“Nonqualified Deferred Compensation Plan” is a mouthful—NDC Plan is easier. In simple English, it’s a supplemental retirement plan for corporate executives and other high earners. If you become eligible for one of these plans, congratulations. Be sure you understand what it means for your retirement, your cash flow, and your taxes.
It may be easiest to understand NDC plans by understanding why they exist and what they are not. ERISA (another mouthful—the Employee Retirement Income Security Act) came into being in 1974, to regulate and standardize corporate retirement plans. It established some minimum rules: corporations had to fund retirement plans adequately, employees had to become eligible to receive those benefits within set timeframes, and plan assets had to be safe from corporate creditors, including in the case of bankruptcy. ERISA-governed retirement plans tie benefits to a maximum, inflation-adjusted earnings limit. For 2019, that number is $280,000. If you earn more than that this year, your standard retirement plans don’t take that into account. For high earners looking to maintain their lifestyles into retirement, these retirement plan limits may be insufficient.
Enter the NDC plan. Unlike traditional retirement plans, these can be somewhat free form, though they have evolved to share some basic provisions. Lack of broad ERISA coverage (there are some limited rules NDC plans must follow) puts some restrictions on these plans, and participants should be aware of those. Overall, these are plans designed to benefit a company’s highest earners, so expect some goodies.
Typically, an NDC plan allows employees to designate some portion of their income as a plan contribution, much like a 401k plan. Unlike a 401k, there is no statutory limit on how much an employee can contribute to an NDC plan. (For 2019, that statutory limit has been increased to $19,000, with an additional $6,000 catch up contribution limit for those 50 and older.) An NDC plan may allow employees to contribute up to 50 percent of base compensation and up to 100 percent of bonuses, for example. To keep income off her tax return, a participant must irrevocably designate how much money she will contribute to the plan before the year begins. This can’t be changed mid-year, though most plans allow participants to change the deferral election annually.
The employer may or may not make its own contributions, and there are no rules for when or how those contributions vest (i.e., when the employee is entitled to keep them). Employer contributions can be fixed (for example, 50 percent of employee contributions), discretionary, or some combination of those two. Expect larger employer contributions to vest over a longer time frame. Employees are typically 100 percent vested in their own salary deferrals.
The participant chooses the way her account is invested, based on some menu of funds. Beyond that, the plan may or may not set aside that money and invest it. A minority of companies go so far as to set up a trust for deferred compensation, safe from all its non-bankruptcy creditors. Most simply track the value of executives’ accounts without setting actual money aside, treating the plan as an unfunded liability.
NDC plans are limited as to when and how participants can withdraw funds. Perhaps most important, money in an NDC plan cannot be rolled out into an IRA. That means it is going to come out as ordinary income sooner rather than later.
Beyond that, an employee must schedule well in advance the distribution’s timing, with only limited and cumbersome changes to the initial election. Employees can chose either a single lump sum or a series of payments. Most often, employees take a lump sum at or shortly after retirement, calculating that the tax hit is better than leaving retirement money at the risk of a former employer’s financial downturn. Certain key employees must wait six months past retirement to take that lump sum.
NDC plans may allow for in-service distributions, though again these must be scheduled in advance. As is the case with traditional retirement plans, the ability to take hardship distributions are very limited.
If all of this sounds like doom and gloom, it is not. NDC plans are designed to benefit high earning executives, who typically have other assets available. NDC plans offer a way to boost retirement income significantly, reduce current taxes, and grow assets tax deferred. C Suite executives would not participate in these plans if they believed there was a realistic possibility they would lose their investments in them.
Before you defer your salary into an NDC, be certain you are maximizing your 401k contributions first. Because NDC dollars will likely be taxed sooner than other retirement monies, the NDC funds should be invested at the conservative end of your overall portfolio. In coordination with your other investments, the NDC can be a powerful tool for retirement savings.
Note: Claire E. Toth, JD, MLT, CFP™, is Vice President at Point View Wealth Management, Inc., a registered investment advisor at 382 Springfield Ave., Summit. Visit us at www.ptview.com.
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