plan may not be a concern for quite awhile, it’s important to understand the options that will be available. Employees will be able to take plan distributions only under certain circumstances, including separation from service from their employer, disability, death, the passage of a specified amount of time, a change in the control of ownership at the firm where they are employed or an unforeseeable emergency. Employees may also be able to take accelerated distributions if their plan assets do not exceed $10,000, or in the event of a divorce. When one of these triggering events occurs, the balance of their account would be distributed as a lump sum or in installments, and the distributions are taxed as ordinary income.

Business owners who want to enhance nest-egg options for highly compensated executives who contribute to business profitability may want to explore NQDC plans. Contact a financial consultant for more information on the how these plans work and how they fit in with your company’s overall financial goals.

Timothy M. Reese is senior vice president-investments with A.G. Edwards & Sons Inc. in Springfield. He may be reached at timothy.reese@agedwards.com.[[In-content Ad]]