By age 73, every American with a tax-deferred retirement account must start taking required minimum distributions (RMDs). So, do deferred compensation plans have RMDs? Yes and no – it depends on the plan type.
- 📊 RMD rules for every kind of deferred compensation plan – from 401(k)s and 457 plans to nonqualified executive plans.
- ⚖️ How federal law and state laws impact deferred compensation distributions – including unique state tax traps and protections.
- 💼 Real-world examples for employees, business owners, and advisors – illustrating how RMDs (or the lack of RMDs) affect different scenarios.
- 🚫 Pitfalls to avoid and compliance tips – like preventing hefty IRS penalties, 409A mistakes, and tax surprises.
- ❓ Expert answers to frequently asked questions – quick yes/no responses to the most common queries from forums and professionals.
Deferred Compensation Plans and RMDs: The Clear Answer
Deferred compensation plans let you postpone part of your earnings until later, often to save on taxes or build retirement income. Required Minimum Distributions (RMDs) are the IRS-mandated withdrawals you must take from certain retirement accounts once you reach a specified age (currently 73 under federal law).
Do all deferred comp plans force RMDs? Under U.S. federal law, some deferred compensation plans do require RMDs, while others do not. It hinges on whether the plan is a qualified retirement plan or a nonqualified arrangement.
Let’s break it down by plan type and RMD requirements:
- 401(k), 403(b), and other qualified retirement plans: Yes. These tax-qualified plans follow federal RMD rules. You must begin withdrawing a minimum amount each year starting at age 73 (the “required beginning date” is April 1 of the year after turning 73). If you’re still working for that employer and you don’t own over 5% of the company, you can delay RMDs from that workplace plan until you retire.
- Traditional IRAs (Individual Retirement Accounts): Yes. Traditional IRAs are subject to RMDs beginning at age 73. Unlike a 401(k), there’s no “still-working” exception for IRAs – even if you keep working past 73, you must take IRA RMDs.
- Roth IRAs: No. Roth IRAs have no RMDs during the original owner’s lifetime. You are never forced to withdraw from your personal Roth IRA at any age. (However, inherited Roth IRAs do have distribution rules for beneficiaries.)
- Roth 401(k) and Roth 403(b): Yes (until 2023), and No (after 2023). Prior to 2024, Roth accounts inside employer plans were subject to RMDs at 73, even though withdrawals are tax-free. A recent law change now eliminates RMDs on Roth workplace accounts starting in 2024, aligning them with Roth IRAs.
- 457(b) Government Deferred Comp Plans: Yes. State and local government 457(b) plans are treated like qualified plans for RMD purposes. Participants must start RMDs at 73, unless they qualify to delay by working past that age (government plans generally allow the same delay if you’re still employed).
- 457(b) Tax-Exempt (Non-Governmental) Plans: Yes. 457(b) plans for tax-exempt organizations (like certain hospitals or charities) also require RMDs starting at 73. One key difference is that these plans cannot be rolled over into an IRA, so RMDs (and all distributions) must come directly from the plan itself once triggered.
- Defined Benefit Pension Plans: Yes. Traditional pensions satisfy RMD rules by beginning lifetime annuity payments no later than age 73. In practice, if you haven’t started your pension by that age, the plan will typically start paying you to meet RMD law.
- Nonqualified Deferred Compensation (NQDC) Plans (e.g. 409A plans): No. NQDC plans are arrangements usually for executives or key employees to defer compensation beyond qualified plan limits. These are not subject to the IRS’s age-based RMD rules. There is no law forcing distributions at age 73 on a 409A deferred comp plan. Instead, distributions occur per the plan’s terms and your deferral elections (commonly at retirement, a set future date, or other allowed triggering events). Important: Just because there’s no RMD doesn’t mean you can leave the money forever – the plan will pay out according to schedule, and all payouts are taxable as ordinary income when received.
- Section 457(f) “Ineligible” Deferred Comp: No. These plans (often for executives at tax-exempt organizations) don’t have RMD requirements. In fact, 457(f) arrangements generally don’t allow long-term tax deferral at all – any deferred compensation is taxed once it’s vested (no substantial risk of forfeiture remains), often well before age 73.
In short, qualified retirement plans and similar accounts (including 457(b)s) come with RMD obligations under federal law. Nonqualified deferred comp plans do not have age-based mandatory withdrawals. This means an executive’s private deferred comp account won’t suddenly force out money at 73, whereas their 401(k) or 457 plan will.
