New Legislation Affects Nonqualified Deferred Compensation Plans

Sharpnack, Richard
December 2006
Journal of Financial Planning;Dec2006, Vol. 19 Issue 12, p68
Academic Journal
The American Jobs Creation Act of 2004, through the new Section 409A, creates additional administrative requirements, but also provides clarification for the design and administration of nonqualified deferred compensation plans. Companies have increased the use of NQDC plans in recent years, so financial planners need to become familiar with the new law and its planning implications. NQDC plans offer tremendous flexibility in the way plans can be designed, and resulting in a variety of plans such as supplemental executive retirement plans, excess benefit plans, discounted stock option plans, and phantom stock plans. Noncompliance with the new rules will result not only in taxation of the deferred amount but also interest on the underpayment of taxes and a 20 percent penalty of the taxable amount. Among the new rules, participants must make voluntary deferral elections in the year before the year in which services are performed, though there are exceptions to this for new participants. The time and form of distributions must be specified and must be based on a specified time or fixed schedule. The new rules eliminate the "haircut" provisions, which allowed immediate distributions in exchange for a nominal reduction in total benefits. Distributions may no longer be accelerated faster than the time period specified in the plan, with certain exceptions such as for divorce payments. Extension of the deferral of distributions cannot take effect until 12 months after the original date of election and they must be deferred at least five years more. Consequently, it's often wise to choose shorter vesting schedules and deferral periods.


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