A Qualified 401(k) vs Nonqualified 409A Plan Primer
As pension programs have largely become a thing of the past, the 401(k) is now the retirement savings vehicle of choice for most employers. If designed properly, a 401(k) allows employees to set aside a significant amount of their income in preparation for retirement. Studies show that the average person needs to save 15% of their income throughout their working years to replace at least 80% of their income in retirement years. This savings rate is much higher for individuals that started late on their retirement savings.
The problem: With the annual IRS 401(k) contribution limit of $19,500 per year (2020 limit) and a $6,500 catch-up for employees 50 or older, your highly compensated employees are left with a significant gap in their ability to save for retirement.
The solution: By offering a Nonqualified Deferred Compensation (NQDC) plan, you can provide a simple solution allowing a select group of key and highly compensated employees the opportunity to defer additional pretax compensation over and above the annual limits of a 401(k) plan. NQDC plans are commonly referred to as “401(k) spillover plans,” as the excess savings rate desired by the highly compensated employee can be set to spill over into a NQDC plan.
NQDC plans are governed under IRS Code Section 409A. While similarities with 401(k) plans exist, important tax, financial, and operational differences should be considered. The table below compares the plans and their impact from a company and a participant perspective.
Questions to ask yourself when considering a Nonqualified Deferred Compensation program for your organization:
If you answered “yes” to any of these questions, a Nonqualified plan may be a good solution for you. Contact LoVasco to learn more about how a Nonqualified plan would benefit your organization.
 Chart Assumptions: Data assumes a 25 year old begins contributing 10% of their income, increasing 3.0% annually, to their qualified retirement program with a 4.0% employer matching contribution. Each year's income is calculated by multiplying the income at the current age, 45, by the natural log of the ratio of the calculated age multiplied by Euler's number, e, divided by the current age, 45. This models an increasing income at an increasing rate.
Contributions are limited by historical and projected IRS 402(g) limits and qualified catch-up, employee and total contribution limits. For years beyond 2020, all aforementioned limits are modeled to increase annually by a rate equal to the 15 year average annual growth rate since 2020. IRS 402(g) limits modeled to grow by 2.1% annually; employee contribution limits modeled to grow by 2.3% annually; total contribution limit modeled to grow by 2.1% annually; catch-up contribution limited modeled to grow by 3.5% annually.
Investment balance is assumed to grow annually at 5.0% before age 65. Annual potential income in retirement is estimated by using the investment balance at retirement as the present value of the future cashflows to calculate each installment of a series of annual cash flows over a 20 year period starting at age 65 with a 2.0% post-retirement investment rate of return.
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance or tax/legal advice. Each plan has unique requirements, and you should consult your attorney or tax advisor for guidance on your specific situation.
Securities and Investment Advisory Services offered through M Holdings Securities, Inc., a registered Broker/Dealer and Investment Advisor, member FINRA/SIPC. LoVasco Consulting Group is independently owned and operated.
Return to Insights Page
LoVasco Consulting Group and their agents are presently licensed to sell traditional life insurance in Michigan as a resident producer and numerous other states as a nonresident producer. This site is not intended as an offer to sell securities, which may be done only after proper delivery of a prospectus and a client suitability review. Proper state registration is mandatory prior to conducting business in any state. Securities and Investment Advisory Services offered through M Holdings Securities, Inc., a registered broker dealer and Investment Advisor, member FINRA / SIPC. Check the background of this Firm and/or investment professional on FINRA's BrokerCheck. LoVasco Consulting Group is owned and operated independently from M Holdings Securities, Inc. LoVasco Consulting Group is a member of M Financial Group. Please click here for further details regarding this relationship.