Nonqualified Deferred Compensation Elections: What to Weigh Before the Plan Deadline

A nonqualified deferred compensation (NQDC) plan lets a highly paid employee ask to receive part of future salary or bonus at a later date instead of now. The governing rule is timing: under Internal Revenue Code section 409A, the election generally has to be made before the year in which the pay is earned, and it is difficult to change afterward. For a calendar-year taxpayer, an election covering 2027 pay generally has to be in place by December 31, 2026, and a plan may set an earlier enrollment deadline. This article covers the election rules, the payout choices, what the deferred balance represents, and how payroll taxes are timed.

When the election has to be made

The general rule is that compensation for services performed in a year may be deferred only if the election is made no later than the close of the preceding year. A salary or bonus deferral for 2027 therefore requires a decision during 2026. A plan may close enrollment well before year-end, so the plan deadline is the date that controls in practice.

Two exceptions are narrow. A person who first becomes eligible for a plan may make an initial election within 30 days of becoming eligible, but only for pay for services performed after the election. Performance-based compensation for a period of at least 12 months may be elected no later than six months before the end of that period, provided the participant keeps performing services and other conditions in the regulations are met.

Payout timing and the cost of changing it

When making the election, the participant also chooses when and how the money will be paid. Section 409A permits payment only on a limited set of events:

• separation from service
• disability
• death
• a specified time or fixed schedule
• a change in ownership or effective control, as provided in regulations
• an unforeseeable emergency

A plan commonly offers a choice between a lump sum and installments, and the choice may differ for each year of deferrals. The statute generally does not allow payments to be accelerated. A later change to the schedule must not take effect for at least 12 months, and it must generally push payment out at least five years beyond the original date, with limited exceptions.

The consequences of an error are significant. If a plan fails section 409A, deferred amounts that are no longer subject to a substantial risk of forfeiture become taxable in that year, with an additional 20 percent tax and interest at the underpayment rate plus one percentage point. Separately, a key employee of a publicly traded company generally must wait six months after separation from service before receiving a separation payment. The same separation rules also matter when employment ends.

What the balance represents

An NQDC balance is generally an employer’s promise to pay in the future, and the participant typically ranks as an unsecured creditor of the company. Payment therefore depends on the employer’s ability to pay when the date arrives. Section 409A restricts attempts to protect the balance. Assets placed in an offshore trust, or set aside in connection with a decline in the employer’s financial health, are treated as transferred property and taxed accordingly.

That makes the employer’s financial condition, and any disclosure about how the obligation is funded, a relevant part of the decision. Participants commonly weigh the size of the deferral against the amount of pay they would rely on elsewhere.

Payroll tax timing

Income tax and payroll tax follow different schedules. Income tax on deferred pay is generally due when it is paid out. Social Security and Medicare taxes (FICA) generally apply under a special timing rule: deferred amounts count as wages at the later of the date the services are performed or the date the right is no longer subject to a substantial risk of forfeiture. Once an amount has been counted, neither it nor its later earnings are counted as wages again when paid.

For 2026, the Social Security portion applies to wages up to $184,500, at 6.2 percent for the employee and 6.2 percent for the employer. Whether a deferral changes the Social Security tax owed in a given year depends on how the participant’s other wages compare with that base. Because Texas has no state personal income tax, the comparison of the deferral year and the payout year is a federal question.

Questions to bring to the plan deadline

Plan terms vary, and the answers may differ from one employer to the next. Items to ask the plan administrator include:

• Which payment events and schedules does the plan offer, and can they differ by deferral year?
• What happens to the balance on separation, disability, death or a change in control?
• Which amounts remain subject to forfeiture, and under what vesting schedule?
• How does the employer fund the obligation, and what is disclosed about its financial condition?
• How does the deferral fit with other cash needs and the rest of the year’s income?

Your adviser can help you think through how a deferral fits with the rest of your financial picture, and a tax professional or attorney should review the plan document and your election before the deadline.

This article is provided by Austin Wealth Management for general educational purposes only. It is not financial, investment, tax or legal advice, it does not consider your individual circumstances, and it does not create an advisory relationship. Austin Wealth Management provides advice and services only under a signed advisory agreement, and the terms of that agreement govern. Rules and limits change, so information here may not be current. Consult a qualified financial professional before making financial decisions.