What is Non-Qualified Deferred Compensation (NQDC)?

Non-Qualified Deferred Compensation (NQDC) is an agreement by which an employee can defer the receipt of a current portion of his salary, bonus, or other income until a future time. NQDC plans are not subject to the same legal requirements for participation and contribution limits that exist with qualified plans, such as 401(k) and pension plans.

NQDC plans are usually used to allow highly paid employees to defer compensation and accrue retirement savings in excess of the limits available through qualified plans. The deferred compensation would be taxed when the employee receives it, not as they earn it.

How is Non-Qualified Deferred Compensation Taxed?

Non-qualified deferred Compensation (NQDC) is when the money is to be taxed at the time the employee receives it, not at the time he/she earns it.

With NQDC, employees voluntarily defer a portion of their salary or bonus to some time in the future (often after retirement). The deferred compensation is not taxed when earned but instead at some (possibly later) date when the employee receives it.

To prevent this result, I require a deferred election to be made at the time the foresight services are performed, and I would like to see an opportunity for annual salary reductions with appropriate back-end tax consequences (ordinary income plus FICA taxes plus state and local taxes). Also, if deferred compensation is paid in a lump sum, then it is often taxed at top dollar rates like your highest marginal tax rate.

How to Set up a Non-Qualified Deferred Compensation Plan?

Generally, a Non-Qualified Deferred Compensation (NQDC) plan requires several steps to set up:

Contact a qualified financial advisor, accountant, or tax professional to discuss the costs and benefits of an NQDC plan for your company and how to arrange them within any permitted regulatory guidelines.
Decide which of your employees will be able to participate in the retirement plan and what the terms are—for example, how much they can contribute and when they’ll fully vest.
Draft a plan document of the terms of the NQDC plan (including, for example, the deferral election process, distribution options, and timing).
Notify eligible employees of the plan and the opportunity to make deferral elections.
Establish a funding mechanism for deferred compensation, such as an employer-owned life insurance policy or a rabbi trust, which can help protect the deferred compensation from creditors.
Meet regulatory requirements, such as the non-discrimination rules, which require that the NQDC plan not discriminate against a highly compensated employee.

Also, See: After-Tax Contributions