Non Qualified 401(k) and Deferred Compensation Plans

In addition to a standard retirement plan such as a 401(k) many companies offer non-qualified deferred compensation plans to high income employees. These plans provide tax-deferred retirement savings beyond the maximums mandated for the standard retirement plan.

Non-qualified means that it does not meet and is not subject to the strict requirements of a qualified plan as defined by the Employee Retirement Income Security Act (ERISA). These rules include requirements for benefits to be distributed proportionately preventing excessive benefits going to higher paid employees, employee participation requirements, funding and vesting requirements as well as requirements to assure the retirement plan’s funds are independent of the employer’s business assets.

Non qualified plans are not taxable to the employee at the time of contribution. However there must be 'substantial' risk of forfeiture for this to be allowed. This is accomplished in two ways. First, certain conditions must be met before the employee can receive the deferred funds. These conditions might include employment for a certain period of time, until a certain age, or until retirement, disability or death.

Second, the funds are not fully protected from the employer’s creditors. Typically a company will set up what is called a “rabbi trust” to secure the non qualified plan assets.. The terms of this trust should prevent the company from changing its mind and taking the funds back. It should also set conditions in the case of a change in control or financial conditions of the company. However it MUST still leave the funds accessible to creditors as an asset of the business.

A detailed examination of any particular plan is required to fully understand what benefits, protections and restrictions it provides. A discussion with the plan administrator is a good place to start. However actually reading the plan document is a good idea. If the document is too complex to readily understand consider hiring an employee benefits expert.

Non-qualified deferred compensation plans provide a valuable benefit to high income employees. However participants should be aware of the risks inherent in the plan.  Non-qualified plan contributions are exposed to the specific financial risks of the employer. Restricted stock, stock options and continued employment are similarly exposed.  Participants should have a full understanding of how these exposures might impact their plans for the future.