Deferred compensation (NQDC) payouts and elections

A nonqualified deferred compensation (NQDC) plan lets some employees put off receiving part of their salary or bonus until a later date, often retirement. You don't pay income tax on the deferred pay until it's paid out. Meanwhile, it's credited with earnings based on investment choices the plan offers.

It sounds like a bigger 401(k), and in one way it is: deferrals can be far larger than qualified-plan limits allow. But the rules are very different. The biggest difference: you must choose when and how you'll be paid, usually before you earn the money. Changing that choice later is tightly restricted.

How NQDC is taxed

• Income tax: due when the money is paid to you, not when you defer it. Payments are taxed as wages.
• Social Security and Medicare (FICA): due when you earn the pay or, if later, when it vests. It's usually not due again when the money is paid out. If your other wages already exceed the Social Security wage base of $184,500, only the 1.45% Medicare tax applies to the deferral.
• State tax: a federal law limits which states can tax certain retirement payments after you move. Installments paid over 10 years or more are protected, so a state you've left can't tax them. A lump sum or shorter installments may still be taxed by the state where you earned the pay.

Because the income tax waits until payout, the timing of payments decides which brackets the money lands in.

The payout election

When you enroll for a plan year, you usually choose:

• The trigger: separation from service, a fixed date, or reaching an age.
• The form: a lump sum, or installments over a set number of years.

Many plans let you make a separate election for each year's deferrals. Over a career you might hold several "classes" of money with different payout dates.

If you're a "specified employee" of a public company, payments triggered by leaving your job must wait at least six months after you leave.

Changing the election later

Section 409A of the tax code governs changes. A later change to an existing election must meet three rules:

1. It can't take effect until 12 months after you make it.
2. It must push the first payment back by at least five years.
3. For a payment tied to a fixed date, you must make the change at least 12 months before that date.

You generally can't speed payments up. Breaking these rules can make the whole balance taxable at once, plus an additional tax and interest. That's why getting the original election right matters.

A worked example

Dana and Chris file jointly. Dana, 58, plans to retire at 60 with $600,000 in her employer's NQDC plan. In the years after she retires, they expect about $40,000 a year of other taxable income until Social Security starts.

Here's the federal income tax in 2026 brackets, with the standard deduction of $32,200, ignoring investment growth and inflation:

The lump sum pushes most of the money into the 35% and 37% brackets. Spread over ten years, each payment stays in the 12% bracket. The installments save roughly $81,000 of federal tax. They'd also be protected from tax by the state where Dana earned the pay, if the couple moves.

The trade-off is risk, covered below. Installments leave Dana's money with her former employer for another decade.

Fitting payments around other income

Installments interact with the rest of the plan:

• They fill brackets you might otherwise use for Roth conversions.
• Large payments can raise Medicare premiums through IRMAA, which looks back two years.
• Payments before age 65 can reduce an ACA premium tax credit.

Many people aim payouts at the years between retiring and claiming Social Security, when other income is low.

The risks to weigh

Your employer's credit

NQDC money isn't held in a protected trust for you. Legally, you're an unsecured creditor of your employer. If the company goes bankrupt, you may recover little or nothing. A longer payout schedule keeps more of your money exposed for longer.

Questions to ask yourself:

• How financially strong is the company, and how might that change over 10 or 15 years?
• How much of your net worth already depends on this employer, through salary, stock and options?

Concentration with company stock

If you also hold employer stock, your NQDC balance adds to the same risk. See equity compensation taxes for ways people reduce concentration.

Plan changes and investment menus

Plans can be amended. Earnings are usually credited based on a menu of reference funds. They aren't separate accounts in your name.

How the app handles deferred compensation

A deferred compensation account holds one balance per plan year, each with its own payout election. The trigger is separation, a date or an age, and the form is a lump sum or installments. You can enter future deferrals by plan year, taken from salary and bonus.

The Deferred compensation screen runs your plan with alternative elections side by side, so you can compare taxes and outcomes. It checks a proposed change against the three 409A rules and explains any problem. It applies the six-month delay for specified employees. It also notes when payments are protected from your former state's tax and when FICA applies.

To test the credit risk, you can set a share of the balance to be lost at a chosen date in a scenario. The screen is part of the Plus plan.

Frequently asked questions

Can I roll NQDC into an IRA?

No. NQDC isn't a qualified plan, so it can't be rolled over. Payments are taxed when you receive them.

Do NQDC payments count as earnings for Social Security?

For the earnings test, pay you earned before you started benefits generally doesn't count when it's paid later. FICA was already handled when the pay was earned or vested.

What happens if I die before the money is paid?

The plan pays your beneficiary under its own terms. Payments are taxable income to them, as they would have been to you.