Non-Qualified Deferred Compensation
Qualified 401(k) plans offer employees the opportunity to defer, grow, and shelter income for retirement and other significant expenses. Executives and top-level managers, however, receive a lower proportion of benefits from qualified 401(k) plans because of government limitations on how much money can be deferred.
As a result, many executives will receive less than 20 percent of their final compensation in retirement income from company sponsored retirement plans. However, to maintain pre-retirement living standards, executives often need to receive 75 to 80 percent of their final compensation in annual retirement income.
To bridge this retirement planning gap, many companies employ non-qualified deferred compensation plans for executives who choose to defer more pay for retirement. Some companies also match a portion of executives’ contributions. These programs encourage higher compensated employees to take responsibility for their own retirement savings. Depending on the financial approach employed and related administrative matters, the tax benefits can include:
1. Income deferred is not subject to current income tax, improving earnings power by increasing total plan contributions.
2. Earnings and investment appreciation on balances are not subject to current income tax.
3. When the income is distributed and then taxed in retirement, the participant may have a lower tax rate.
4. Accounts may be re-allocated to different investment alternatives without triggering current taxation.