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How Bankruptcy Affects Your Nonqualified Deferred Compensation

One of the biggest risks you face with nonqualified deferred compensation is the possibility of your company’s bankruptcy. Unlike 401(k) plans, NQDC plans do not receive ERISA protections, and the funds in the plans are at risk of being included in a company’s bankruptcy estate. This article addresses key issues that NQDC participants should know about corporate bankruptcy.

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Key Points in This Article
What happens to NQDC depends on the type of bankruptcy: Chapter 7 or Chapter 11.
While rabbi trusts reduce the risk of losing "unfunded" NQDC benefits, trust assets remain subject to company creditors. However, by limiting the field of potential creditors, a 2003 court ruling has made recovering deferred money less difficult.
Corporate bankruptcy can put more than NQDC benefits at risk. If it causes the plan to violate IRC Section 409A, you may have to pay penalty taxes. The rules also limit the company's ability to substitute a retention bonus or severance payment.