What Are 409A Plans?

What Are 409A Plans?

Let me explain what a 409A plan is—it's a type of retirement savings plan for non-qualified deferred compensation, or NQDC. Governed by IRS code 409A, this plan lets you save compensation you've earned from your employer but haven't received yet. Since it's not in your hands, it's not part of your taxable income right away. These are popular with high earners because they have fewer restrictions on contributions and payouts than other plans.

Key Takeaways

Here's what you need to know: Non-qualified deferred compensation is money you've earned but not yet gotten from your employer. 409A plans came about because of limits on contributions to government-sponsored retirement plans. If your plan is sponsored by a for-profit company, it's under IRC Section 409A. For nonprofit or government sponsors, it's governed by IRC Section 457(b) or 457(f).

Understanding 409A Plans

These non-qualified deferred compensation plans are outlined in IRC 409A. They were designed to address the contribution caps on standard retirement savings. If you're a high-income earner, an NQDC lets you defer owning that income, skipping immediate taxes and getting tax-deferred growth on investments. You can't put in the same percentage as lower earners in tax-deferred accounts.

Take Sarah, an executive making $750,000 a year—her max 401(k) contribution of $23,000 in 2024 is just 3% of her income, which isn't enough to build retirement savings that match her salary. By using an NQDC to defer earnings, she delays taxes and saves a bigger chunk than her 401(k) allows. Deferrals often last five or 10 years, or until retirement.

Unlike strict retirement plans, NQDCs don't have the same rules—you could use the money for things like travel or education. The investment options depend on your employer and might mirror what's in their 401(k).

Fast Fact

Remember, an NQDC from a for-profit sponsor falls under IRC Section 409A, but if it's from a nonprofit or government sponsor, it's under IRC Section 457(b) and 457(f).

Limitations of 409A Plans

409A plans and other NQDCs can be useful for highly paid workers who've maxed out other options, but they're not without downsides. A big risk is no ERISA protection, unlike 401(k)s or 403(b)s. If your company goes bankrupt or gets sued, your NQDC assets aren't shielded from creditors—you're just like any unsecured creditor.

You also can't roll NQDC payouts into an IRA or other retirement accounts. And if tax rates rise by the time you access the money, your tax bill could be higher than when you earned it.

When Do I Pay Tax on an NQDC Plan?

You pay taxes on NQDC compensation when you actually receive it, not when you earn it. Payouts happen on a set date or schedule in the plan, or after events like retirement, leaving the job, an emergency, or disability.

How Is Deferred Compensation Taxed?

Deferred compensation gets taxed when you take it out, based on your income bracket at that time—not when you earned it.

How Do I Report Distributions From a 409A Plan?

These distributions are income you earned earlier but got later, so your employer reports them on your W-2, even if you're not working there anymore. They're treated as wages for taxes and might show up on a 1099-MISC too.

The Bottom Line

In summary, a 409A plan is a non-qualified deferred compensation setup that helps high earners save more for retirement without immediate taxes, since the money is earned but not received yet. It lets you go beyond 401(k) limits, but you should be aware of the risks, like no protection in bankruptcy and no IRA rollovers.