Deferred Comp & RMD Pitfalls: What to Avoid
Everyone should be careful when dealing with deferred compensation and withdrawal rules. Here are common mistakes to avoid:
- 🚫 Forgetting required distributions: If your deferred comp plan is subject to RMDs (like a 401(k) or 457 plan), missing an RMD can trigger a hefty tax penalty. The IRS penalty for a missed RMD is 25% of the amount you failed to withdraw (though it can be reduced to 10% if you quickly correct the mistake). Always track your RMD deadlines and withdraw at least the minimum on time.
- 🚫 Violating 409A rules: Nonqualified deferred comp plans come with strict IRS rules (Section 409A). You typically can’t change your payout schedule or withdraw early unless the plan permits it under limited events. Trying to cash out or reschedule distributions outside the allowed rules will backfire – the IRS can deem the entire deferred amount immediately taxable with an additional 20% penalty. Both employees and employers need to follow the plan document and 409A regulations closely.
- 🚫 Not planning for lump-sum taxes: Unlike RMDs which spread money out yearly, many NQDC plans pay out in a lump sum or over a few years. This can spike your income (and tax bracket) in those years. For example, receiving a five-year lump-sum payout at retirement could push you into a higher tax bracket than if that money were spread over a decade. Plan ahead with a tax advisor on how to time distributions to manage the tax impact.
- 🚫 Ignoring state tax traps: State taxes can sneak up on deferred compensation. If you earned deferred income in a high-tax state and then retire in a no-tax state, you might assume you’ve dodged state taxes. But if your payout isn’t structured carefully, your former state could still tax a portion as “source” income. (For instance, taking your deferred comp in a 5-year payout after leaving California could let California tax those payments, whereas a 10+ year installment might avoid California’s tax under federal law.) Always consider where you’ll live during distribution and adjust the payout schedule if needed to minimize state taxes.
- 🚫 Overlooking the 5% owner rule: Business owners and executives who own more than 5% of the company can’t use the “still working” exception to delay RMDs. If you’re a significant owner of your company’s stock and still employed at 73+, you still must take RMDs from your qualified plan. Don’t assume working longer lets you skip required withdrawals in this case.
- 🚫 Assuming you can roll over funds: With qualified plans like 401(k)s, you can roll your balance into an IRA at retirement (and continue deferring taxes, though RMDs will still apply from the IRA). But nonqualified deferred comp balances cannot be rolled over into an IRA or other plan. They must be paid to you as taxable wages per the plan’s schedule. Don’t plan on a rollover to avoid taxes or RMDs for NQDC – it’s not allowed.
Real-Life Examples: RMDs in Different Deferred Comp Plans
Example 1: Government Employee with a 457(b) Plan
Alice, age 75, is a city employee participating in a governmental 457(b) deferred compensation plan. She is still working past the RMD age. Because Alice remains employed by the plan sponsor and isn’t a 5% owner (government employees have no ownership stake), she hasn’t had to take any RMDs from her 457(b) yet. Once she retires next year, she’ll need to begin taking annual RMD withdrawals from her account (or she could roll her 457 savings into an IRA at retirement, at which point IRA RMD rules would kick in).
Example 2: Executive with a Nonqualified Deferred Comp (409A) Plan
Brian, 65, is a recently retired executive who had a nonqualified deferred compensation plan through his company. During his career, he maxed out his 401(k) and also deferred additional bonuses into the NQDC plan. He chose to have his deferred comp paid in five annual installments after retirement, starting at age 61. By age 65, Brian has received all five installments from the plan – all taxable as ordinary income, but not subject to any RMD rules.
There was no age-based requirement forcing out money at 73; his deferred comp was distributed on the schedule he elected. (Meanwhile, Brian’s 401(k) from that employer remains intact and will face RMDs when he turns 73.)
Example 3: Business Owner Over 73 Still Working
Carol, 74, is the owner of a small business (and owns 100% of the company). She continues to work and contributes to her company’s 401(k) plan. However, because Carol owns more than 5% of the business, she does not qualify for the still-working RMD deferral. Even though she’s still on the job, Carol must begin taking RMDs from her 401(k) this year. In contrast, one of her employees who is also 74 and still working for Carol’s company doesn’t have to take an RMD from the plan yet (thanks to the still-working exception that applies to non-owners).
