Nonqualified Deferred Compensation Plans - Pros & Cons of Contributing to These

Nonqualified Deferred Compensation Plans - Pros & Cons of Contributing to These

July 29, 2020

Non-qualified deferred compensation plans (NQDCs) allow an employee to earn wages compensation, and bonuses in one year while deferring the income tax payment on them to be settled in a later year.1

Pros of Contributing to an NQDC

As with any type of compensation plan, there are both pros and cons of contributing to them. When it comes to the NQDCs some of the advantages that come from contributing include:

An Ability to Save More 

When contributing to a 401(k) or another qualified retirement plan, there are limitations on the amount of money that is allowed to be contributed. With a deferred plan, there are no set limits except ones that may be imposed by the employer. This allows you to contribute more and build your retirement savings more rapidly.

Reduced Tax Liability

You will not only enjoy tax benefits by being able to contribute more but also may reduce your annual tax liability by deferring compensation. It might even put you into a lower tax bracket, which reduces tax liability even further.2

The Ability to Invest on a Larger Scale

NQDC plans provide for investment options similar to 401(k) plans, such as stock options and mutual funds. But since there are no limits to your contributions, you will be able to possibly grow your wealth at a more exponential rate, making larger-scale investments that might lead to higher gains. 

Cons of Contributing to an NQDC

There are some drawbacks to contributing to an NQDC. While one of the most significant downsides to an NQDC for many people is the fact that they can't roll their deferred compensation into a non-qualified plan, there are other issues that may make contributions to an NQDC a less appealing option. 

A Strict Schedule for Distribution

With a 401(k), you are allowed to withdraw money when you need it, though, in some instances, it may result in fees and interest. With an NQDC, the schedule for the distribution of your funds will need to be determined in advance and will not be able to be changed.2 This means the timing of your distribution could result in a loss during the liquidation of the assets in your portfolio. There are no provisions for early withdrawal in an NQDC, even for financial hardship, which means your money will be tied up until the designated distribution date. 

No Protection From Creditors

The Employee Retirement Income Security Act of 1974 (ERISA) provides protections from creditors for many forms of retirement plans.Since an employee deferral is seen as a liability on an employer's balance sheet, it is considered to be an unsecured loan between the employer and the employee, and it is not protected by ERISA laws. Your employer has agreed to pay in the future based on a distribution schedule, but the promise to pay does not provide any protection in the event that the employer has difficulty paying debts. In this situation, the funds that are being put aside to pay the employee are susceptible to be taken for payment by creditors.

There are both pros and cons to choosing to contribute to an NQDC. An employee will have to decide whether the removal of contribution restrictions and tax benefits are worth the restrictions on distributions and possible vulnerability to creditors before making a decision. 

Important Disclosure Information

The comments above refer generally to financial markets and not Bazis Young portfolios or any related performance. The content of this article should not be considered financial advice. The article is not intended to  offer specific investment recommendations and  is general in nature and should not be considered a comprehensive review or analysis of the topics discussed. This article is not a substitute for a consultation with an investment adviser in a one-on-one context whereby all the facts of the attendee’s situation can be considered in its entirety and the investment adviser can provide individualized investment advice or a customized financial plan. Opinions expressed are current as of the date shown and are subject to change. Past performance is not indicative of future results and diversification does not ensure a profit or protect against loss.  All investments carry some level of risk including loss of principal. Information or data shown or used in this material was received from sources believed to be reliable, but accuracy is not guaranteed. This information does not provide recipients with information or advice that is sufficient on which to base an investment decision. This information does not consider the specific investment objectives, financial situation or need of any particular investor and may not be suitable for all types of investors. Recipients should consider the content of this information as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report.

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