In some cases, you may want to provide supplementary compensation for key executives or employees, and you may want to defer payment into the future. For example, you may want to induce a particularly valuable employee to remain with you for a certain number of years ("golden handcuffs"). In that case, you could offer the employee a deferred compensation plan that would pay the employee additional compensation upon the completion of a certain number of years service to you. In other cases, you may want to defer compensation for yourself, or for yourself and your partners, to avoid paying taxes on it this year.
You cannot achieve these goals through a traditional retirement plan (assuming you want the tax advantages) because the laws require you to provide benefits that are uniform and that don't discriminate too much in favor of key executives. The best arrangement, then, for accomplishing your goals may be through a nonqualified plan.
By "nonqualified," we mean simply that the plan is not subject to certain federal pension law provisions, such as the ones on nondiscrimination, eligibility, funding, and vesting. As a result, it doesn't get as many tax breaks as regular pension plans do. You should not be lulled into believing that nonqualified plans are not subject to any of the provisions that govern qualified plans; they are in fact generally subject to all of the provisions except those mentioned above.
Too good to be true? At this point, you're probably thinking, "This sounds too good to be true — there must be a downside." If you are, you'd be right. There is a downside. If there weren't, every plan would be nonqualified. The main downside is that your business income tax deduction is also deferred; your business is not entitled to a deduction for the deferred compensation until the funds are available to the recipient, which could be years away.
Terminology. The world of nonqualified plans has a colorful language all its own. There are
Behind the interesting language, however, are all the familiar (and complex)
pension concepts. Because this area is so complex, you should discuss with your
attorney or accountant whether a nonqualified plan is appropriate for you.