Introduction to Nonqualified Deferred Compensation

Deferred compensation is a contractual arrangement between the employer and employee in which the employer generally makes an unsecured promise to pay benefits in a future tax year in exchange for services rendered currently. Nonqualified plans can also be set up for outside directors and other independent contractors. In general, the same tax rules that apply in employer-employee plans apply to plans that cover independent contractors. One distinction with respect to plans covering only independent contractors is that ERISA does not apply.

A nonqualified deferred compensation plan is a deferred compensation plan that does not meet the tax and labor law requirements applicable to qualified plans.

There are two major types of nonqualified deferred compensation plans:

  • in addition plans, (also called “salary continuation” or “Supplemental Executive Retirement Plans”—SERPs); and
  • elective plans, also called “salary reduction” or “salary deferral” plans.

“In addition” nonqualified deferred compensation plans are used to provide retirement benefits to a select group of executives (or other key employees), or to provide that select group with supplemental benefits over and above those provided by the employer’s qualified plan. This is a nonelective form of deferred compensation; the employer provides it in addition to the key employee’s salary and other compensation.

Elective nonqualified deferred compensation plans are those under which a select group of key employees voluntarily choose to defer a portion of their future salary (or bonus) as a means of tax deferred savings.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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