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Nonqualified Plan Disadvantages

Despite its advantages, a nonqualified deferred compensation plan does have some disadvantages too. The following are the major drawbacks to consider when evaluating such plans:

warning

Warning

The tax consequences resulting from a plan's failure to comply with the applicable rules will be borne exclusively by the individual plan participant to whom the deferral relates. At the same time, the failure to comply with the governing rules will not subject either the plan or the sponsoring employer to tax and penalties.

It is crucial, therefore, that any participant in a nonqualified deferred compensation plan have their situation reviewed by a tax professional to make sure that everything is in order.

Tip

Tip

With the exception of availability in the event of insolvency, there are several methods that employers can use to secure payments from nonqualified plans. One increasingly popular way is by establishing an irrevocable grantor trust, also called a rabbi trust. Other methods of securing nonqualified benefits include establishing secular trusts and using life insurance.

Tip

Tip

A nonqualified plan based on pay-for-performance usually is able to withstand the legal challenges of shareholder activism. The executive compensation should be linked to corporate financial growth and paid on the basis of solid corporate performance. As such, equity and equity-based compensation techniques, like long-term incentive stock options, are increasingly becoming more popular.


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