Deferred compensation is employee income that is paid out at a later date. There are two general categories of deferred compensation: qualified and nonqualified plans. In this blog post, we’ll focus on nonqualified deferred compensation (NQDC) plans.
What Is Nonqualified Deferred Compensation?
For reference, qualified deferred compensation plans are subject to the Employee Retirement Income Security Act (ERISA), which is a set of retirement regulations implemented by the federal government. Perhaps the most well known qualified deferred compensation plan is the 401(k).
NQDC plans, on the other hand, are not subject to ERISA guidelines. They are called “nonqualified” because they don’t meet the IRS qualifications for favorable tax treatment like qualified retirement plans do. So while they are more flexible than qualified plans in terms of contributions and withdrawals, they don’t provide the same tax advantages. Taxes are paid when the employee actually receives the money in hand, as opposed to when a NQDC plan is drawn up.
Historically, NQDC plans have been associated with executive retention, though they can be used for any key employees that a company may want to retain, including contractors. Phantom stock is a type of NQDC plan, as are several other stock and bonus plans.
How Does a Nonqualified Deferred Compensation Plan Work?
A nonqualified deferred compensation plan lets you put off receiving part of your pay until a later date. Here’s how these plans usually work, step by step.
Eligibility
Generally, qualified plans must be offered to all eligible employees at a given company. Non-discrimination rules do not apply to NQDC plans, however, meaning that employers can award specific individuals as they see fit.
Contributions
With a nonqualified deferred compensation plan, employees can choose to delay part of their salary, bonuses, or commissions. There aren’t IRS contribution limits like you see with a 401(k). This means you can defer more of your pay if you want.
Vesting
Some plans make you work a certain number of years before you get full rights to your deferred money. If you leave early, you might lose some or all of what you’ve set aside.
Investment Options
Your deferred money often gets invested in company stock or mutual funds. This gives your balance a chance to grow over time. But growth isn’t guaranteed, and you could lose money if the investments don’t perform well.
Distributions
You get paid out according to the rules your employer sets. Most plans pay at retirement, when you leave the company, if you pass away, or at a date you pick in advance.
Tax Treatment
Qualified plans are taxed at the time of deferral; NQDC plans are taxed upon distribution. There are pros and cons that come with this tax treatment. For example, if an employee gets her deferred compensation upon retirement, she could benefit from years of tax-free growth and potentially plan to be in a lower tax bracket upon distribution. However, being taxed at ordinary income rates is not nearly as favorable as the tax treatment for qualified plans.
Common Questions About Nonqualified Deferred Compensation
If I withdraw money from a nonqualified plan, am I taxed?
Yes. Money you receive from a nonqualified deferred compensation plan is taxed as ordinary income in the year you actually receive it, at your regular income tax rate. Unlike a 401(k), there is no separate tax-advantaged treatment on the way out. The deferral moves when you are taxed, not whether you are taxed, which is the entire point of the arrangement: you are betting that receiving the income later, often in retirement, puts it in a lower bracket than receiving it today.
Can you roll over a nonqualified deferred compensation plan?
No. An NQDC balance cannot be rolled into an IRA, a 401(k), or any other qualified plan, and it cannot be rolled into a new employer's NQDC plan either. This is the sharpest practical difference between nonqualified and qualified plans, and it surprises people who assume the rollover rules they know from a 401(k) carry over. When a distribution event occurs under the plan's terms, the money is paid out and taxed as ordinary income. There is no vehicle to move it into that defers the tax further.
Are nonqualified deferred compensation plans subject to self-employment tax?
For employees, no. NQDC is treated as wages, so it carries FICA rather than self-employment tax, and FICA generally applies when the amount vests rather than when it is paid, under what is known as the special timing rule. That timing matters: it is common to owe Social Security and Medicare tax on a balance years before you see any of it. Self-employed individuals are a different case and cannot participate in an employer NQDC plan the way an employee does.
Are NQDC plans easy to set up?
They are more involved than a 401(k), and the complexity is legal rather than administrative. An NQDC plan needs a written plan document, and its deferral elections, distribution triggers and payment timing all have to comply with Section 409A. Getting 409A wrong is expensive for the participant rather than the company: the deferred amounts can become immediately taxable, with an additional penalty tax on top. Most businesses set these up with an attorney who does this specific work, not with a generic template.
Who is a nonqualified deferred compensation plan actually for?
NQDC plans exist because qualified plans cap what a high earner can defer. If an executive is already maxing out a 401(k) and still wants to defer more compensation, an NQDC plan is the usual answer. The tradeoff is real: the money remains an unsecured promise from the company and, if the business fails, participants are general creditors. That risk is why these plans are typically offered to a small group of senior people rather than across a whole workforce.
This is general information, not tax or legal advice. Section 409A rules are detailed and the consequences of getting them wrong fall on the participant. Talk to your own tax advisor or an attorney before setting up or deferring into a nonqualified plan.
Nonqualified Deferred Compensation vs. Qualified Plans
Qualified plans like 401(k)s and IRAs have strict contribution limits set by the IRS. NQDC plans don’t have these caps, so high earners can defer more income if they want.
Both types of plans let you defer taxes on your contributions and investment growth. But with NQDC plans, the money is taxed as ordinary income when you get paid out, not when you defer it.
