Plan Sponsor FAQs

A deferred compensation plan is an agreement or arrangement under which the payment of compensation is deferred. A deferred compensation plan can be either qualified [401(k)] or nonqualified [409A].  

A nonqualified DCP (often referred to as simply a “DCP”) is a nonqualified employer-sponsored plan, meaning that it is not subject to all of the rules, limitations and regulations of qualified plans, such as a 401(k) or an IRA. The plan is a commitment by an employer to a select group of employees that allows them to defer—pretax—an unlimited* amount of compensation and receive that compensation, plus any earnings, as a distribution at a future time.  

With a DCP, key employees can elect to have a portion of their compensation (e.g., salary, bonus) withheld and paid out at a later date, such as retirement, termination of employment (also known as separation of service) or at specified future date (e.g., 2032). Because these payouts are future expenses (liabilities) for the company, DCPs are typically structured with an offsetting asset to ensure minimal or no P&L impact to the company. This asset is often held in trust to provide protection for plan participants; however, the trust does not protect again the risk of corporate insolvency. **  

Companies typically invest the withheld compensation in tax-deferred accounts such as Corporate-Owned Life Insurance (COLI), and the investment of this deferred compensation grows tax-free for the participant. From the company’s perspective, these compensation deferrals are viewed as a future promise to pay.  

DCPs are commonly used by employers as a form of executive compensation that can provide tax benefits to both the employer and the employee. In addition, deferred compensation plans can be designed to offer flexibility in the timing and form of payouts to employees. 

*Subject to plan provisions

**It’s important to note that deferred compensation plans are not without risks. The deferred compensation is subject to the employer’s financial health, and there is no guarantee that the employee will receive the promised benefits in the future.

In simple terms, a qualified retirement plan is one that meets the Employment Retirement Income Security Act of 1974 (ERISA) guidelines, while a nonqualified retirement plan falls outside of ERISA guidelines but is subject to compliance with IRS Code Section 409A. 

Check out our 401(k) vs. Deferred Compensation Plan chart for more information about the differences between a qualified plan [401(k)] and a nonqualified deferred compensation plan [DCP].   

The IRS defines a highly compensated employee as someone who meets either of the two following criteria-

• An employee is an HCE if he or she is an employee during the initial plan year (determination year) and is a 5% owner at any time during the plan year or the 12-month period immediately preceding the plan year (lookback year)
• A worker who received $150,000 or more in compensation from the employer that sponsors his or her plan in 2023.

• Minimal corporate cost
• Offers a key executive benefit designed to attract and retain employees

Gives your key employee group the ability to set aside more of their compensation (pretax) to meet their financial and retirement goals by allowing them to defer more than $23,000 per year, which is the maximum allowed by 401(k) plans. [Note: The maximum 401(k) contribution level does not include the $7,500 catch-up contribution allowed for employees aged 50 or older.]  

Deferred compensation plans are governed by section 409A of the Internal Revenue Code which allows for income deferrals above 401(k) limits if the plan is offered to only a select group of employees.

The American Jobs Creation Act of 2004 added section 409A to the Internal Revenue Code, providing new rules for nonqualified deferred compensation plans. Section 409A provides that unless specified requirements are met, all amounts deferred under a nonqualified deferred compensation plan for all taxable years are currently includible in gross income, to the extent not subject to a substantial risk of forfeiture and not previously included in gross income.

Compliance with 409A is critical because companies must abide by its rules and specific requirements; otherwise, the IRS can assess penalties. These penalties usually affect company employees and shareholders and can result in significant financial loss.

A deferred compensation plan can only be informally funded but it is not required to be informally funded. Most plans are informally funded with either taxable securities or nontaxable securities. Companies acquire assets to hedge the liability created when a plan participant defers income. Informal plan funding can effectively mitigate and may eliminate any P&L impact by efficiently managing the company’s balance sheet.

The corporation will invest in assets and allocate the dollars received to mirror that of the plan participants’ investment allocations. This type of funding approach is called match funding (i.e., asset is equal to the liability).

The preferred type of informal funding is an asset whose investment earnings are not subject to income tax. This can be accomplished with a nontaxable securities portfolio structure which is corporate owned life insurance or COLI. Contributions, distributions, reallocations and rebalancing of the asset can be structured in a tax efficient manner.

The investment options in a deferred compensation plan can be robust. The more prevalent investment options will be a fixed rate of return, a market-based rate of return or both. An example of a fixed rate would be crediting plan participants with a guaranteed 4% rate of return. 409A Direct offers market-based investment options which can include a variety of fixed income and equity investment fund managers. These are well-known fund managers such as JP Morgan, Goldman Sachs, Vanguard, Fidelity, T. Rowe Price, PIMCO and many others. Plans typically allow 10 to 20 investment fund choices. Custom portfolios based on various levels of risk and return can also be an investment option, as can company stock.

The investment options of the plan participants often mirror the investment funds within the COLI asset structure. For example, if Goldman Sachs has an investment fund within the COLI which is considered a best-in-class fund, then the plan sponsor can make this fund available to plan participants. That fund will earn a rate of return within the COLI asset, and the plan participants will be credited with the same rate of return.

