Nonqualified deferred compensation plans are alternative retirement vehicles, and we’ll explain what you should know about deferred compensation plans.
The 401(k) has become one of the most popular employer-sponsored retirement plans. However, it’s interesting to know that the 401(k) hasn’t even been around for 50 years, although it’s a retirement tool that helps so many people feel financially secure, offering people additional income besides social security benefits. According to Northwestern Mutual, Congress passed the Revenue Act of 1978, which included a provision added to the Internal Revenue Code Section 401(k), allowing employees to avoid taxation on deferred compensation.
Then, in 1980 benefits consultant Ted Benna referred to Section 401(k) while looking for ways to create more tax-friendly retirement programs for a client. Benna developed the idea to allow employees to save pre-tax money into a retirement plan with an employer match. His client rejected the idea. Therefore, Benna’s company, The Johnson Companies, was the first to offer its workers a 401(k) plan.
In 1981, the IRS allowed employees to fund their retirement through payroll deductions. According to the Employee Benefit Research Institute, within two years, the 401(k) skyrocketed in popularity, and nearly half of all the large companies were offering 401(k) plans or considering it. However, the IRS caps how much you can contribute to your 401(k). According to Forbes, the total 401(k) contributions by an employee and employer cannot exceed $66,000 in 2023. Catch-up contributions for adults 50 and older cannot exceed $73,500.
For that reason, some people, particularly executives or business owners, explore alternative retirement vehicles because they can struggle to save money after their 401(k) plan maxes. Nonqualified deferred compensation (NQDC) plans are excellent alternative retirement vehicles, and we’ll explain what you should know about deferred compensation plans.
What is an NQDC Plan?
Corporate executives can defer a substantial portion of their pay and defer taxes on the money until the deferral is paid with an NQDC plan. Many NQDC policies allow you to schedule distributions throughout your career and not only when you retire. Therefore, you can defer compensation to pay for shorter-term goals, such as a child’s higher education expenses. If you’re an executive, you should only contribute to an NQDC plan if you plan on maxing out your 401(k).
You should know that NQDC plans aren’t for everyone. Before you enroll in any policy, you want to understand how it works and will fit into your overall financial plan. NQDC plans offer tax-deferred growth, but they don’t come without risks. Thus, reaching out to an insurance broker is always best to fully understand alternative retirement vehicles.
More About How NQDC Plans Work
An NQDC plan is an employee-employer agreement to postpone a portion of your annual income until a particular future date. This date could be in the next five or ten years or retirement. You decide how much you want to defer, and you don’t pay federal or state income taxes on that part of your pay in the year you defer it. You’d only pay social security and Medicare taxes, with your retirement fund being able to grow without a limit until you receive it.
Many companies offer NQDC policies as an executive retirement benefit because 401(k)s aren’t sufficient enough for high earners. The only downside to an NQDC plan is that you can’t take loans from it, and you can’t roll the money over into an IRA or other retirement account when the compensation goes to you. Additionally, unlike a 401(k) plan, the deferred NQDC plans are subject to potential loss because the company essentially owns the policy. Therefore, the NQDC plans would be subject to creditors’ claims if your company goes bankrupt.
We hope that you found this explanation of alternative retirement vehicles helpful. Therefore, having other alternative retirement vehicles, such as an IRA, is helpful. Call us today if you’re an executive or business owner who wants to learn more.
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