Deferred Compensation State Tax: What Happens When You Move (the 10-Year Rule)

Deferred compensation can be taxed by the state where you earned it, even after you move away, unless the payout qualifies for federal protection. Under 4 U.S.C. §114, a former state generally cannot tax nonqualified deferred compensation you receive as a nonresident if it is paid in substantially equal installments, at least annually, over 10 years or more (or over your life), or if it comes from a qualifying excess benefit plan.

That makes your payout election one of the most important state tax decisions in a non-qualified deferred compensation (NQDC) plan. A lump sum, or a schedule shorter than 10 years, does not get that federal protection. So the state you are leaving may still claim a share of income you collect after you have moved.

This guide covers how states tax deferred pay, what the federal 10-year rule protects and what it does not, how residency changes and no-income-tax states fit in, and why the choice you make at enrollment can matter years later. It is written for private-employer 409A plans, not state or municipal 457(b) plans.

Why your former work state may still tax deferred pay

Deferred compensation is pay for work you have already done. You defer the income tax, but the pay is still tied to the place where you earned it.

States commonly tax nonresidents on income from sources inside the state, and wages for work performed in a state are a classic example. Without a federal rule, a state could argue that a payout received years later, after you moved, is still compensation for services performed there. This is often called source taxation.

Your new home state may also want to tax the same payout because you now live there. When two states both have a claim, the result depends on each state's rules and on the federal limit described below.

Federal income tax is a separate matter. Moving does not change your federal tax on the payout, which is ordinary income wherever you live. For the federal side, see how deferred compensation is taxed.

The 10-year rule: what 4 U.S.C. §114 protects

Federal law limits states' ability to tax the retirement income of former residents. The statute says no state may impose income tax on the "retirement income" of an individual who is not a resident or domiciliary of that state, as determined under that state's laws.

For NQDC, the statute covers two kinds of payments.

1. Substantially equal periodic payments. Payments from a plan described in IRC 3121(v)(2)(C), which includes typical NQDC plans, are covered if they are part of a series of substantially equal periodic payments that are:

• made not less frequently than annually, and
• paid for your life or life expectancy (or the joint lives of you and a beneficiary), or for a period of not less than 10 years.

2. Excess benefit plan payments. Payments made after termination of employment under a plan maintained solely to provide benefits above the limits that apply to qualified plans (such as the 401(a)(17) compensation limit, the 402(g) deferral limit or the 415 limits) are covered regardless of the payout schedule. Many elective deferral plans let you defer more than just the amounts that exceed those limits, so whether your plan fits this narrow category is a question for your plan administrator.

The statute also says that adjusting payments under a predetermined formula, or for cost of living or similar adjustments, does not by itself stop payments from counting as substantially equal.

What is not protected

The protection is specific. Several common payout choices fall outside it.

Two points trip people up:

• Nine installments are not close enough. The statute says "not less than 10 years." A 9-year schedule does not qualify under the equal-payments test.
• Installments that vary with investment results. Many plans recalculate each installment as the remaining balance divided by the remaining number of payments, so the dollar amounts move with the plan's returns. The statute allows adjustments under a predetermined formula, but whether your plan's method counts as substantially equal is a technical question. Ask the plan administrator, and a tax professional, before relying on it.

Residency, domicile and no-income-tax states

Federal protection only matters if you are actually a nonresident of the former state when you are paid. Residency and domicile are determined under each state's own laws, and states differ in how they test them. A move that looks good on paper but leaves strong ties behind (a home, family, a business) can be challenged.

Timing matters too. The protection looks at your status when the payment is received, not when the pay was earned. If you move after the first few installments, the earlier payments were received while you were still a resident.

Moving to a state without a wage income tax can make the payout election especially valuable:

• With a qualifying 10-year (or longer) schedule, the former state cannot tax the payments, and your new state has no wage income tax to apply.
• With a lump sum or a shorter schedule, the former state may tax the payout as source income, and you may have no resident-state tax to offset it.

