November and December are high-traffic times for our sibling website myNQDC.com, a comprehensive resource on nonqualified deferred compensation (NQDC). The last quarter of the year is the most common period during which salary deferrals are elected through NQDC plans for the year ahead. Participants in NQDC plans choosing how much of next year's salary to defer can find plenty of financial-planning guidance at myNQDC.com. See also our FAQ on year-end planning issues, which may shift in upcoming years with a new president and the possibility of tax reform.
As expected, this presidential election year brought no tax changes of significance. Therefore, known tax-rate increases or decreases are not big factors in decisions at year-end 2016. However, after the new president has been elected, the likelihood of major tax reforms in the next few years may affect your long-term decision-making.
Year-End Issues To Consider
In the analysis for choosing deferrals to make in 2017, one ongoing issue stems from the tax increases that took effect in 2013, including the additional Medicare taxes for high earners. Other points to consider include the following.
1. Maximizing the amount you can contribute to your 401(k) plans.You should participate in the NQDC plan only if you can also afford the maximum annual contributions to your qualified deferral plans, as those are fully funded and protected by ERISA.
2. Cash needs for the year ahead and multi-year projections for your income. At a minimum, these considerations will tell you whether you have extra cash to defer. Your cash-flow projections should factor in all sources of income, including equity compensation, against spending needs in the near future to help you decide how much to defer.
3. The financial security of your company, and your job security.If you have concerns about your company's solvency, you may want to avoid contributions to nonqualified plans because of the risks presented by corporate bankruptcy. Any potential for job loss may also make NQDC deferrals unwise. If you lose your job during the deferral period, the income in the plan will be distributed to you immediately, triggering taxes you may not want to pay at that time.
4. Company match. Though company matches are not as common in NQDC plans as they are in 401(k) plans, if a company match requires you to contribute a certain amount to your NQDC plan, you will need to consider deferring at least that minimum.
5. The thresholds for higher taxes and rates. Higher tax rates make deferring income appealing. Consider whether the tax rate at the time of distribution is likely to be lower or higher than it is at the time of deferral. If you think the rate will be lower, then pre-tax deferrals can make sense. Deferrals can keep your income below the current triggers for higher taxes.
To make projections for current and future tax rates, and to compare returns both through deferrals and through not deferring income, try the calculator at myNQDC.com.
Alert: Because of the NQDC election rules, participants should carefully consider elections. The rules of IRC Section 409A severely restrict the ability to make changes in NQDC deferrals.
Consider Limits On Contributions To Qualified Plans
Influencing year-end decisions about nonqualified plans are the contribution and benefit limits that apply to qualified retirement plans. These limits are provided under Section 415 of the Internal Revenue Code, and every autumn the IRS announces inflation-adjusted figures for the following year. Importantly, the contribution limits of qualified plans form the major reason for the existence of nonqualified plans: to allow executives and key employees to save additional amounts for retirement with an elective nonqualified plan or an excess 401(k) plan.
What this means: The changes in limits from 2016 to 2017 are slight. If you have already maxed out your qualified plan contributions for 2016, you will probably do the same in 2017, so you will need to rely on NQDC plans to defer any salary and bonus increases you expect in 2017.
The contribution limits for qualified plans are provided under Section 415 of the Internal Revenue Code, and every autumn the IRS announces figures for the following year. The limits are adjusted annually for inflation. While there are slight increases in some limits for 2017, in others the 2016 limits continue. (See the IRS release announcing the figures for 2017.)
|Compensation allowed in qualified deferral and match calculation||$265,000||$270,000|
|Elective compensation deferrals||$18,000||$18,000|
|Catchup contributions for people aged 50 or older||$6,000||$6,000|
|Total defined contribution limits (employee and employer contributions)||$53,000 + catchup contribution||$54,000 + catchup contribution|
|Defined benefit plan payout limits||$210,000||$215,000|
|Income threshold defining key employees for the purposes of top-heavy plans and the six-month delay on payout upon separation||$170,000||$175,000|
|Income threshold defining highly compensated employees for the purposes of nondiscrimination testing||$120,000||$120,000|
Set by the Social Security Administration, the Social Security wage cap will rise in 2017 to $127,200, a significant increase from $118,500 in 2016. With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding in 2017 is $7,886.40.
For a table comparing the features of 401(k) plans and NQDC plans, and their relative advantages and disadvantages, see an FAQ at myNQDC.com.