409A Deferred Compensation Definition

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What is a 409A deferred compensation? You may want to know about the definition of this term. Actually, if this term is the first time for you to hear, you surely do not know what it is. However, some of you may have heard this term, but you do not know what it is. If so, you are able to read the explanation below about 409A deferred compensation according to some online sources.

Definition of Deferred Compensation

According to the Investopedia, deferred compensation is when part of an employee’s pay is held for disbursement at a later time, generally a tax deferred benefit is provided to the employee. Here is the explanation about Deferred Compensation according to the Plan Sponsor site.

409A Deferred Compensation Definition

Mort and Gaknoki explains that Section 409A covers not only the types of arrangements that traditionally have been thought of as NQDC such as supplemental executive requirements plans, or “SERPs,” and excess benefit plans, but an entire host of other typical compensation arrangements, including annual and long-term bonus and other incentive arrangements; salary and bonus deferral arrangements; severance pay arrangements; certain in-kind benefits such as automobiles and club membership; taxable reimbursement arrangements; change in control agreements; certain equity-based compensation including discounted stock options and stock appreciation rights, non discounted stock options and stock appreciation rights with additional deferral features, restricted stock units, performance units and phantom stock; retention arrangements; and commission arrangements.

There are a number of exceptions that permit certain arrangements to avoid coverage under Section 409A and the most common is the short-term deferral exception. This exception usually exempts from Section 409A amounts that, in all possible circumstances, will be paid by the 15th day of the third month following the end of the taxable year of the employee or the employer where the right to the compensation is vested.

Let’s take an example. For an employer who has a taxable year that ends on December 31st, to fall in the short-term deferral exception, the payment would have to be made by March 15 following the end of the year where the right to compensate becomes vested.

About Non-Qualified Deferred Compensation

According to the Bloomberg Tax site, a nonqualified deferred compensation arrangement subject to Section 409a is any plan including any agreement or arrangement, that provides for the deferral of compensation other than a qualified employer plan and any bona fide vacation leave, compensatory time, sick leave, disability pay, or death benefit plan.

According to The Hart Ford site, a nonqualified deferred compensation plan is a type of retirement plan which allows select, highly compensated employees to enjoy the advantages of tax by deferring a greater percentage of their compensation and current income taxes than is permitted by the IRS in a qualified retirement plan.

According to the Investopedia, a non-qualified deferred compensation is compensation which has been earned by an employee but not yet got from their employer. Due to the ownership of the compensation which may be monetary or otherwise has not been transferred to the employee, it is not yet part of the employee’s earned income and it is not calculated as taxable income.

The Differences Between Qualified and Nonqualified Plans That You Have to Know

According to The HartFord sites, Qualified and Nonqualified Plans offer tax-deferred benefits to employees. However, there are differences in eligibility, deferral limits, asset security, distribution timing, and other features along with IRS-defined rules that will influence whether you offer one of the other or both.

The Way Nonqualified Deferred Compensation Plans Work

According to The Hart Ford site, here is the explanation about the way nonqualified deferred compensation plans work. There are laws that you need to follow when you set up a NQDC plan with your employees. The rules for nonqualified deferred compensation plans are outlined by IRS Section 409A. You are not just able to have a verbal agreement with your employees to defer their income until a later date. If you want to set up a NQDC plan, here are the things that you have to do according to The Hart Ford.

  • You have to put the plan in writing. You have to think of it as a contract with your employee. You have to make sure that you include the deferred amount and when your business will pay it.
  • You have to decide on the timing. You will have to select the events that can trigger when your business will pay an employee’s deferred income. Events include change in business ownership, a fixed date, retirement, death, termination, and unforeseeable emergency.
  • You have to note requirements or exclusions of the plan. You have to detail any qualifiers that your employee needs to follow to get their pay. For instance, your NQDC plan may state that your employee is not able to work at a competing business after he retires.

The Advantages of Nonqualified Deferred Compensation Plans

Here is the explanation about the advantages of nonqualified deferred compensation plans according to The Hart Ford. For you and your employees, nonqualified deferred compensation plans benefit. For employers like you, here are the things which are offered by a NQDC plan.

  • Flexibility
    You are able to choose which executive or highly compensated employees are able to take part. Since there are not any non-discriminatory rules, you do not need to offer this plan to every employee.
  • Small Management Fees
    To set up a NQDC plan, there are small upfront costs. However, you will not need to encounter ongoing fees to be able to manage it.
  • Cash Flow Increases
    The money your business brings in is able to be used for other things since it does not need to go to pay your employees right away.

And for your employees, here are the benefits for a nonqualified deferred compensation plan.

  • There is no maximum contribution amount.
    The IRS puts a limit to how much an employee is able to contribute to their 401(k) each year. With a NQDC plan, the limit does not exist.
  • There are tax advantages. Let’s say that your employee makes their deferral election. If so, they will have less taxable income which is able to put them in a lower tax bracket.

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