Non-Qualified Deferred Compensation (NQDC) is a type of retirement plan that allows employees to defer some of their income and pay taxes on it in the future, which can potentially lead to significant savings. This type of planning involves setting aside a portion of an employee’s wages for retirement that is not covered by a qualified retirement plan, such as a 401(k), 403(b), or 457(b). NQDC also typically provides employers with a way to reward key employees with an incentive that is more favorable from a tax perspective than an additional bonus or higher salary.

NQDC plans are usually established and implemented by the employer, and all contributions are made by the employer. Employers can choose which amount and type of contributions, within the limits of the Internal Revenue Code, to make to the plan. However, employers don’t get a deduction for the contribution or the benefit. Instead, when the benefit is paid out, employees pay income tax on it.

One common participant-directed NQDC plan is a Non-Qualified Stock Option (NSO) plan. This type of plan allows employees to purchase stock options at a discounted rate from their employer. The benefit of an NSO plan is that the employee has the opportunity to buy stock in their employer’s company at a lower price than it would cost on the open market, thus allowing for a potentially greater return on their investment.

NQDC plans can also allow employees a greater degree of control over the timing of their retirement savings. With a qualified plan, contributions must be made within a specific time frame in order to secure the tax advantages. With an NQDC plan, however, the employee can choose the exact timing of their contributions and the amount they contribute. This could potentially provide more flexibility when it comes to long-term planning and investment management.

Overall, while NQDC plans provide a potential tax savings benefits and greater flexibility to key employees, they also come with a certain degree of risk. For example, if the company experiences financial hardship and has to reduce contributions or benefits, the employee could be left with insufficient retirement savings. Additionally, the IRS could choose to dispute the use of the NQDC plan. Therefore, it is important for an employer to carefully consider the risks and rewards before setting up an NQDC plan.