With a focus on retaining key people in an organization and recruiting more experienced executives, non-profits and businesses might consider the use of deferred compensation plans that go beyond the typical 401(k).
Many businesses and non-profits have some form of qualified retirement plan that allows the business, employee or both to fund tax-deferred benefits. If anything happens to the company, these pensions and 401(k)s are protected from creditors.
But non-qualified plans can sometimes be a good solution, and can be used in addition to qualified plans, particularly when a business is facing a specific need regarding specific employees.
The biggest advantages of non-qualified deferred compensation plans compared with qualified plans are:
- They don't have to be offered to everyone equally.
- A business can either fund them now or fund them later.
- They can be fashioned in many forms to meet a variety of business purposes.
- Contributions are not limited, thus they can be used to supplement the executive's retirement income.
Organizations might use non-qualified deferred compensation to create a benefit as an incentive to an employee to meet certain specified goals.
When a company is trying to recruit a mid-career executive, a non-qualified plan might be used to compete with potential retirement benefits that have built up and would be lost if the executive left his current job. Most commonly, they are used to retain and compensate key personnel.
For the employee, the plans have the advantage of deferring a portion of their compensation. This could be helpful so that income in any one year does not push the person into higher tax bracket.
But while for-profit entities can spread that deferred income to the executive over a number of years, non-profit organizations must follow more strict IRS rules. Executives for non-profits generally must take all of the deferred benefit in one lump sum.
Non-qualified plans do have some disadvantages. For the employee, the biggest one is that sucha a plan is not protected from creditors in the event of a bankruptcy of the employer. This factor alone makes it risky for an employee to voluntarily elect to defer a portion of his current salary. More commonly, it's the employer who offers to pay the benefit as an incentive to the employee to meet certain goals that benefit the organization.
One negative for the employer is that if it sets contributions aside each year for the deferred compensation, those contributions cannot be deducted as an expense until the employee takes the benefit. That's unlike a typical 401(k) in which contributions, within limits, can be deducted when they are made.
Overall, each type of plan offers advantages, but when an organization is facing a specific need, exploring the possibilities of a non-qualified plan could yield the right result.