Recruit and Retain Top Talent with a Deferred Compensation Plan

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A fundamental part of most successful businesses is the right talent, but attracting the industry’s best can be competitive. One way for companies to stand out in this hiring environment is by offering creative compensation packages that include a non-qualified deferred compensation (NQDC) plan. While highly compensated executives are subject to a higher tax bracket, a NQDC plan allows your top employees to defer income (subsequently minimize current tax liabilities and supplement their retirement savings) until later when they might be in a lower tax bracket.

What It Is

A voluntary deferral plan is an employer-sponsored, non-qualified retirement plan that allows executives to defer a portion of their compensation, such as bonuses, commissions or salary, into the plan, effectively postponing taxes on that income until it is received in the future.

A NQDC plan benefit is not subject to the 2024 deferral limit of $23,000 or the 10% penalty for a distribution before age 59½.

In addition to employees, employers may also contribute to the plan on behalf of employees, either as matching contributions or discretionary contributions. NQDC plans typically offer a range of investment options, similar to those found in qualified retirement plans like 401(k)s. Unlike qualified retirement plans, assets in NQDC plans are subject to the claims of the employer’s creditors in the event of bankruptcy. Therefore, employees bear the risk that the employer may not be able to fulfill its obligations under the plan.

How To Make Distributions

At the executive’s retirement or another triggering event, such as termination of employment or disability, participants receive their deferred compensation according to a predetermined schedule or payment options specified in the NQDC plan. These payments are taxable income for the executive and may be tax-deductible for the employer.

While most voluntary deferral plans are designed to provide retirement benefits, some plans may allow for distributions while the executive is still employed and may even offer survivor benefits should the executive die before the voluntary deferral benefit has been fully distributed.

Employer Advantages

In addition to the ability to recruit and retain valuable executives by providing a significant benefit upon their retirement, a voluntary deferral plan offers several advantages to the employer.

The employer controls the plan and can choose to only offer the option to select executives. This allows for further creativity in the compensation packages offered to employees.

With a NQDC plan, the employer can invest elective deferrals into any asset they deem appropriate to help pursue the growth promised to the employee. Otherwise, they can simply pay the promised growth from future cash flows. If the employer chooses to informally fund the plan with an asset, that asset is carried on the company’s balance sheet and can potentially offer tax benefits.

Some employers choose to use life insurance to informally fund the voluntary deferral plan as it may provide the employer with tax-deferred growth of the policy’s cash value, as well as a death benefit that they can use to fund the plan and pay survivor benefits to the executive’s heirs. To use life insurance as the informal funding vehicle for the plan, the executive should own more than 5% of the business, be a director of the business or be a highly compensated employee as defined by the IRS. If life insurance is used as the informal funding, the cash value accumulates tax-deferred; the death benefit may help provide survivor benefits to the executive’s heirs; and the policy can be structured to allow the employer to recover some of the cost.

Furthermore, NQDC plan benefits (when paid) may be tax-deductible for the employer. However, the deductibility of the distributions is subject to, among other things, the reasonable compensation limits set forth by the IRS.

Offering potential tax savings to executives can be a great way to build loyalty and attract the best talent, but it may be complicated to execute. Similarly, employees should carefully consider the risks of the plan. That’s when CoSource Financial Group can help. Contact us today to get the conversation started.

Retirement plan withdrawals may be subject to taxation and penalties when withdrawn early.

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