Executives often ask if they should be saving using an executive deferred compensation plan (formally known as a nonqualified deferred compensation plan).
If you respond yes to these questions, then a nonqualified deferred compensation plan may be the answer.
- Are you in your highest earning years and would like to save more pretax for your retirement?
- Are you thinking about changing careers or taking time off and wonder how you could afford this?
- Could you save your bonus or even some of your salary?
- Do you like the idea of saving money pretax so you can take it out when you are in a lower tax bracket?
Determining If You Qualify to Use a Nonqualified Deferred Compensation Plan
- Does your company have a nonqualified deferred compensation plan?
- Are you confident in the financial stability of your employer?
- Can you ask a financial professional for help to make sure you understand the details of the plan and your options?
In summary, if your answers to these questions were more or less in the affirmative, read on.
What Is a Deferred Compensation Plan?
A nonqualified deferred compensation plan goes by many names such as executive deferred compensation plan and SERP. But it is not a 401(k) plan, which is a qualified plan. The difference is in the ERISA and IRS rules to which the nonqualified deferred compensation plan must adhere. Deferred compensation plans allow you to defer “save” your compensation and take it later.
Who Can Use a Deferred Compensation Plan?
If your company offers a nonqualified deferred compensation plan, it usually applies to those who make greater than $150,000 per year. So, you do not have to be an “executive” to be in the plan.
Why Executives Should Use a Deferred Compensation Plan
Because of ERISA rules around 401(k) plans, people who have higher income are often not allowed to save the maximum allowed to their 401(k). To help these employees save for retirement, companies often create a nonqualified deferred compensation plan.
Unique Contribution and Distribution Rules
The most complicated issue you must understand will be the rules for contributions and distributions.
Nonqualified deferred compensation plans have their own set of rules when it comes to how you contribute and then how you can take money out (distribution).
Noting that your plan will be unique (so you need to read the plan documents and review them with your benefits representative), here are the general rules:
- You usually select how much of your compensation is set aside once a year during a specific time period. This is unlike 401(k)s that allow you to make this decision any time and multiple times a year. Also, unlike 401(k)s, a nonqualified deferred compensation plan does not have limits on the amount you can contribute.
- Once you have deferred your compensation, it will be held in an account for you with a financial institution and you will be able to invest it much like a 401(k).
If You Read Anything About Saving With a Deferred Compensation Plan, Read This
You will need to select the event that will trigger the distribution, for example, upon termination or age 65, whichever comes first.
If you decide to change when you will receive your distribution, you CANNOT take it earlier. Instead, you will have to push it out from the original distribution date by five years. This rule requires careful planning around your distributions along with continual review. For example, if you selected “termination or age 65” and decide to change companies, everything in your nonqualified deferred compensation plan will be paid out when you leave your current company. This may be just fine with you, or maybe not.
Deferred compensation is a great benefit, but you must take the time to understand the rules and monitor your asset. If you have questions about using a nonqualified deferred compensation plan, you should ask your financial advisor for help to determine if such a plan would be right for you.