Certified Plan Sponsor Professional (CPSP) Practice Exam

Which statement about the funding of NQDC plans is true?

1. They must be fully funded immediately

2. They are often unfunded and rely on the employer to pay benefits

3. They require state-mandated contributions

4. They must be funded by employee contributions only

The correct answer is: They are often unfunded and rely on the employer to pay benefits

Non-qualified deferred compensation (NQDC) plans are designed to provide additional retirement benefits to employees beyond what is permitted under qualified plans like 401(k)s. One of their defining characteristics is that these plans are often unfunded, meaning that they do not require the employer to set aside specific assets to cover the promised benefits. Instead, the employer essentially makes a promise to pay the benefits in the future, and the funds for those benefits are typically generated from the employer's general assets or cash flow at the time of payout. This structure allows employers more flexibility in managing their cash flow and can also provide potential tax benefits. Because the plans are not funded in the same way as qualified plans, participants may be subject to more risk if the employer encounters financial difficulties, but this aspect is a fundamental feature of NQDC plans. The other choices address misconceptions about NQDC funding. Immediate full funding is not a requirement for these plans, and there are no state-mandated contributions necessary. Additionally, while employee contributions are common, they are not the sole means of funding these plans, as the employer's commitment plays a significant role. Thus, the characterization of NQDC plans as often unfunded and reliant on employer payments is accurate and aligns with