Many eligible participants in nonqualified deferred compensation (NQDC) plans are now making decisions about their salary deferrals for 2014. In fact, the fourth quarter of the year is the most common period during which salary deferrals are elected through NQDC plans for the year ahead. In the analysis for next year's deferrals, one new development is the need to consider the tax increases that took effect in 2013 (those tax hikes were still uncertain at the end of 2012). The tax changes of 2013 include the introduction of additional Medicare taxes for high earners. Issues to consider in your decision-making at enrollment 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. In the table below are the amounts for 2013 (assume slight inflation adjustments for the year ahead).
| Tax rate | Yearly income threshold |
| Top ordinary income rate (39.6%) | Taxable income of $400,000 (single) or $450,000 (joint) |
| Top capital gains rate (20%) | Taxable income of $400,000 (single) or $450,000 (joint) |
| Medicare surtax on investment income (3.8%) | Modified adjusted gross income of $200,000 (single) or $250,000 (joint) |
| Additional Medicare tax on earned income (0.9%) | Earned income of $200,000 (single) or $250,000 (joint) |
| Phaseout of itemized deductions and personal exemptions | Adjusted gross income of $250,000 (single) or $300,000 (joint) |
Alert: Because of the NQDC election rules, you should predict cash-flow needs and tax brackets for the year ahead. The rules of IRC Section 409A severely restrict your ability to make changes in NQDC deferrals.
See an FAQ at myNQDC.com for other factors that can make participation in your company's NQDC plan beneficial. 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.
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