When you’re going through a career transition—whether it’s a promotion, a company exit, or even early retirement—your financial to-do list can be long and complicated. Among the most overlooked (and misunderstood) elements of executive compensation are the non-qualified deferred compensation (NQDC) plans for a) salary reduction arrangements and b) bonus deferral plans.
If you’re fortunate enough to have either the salary reduction arrangement or the bonus deferral NQDC plans, it’s critical to understand how they work—and how to make the most of your plan(s). Misunderstanding non-qualified deferred compensation can lead to unnecessary taxes, loss of benefits, or even forfeiture of income you’ve already earned.
In this post, we’ll break down the basics of deferred compensation, common mistakes to avoid, and steps you can take to make sure you don’t leave money on the table.
What Is a Deferred Compensation Plan?
Deferred compensation refers to income earned in one year but paid out in a future year, usually to help high earners manage their tax burden or plan for retirement. There are two main types:
Qualified Deferred Compensation – These include retirement plans like 401(k)s and 403(b)s, which follow ERISA regulations and come with contribution limits and creditor protections. In a future post, we will explore qualified deferred compensation plans and steps you can take to work to maximize your 401(k), 403(b), or other qualified deferred compensation plans.
Non-qualified deferred Compensation (NQDC)—These plans are offered to select employees (usually executives) and include bonuses, salary deferrals, and stock options. They do not have the same legal protections as qualified plans and are often subject to specific rules and conditions set by the employer.
Most deferred compensation for executives falls in the non-qualified category. For the remainder of this post, we will primarily focus on NQDC plans that allow executives and employees to defer salary and bonus compensation, although we’ll touch a little bit on other types of NQDC plans (e.g., stock awards).
Why Do Companies Offer Non-Qualified Deferred Compensation Plans?
Deferred comp plans allowing you to defer salary and bonus compensation can serve two purposes:
- Retention: Companies often provide access to NQDC salary reduction and bonus deferral plans, which can be an attractive tax and retirement planning tool for executives and high-income earners.
- Companies also provide NQDC plans such as Restricted Stock Units (RSUs) and stock options to keep key employees by tying payouts to tenure or future company performance. If you have NQDC through company RSUs or stock options, make sure to like or subscribe to our social media channels if you would like to be notified when we will cover common planning mistakes executives make with their company stock awards.
- Tax Efficiency: Highly compensated employees are often attracted to employers who offer salary reduction and bonus deferral NQDC plans; there are significant potential opportunities to defer income through salary and bonus deferrals to a later year—ideally, when their tax rate may be lower compared to the year they are deferring income
But deferred comp is not without risk. Since NQDC plans are not protected under ERISA, your deferred earnings are technically considered an asset of your employer until they’re paid. If the company goes bankrupt, your deferred comp may be at risk.
The devil is often in the details, so it’s critical to understand how your NQDC plan works.
The Risks of Deferred Compensation During a Job Change
Significant issues with deferred compensation can arise when you leave your job or if your employer terminates your employment.
Here are a few key risks:
- Immediate Taxation Upon Separation: Depending on the structure of your plan, a job change may trigger payout—and thus, immediate taxation. If you receive a lump sum in one year, it could bump you into a higher tax bracket. Some tax bracket jumps can cost taxpayers an additional 8% in federal income tax for income earned in the higher bracket!
- Loss of Unvested Balances: Some plans require you to stay with the company for a certain number of years. If you’re not fully vested at the time of departure, you could lose a portion (or all) of your deferred compensation. For this reason, it’s critical to understand your plan or review the details with a trusted advisor before participating in salary reduction or bonus deferral NQDC plans.
- Poor Payout Timing: Unlike qualified deferred compensation plans (e.g., 401(k) plans) that allow more flexibility for taking distributions, NQDC plans often have a set schedule for the timing of your payouts. For example, your plan may pay out your full balance at termination of employment. Your plan might offer three payout options if you retire from your company: lump sum, equal installments over 5 years, or installments over 10 years. If your NQDC plan calls for a payout when the market is down, you could be forced to sell shares of your investment holdings, which is not ideal. Another poor-timing payout event could occur if you’re already in a high-income bracket ( e.g., receiving severance or exercising stock awards) and you’re required to take a substantial NQDC payout from your salary or bonus deferral compensation—you may take a bigger tax hit than expected.
- Creditor Risk: Because NQDC is essentially an unsecured promise to pay if the employer falls on hard times financially and must pay off debts, the funds that might have been used to pay your employee distributions can be claimed by creditors.