Example 4: Retiree Moving to a No-Tax State with NQDC
Danielle, 60, earned a large deferred bonus in New York via a nonqualified deferred comp plan, and moved to Florida upon retiring. To avoid New York state taxes, she elects to receive her NQDC payout in annual installments over 10 years. Under a federal law that protects certain retirement income for non-residents, New York cannot tax her deferred comp distributions once she’s a non-resident receiving payments over 10 years. Florida has no state income tax, so those distributions are completely free of state tax for her.
The Law Behind RMDs and Deferred Compensation (Evidence & History)
Evolution of RMD Rules
Why do RMDs exist at all? The government wants to ensure tax-deferred retirement money isn’t sheltered forever. Congress established RMD rules decades ago (Internal Revenue Code §401(a)(9)) to make retirees start drawing down accounts and paying taxes in their later years. For a long time, age 70½ was the magic number for RMDs. Recently, lawmakers pushed the age higher: the SECURE Act of 2019 raised the RMD age to 72, and SECURE 2.0 (passed in late 2022) raised it further to 73 (for those born in 1951 or later) and eventually age 75 (for those born 1960 or later). These changes acknowledge longer lifespans and evolving retirement patterns.
The IRS enforces RMD requirements strictly – historically there was a 50% excise tax on any missed RMD amount. (As of 2023, this penalty was reduced to 25%, or 10% if you promptly correct the mistake, but it’s still a significant hit.) In short, RMDs are a legal mechanism to ensure Uncle Sam gets his tax revenue from your retirement savings at some point.
Section 409A and NQDC: Lessons from Enron
Unlike qualified plans, nonqualified deferred compensation had fewer rules until the early 2000s. That changed after corporate scandals (notably the Enron collapse in 2001) exposed how executives could exploit deferred comp. Enron’s executives famously accelerated and protected their deferred compensation payouts right before the company went bankrupt, even as other employees’ retirement funds (and jobs) were wiped out. In response, Congress enacted Section 409A of the tax code in 2004. This law imposed a strict regime on NQDC plans to prevent abuse.
Under 409A, deferrals must be elected in advance, and payouts can only happen upon specific events (retirement, a set future date, separation from service, death, disability, or a bona fide emergency). No sneaky early withdrawals or last-minute changes are allowed. If the rules are violated, the consequences are severe: all deferred amounts become immediately taxable to the employee (as if paid out), plus a 20% penalty tax and interest on that tax. The 409A rules – and their harsh penalties – serve as evidence of how serious the government is about preventing tax avoidance and abuse in executive compensation.
ERISA Protection vs. Unsecured Promises
Another legal distinction: qualified retirement plans are protected by ERISA (the Employee Retirement Income Security Act of 1974), whereas nonqualified plans are basically exempt from it. Under ERISA, qualified plans must hold assets in trust (or insurance contracts) for participants’ benefit, and those assets are generally shielded from employer creditors. There are also participant rights and fiduciary standards. In contrast, a nonqualified deferred comp plan is often just a promise on the employer’s books. The deferred funds remain part of the company’s general assets (sometimes informally set aside in a “rabbi trust,” which still stays accessible to creditors).
If the company goes bankrupt, NQDC participants line up as unsecured creditors – meaning they could lose part or all of their deferred money. There’s no federal pension insurance for NQDC either. This stark lack of protection explains why nonqualified plans carry more risk. It also illustrates why RMD rules don’t cover NQDC – the government doesn’t give these plans the same tax-favored status, so it doesn’t impose the same withdrawal mandates; instead, NQDC taxation is governed by 409A and the plan’s terms.
