How NQDC Decisions Factor in IRS, OBBBA Rules

By year-end, executives and other employees who participate in nonqualified deferred compensation plans will have to decide how much of next year’s salary to defer. While choosing whether to contribute to an NQDC arrangement is a decision in and of itself, those who are contributing will likely consider the IRS’ newly released 2026 contribution limit for qualified retirement plans and the implications of the One Big Beautiful Bill Act as they make their elections.

The contribution limits on qualified plans are a chief reason for the existence of nonqualified plans: to allow employees who max out their qualified plan contributions to set aside an additional amount of their income—tax-deferred—for retirement.

Additionally, the OBBBA could boost the appeal of NQDC deferrals, according to a recently published article from myNQDC. The OBBBA raised the cap on state and local tax deductions, but it also phased out the additional deduction for yearly modified adjusted gross income exceeding $500,000. An income deferral could help participants avoid the phaseout in 2026, according to myNQDC.

Unlike qualified retirement plans such as 401(k)s, NQDC plans allow participants to withdraw money while they are still employed—at any age—without a penalty, says Monte Harrick, OneDigital’s senior vice president of executive benefits consulting. However, once a participant separates from the employer, the NQDC money cannot be rolled over into an individual retirement account, and the participant must take a payout.

In-Plan Decisionmaking

Harrick says someone entering a deferred compensation plan has four decisions to make: how much money to defer, whether to receive that money in service or in retirement, how to receive the money, and how to invest the deferrals.

Installments can be beneficial because the unpaid balance accumulates on a tax-deferred basis, Harrick says. He has seen some participants choose installments to finance their children’s college education.

Planning to move out of a state with a high income tax can also be a beneficial strategy. A federal law limiting state source taxation allows for the taxation of deferred compensation based on the state in which the work was performed. However, if an individual moves out of state while receiving payments from an NQDC plan and elects to receive the payments over a period of at least 10 years, they will instead be taxed in the state to which they move.

Investing those deferrals has a similar process to qualified plans, Harrick says.

“Just like a 401(k) investment menu, nonqualified plan clients usually select a menu of six to 14 funds [for] participants,” says Harrick. “The company will then monitor those funds and credit the participant’s account. The participant’s deferrals are not invested in the funds—just credited.”

Harrick adds that the best practice for a company is to review all participants’ allocations and then purchase those same investments using the deferred dollars the company is holding. That way, as the liability grows on the company’s balance sheet, it has an asset growing at the same rate of return.

Another important point to consider is that participants must treat each year as a “separate bucket of money and decisionmaking.” Participants decide how much of their salary and bonus are deferred—and until when—only for the upcoming year.

If participants change their mind, Harrick says they can alter their deferrals—but IRS rules set limits. By the terms of the agency’s “one-year rule,” participants may change the timing of their NQDC payment up until one year before the scheduled payment date, Harrick explains. The “five-year” rule means that all deferrals must be for at least five years. So, if a participant is due to receive a payment on February 1, 2030, the deadline to delay it would be January 31, 2029, and the payment could be rescheduled no sooner than February 1, 2035.

Education, Guidance for Participants

While there are several benefits to NQDCs, there is also a risk of insolvency, Harrick explains.

“Deferred compensation is simply an agreement between you and your company,” he says. “If the company goes bankrupt, you’re not guaranteed to get your money back.”

However, there are ways to provide an additional layer of protection to the account balance.

According to Harrick, companies can set up trusts to provide protection for participants in case of a change of control or a change in financial condition. A participant whose deferred compensation is protected by a trust can obtain a legal document and statement from their plan administrator of what is owed to them, in the event a company refuses or cannot pay. In most cases, the plan sponsor could use the document to make a request for payment to the trustee on behalf of the employee.

OneDigital’s “Preparing NQDC Plan Participants for Distribution Decision-Making,” an article authored by Harrick, suggested that employers provide webinars, live Q&A meetings or personalized financial planning sessions to help participants understand NQDC distribution elections. An executive benefits adviser or consultant can also refer participants to a vetted list of tax, legal or plan design professionals for further education. Design modeling tools like financial calculators or modeling software can also enable participants to visualize different benefit distribution scenarios.

Overall, proactive communication with NQDC participants can facilitate strategic decisions and ensure regulatory compliance during the benefit distribution process.

“When employees feel supported in their decisionmaking, they are more likely to grow in confidence in the company and its leadership,” the article stated.