Recruiting and holding onto top talent for your company is tougher than ever. A non-qualified deferred compensation plan (or NQDC, as it’s often called) can be a useful tool for attracting talented people while giving them a strong incentive to stick around for the long haul.
A NQDC plan is an additional retirement benefit that your company can offer to select, highly-paid employees in addition to a 401(k) or pension. It’s an agreement your company makes with a key employee to pay at a future date — usually upon retirement — income for services rendered today.
This option isn’t right for every company. Since it’s a long-term arrangement, a NQDC plan is more appropriate for stable, mature companies that are more likely to be around to pay benefits in the future. But if your company fits the bill, and you want to attract and keep highly qualified, highly compensated people, an NQDC plan may be a strategy worth exploring.
Implementing a NQDC Arrangement
A NQDC arrangement is simply a substitute, or supplement to, current compensation. These deferred benefits, instead of being paid and taxed now, are received after retirement or at the end of a specific timeframe. You choose which employees are to be covered, the amount of the benefit to be provided, and whether the benefit is subject to a vesting schedule. Have an attorney draft an agreement to reflect the terms.
Once a NQDC arrangement is adopted for one or more selected key employees and implemented by a written agreement, the employer incurs a future liability to make specified payments. It is a sound business practice to hedge this liability by establishing some type of reserve fund from which the payments can be made. Life insurance can be well suited for this purpose and can be a practical and economical method of helping to ensure the funds will be available when the employee is entitled to them.
In this scenario, the employer purchases a life insurance policy, subject to underwriting, on the key employee. The company will be the owner and the beneficiary of the policy. While the company cannot deduct the premiums it pays for the policy, the income the the company eventually pays to the key employee or their family can be tax-deductible as payment of reasonable compensation.
Further, since NQDC plans often provide pre-retirement salary-continuation death benefits to the key employee’s family, life insurance can fully and instantly create the funds necessary to complete the arrangement. The death proceeds received by the corporation are generally tax-free and can help to offset its after-tax cost of providing these benefits. (In some cases the alternative minimum tax may apply.)
An additional benefit for the company is that when a NQDC plan is funded using a life insurance policy with guaranteed premiums, its annual costs are predictable. Meanwhile, the key employee covered under the NQDC agreement can feel secure in the notion that their employer has the means to help pay for future income benefits.
Hire and Retain the Best and Brightest
If you want an attractive option to attract and retain key employees, a NQDC plan can be a useful tool for your organization. Part of what can make a NQDC plan an effective method for retaining valuable, highly paid employees is that if the employee leaves the company before the agreed-upon date, they may lose some or all of the deferred compensation. Since they can’t take it with them, they have more incentive to stay.