A nonqualified deferred compensation plan is a type of employer-sponsored savings or retirement plan that lets select employees defer a percentage of their compensation (and current income taxes) until a future year. The plans are used by businesses to supplement qualified plans, such as a 401(k) plan, and to provide an extra benefit to certain highly compensated employees.
Unlike a qualified plan, in which participant assets are invested in a trust separate from company assets, a nonqualified plan represents a promise by the company to pay a participant’s deferred compensation at a future date. In order to receive tax advantages, plan assets are placed in an irrevocable trust where they grow tax-deferred. But one of the issues associated with this is that the assets must be available and may be distributed to creditors if the company goes out of business.
Nonqualified plans are not limited by the non-discrimination rules imposed on qualified plans. This allows them to be offered exclusively to a small subset of employees, often the owner, founder, and top management personnel.