What are the best practices for NQDC plan governance and oversight?

1 Plan objectives and strategy

Before establishing or reviewing a NQDC plan, plan sponsors should clearly define the objectives and strategy of the plan. What are the goals of the plan in terms of attracting, retaining, and rewarding key employees? How does the plan align with the overall compensation and benefits philosophy and strategy of the organization? How does the plan fit into the total rewards package and the market competitiveness of the employer? These questions can help plan sponsors design a NQDC plan that meets the needs and expectations of both the employer and the participants.

2 Plan documentation and communication

A NQDC plan should have a written plan document that outlines the terms and conditions of the plan, such as eligibility, participation, deferral elections, distribution options, vesting, forfeiture, and plan administration. The plan document should also include a summary plan description (SPD) that summarizes the main features of the plan in a clear and concise manner for the participants. The plan document and the SPD should be reviewed and updated regularly to reflect any changes in the plan or the law. Additionally, plan sponsors should communicate effectively with the participants about the benefits and risks of the plan, the deferral and distribution options, the tax implications, and the plan performance. Communication can be done through various channels, such as newsletters, webinars, seminars, or one-on-one consultations.

3 Plan funding and accounting

One of the major challenges of NQDC plans is how to fund them. Unlike qualified plans, NQDC plans are not funded with trust assets that are protected from creditors in case of bankruptcy. Instead, NQDC plans are typically funded with corporate assets that remain subject to the claims of creditors and shareholders. This means that participants are exposed to the credit risk of the employer and may lose their benefits if the employer becomes insolvent. To mitigate this risk, plan sponsors can use various funding mechanisms, such as rabbi trusts, secular trusts, corporate-owned life insurance (COLI), or mutual funds. However, each funding mechanism has its own advantages and disadvantages in terms of cost, tax, accounting, and legal implications. Therefore, plan sponsors should carefully evaluate the funding options and choose the one that best suits their financial situation and risk tolerance.

4 Plan compliance and reporting

Another challenge of NQDC plans is how to comply with the complex and evolving tax and legal regulations that apply to them. The most important tax regulation for NQDC plans is Section 409A of the Internal Revenue Code, which sets strict rules for the timing and form of deferral elections and distributions. Failure to comply with Section 409A can result in severe penalties for both the employer and the participants, such as immediate taxation, interest, and additional taxes. Therefore, plan sponsors should ensure that their NQDC plans are designed and administered in accordance with Section 409A and any other relevant tax laws. Additionally, plan sponsors should comply with the reporting and disclosure requirements for NQDC plans, such as Form W-2, Form 1099-MISC, Form 5500, and proxy statements. Plan sponsors should also monitor any changes in the tax and legal environment that may affect their NQDC plans and make necessary adjustments accordingly.

5 Plan oversight and review

Finally, a NQDC plan should have a formal oversight and review process that involves the board of directors, senior management, and external advisors. The oversight and review process should ensure that the NQDC plan is operating effectively, efficiently, and ethically, and that it is meeting its objectives and strategy. The oversight and review process should also identify and address any issues or risks that may arise in the NQDC plan, such as operational errors, participant complaints, litigation, or audit findings. The oversight and review process should be conducted periodically, at least annually, and documented properly. The oversight and review process should also involve external advisors, such as legal counsel, tax advisors, auditors, or consultants, who can provide independent and professional advice and guidance on the NQDC plan.