A deferred compensation plan is a promise, not an account, and the design has to be honest about that.
Nonqualified deferred compensation lets key employees set aside pay beyond what qualified plan limits allow, with income tax deferred until it is paid. Until then the money remains a company asset and the executive is an unsecured creditor. We work through the design, the informal funding and the insurance side, while your CPA and legal counsel draft and sign off on what is theirs to decide.
Most of the plan is locked in before the first dollar is deferred.
Section 409A requires the time and form of payment to be fixed in advance. Choices that feel administrative at setup are, in practice, permanent.
Who Is Eligible
These plans depend on being limited to a select group of management or highly compensated employees. Opening one too widely can pull it into ERISA’s funding and vesting rules, so counsel reviews eligibility first. Careful eligibility design keeps a deferred compensation plan within the top-hat rules.
When Elections Happen
An initial deferral election generally has to be made before the calendar year in which the pay is earned. Bonuses and newly eligible participants have their own timing rules, so we build the election calendar before enrollment, not after the first bonus is declared.
How It Pays Out
Payment can only be triggered by events the plan names, such as separation from service, a fixed date, disability or a change in control. A plan that pays on the wrong event fails for everyone in it. Clear payment triggers are central to Section 409A compliance.
Vesting and Forfeiture
Company contributions can vest on a schedule tied to tenure or performance, which is what makes the plan a retention tool. Vesting also affects when amounts are reported for payroll tax, so the CPA sets the reporting before the schedule is final.
A Section 409A failure is taxed to the executive, not the company.
When a plan fails Section 409A in its terms or in its operation, IRS guidance makes the deferred amounts taxable immediately, with an additional 20% income tax and an interest charge on top. The employer made the mistake; the participant pays for it.
Failures in the Document
Vague payment terms or a discretionary acceleration clause can fail a plan before anyone defers a dollar. Counsel drafts it; we make sure the design we modeled is the design they wrote. A well-drafted plan document is the first defense against a Section 409A failure.
Failures in Operation
A payment made early because payroll did not know the rule is an operational failure. The fix is a written process, owned by a named person, tying each payment to the plan’s terms, so we map who does what before the first distribution.
Catching Errors Early
The IRS offers correction procedures for some errors, and many work only when the error is found quickly. That is a reason to review how the plan operates every year, not only when an executive retires. Annual operational review keeps a deferred compensation plan compliant.
The company owes the benefit either way. Funding decides whether the cash is there when it is due.
Assets set aside for the plan remain company assets, available to general creditors. Informal funding matches a future liability; it does not secure it.
Leaving It Unfunded
The simplest option carries the liability on the books and pays from cash flow. It works when payouts are small and spread out, and strains when several executives retire in the same year. Pay-as-you-go plans suit small, spread-out payouts. Several retirements at once can strain cash flow.
Company-Owned Life Insurance
Policies owned by the company on participants can grow tax-deferred and pay a death benefit to the company. They carry notice and consent requirements before issue, and the cost only works over a long horizon, so we model the break-even year first.
Rabbi Trusts
A rabbi trust protects the money from a change of heart by future management, but not from the company’s creditors. Executives often assume the second, which is why we explain the difference before they defer. Clear communication about rabbi trusts protects executive trust in the plan.
What owners ask before offering deferred compensation.
Is this a retirement plan?
No. It sits alongside whatever qualified plan you offer, under different rules, and that plan is run by its own provider. Our work is the nonqualified design, the insurance funding and coordination with your advisors. Nonqualified deferred compensation is its own plan with its own rules.
Can the executive take money out early?
Only on the events the plan names. Withdrawals for an unforeseeable emergency are narrowly defined and must be written into the plan. Anything more flexible is exactly what Section 409A is designed to prevent. Section 409A limits keep deferred compensation distributions predictable.
Does it work for an S corporation or partnership?
Owners of pass-through entities get different results from deferring their own pay, and sometimes the plan only makes sense for non-owner executives. That call belongs to your CPA, and we bring one in early. Entity type shapes deferred compensation design, which is why a CPA reviews it before anyone defers.
Where the Rules Come From.
The laws and rules named on this page link to the statute or regulation they come from. This is general information, not legal or tax advice, and rules change, so check the current text.
ERISA (29 U.S.C. Chapter 18)
The federal law that sets reporting, disclosure and fiduciary rules for employer-sponsored benefit plans.
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