How to Navigate Your Deferred Comp Plan with Confidence
- Review Your Plan Documents Thoroughly
All deferred compensation plans are not created equal. Every plan has its own payout schedule, vesting rules, and conditions for distribution. We recommend working with your financial advisor to review the following:
- Vesting schedules
- Payment triggers (e.g., retirement, separation, death)
- Payout form (lump sum vs installments)
- Change-in-control provisions
- Deferral elections
Many plans require you to elect your deferral amount and payout timing in advance—sometimes up to 12 months before the income is earned. Missing these deadlines can limit your options.
- Understand the Tax Implications
A key advantage of deferred comp is tax deferral—but only if managed strategically. Here are a few tax planning tips:
- Coordinate with other income sources: If you’re receiving severance, stock payouts, or starting a consulting gig, you may want to defer NQDC payments to avoid a tax spike.
- Consider spreading payments over time: If your plan allows it, electing installment payments over 5-10 years may reduce your marginal tax rate in retirement.
- Factor in state taxes: If you’re moving states after retirement or during a job change, note that some states may tax your deferred compensation differently. For example, some executives move to states with lower tax rates and are later surprised to learn that their NQDC payouts are taxed at the state where they earned income (at a higher rate!)
We recommend consulting your financial advisor or a tax advisor who understands executive compensation planning to model different tax scenarios before electing a payout structure.
📌 Pro tip: At One Life Financial Group, we can help you try on and model different tax scenarios as part of our regular services when working with corporate executives. To learn more about our Tax Minimization services, please click here.
- Evaluate the potential impact on your plan’s Roth conversion strategy
Often, executives we work with have meaningful opportunities to lower their family’s projected tax bill by hundreds of thousands or millions of dollars by utilizing Roth conversions. The payout timing of NQDC plans can lower the potential tax savings of Roth conversion opportunities. Click here to learn more about Roth conversions.
- Plan for Cash Flow Needs
While deferring income can reduce taxes, you won’t have immediate access to that money. Ensure your short-term cash flow needs are met through other savings or severance. Otherwise, you might need to dip into investment accounts or take on debt.
- Evaluate Your Employer’s Financial Health
Since NQDC is not protected during bankruptcy, you’re relying on your company’s future solvency to receive your payout. If you’re leaving a financially unstable company, you may want to weigh the risk of deferring versus accelerating your payout (if allowed).
- Integrate Deferred Comp into Your Overall Plan
Too often, executives treat deferred comp like a side account. However, we believe it should be considered a core part of your retirement and tax minimization strategy. When we work with clients at One Life Financial Group on their NQDC decisions, we help them:
- Model the cash flow and tax impact of different payout schedules
- Sync deferred comp with other retirement assets (IRAs, 401(k), etc.)
- Coordinate payouts with Medicare, Social Security, and RMDs
- Plan charitable giving strategies using high-income years.
Bottom Line: Don’t Leave It to Chance
Deferred compensation can be a powerful wealth-building tool, but it’s not something you want to navigate alone—especially during a significant life or career change.
At One Life Financial Group, we help successful professionals create a plan that turns complexity into clarity—so you feel confident in every financial decision you make. If you would like to review your deferred comp plan together and build a smart strategy tailored to your goals, please schedule a no-cost consultation.
Deferred Compensation FAQs
What is a 457 deferred compensation plan?
A 457 deferred compensation plan is a type of non-qualified, tax-advantaged retirement plan available primarily to state and local government employees and certain non-profit organizations. It allows participants to contribute a portion of their salary into a retirement account on a pre-tax basis, deferring income taxes until withdrawal—usually at retirement.
What is the 457 deferred compensation plan maximum contribution?
As of 2025, the maximum annual contribution limit for a 457(b) plan for those under age 50 is $23,500. Participants age 50 or older can make an additional catch-up contribution of $7,500, bringing the total to $31,000.
Deferred compensation plan vs 401k?
401(k) plans are regulated broad-based retirement vehicles. Deferred comp plans (especially non-qualified) offer more flexibility and tax planning opportunities for high earners—but with more risk.
How does a deferred compensation salary reduction or bonus deferral plan work?
In a deferred compensation plan, an employee elects the option to set aside a portion of their income—typically base salary or bonuses—to be paid out at a future date, such as retirement or termination.
What is a Non-Qualified deferred compensation plan?
A Non-Qualified Deferred Compensation (NQDC) plan is a contractual agreement between an employer and select employees (typically executives or high earners) that allows the employee to defer income to a later date for tax purposes. The plan does not have participation or funding rules governed by ERISA.
What is a Qualified Deferred Compensation Plan?
A Qualified Deferred Compensation plan is a retirement plan that meets the requirements of the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. Contributions are pre-tax (or Roth, after-tax), and earnings grow tax-deferred.