Retirement plans help millions of Americans save for the future, but most include limits on how much can be saved. For those very highly paid employees who want to set aside more money, nonqualified deferred compensation plans can be helpful.
IRS section 409A covers certain nonqualified deferred compensation plans
. It covers income earned in one year but not paid out until the next. The most common example of this kind of income is a teacher who works a nine-month contract, but elects to be paid over 12 months. The IRS explained 409A plans are important, because people who do not meet the requirements of this plan could potentially face a 20 percent extra income tax on money earned in one year and paid out in the next.
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Nonqualified deferred compensation plans are not for everyone, Fidelity said
. In general, for people who are more highly compensated, the plan allows for setting aside larger tax-deferred amounts for retirement. The nonqualified deferred compensation plan allows the employer to agree to pay in the future, rather than in the year it is earned. It can grow tax deferred until it is received. There are risks to this kind of agreement particularly if a company is not stable.
The 409A code requires employers offering deferred compensation to specify the time of payment and the form of payment, according to the Association of Corporate Counsel
. If this is not done, the employee could face those big 20 percent additional taxes. Among the specifics required is that the deferred compensation not be paid before the employee leaves the company, the employee dies or becomes disabled or faces an emergency. There must also be a specified time for the employee to receive the money.
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