State tax laws also change. Washington, long known for not taxing wage income, enacted a 9.9% tax on income above a $1 million deduction starting in 2028, and a measure to repeal it was on the November 2026 ballot. A payout that stretches 10 or 15 years will cross many legislative sessions, so treat today's rates as an assumption, not a promise.

Local income taxes

Some cities and counties levy their own income taxes on top of state tax. Maryland, for example, adds a county income tax that ranged from 2.25% to 3.30% for 2025. Local taxes follow their own residency and sourcing rules, so check them for both your old and new locations.

Credits for tax paid to another state

If two states tax the same payout, your resident state generally allows a credit for tax paid to the other state on that income. Credits are often limited to the tax your resident state would have charged on the same income, so you may end up paying roughly the higher of the two states' taxes rather than both in full. The rules vary by state, and a state with no income tax has no tax to credit against.

Why the payout election matters

Under the 409A rules, you normally choose the payout form when you make the deferral election, usually before the year the pay is earned. Changing it later generally requires an election at least 12 months before the first scheduled payment that pushes the first payment back at least 5 years. That means the state tax treatment of a payout can be locked in years before you know where you will live.

Here is an illustrative, simplified example. It uses a hypothetical flat 9% former-state rate and ignores investment earnings, progressive brackets and any credits.

The longer schedule is not free, though. The trade-offs include:

• Credit risk. Your balance stays an unsecured promise from your employer for longer. See NQDC risks and rabbi trusts.
• Federal brackets. Spreading payments often helps here as well, but your other income during the payout years matters. See lump sum vs installments.
• Flexibility. You cannot speed up installments later just because your plans change.

You can test these trade-offs with the free NQDC calculator. Enter the state you live in now and the state you expect to live in at payout, choose a payout schedule from a lump sum to 15 annual installments, and decide whether the former work state can tax the payout. The calculator applies the §114 protection to 10 or more equal annual installments and can add a local income tax rate. It assumes your plan and payments qualify; it does not verify that.

Your plan document governs what payout options you have, and state residency and sourcing rules can be complex, so consult a qualified tax or financial professional before making an election based on a planned move.

Frequently asked questions

If I earn deferred compensation in a high-tax state and retire to a no-tax state, which state taxes it?

It depends mainly on the payout schedule. If you are a genuine nonresident and the payments qualify under 4 U.S.C. §114, such as substantially equal annual installments over at least 10 years, the former state cannot tax them. A lump sum or a shorter schedule is not protected, so the former state may tax it as income earned there.

What is the 10-year rule for deferred compensation?

It is the part of 4 U.S.C. §114 that protects nonqualified deferred compensation paid in substantially equal periodic payments, at least annually, over a period of not less than 10 years (or over your life or life expectancy). Payments that meet the test cannot be taxed by a state where you no longer live.

Do 9 annual installments or a lump sum protect me from my former state's tax?

No. The statute requires a period of not less than 10 years, so a 9-year schedule does not meet the equal-payments test, and a lump sum is not a series of payments at all. Unless the plan is a qualifying excess benefit plan, those payouts can still be taxed by the source state.

What is the excess benefit plan exception?

Payments made after you leave employment from a plan maintained solely to provide benefits above qualified-plan limits (such as the 401(a)(17), 402(g) or 415 limits) are protected regardless of the schedule. Many elective NQDC plans do more than that, so check with your plan administrator before assuming your plan fits.

Is residency tested when I earn the money or when it is paid?

The federal protection applies to income received by someone who is not a resident or domiciliary of the state, so it looks at your status when you receive each payment. Each state decides residency and domicile under its own laws, and payments received before your move were received as a resident.

Does a 10-year payout have any downside?

Yes. Your balance stays exposed to your employer's credit risk for longer, you give up flexibility, and future tax law in either state may change. Whether the state tax savings outweigh those costs depends on your numbers.