Qualified plans are protected by ERISA, which means your money is safe from company creditors if the business fails. NQDC plans, on the other hand, are just a promise from your employer—if the company goes under, you could lose your deferred compensation.
That’s the main risk with NQDC plans: your payout depends on your employer’s financial health.
Types of Nonqualified Deferred Compensation Plans
Nonqualified plans come in several forms, each designed to meet different needs for employers and employees. Here are some of the most common types you’ll see.
Nonqualified Retirement Plan
This is the broad category for plans that let employees defer compensation outside of traditional, IRS-regulated retirement accounts.
Nonqualified Pension Plan
These plans work alongside regular pensions. They let employers offer extra retirement benefits, usually to select employees.
Salary Deferral Plans
With these plans, employees can put off receiving part of their base salary or bonuses until a later date. This can help with tax planning and long-term savings.
SERPs (Supplemental Executive Retirement Plans)
SERPs are designed for senior leaders. They offer extra retirement benefits on top of what’s available to everyone else, helping companies attract and keep top talent.
Phantom Stock Plans
Phantom stock is another type of nonqualified deferred compensation. Instead of deferring salary or bonuses, employees get units that track the value of company stock. When a payout event happens—like retirement or the sale of the company—employees receive cash based on the value of those units. Phantom stock plans align employees with company growth, offer flexible design options, and don’t dilute ownership. But, like other NQDCs, payouts depend on the company’s financial health.
At Reins, we specialize in designing and managing phantom stock plans that give employees a real stake in growth without giving up equity. We make it simple for business owners to roll out phantom stock programs—without lawyers, headaches, or giving up real equity.
And it’s already working:
- Wirenut kept their top techs by rolling out phantom equity.
- Wes Carver Electric gave employees a real stake in growth—without losing control of the business.
- Cooper’s Plumbing and Air is using phantom stock to attract better talent.
If you'd like to learn more about phantom stock, you can schedule a free consultation call with our team.
Benefits of Nonqualified Deferred Compensation Plans
Nonqualified deferred compensation plans offer several advantages for both employees and employers. Here are some of the main benefits you’ll find with these plans.
Tax Deferral
NQDC plans let you delay paying income tax on deferred money until you actually get paid. This can help you manage your tax bill and keep more of your earnings working for you.
Retirement Planning
You can set up payout schedules that match your retirement goals. This gives you more control over when and how you receive your money.
Talent Retention
Employers use these plans to keep key people on board. The promise of future payouts can make it harder for top talent to leave.
No Contribution Limits
Unlike 401(k) plans, there are no IRS-imposed limits on contributions to NQDC plans, which can be beneficial to high earners who want to save beyond what a 401(k) allows. This can be a huge boost to retirement savings, depending on the payout size.
Highly Customizable
The MARE Stock Plan is a great example of just how customizable NQDC plans can be. The value of the award, when it is paid out, and under what circumstances can be tailored per company and even per employee.
Considerations With Nonqualified Deferred Compensation
Before setting up a nonqualified deferred compensation plan, it’s smart to understand the potential risks and rules involved. Here are some key considerations to keep in mind.
Creditor Risk
While 401(k) plans are federally protected against creditor claims if a company goes bankrupt, NQDC plans have no such legal protections. If the company runs into financial trouble, employees could lose their deferred compensation.
Limited Flexibility After Elections
NQDC plans are flexible when it comes to design. But once elections are made, they’re tough to change. For example, an employee can withdraw money from their 401(k) (with penalties and taxes), but can’t deviate from a phantom stock distribution schedule once it’s set.
Strict Compliance Requirements
NQDC plans must follow IRC Section 409A, which sets strict rules on payment triggers, schedules, and how the deferred award works. Not following these rules can lead to serious tax consequences for participants.
Nonqualified Deferred Compensation Example
Wirenut, an electrical contractor, worked with Reins to roll out a phantom stock plan for their top technicians. Instead of granting traditional equity, they awarded phantom units tied to company growth. This gave techs a clear financial stake in staying long-term. As a result, Wirenut was able to retain its best people and keep them invested in the company’s success — without giving up ownership.
“Almost overnight, people start thinking like owners. They make decisions in the best interest of the whole company, not just themselves.” — Trent Urban, Owner, WireNut Home Services
Phantom stock isn’t just for big corporations. With the right plan, small and mid-sized businesses can use it to keep top employees, reward performance, and stay competitive — without giving up equity. Want to see if phantom stock is right for your business? Schedule a free call with Reins and we’ll walk you through how it works, what it costs, and whether it makes sense for your team.
Is a non-qualified retirement plan the same thing?
Largely, yes. A non-qualified retirement plan and a nonqualified deferred compensation plan describe the same arrangement from two directions: an agreement to pay an employee later that sits outside the rules governing qualified plans such as a 401(k).
The distinction that matters is not the name. It is that a qualified plan holds assets in trust for the employee, and a non-qualified plan does not. Money in a non-qualified arrangement remains a company asset and an unsecured promise to the employee, which is why these plans are offered to executives and key staff rather than to everyone: the participant is accepting the company’s credit risk in exchange for deferral.
That single difference drives the rest. There are no contribution caps, because there is no tax shelter to cap. There is no protection if the company fails. And the timing of the election is strictly regulated, because without those rules the arrangement would let someone choose their own tax year after the fact.
