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A contractual arrangement between a company and a participant in its nonqualified deferred compensation (NQDC) plan, usually an executive or other key employee. Based on the participant's elections, the NQDC plan defers a portion of current compensation, and the related taxes, to a payout date in the future, when the participant receives the income and pays the related taxes. In addition to gaining the potential benefits of tax deferral, the income may achieve tax-free growth through investments during the deferral period. These plans are "nonqualified" because they do not meet the rules of the sections in the Internal Revenue Code that permit tax-qualified plans (e.g. 401(k) plans).
Editor's Note: For a resource covering all aspects of nonqualified deferred compensation, from the basics to advanced tax and financial planning, see our sibling website myNQDC.com.
While the deferrable types of income depend on your company's rules, they can include salary, bonuses, or other forms of pay, even share-based compensation from restricted stock units or performance awards. You may defer this compensation until retirement or to some other time for shorter-term financial goals.
Crucially, nonqualified deferred compensation allows you to save much more money than you could under standard qualified plans, such as 401(k) plans, while still providing the benefits of investment during the deferral period. However, NQDC is heavily subject to the rules of Internal Revenue Code Section 409A, which you and your company must follow carefully if you are to avoid expensive penalties from the IRS.
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