The Bankruptcy Risk Hiding in Your Deferred Compensation Plan

Executives who walk years gathering up a non-qualified deferred compensation equilibrium often presume it's harmless due to the fact that it shows up connected a institution statement. It's not a status account. It's not held successful a protected trust. It is, legally speaking, a committedness from your leader to wage you later. But here's the catch: if that leader files for bankruptcy, you are lasting successful the aforesaid enactment arsenic the vendors, bondholders, and landlords.

Nonqualified deferred compensation (NQDC) plans fto precocious earners hold receiving portion of their wage oregon bonus, deferring income taxes until the wealth is paid out. Unlike a 401(k), an NQDC program is not governed by ERISA (the national instrumentality that requires qualified status assets to beryllium held successful a separate, protected trust).

Here is what is typically astatine stake:

1. Who uses NQDC plans: Executives and highly compensated employees, often with balances ranging from $100,000 to respective cardinal dollars

2. The halfway appeal: Tax deferral connected income that would different beryllium taxed instantly astatine the highest national rate

3. The halfway risk: NQDC balances are an unsecured wide work of the leader not a segregated status asset

4. What bankruptcy means for you: In Chapter 7 bankruptcy, NQDC participants basal successful enactment with commercialized creditors and bondholders, typically recovering 10 to 30 cents connected the dollar implicit a multi-year process

The Enron illness made this hazard intolerable to ignore. Enron executives had an estimated $465 cardinal successful corporate NQDC balances astatine bankruptcy, and betterment was a fraction of look value. The instrumentality worked precisely arsenic written.

ERISA-qualified plans, including 401(k)s and pensions, indispensable clasp assets successful a spot legally abstracted from the employer. If the institution collapses, those assets cannot beryllium touched by creditors. Congress made this prime deliberately to support workers.

NQDC plans were carved retired of ERISA specifically due to the fact that giving executives the aforesaid extortion would necessitate the deferred income to beryllium taxed immediately. The tradeoff is explicit: you get the taxation deferral, but you instrumentality connected the employer's recognition risk. The IRS enforces this by requiring that deferred amounts stay astatine hazard to wide creditors. If they were genuinely protected, the IRS would dainty them arsenic constructively received and taxation them close away.

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