Non-Qualified Deferred Compensation Plans (NQDC)
Many employers use Non-Qualified Deferred Compensation (NQDC) plans to help attract, retain, and reward executives or other highly compensated employee. Simply stated, a non-qualified deferred compensation plan is an unfunded, unsecured promise by the employer to high income earners to pay compensation at a specific time or upon a specific event in the future. The plan is a contract between the employer and the employee for payment of these future benefits.
The NQDC plans emerged because of the cap on contributions to government-sponsored retirement savings plans. High-income earners are unable to contribute the same proportional amounts to their tax-deferred retirement savings as average or low-income earners. NQDCs, therefore, are a way for high-income earners to defer the actual ownership of income and avoid income taxes on their earnings while enjoying tax-deferred investment growth.
The term “non-qualified” means that the plan is not required to meet most of the requirements of the Employee Retirement Income Security Act (ERISA) or the Internal Revenue Code that are imposed on tax-favored, or qualified plans.
The funds in the NQDC plan are compensation that has been earned by an employee, but not yet received from the employer. Because the ownership of the compensation - which may be monetary or otherwise - has not been transferred to the employee, it is not yet part of the employee's earned income and is not counted as taxable income.