Nonqualified Deferred Compensation (NQDC) Plans

For example, a $500,000 earner relying on traditional sources may expect approximately: 

Graphic showing goal retirement savings $00K, $135K per year from traditional 401(k), $45K per year from Soc Sec, leaving a $220K gap - that can be filled with a NQDC

 This means that conventional plans replace less than half the income a high earner needs in retirement.*

A nonqualified deferred compensation plan is designed to address this shortfall.

Nonqualified deferred compensation (NQDC) plans are a key strategy that employers use to help high-income employees bridge the retirement income gap created when traditional retirement plans and Social Security fall short. 

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How nonqualified deferred compensation plans work

Employees elect to defer a portion of their compensation — salary, bonus, or other earnings — into the plan before taxes are assessed. Any earnings on the deferrals grow on a tax-deferred basis and are distributed at a future date chosen by the employee —  typically at retirement or separation from service. At distribution, benefits are taxed as ordinary income.

Because NQDC plans are not subject to ERISA qualification rules, employers have wide flexibility in plan design, including who is eligible, how benefits vest and when distributions occur.

Key benefits of nonqualified plans

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If your organization is evaluating whether a nonqualified deferred compensation plan is the right fit, our team can help you assess plan design options, funding strategies and implementation.

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Frequently Asked Questions (FAQs) for nonqualified plans

What’s the difference between a qualified and nonqualified plan?

Qualified plans (like 401(k)s) are governed by ERISA, have IRS contribution limits, and offer certain protections to participants. Nonqualified plans are not subject to these rules, allowing greater flexibility in design and contribution amounts – but they also do not carry the same ERISA protections. 

How do employers fund nonqualified plans?

NQDC plans are typically unfunded, meaning future benefit payments come from the employer’s general assets. However, many companies use Corporate-Owned Life Insurance (COLI) as an informal funding mechanism. COLI can help employers offset future benefit obligations and may benefit from tax-deferred growth of policy cash values. 

How are nonqualified plans taxed?

Contributions are typically deferred for income tax purposes, but distributions are taxed as ordinary income when received.

Why might an employer use life insurance to fund a nonqualified plan? 

Employers may use Corporate-Owned Life Insurance (COLI) to fund nonqualified deferred compensation (NQDC) plans because COLI offers a practical way to offset future benefit obligations. By purchasing life insurance policies on key employees, the employer can benefit from the tax-deferred growth of the policy’s cash values. This growth can help accumulate assets to cover the costs of future payments promised to employees under the NQDC plan, while also providing flexibility in managing benefit liabilities. Additionally, COLI proceeds can be used to pay out benefits in the event of an employee’s death, further supporting the company’s financial commitments to its executive compensation programs.

When should a company offer a nonqualified deferred compensation plan?

A company should consider an NQDC plan when it wants to attract, retain and reward top talent whose retirement needs exceed what qualified plans can provide – particularly when flexibility and performance-linked incentives are important to the organization’s compensation strategy. 

Who is eligible for nonqualified deferred compensation plans? 

Eligibility is determined by the employer. NQDC plans are typically offered to executives, highly compensated employees and key personnel who have exceeded the benefits available through qualified plans.

What are the risks of nonqualified deferred compensation plans?

Because nonqualified deferred compensation plans are not protected under ERISA in the same way qualified plans are, unfunded future payments are typically made from the employer’s general assets and are subject to the employer’s ability to pay at the time of distribution.

*Hypothetical projection not intended to represent any specific individual. Not tax or legal advice. Consult a tax advisor.

The information presented here is for educational purposes only, and not intended to be legal or tax advice. Each plan must consider the appropriateness of the investments and plan services offered to its participants. All investing involves risk, including the loss or principal. There is no guarantee an investment, investment strategy or managed portfolio will meet its stated objective.

Each plan has unique requirements and should consult its attorney or tax advisor for guidance on its specific situation. Voya strongly suggests speaking with tax and legal advisors before making changes to a plan.

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