This type of employer-executive partnership lets executives invest their own pre-tax money to generate retirement income on a tax-advantaged basis. Employers agree to pay retirement or survivor benefits in exchange for the executive’s deferral of current compensation. By foregoing current income, executives defer tax until retirement. They also earn tax-deferred interest on their investments. Executives (or their beneficiaries) pay income tax when they receive the benefits, and employers deduct the benefits as they are paid.

Nonqualified 401(k) vs. Qualified 401(k)

Qualified 401(k) plan:

  • Contributions limited to $17,500 in 2013, plus the $5,500 “catch-up” provision after age 50
  • represents only two to five percent of annual compensation for most executives
  • Executives lose the chance to invest the full percentage of pre-tax income allowed under their plan

Nonqualified 401(k) plan:

  • Can be structured so combined qualified and nonqualified contributions equal the qualified plan formula, often around 15% of pay
  • Executives channel contributions that cannot go into the qualified 401(k) into the nonqualified 401(k) plan
  • Result: tax-deferred earnings and often a higher rate of return

Bonus Deferral:

  • Capital accumulation plan that lets executives defer a bonus (or salary) pre-tax and accumulate earnings tax-deferred
  • Can also be used to help directors defer fees in exchange for retirement and survivor benefits