Non-qualified deferred compensation (NQDC) pays out on a schedule elected years before retirement, before most people can see their full income picture. Each payout counts as ordinary income the year it lands, with no capital gains treatment. Redeferral is possible but must happen at least 12 months before the original date and push payment out at least 5 years.
What is a distribution election, and when do you make it?
Most plans require the election before the compensation is earned, either before the start of that calendar year or within 30 days of first becoming eligible for a new plan. An executive signing up for a deferred comp plan in their 40s is choosing a payout date and structure that will not take effect for a decade or two, based on a guess about a financial situation they cannot yet see.
What are your distribution options?
| Election type | When it pays | What it locks in |
|---|---|---|
| Specified date | A fixed calendar date chosen at deferral | Pays that year regardless of your income in it |
| Separation from service | When you leave the company | Delayed 6 months for “specified employees” at public companies |
| Installments | Spread over a period you chose, such as 5 or 10 years | Smooths the income, but the schedule itself is still fixed |
| Lump sum | One payment | Concentrates a large amount of ordinary income into a single tax year |
What is the six-month delay rule for public company executives?
If you rank among the top group of officers at a public company, a “specified employee” under the rules, a distribution triggered by separation from service cannot begin until six months after you leave. The delay exists to keep insiders from timing a payout around material information. It also means a lump sum you were counting on the month you retire may not arrive until half a year later, a gap worth planning cash flow around before it happens rather than after.
Can you change your election after you make it?
Within limits, and only in one direction. A redeferral must be filed at least 12 months before the original payment date, cannot take effect for at least 12 months after you file it, and must push the new date out at least 5 years from the original one. You can delay a payout you no longer want landing in a given year. You cannot move one closer.
How does a fixed payout date collide with the rest of your plan?
An NQDC distribution taxed as ordinary income does not check your calendar before it arrives. A lump sum scheduled for the same year you planned a large Roth conversion crowds out the bracket room the conversion needed, turning a well-sized conversion into an expensive one. A payout that lands the same year RMDs begin at 73, or 75 if you were born in 1960 or later, stacks two forced income sources in a single tax year, neither of which you can decline. An installment schedule elected to smooth income can still miss the mark if Social Security, a pension, or a spouse’s earnings shift around it later.
Picture an executive with a $400,000 NQDC lump sum scheduled to pay out the year they turn 66, an election signed 15 years earlier when 66 looked like a reasonable retirement age. Retirement comes early instead, at 61, with five years of Roth conversions planned for the gap and Social Security set to start at 67. The lump sum arrives at 66 regardless, the same year the conversions were still running, and fills the entire bracket the conversion needed, pushing that year’s MAGI into an IRMAA tier that raises their Medicare premiums two years later, at 68. A redeferral filed years ahead of the original date could have pushed the payout past the conversion window, but nobody looked at the election again until the check arrived. None of this looked like a problem the year it was signed. It became one fifteen years later, on a schedule nobody revisited in between. The figures here are illustrative, meant to show the mechanism rather than predict an outcome for any household.
What should you do next?
Map every future NQDC payout date against the rest of your projected income before you retire, not after the first check arrives. Check the redeferral window while you still qualify, since the 12-month rule closes fast once a payout date approaches. Coordinate the payout schedule with your Roth conversion window and your RMD start date so the three do not land on top of each other by accident. If your compensation includes illiquid company equity alongside the deferred cash, the deferred compensation guide and the page on private equity buyouts cover the additional wrinkles that adds. If you signed the elections while working in another state, see retirement planning in Franklin and Brentwood for when that state can still tax the payouts after a move to Tennessee.
An NQDC schedule set a decade ago does not know what the rest of your retirement income looks like today. Schedule a consultation to line the two up.
Common questions
- When do you make an NQDC distribution election?
- Either before the start of the calendar year in which you earn the compensation being deferred, or within 30 days of first becoming eligible for a new plan. The election is locked in long before you know what your retirement income will look like.
- What happens to unpaid NQDC if the company is acquired or runs into financial trouble?
- It remains a general unsecured obligation of the employer. NQDC sits on the company’s balance sheet, not in a trust for your benefit, so a distressed or acquired employer can leave a deferred balance at risk alongside its other creditors.
- Can you accelerate an NQDC payout if you need the money sooner?
- In most cases, no. Section 409A allows a few narrow exceptions, such as a distribution for an unforeseeable emergency if your plan offers one. A redeferral can push a payment date later, within limits, but there is no election that moves a payment earlier.
- Is NQDC subject to Social Security and Medicare tax?
- Yes, and earlier than you might expect. FICA tax applies when the compensation is no longer subject to a substantial risk of forfeiture, which can be years before the distribution itself, while income tax applies later, when the money pays out.
- Does an NQDC payout count toward provisional income and IRMAA?
- Yes. A distribution is ordinary income in the year it lands, which counts toward both the provisional income test for Social Security taxation and the MAGI test behind IRMAA.
If the decisions on this page are ahead of you, the two of you can work through them with Robert Boeck before any of them becomes permanent.
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