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Employer Sponsored
Retirement Plans
Non-Qualified Deferred Compensation
Non-qualified deferred compensation is an incentive compensation arrangement established by employers to provide retirement income and perhaps death and disability benefits to selected employees. The arrangement is a written agreement in which the employer makes an unsecured promise to make future payments to a key executive if the executive meets certain agreed upon requirements. The arrangement can also be made with an independent contractor, and in all cases it specifies when and how the future compensation will be paid. When properly arranged, the employee (or beneficiary) will defer taxation until benefits are paid at some future time.
The employer cannot deduct benefits until they are paid. A deduction can be taken in the same taxable year as the benefit is reported on the employee's income tax return.
Arrangements do not have to be pre-approved by the IRS nor are they generally subject to the regulatory requirements applicable to qualified retirement plans.
The arrangement may provide that the employee will receive future compensation as a result of a current salary reduction or in lieu of a bonus or salary increase. This is the traditional deferred compensation arrangement. In more recent times, a more popular alternative emerged: the salary continuation arrangement. Here, the employer simply commits to pay future compensation in addition to current earnings, which are not reduced by participation in the arrangement. The familiar name, "deferred compensation," is often used generically to include both types of approaches.
The employer can purchase employer owned life insurance on the life of the executive, which serves to informally fund the future payments and can allow the employer to recover the costs upon the death of the executive.
Benefits to the Executive
- The executive receives a supplemental retirement benefit
- The executive generally pays no tax on the benefits until they are received
- Death and disability benefits can be added to the arrangement
Benefits to the Employer
- The employer has the right to pick and choose the participants from their select group of highly compensated employees
- Deferred Compensation is an attractive method of recruiting, retaining, rewarding and retiring valuable employees
- Benefits are tax deductible when paid
- The terms of the arrangement can be structured to serve the individual needs of covered employees
- The employer is owner and beneficiary of the life insurance contract
- The life insurance contract can provide the employer with informal funding for the benefits as well as cost recovery