Non-Qualified Deferred Compensation Programs (NQDC)

While qualified plans have strict contribution limits and non-discrimination requirements, non-qualified deferred compensation (NQDC) programs allow executives and highly compensated employees to defer compensation beyond those limits. The tradeoff: far less protection.

Characteristics

• Allow executives and highly compensated employees to defer compensation beyond qualified plan limits
• Subject to Internal Revenue Code (IRC) Section 409A rules governing timing of deferrals and distributions
• Assets remain part of the employer's general assets (the employee is an unsecured creditor)
• No contribution limits (unlike qualified plans)
• Distributions are taxed as ordinary income when received
• Can be offered selectively: no non-discrimination requirements
• Deferral elections must generally be made before the year in which the compensation is earned

IRC Section 409A

Section 409A imposes strict rules on NQDC plans:

• Deferral elections must be made before the beginning of the year in which services are performed
• Distribution triggers are limited to: separation from service, disability, death, change in control, unforeseeable emergency, or a fixed date/schedule
• Violations result in immediate taxation plus a 20% additional tax and interest

Exam Tip: Gotchas

Section 409A penalties are severe: immediate taxation + 20% penalty + interest. If a question describes an NQDC plan that lets the executive change distribution timing after the deferral year, that is a 409A violation.

Rabbi Trusts

A rabbi trust is an irrevocable trust used to hold NQDC plan assets:

• Named "rabbi trust" because first approved by the Internal Revenue Service (IRS) for a rabbi's deferred compensation arrangement
• Assets are protected from the employer changing its mind about paying the deferred compensation
• Assets are NOT protected from the employer's creditors in bankruptcy
• Provides some security to the employee while maintaining non-qualified tax status

Exam Tip: Gotchas

A rabbi trust does NOT protect assets from the employer's creditors. If the employer goes bankrupt, the rabbi trust assets are available to satisfy creditor claims. This is what keeps the plan "non-qualified." Full creditor protection would make it a funded plan subject to immediate taxation under Section 402(b).

NQDC vs. Qualified Plans

Exam Tip: Gotchas

The employer gets no tax deduction when NQDC contributions are made. The deduction comes only when the employee receives the distribution and pays tax on it. This is the opposite of qualified plans, where the employer deducts at contribution time.