For many participants in nonqualified deferred compensation (NQDC) plans, November and December are the time to be like an autumn squirrel and decide how much of next year’s salary to defer and store for the future. This decision about nonqualified plans is heavily influenced by the IRS contribution limits for qualified retirement plans. The IRS just set the qualified plan limits for 2023.
Those yearly contribution limits for qualified retirement plans are a big reason why companies offer nonqualified plans: to let executives and other highly compensated employees put away extra amounts for retirement with an elective nonqualified plan or an excess 401(k) plan. NQDC allows you to put away amounts of money beyond the permissible contribution amounts of standard qualified retirement plans.
The deferred income is “nonqualified” because it does not fit the rules in the tax code that allow tax-qualified plans, such as 401(k) plans. For retirement planning, NQDC can therefore bridge the considerable gap that arises between the amount of income that you will actually need in retirement and the amount of income that can be provided via your 401(k) plans and Social Security.
The complex rules under Section 409A of the US tax code must be followed in the deferral and distribution elections. The amount that you defer can only be informally funded by your company and is at risk should the company enter bankruptcy proceedings. Our sibling website myNQDC.com is a comprehensive resource on NQDC plans, including the basics, the deferral/distribution process, the risks, and the related financial and tax planning.
How 2023 IRS Qualified Plan Limits Affect NQDC Deferrals
Generally, you defer income via nonqualified plans only when you know you will max out your yearly contributions to qualified plans, such as your 401(k). Therefore, the contribution limits set by the IRS on qualified plans, adjusted annually for inflation, are important for NQDC planning:
| Contribution type/limit | 2022 | 2023 |
|---|---|---|
| Compensation allowed in qualified deferral and match calculation | $305,000 | $330,000 |
| Elective comp deferrals | $20,500 | $22,500 |
| Catchup contributions for people 50+ | $6,500 | $7,500 |
| Total defined contribution limits (employee and employer contributions) | $61,000 + catchup contribution | $66,000 + catchup contribution |
| Defined benefit plan payout limits | $245,000 | $265,000 |
| Income threshold defining key employees for top-heavy plans and six-month delay on payout upon separation | $200,000 | $215,000 |
| Income threshold defining highly compensated employees for the purposes of nondiscrimination testing | $135,000 | $150,000 |
Given the current inflation, the IRS changes in limits from 2022 to 2023 are much larger than they have been in recent years. However, if you’ve already maxed out your qualified plan contributions for 2022, you will still probably do the same in 2023, so you will need NQDC plans to defer any salary and bonus increases you expect in 2023. Also, if you believe tax increases are on the way and will affect you, you may feel a growing need to defer income.
Set by the Social Security Administration, the Social Security wage cap will rise in 2023 to $160,200, up from $147,000 in 2022. With the 6.2% rate of Social Security tax, the maximum possible Social Security withholding is $9,114 in 2022 and will rise to $9,932.40 in 2023. Social Security tax (up to the yearly limit) and Medicare tax (uncapped) are withheld at the time of deferral.
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. See also the website’s FAQ on the top NQDC-related issues in year-end planning.
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