Non-qualified deferred compensation (NQDC) is compensation earned by an employee that is not paid out until a point in the future. Most commonly, employees receive this compensation when they retire or are forced to terminate employment due to disability. In the event that an employee dies before the compensation is paid out, survivors of the employee will receive the non-qualified deferred compensation. NQDC is a benefit for employees that is generally used for high-earning employees and upper management.
While people are working and making a lot of money, they can be in a very high tax bracket that creates large tax liability. Employees can use a number of techniques to reduce their tax liability with the assistance of an employer. One of the most common is contributing to a retirement plan. Funds contributed to retirement plans are not taxed until the employee starts using the plan. Since the employee will not be earning as much when the plan is drawn upon, the tax bracket will be lower, and so will the tax liability.
However, there are limits on contributions to retirement plans, designed in part to prevent situations where employees dump most of their income into retirement and avoid paying high taxes on it. Non-qualified deferred compensation is compensation that an employee earns, but the employer retains. Because the compensation is not transferred to the employee, no taxes are due on it when it is earned. When the employee retires, the employer transfers the funds and the employee must pay taxes on them at that time.
This type of compensation is referred to as non-qualified because it does not qualify for the tax benefits available with certain other types of retirement and savings plans for employees. It is also not subject to the same laws that dictate how employers can handle qualified deferred compensation such as payments into retirement plans. Employers are allowed to discriminate when they offer non-qualified deferred compensation, for example, offering it only to certain employees.
Typically, employers put non-qualified deferred compensation into investments on behalf of their employees. When someone is ready to retire, the money will be available, along with any interest and other payouts earned. Employers can also choose to make contributions to the fund.
Non-qualified deferred compensation is usually offered as a supplement to an existing plan. Thus, an employee can enroll in a regular deferred compensation package with all the tax advantages it offers, and contribute addition income to the non-qualified plan.