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Nonqualified deferred compensation

A contractual arrangement between a company and a participant, nearly always an executive or other key employee, to defer a portion of current compensation and the related taxes. Distributions are received in the future according to the participant’s elections and the plan’s provisions. The participant receives the income and pays the related taxes at the time of distribution. In addition to the potential benefits of tax deferral, the income may achieve tax-free growth through investments during the deferral period. These plans are “nonqualified” because they do not meet the rules of the sections in the Internal Revenue Code that permit tax-qualified plans (e.g. 401(k) plans), and because they are not protected by ERISA.

While the deferrable types of income depend on your company’s rules, they can include salary, bonuses, or other forms of pay, even share-based compensation from restricted stock units or performance awards. You may defer this compensation until retirement or to some other time for shorter-term financial goals.

Crucially, nonqualified deferred compensation allows you to save much more money than you could under standard qualified plans, such as 401(k) plans or 403(b) plans, while still providing the benefits of investment during the deferral period. However, NQDC is heavily subject to the rules of Internal Revenue Code Section 409A, which you and your company must follow carefully if you are to avoid expensive penalties from the IRS. If permitted by the company’s NQDC plan, certain exceptions allowing the penalty-free early withdrawal of deferred amounts may apply upon specific life or job events (e.g. personal emergencies, job termination, or the impact of a merger/acquisition).

In writing, the term nonqualified deferred compensation is often abbreviated NQDC, though the abbreviation is seldom used in speech.