Deferred Comp vs. Qualified Plans: Key Differences
To summarize, here is a side-by-side comparison of qualified retirement plans versus nonqualified deferred compensation plans:
| Qualified Retirement Plans (401(k), 403(b), 457(b), etc.) | Nonqualified Deferred Comp Plans (409A NQDC) |
|---|---|
| RMDs: Yes – RMDs must start by age 73 (with a delay allowed if still working and not a 5% owner). Contribution Limits: Annual contributions are capped by IRS limits (e.g. $22,500 annual 401(k) deferral limit in recent years). Early Withdrawal Penalty: 10% penalty on withdrawals before age 59½ (except governmental 457 plans, which have no early withdrawal penalty). Rollovers: You can roll over balances to an IRA or another employer’s plan when you leave the job, continuing tax deferral (IRA will have its own RMDs later). Creditor Protection: Plan assets are held in trust and generally protected (ERISA safeguards apply); very low risk of loss if employer goes bankrupt. | RMDs: No – not subject to age-based RMD rules (no forced distributions at 73; payouts occur per plan schedule). Contribution Limits: No fixed IRS limit on how much you can defer (you can defer large amounts if the plan allows, far beyond 401(k) limits). Early Access: No 59½ penalty since it’s not a qualified plan, but you can only withdraw under the plan’s terms (typically at retirement, a set date, or hardship if allowed – no arbitrary early cash-outs). Rollovers: Cannot roll over NQDC balances to an IRA or other plan. Distribution must be taken as taxable income per the plan; no further tax deferral once paid. Creditor Risk: Assets are unsecured promises (often informally funded by the company). If the employer fails, you become a general creditor and could lose your deferred money. |
Key Terms and Definitions
| Term | Definition |
|---|---|
| Required Minimum Distribution (RMD) | A minimum amount you must withdraw each year from certain retirement accounts once you reach a certain age (currently 73). RMDs are mandated by the IRS to ensure tax-deferred savings are eventually taxed. |
| Nonqualified Deferred Compensation (NQDC) | An arrangement where an employer allows selected employees to defer a portion of their earnings beyond the limits of qualified retirement plans. NQDC plans (also called “nonqualified plans” or “top-hat” plans) are not subject to most ERISA rules or IRS contribution limits. |
| Section 409A | The section of the Internal Revenue Code that governs nonqualified deferred compensation. It sets strict rules on deferral elections and distributions; violations result in immediate taxation and penalties on deferred amounts. |
| 457(b) Plan | A tax-advantaged deferred compensation plan for employees of state and local governments (and some nonprofits). Similar to a 401(k) in tax treatment, with pre-tax contributions and required distributions, but 457(b) plans have no early withdrawal penalty for distributions after separation from service. |
| 457(f) Plan | A nonqualified deferred compensation arrangement for certain tax-exempt or government employees that does not meet 457(b) limits. It taxes deferred amounts once they vest (i.e., when the risk of forfeiture lapses), so long-term deferral is limited. |
| ERISA | The Employee Retirement Income Security Act of 1974. U.S. law that sets standards and protections for pension and 401(k)-type plans (qualified plans). ERISA requires fiduciary oversight and secures plan assets, but it generally does not cover nonqualified deferred comp plans. |
| Rabbi Trust | A trust established by a company to hold funds set aside for a nonqualified deferred comp plan. The assets in a rabbi trust are for the benefit of employees but remain accessible to creditors if the company goes bankrupt (so they don’t remove the risk). |
| “Still-Working” Exception | A rule that allows you to postpone RMDs from an employer-sponsored retirement plan if you are still employed by that employer at RMD age (as long as you don’t own more than 5% of the company). This lets continued workers delay withdrawals until retirement. |
Pros and Cons of Deferred Compensation Plans
| Pros (Why defer compensation) | Cons (Challenges & risks) |
|---|---|
| – Allows higher savings: You can invest more for retirement beyond the normal 401(k) limits, which is valuable for high earners. – Tax deferral benefits: Lowers your current taxable income and lets your money grow tax-deferred until you receive it (potentially when you’re in a lower tax bracket or in a tax-friendlier state). – Customized payout timing: You often can schedule when and how you’ll receive the money (e.g. lump sum at retirement or over 5-10 years), which can help with retirement income planning (like bridging income before Social Security or RMDs from other accounts). – Employer contributions: Some plans offer matching or supplemental employer contributions for deferred amounts (especially to “make up” for 401(k) limits), boosting your savings further. – No age restrictions: NQDC plans aren’t bound by age 59½ rules – if the plan allows, you could start receiving distributions in your 50s or early 60s without IRS early withdrawal penalties (useful for early retirees). | – Creditor risk: Your deferred money is not guaranteed – if your employer goes bankrupt or faces financial trouble, you could lose some or all of your deferred compensation (since you’re an unsecured creditor). – Lack of liquidity: You generally cannot access the funds on a whim. Until the specified distribution time (retirement or other trigger), your money is locked away (no loans or emergency withdrawals unless narrowly allowed). – Strict rules & no do-overs: Once you elect a deferral and payout schedule, you’re largely locked in. Changing distribution timing later is very difficult (and violating 409A rules to cash out early leads to heavy penalties). – Tax rate uncertainty: While deferral aims to lower taxes, there’s a risk you could end up in a higher tax bracket later, or tax laws could change. All payouts are taxed as ordinary income, so if rates rise or you have large lump-sum income, you might pay more tax than expected. – No rollover or special tax treatment: Unlike a 401(k), you can’t roll an NQDC payout into an IRA to continue deferring taxes. You also miss out on special options like Roth accounts or capital gains treatment – it’s all ordinary income when paid. |
State-Level Nuances: Taxes and Rules by Location
Federal rules aren’t the whole story – where you live and earn can affect your deferred compensation outcomes. In 1996, Congress passed a law (4 U.S.C. §114) to stop states from taxing retirees’ “retirement income” after they move away. Under this federal law, distributions from qualified plans, IRAs, and certain annuities are protected from taxation by any state other than your state of residence. Some nonqualified plan payouts can count as “retirement income” too, but only if taken as a lifetime annuity or in at least 10 annual installments – which is why, as seen in our example, spreading NQDC payments over 10+ years can shield you from the old state’s taxes.