• Easy to use
• Quick to implement
• Makes what is typically a complex process extremely simple
• Offers low-cost implementation and on-going administration
• Provides automated and validated asset/liability management
• 409A-compliant platform to reduce risk
• Provides a dynamic platform for plan design and implementation   

Your company can select a variety of situations where your key employees can opt to receive distributions from the deferred compensation plan, including some unplanned, or hardship, events.

• Retirement (at separation of service or when participant reaches retirement age)
• Scheduled distribution
• Separation of service
• Delayed separation of service (separation of service, plus an additional number oyears)
• Disability
• As a survivor benefit
• Change in control in the event the company is acquired  

The company can determine which of the following ways plan participants can defer their compensation—

• Dollar amount
• Whole percentage
• Percentage up to a dollar amount
• Percentage in excess of a dollar amount

Note: With 409A Direct, your company can also allow participants the option of electing automatic annual deferral increases.

If you want to add additional participants, please email us at info@409ADirect.com 

With 409A Direct, the minimum number of plan participants is 5 (plus the company must have at least 34 total employees).  

Note: The maximum number of employees that can be on a 409A Direct DCP is 15% of your total number of employees. For example, if you have 100 employees, your plan can have a total of 15 employees in the plan.   

You’ll want to get buy-in from your senior management team, but implementation requires information and input from only your company’s head of human resources and head of finance.

409A Direct is the first solution for automating deferred compensation plan* design, funding, implementation and administration. We have leveraged one-of-a-kind technology to provide a secure, scalable, 409A-compliant automated experience. Our platform allows small- to medium-sized companies throughout the U.S. to implement nonqualified deferred compensation plans quickly, easily and cost-effectively. 

*For nonqualified deferred compensation plans as defined by IRC 409A.   

Small to medium sized businesses with 34 or more employees and at least 5 eligible participants looking to provide incentives to attract and retain employees, senior management and execs.  

Absolutely! 409A Direct is a secure cloud-based enterprise platform, designed utilizing Salesforce’s force.com infrastructure, SQL Server, and .NET technology, and has obtained SSAE 18, SOC 1 Type II and SOC 2 Type II Compliance. 

The 409A Direct platform makes it easy for you to set up your company’s DCP. Our streamlined, step-by-step process walks you through implementation, so you have guidance and support along the way.

Your company can select a variety of situations where your key employees can opt to receive distributions from the deferred compensation plan, including some unplanned, or hardship, events.

-Retirement (at separation of service or when participant reaches retirement age)

-Scheduled distribution 

-Separation of service 

-Delayed separation of service (separation of service, plus an additional number of years) 

-Disability 

-As a survivor benefit 

-Change in control in the event the company is acquired 

Because 409A Direct has automated the deferred compensation plan process, you can build your own customized DCP at a significantly lower cost compared to the traditional process! Check out our pricing for more information.

Monthly participant admin fees for 409A Direct are $20 per participant per month, which is below the industry average of $25 to $50 per participant per month.  

It takes less than 30 days to implement a deferred compensation plan using the 409A Direct platform. Note that this timeframe is largely dependent on how quickly you can provide the information needed throughout the process.  

Yes, a short-term deferred compensation plan can be established. Please email us at info@409ADirect.com for more information.

• Deferred Compensation Plans (DCP) 
• Long-Term Incentive Plans (LTIP) 
• Supplemental Executive Retirement Plans (SERP)

The 409A Direct process is intuitive and you will have access to subject matter experts associated with each part of the process. In addition, you will be assigned a 409A Direct Ambassador if you need additional assistance.

The platform reviews a set of assumptions based on your company’s DCP selections and illustrates the projected profit & loss and cash flow statements to show the impact to the company. The financial impact will vary based on the amount of deferrals, corporate structure, tax rate and rate-of-return assumptions. Three different models can be created and saved for you to access at any time in the future.

The focus of performing product due diligence is to identify the lowest cost COLI asset combined with the best performing investment funds.

Establishing a trust can be important for providing better benefit security for the plan participants. A grantor trust, often called a Rabbi Trust, can provide participants with benefit security given a change in control, change of heart, or the company’s inability to pay benefits from a cash-flow perspective. Dollars set aside in trust to fund the plan can only be used to pay plan benefits to participants. Note: Establishing a trust is not a requirement. 

Company involvement is minimal. It is recommended that you review the trust document and execute the document accordingly. 

Initial enrollment is recommended to be at least 3 to 4 weeks to accommodate schedules and to educate your eligible employees. 

Yes, we provide a plan overview, enrollment instructions, a prerecorded webinar link and sample email communications that you can share with your eligible group.  

Your company will need to provide a payroll deduction report each pay period to process deferrals. All payroll reports are validated by 409A Direct prior to crediting plan participants with deferral amounts and interest. 

Yes. At minimum, an annual meeting will be held to discuss your plan. Your 409A Direct Ambassador is also available to you if you have any questions.

There is a dedicated team of client relationship managers to support and assist Human Resources, Finance and Accounting in the management of your plan(s).