Enhanced Retirement From Lake Norman Benefits
Whether you work for a private company or a nonprofit organization, you may be in the enviable position of being able to postpone income taxes on your earned income for years to come — even if your employer offers a regular retirement plan such as a 401(k).
Non-qualified deferred compensation plans
This is a fancy name for a simple concept. It’s deferred because you defer compensation for a later time (retirement) and it’s non-qualified because it isn’t a retirement plan officially recognized by the Internal Revenue Service.
The results can be dramatic. Let’s assume you decide to defer $5,000 a year in current income for 20 years. You tell your employer not to put the money in your paycheck but into your deferred compensation plan. If you just took it in your paycheck and invested it after paying 40% in taxes (federal and state), you would have $92,907. But if you used deferred compensation, you would have, after taxes, $131,595. This assumes you (or your employer) invest the money in a plan that pays an average annual return of 7%. You can decide how long you want to spread out payments from the plan. So let’s say you decide on a 10-year payout of the account. If you saved this money using after-tax income, you’d have $11,456 a year. But you’d have almost twice as much — $20,299 — if you used the deferred compensation route.
Non-qualified deferred compensation is most useful for you if:
- You don’t need the income now.
- You want to invest your tax money instead of paying it to Uncle Sam.
- Your employer doesn’t offer you a qualified plan, such as a 401(k) or 403(b).
- You need the discipline of saving.
- You are an employer, and you want to give an extra incentive to key employees (or yourself) to keep them around.
The rules get a little complicated because the plans are different depending on whether you work for a private or a nonprofit employer.
The basics in order to qualify:
- The biggest issue is “constructive receipt.” This means you can’t get your hands on the money. You solve this problem by filling out forms electing to defer the income before you receive it.
- The plan has to be selective — all employees can’t be eligible. Usually, that means high-ranking managers and highly paid employees don’t qualify.
- In general, the employer is promising to pay you the income in the future. In other words, it’s an unsecured debt and you’re a general creditor of the employer if it gets into financial trouble. There are ways around this, but they are complicated.
Non-qualified deferred compensation is generally a better deal in the private sector than the public. Why?
- If you work for a company, you can defer as much money as you want and you can still put money into a qualified retirement plan if the employer offers it. It doesn’t affect how much you can put into your 401(k). If you’re putting money into a nonprofit group’s 403(b) plan, the amount you can contribute is based on your past non-qualified deferred compensation contributions. It goes without saying that you need your employee benefits manager to help you out with these calculations, no matter where you work.
- If you work for a private company, you can choose distributions based on a certain date, or for such uses as buying a house, your kids’ college education or your retirement. With a 501 organization, you’re limited to retirement (the year you turn 70 1/2) or an unforeseen emergency (and divorce doesn’t qualify). But with either type of plan, whenever you terminate employment (quitting, getting laid off, retiring, etc.) the money has to be distributed to you.
There is one benefit to working for a nonprofit, and that is the “catch-up provision.” If you didn’t take full advantage of your deferred compensation opportunities in the past (or even if you left the job for a while) you can play “catch-up” by putting extra money in the account three years before your normal retirement date as defined by the plan. You can put in a maximum of $15,000 in each of those years, including whatever you’re contributing to your regular retirement plan (401(k), 403(b), etc.). This can be a great way to shelter some extra cash from taxes just as you’re completing your retirement plan.
Non-qualified deferred compensation is a great way to build up your retirement portfolio.
That is, if you’re willing to let go of the money and let your employer invest it for you. You also need to feel confident of your employer’s financial future. But, if you meet the criteria above and are looking for extra ways to shelter money from taxes so it can be invested in the meantime, non-qualified deferred compensation is the way to go. And if your employer doesn’t offer any other retirement plan, it is the only way to go.
As with every line of coverage we implement, we represent many different carriers to assist us in providing this coverage. Our experience has shown that no one carrier is the perfect solution for everyone. Comparing plans from the top providers in the market place ensures that we get you the best coverage for the lowest cost. Please email or call us or request a quote.