Is Deferred Comp an IRA? Key Differences Explained
Deferred compensation and IRAs are not the same. Understand their key distinctions in asset security, tax rules, and flexibility for your retirement plan.
While both deferred compensation plans and Individual Retirement Arrangements (IRAs) serve as vehicles for retirement savings, they are not the same. It is a common point of confusion, but these are fundamentally distinct financial instruments. They operate under different regulations, offer different benefits, and carry different levels of risk.
Understanding Deferred Compensation Plans
A non-qualified deferred compensation (NQDC) plan is an agreement between an employer and an employee to pay a portion of the employee’s compensation at a future date. These plans are typically offered to a select group of management or highly compensated employees as a way to save for retirement beyond the limits of standard qualified plans. Unlike a 401(k), an NQDC plan is not governed by the stringent requirements of the Employee Retirement Income Security Act (ERISA).
The core of an NQDC plan is the deferral election, where an employee decides in advance to postpone receiving a part of their salary or bonus. This money is not placed in a separate, protected account for the employee. Instead, it remains a part of the company’s general assets, representing an unsecured promise from the employer to pay the employee in the future. This structure is a defining characteristic and a primary source of risk for the employee.
The flexibility in NQDC plan design allows employers to set their own rules regarding eligibility and contribution amounts, which can be substantially higher than those for qualified plans. This makes them an attractive tool for executives looking to defer significant income and the associated taxes.
Defining an Individual Retirement Arrangement
An Individual Retirement Arrangement (IRA) is a personal savings account that provides tax advantages for retirement savings. Unlike an NQDC plan, an individual opens an IRA independently of their employer. To contribute, an individual must have earned income. The account is owned entirely by the individual, offering a level of security not present in NQDC plans.
There are two main types of IRAs. A Traditional IRA allows for pre-tax contributions, which may be tax-deductible, reducing your current taxable income. The funds grow tax-deferred, and you pay income taxes on the withdrawals you make in retirement. A Roth IRA is funded with post-tax contributions, so qualified withdrawals in retirement are completely tax-free.
The Internal Revenue Service (IRS) sets annual limits on how much an individual can contribute to all their IRAs combined. For 2025, this limit is $7,000 for individuals under age 50. Those aged 50 and over can make an additional “catch-up” contribution of $1,000, bringing their total to $8,000. Eligibility to contribute to a Roth IRA or to deduct contributions to a Traditional IRA can be limited based on your income.
Core Distinctions Between NQDC and IRAs
Asset Security
IRA assets are held in a custodial account in the individual’s name, completely separate from their employer’s finances. These funds are protected from the employer’s creditors. In contrast, NQDC funds remain part of the employer’s general assets as an unsecured promise to pay. This means if the company faces bankruptcy, the employee becomes a general creditor and could lose their entire deferred compensation.
Contribution Limits
Contribution limits for these two account types are vastly different. NQDC plans do not have IRS-mandated contribution limits. The employer determines how much an eligible employee can defer, which can be a significant portion of their salary or bonus, often far exceeding what could be saved in an IRA.
Tax Treatment
The tax treatment of contributions and distributions also differs. With an NQDC, the deferred compensation is subject to Federal Insurance Contributions Act (FICA) taxes—Social Security and Medicare—at the time of deferral, as governed by IRC Section 3121. Income tax is deferred until the money is actually paid out to the employee. For IRAs, FICA taxes are paid on the income before it is contributed.
Rollover Options
Funds from an IRA can typically be rolled over into another IRA or, in some cases, an employer-sponsored plan like a 401(k). This allows for consolidation and continued tax-deferred growth. NQDC funds, however, generally cannot be rolled over into an IRA or any other qualified retirement plan. Once the funds are scheduled for distribution, they are paid out and become taxable income to the recipient.
Distribution Rules
Distribution rules for NQDC plans are typically rigid and must comply with IRC Section 409A. The employee must make an irrevocable election about the timing and form of their distributions (e.g., lump sum or installments) at the time they choose to defer the compensation. IRAs offer much more flexibility. While rules exist, such as penalties for withdrawals before age 59½ and required minimum distributions after a certain age, the account owner generally has more control over when and how much to withdraw.
How NQDC Plans and IRAs Can Work Together
The common strategy is to first contribute the maximum allowable amount to tax-advantaged accounts like a 401(k) and an IRA. This ensures the individual captures the full benefit of features like employer matches in a 401(k) and the direct ownership and creditor protection offered by an IRA. These accounts form the secure foundation of a retirement portfolio.
Once contributions to qualified plans and IRAs are maxed out, an NQDC plan can serve as a powerful vehicle for additional, tax-deferred savings. It allows executives to set aside substantial amounts of pre-tax income that would otherwise be taxed at their highest marginal rate. By layering the use of these accounts, an individual can build a more robust and tax-efficient retirement nest egg than would be possible with either type of plan alone.