Recommend a Nonqualified Plan for Clients with 401(k) Plan Testing Issues
Advisors who focus on the retirement space know nondiscrimination testing is a potential pitfall plan sponsor clients can face with 401(k) plans.
Qualified plans are still the most effective retirement tool employers offer to their employees. And there are traditional strategies to help clients avoid testing failures. However, the expense of eliminating testing failures is a key consideration for many employers.
For example, a safe harbor 401(k) plan will effectively eliminate testing requirements. But an employer must make either matching or nonelective contributions to the plan—and these contributions may be a significant expense.
With the right planning, there are alternative, cost-effective solutions to consider. They can help minimize or eliminate the impact of testing failures—while enabling executives and key personnel to take advantage of retirement savings that aren’t subject to the contribution limits that apply to tax-qualified plans.
Nonqualified deferred compensation (NQDC) plans: A defensive strategy
An NQDC plan may be a good solution for some employers to resolve qualified plan testing failures.
- One option is to carve out a subset of the highly compensated employees (HCEs) from the 401(k) plan and place them in an NQDC plan. This may alleviate testing failures and allow HCEs to continue to save for retirement.
- Another alternative is to establish an NQDC plan to help HCEs offset taxable income they may incur as the result of receiving corrective distributions from a 401(k) plan.
Requiring HCEs to defer only to the NQDC plan makes it possible for the 401(k) plan to meet its testing requirements while preserving HCEs’ ability to defer salary and receive a matching contribution. If HCEs are allowed to defer to both the 401(k) plan and the NQDC plan, deferrals into the NQDC plan can help offset income taxes attributable to any required refunds from the 401(k) plan.
Employers can implement NQDC plans without the financial burden of having to make additional contributions to a 401(k) plan. Since these plans are financed with money that would have gone into the 401(k) plan, a typical NQDC plan only has a start-up fee and a yearly administration fee.
A quick primer on NQDC plans
The primary difference between 401(k) and NQDC plans is that NQDC plans are not subject to many of the rules of ERISA—including, for instance, compliance testing.
With fewer applicable regulations, plan sponsors have greater flexibility in both their NQDC plan design and participant eligibility. Additionally, plan sponsors are not required to finance NQDC plan liabilities until a triggering event occurs. And any money set aside for NQDC plan financing remains an asset of the company until it’s paid. As with pre-tax contributions to a 401(k) plan, when benefits are paid from an NQDC plan, the HCE pays income taxes on that money.
The following chart highlights some of the key benefits of an NQDC plan.
| Highlights of an NQDC Plan | |
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Contributions |
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Trust |
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In-Service Distributions |
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Taxation |
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Business Structure |
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Are your clients a good fit for an NQDC plan?
If you answer "yes" to any of the following questions, it could be the right time to explore the benefits of an NQDC plan with your clients.
- Has your client encountered contribution limitations for highly compensated employees due to nondiscrimination testing?
- Is your client concerned about whether employees are saving enough for their retirement?
- Does your client have a need for a tax deferred savings option for employees who receive a large percentage of income in incentive pay?
- Is your client concerned about how their compensation and retirement benefits rank among competitors?
- Does your client need enhanced employee benefit options as an incentive for senior employees to stay with the firm?
Learn more about NQDC plans today
When the time is right to propose an NQDC plan, it pays to work with a provider who has deep experience and dedicated resources that serve the nonqualified market space. By selecting Newport, an Ascensus company, you’ll benefit from our unique approach focused on Total Plan Management™: plan consulting, independent financing strategies, plan administration, and communication and education resources—all from responsive, experienced nonqualified plan specialists.
Contact your Newport representative for more information.
| Newport Representative Contact | Serving These States |
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Regional vice president, nonqualified plans |
CT, DC, DE, KY, MA, MD, ME, NC, NH, NJ, NY, OH, PA, RI, SC, VA, VT, WV |
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Regional vice president, nonqualified plans |
IA, IL, IN, KS, MI, MN, MO, ND, NE, SD, WI |
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Ryan Moore, CRPS |
AL, AR, FL, GA, LA, MS, NM, OK, TN, TX |
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Regional vice president, nonqualified plans |
AK, AZ, CA, CO, HI, ID, MT, NV, OR, UT, WA, WY |
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Vice president, insurance and nonqualified retirement plan sales |
Head of sales |