State income tax laws vary widely. Some states (for example, Illinois and Mississippi) fully exempt retirement income (including 401(k) or pension distributions) from state taxes. Other states (like California and New York) tax retirement and deferred comp distributions just like any other income. Many states offer partial exclusions or credits – for instance, a state might let you exclude a certain dollar amount of retirement income each year. The key point is that your payout structure and the state you reside in during retirement can have big tax implications. Always check how your current state (and any state you plan to move to) will tax deferred compensation plan payouts and retirement withdrawals.
Frequently Asked Questions (FAQs)
Q: Do 457 plans have required minimum distributions?
A: Yes. Both governmental and non-governmental 457(b) deferred compensation plans follow the same RMD rules as other retirement plans (starting at age 73 under current law). Participants must begin annual withdrawals by the required deadlines to avoid penalties.
Q: Do nonqualified deferred compensation plans have RMD rules?
A: No. Nonqualified deferred comp plans (under Section 409A) are not subject to the IRS’s required minimum distribution rules at any age. Distributions occur only per the plan’s terms – usually at retirement, a specified future date, or other allowed events.
Q: Can I delay RMDs if I’m still working at age 73?
A: Yes – but only in your current employer’s retirement plan (and only if you do not own over 5% of the company). As long as you keep working there, you can postpone RMDs from the plan until you retire.
Q: Do Roth accounts have RMDs?
A: No. Roth IRAs never require distributions during the original owner’s lifetime. (And beginning in 2024, Roth 401(k) and 403(b) accounts no longer have RMDs either.) You can keep Roth money invested as long as you live.
Q: Can I roll over a deferred compensation plan into an IRA?
A: Yes – if it’s a qualified plan like a 401(k) or government 457(b), you can roll it into an IRA after leaving your job. No – nonqualified deferred comp plans cannot be rolled into an IRA.
Q: Are there penalties for missing an RMD?
A: Yes. The IRS imposes a steep excise tax if you fail to take a required minimum distribution. The penalty is generally 25% of the amount not withdrawn (reduced to 10% if you promptly correct the mistake by taking the RMD).
Q: Do my beneficiaries have to take RMDs from an inherited deferred comp account?
A: Yes. Beneficiaries must take distributions after you die. Inherited 401(k) or 457 accounts must be emptied within 10 years under current law (for non-spouse heirs). Nonqualified deferred comp balances are paid out per the plan (often as a lump sum).
Q: Are deferred compensation plan distributions taxed as ordinary income?
A: Yes. Money paid out from a deferred compensation plan is taxed as regular income in the year you receive it, just like a paycheck or a 401(k) distribution. There’s no special lower tax rate on these payouts.
Q: Can I withdraw from my deferred comp plan early if I need the money?
A: No. Nonqualified deferred comp plans do not allow early cash-outs (except in very rare, plan-approved hardship cases). Even 401(k)-type plans impose a 10% penalty if you withdraw before age 59½. Deferred comp funds aren’t accessible until their scheduled payout.
Q: Are nonqualified deferred compensation plans protected if my company goes bankrupt?
A: No. NQDC plans are unsecured promises. The funds remain part of the employer’s assets, so if the company goes bankrupt, deferred comp participants become general creditors. Unlike a 401(k), there’s no federal insurance or full security for NQDC assets.