Qualified Deferred Compensation
Last week we discussed non-qualified deferred compensation (NQDC) and the possibility for startup companies to reward high-earning executives. It would seem reasonable and logical, then, to enquire about qualified deferred compensation plans and how they differ from the non-qualified plans. Therefore, today’s article is about qualified deferred compensation (QDC), how it differs from NQDC, and, more importantly, the tax implications of such plans.
As we discussed previously, deferred compensation, just as it sounds, is compensation that has been earned by an employee, but not yet paid by the employer. Qualified in this case means that the contributions made to the plan may be tax-deductible to the employee. It also means that a company can write off from its taxes the contributions it makes for its employees. Some examples of QDC are retirement plans, pension plans, and stock option plans. You have no doubt heard of plans such as the ubiquitous 401(k), as well as the 403(b). In such plans, a portion of an employee’s pay is withheld until some point in the future, which is usually retirement, after which either a lump sum is paid out to the employee, or regular payments are made over time. These plans are governed by the Employee Retirement Income Security Act (ERISA), and companies who offer these plans must offer them to all employees.
The most notable benefit of such plans is that they are tax-deferred and also may be tax-deductible to employees. This means that contributions are deducted from employees’ paychecks before being taxed, and these funds are then placed into an investment account to (hopefully) grow through the years. Also, this necessarily means that contributions to such plans lower one’s taxable income. Another benefit over an NQDC plan is that with a QDC plan, contributions to the plan are held in a trust account that is protected against creditors and bankruptcy, giving you peace of mind that your funds cannot be accessed and taken away by creditors if your company goes under.
However, along with these benefits come some drawbacks. Specifically, QDC plans usually have a 10 percent penalty on withdrawals made before a certain age (such as 59-and-a-half). Additionally, of course, the balance in the account can rise and fall in value, depending on how well the investments perform(which in reality is no different from NQDC plans). Further, unlike with NQDC plans, QDC plans have contribution limits. Finally, given that QDC plans are tax-deferred, you will have to pay tax on the funds you withdraw at retirement age.
However, in spite of the few drawbacks, QDC plans are a powerful way for tech employees and executives to defer taxes to a later date, while saving more money for retirement.
If you are the founder of a startup, an executive looking to change jobs, or a high-earning expat, please get in touch today to discuss your options for offering or contributing to a QDC plan, and the tax implications of doing so. Indeed, in today’s hyper-inflationary environment, where the cost of many things such as housing and healthcare are skyrocketing, you want to make sure you are doing everything you can do both save for retirement and lower your tax burden. One of the ways you can do that is through a QDC plan, whereby you diligently set money aside in order to reap the benefits of tax-deferred growth at a later date, while taking a tax deduction today.