Non-Qualified Deferred Compensation (NQDC) 409a plans are an exceptional employee benefit provided by many public and private companies. Primarily available to higher-income employees, these plans offer potential for substantial savings and immediate tax benefits. However, it’s essential to understand that NQDC 409a plans are not synonymous with a 457 plan. Used appropriately, NQDC 409a plans can serve as a potent tool for financial planning. This article will walk you through the intricacies of these plans.
*For the purposes of this article, all references to a “deferred compensation plan” refer to NQDC 409a plans.
Enrollment in Deferred Compensation Plans
Like health insurance and other benefits, Deferred Compensation plans have an open enrollment period, usually at the year’s end. During this window, eligible employees can choose to defer a portion of their income into the plan.
How NQDC 409a Plans Function
Contributions to the plan grow tax-deferred and are usually taxed as ordinary income upon separation from your employer. You can choose to receive the payout all at once or as installments, as permitted by your plan. One notable difference between a deferred compensation plan and a 401k is that your contribution amount is fixed for a year in the former, whereas you can adjust your contribution in a 401k anytime.
Taxation on Deferred Compensation Plans
Generally, Deferred Compensation plans are taxed at ordinary income rates, but specifics may vary based on the plan. For instance, a small medical practice might require payment of FICA taxes in addition to ordinary income taxes when distributions are made.
Company Risk and Deferred Compensation Plans
Deferred Compensation plans are considered unfunded liabilities for your employer. If the company files for bankruptcy, the deferred compensation might not be paid out. This risk is generally lower for large, publicly traded companies but should be considered if you work for a smaller private entity.
Investment Allocation in Deferred Compensation Plans
Deferred Compensation plans typically permit you to invest the cash in the plan, similar to a 401k. However, it is crucial to distinguish between the investment allocations for your 401k and deferred compensation plan. Your investment options within the plan and how to allocate them according to your financial plan are vital considerations.
The distribution schedule offered by your company needs strategic planning. Your plan may offer a variety of schedules, such as Lump Sum Distribution Upon Separation, or a 5-Year, 10-Year, or 15-Year Installment Plan Upon Separation. Understanding your distribution options is essential for creating a financial plan that matches your needs.
Should You Enroll in Your Deferred Compensation Plan?
With effective financial and tax planning, Deferred Compensation plans can significantly benefit you, especially during the high-earning years of your career. However, it is critical to have a robust plan regarding investment choices, contribution amounts, distribution structure, and integration with your overall financial picture. If you need guidance on developing a comprehensive plan, don’t hesitate to contact us.
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