A salary (or wage) continuation plan is a written agreement in which a business promises to keep paying an owner or key employee, or their family, for a set period if death, disability, or retirement stops them from working.
When we work with owners planning a sale to insiders or a transfer to children in the business, two tools often come up together: Non-Qualified Deferred Compensation (NQDC) and Salary Continuation. They sound similar, and both involve payments to the owner after something changes. However, they solve very different problems. Using the wrong one, or assuming one covers the other, can leave real gaps in your plan.
Non-Qualified Deferred Compensation: Paying Out Income Already EARNED
NQDC lets highly compensated people, in this case the exiting owner, defer part of their pay beyond the limits the IRS allows in a qualified plan such as a 401(k). The income is earned now and paid later, often after the owner steps away. Income taxes are deferred until the money is actually received.
NQDC is especially useful in insider and family transitions:
It can shift taxable income into years when the owner may be in a lower bracket.
The company generally deducts the payments when they're made, which makes it a tax-efficient way to move value to the exiting owner alongside, or in place of, a portion of the purchase price.
Keep one point in mind. NQDC is typically an unsecured promise from the company. Your payments depend on the business continuing to perform under its new leadership.
Salary Continuation: Protecting Income NOT YET EARNED
A Salary (or Wage) Continuation Plan has a different purpose: it provides personal financial stability for an owner or key employee when a triggering event, such as death, disability, or retirement, stops them from working. It continues income that hasn't yet been earned, and its goals are to:
Provide salary for a set period, typically 60 days to 12 months, when you are unable to work
Bridge the gap until insurance benefits begin
Protect you and your family from financial loss
Questions to Ask Yourself
If you're wondering whether a Salary Continuation Plan belongs in your plan, start here:
What short-term gaps exist in your personal insurance and benefits package?
If you die or become disabled, is it important for your spouse or family to keep receiving your salary for a time? How long?
Could the company afford to continue your salary if you weren't working? For how long?
Are you relying on a co-owner's verbal commitment to keep paying you? If so, what happens if that co-owner is no longer there, or changes their mind?
The Bottom Line
NQDC is about when you receive income you've already earned. Salary Continuation is about protecting income you can no longer earn. Many owners in transition need to consider both.
If you think either could help in your situation, your business attorney, employee benefits advisor, or insurance advisor can help analyze and structure the right plan. Both should be documented in writing, and NQDC must also comply with IRC Section 409A (Listen to our episode on Section 409A at the ExitReadiness® PODCAST). And, as always, please contact us if we can be of assistance at email@ennislp.com.
