For executives, Social Security makes up less savings than for lower-income employees.
Speaking on a panel at the 2017 PLANSPONSOR National Conference in Washington, D.C., Jeff Roberts, regional channel manager at ADP, said executive benefit and nonqualified deferred compensation plans (NQDCs) are used by employers to attract and retain key employees.
Jason Burlie, sales and strategic relationships – nonqualified practice leader at Prudential, added that the plans are used to make up for missed deferral opportunities for executives in the company’s qualified plan and to provide another retirement vehicle for executives.
Nonqualified plans are tax-deferred retirement vehicles that may be used by only a select group of highly compensated employees, Roberts explained. Some of their advantages: Nonqualified plans are exempt from Employee Retirement Income Security Act (ERISA) requirements that may be problematic; the Department of Labor( DOL) fiduciary rule is not a concern; and the plans are exempt from coverage and nondiscrimination testing and from Form 5500 filing.
Burlie added that NQDC plans offer unlimited deferral capability to executives. They are technically unfunded plans, even if the plan sponsor sets aside assets to help pay for future obligations. They are always subject to insolvency risk, and assets can go to creditors in bankruptcy.
Although they are exempt from many ERISA rules, NQDCs are subject to 409A regulations. But this doesn’t have to be complicated, Burlie said. In effect, in 2009, 409A set rules for NQDC plans, which previously came from case law. There are rules about when employees can make an election to defer to the plan, and 409A addresses how money can be taken out of the plan.
Roberts said data from the Boston Research Group found that the average participant in an NQDC plan will receive 20% of retirement income from this plan alone. “Some don’t participate because they don’t understand the plan. Creating communication that is simple and actionable is important. Just because they are executives doesn’t mean they understand,” he said.
Burlie said he sees a rapidly growing rate of plans bundling both defined contribution (DC) and NQDC retirement services. “For many years, NQDC was a niche market, and there were a few niche providers; now more DC providers are developing expertise,” he said. The industry has seen a 20% increase, year-over-year, in bundling of these services, he said. There has also been an increase in advisers and consultants getting into the NQDC market, mostly due to financial wellness efforts.
According to Roberts, the growth in the NQDC market is coming from midsize companies, which are attracting employees who left large firms that had these benefits. So there is an increase in plan creation. At privately held companies, the market is seeing more company money going into NQDC plans as a bonus, rather than using company equity, to appease those who came from publicly owned companies that provided equity compensation.NEXT: What’s ahead for NQDC design and funding
Burlie noted that, in Fortune 1000 companies, one-third use corporate-owned life insurance (COLI) to fund their plan obligations; one-third use mutual funds; and one-third are not funded. But plan sponsors in the small market mostly use mutual funds.
Robert Massa, director, retirement, at Ascende Wealth Advisers Inc., and moderator of the panel, told conference attendees that President Donald Trump is talking about changing the tax structure of retirement plans, and this may affect the offering and funding of NQDC plans.
If the Trump tax plan is implemented as laid out, it calls for 10%, 25% and 35% tax brackets, Burlie said. Most participants in these plans will be in a higher tax bracket, so he didn’t expect a significant change in plan offerings; executives will still be interested in these plans because of the insufficiency of qualified plans. However, he observed, capital gains tax changes may be different. If corporate tax rates drop to 15%, the NQDC market will see less use of COLI—a tax shelter—because returns of this long-term investment will be too far out, and no one expects tax cuts to be permanent.
He pointed to one plan feature often overlooked in NQDC plans: a restoration match. When executives defer into a deferred compensation plan, that money comes out before the income that is subject to defined contribution (DC) plan deferrals, so executives in these plans can’t defer as much on total income as the lower-paid, he explained, adding that 47% of NQDC plan sponsors do a restoration match or some kind of match to help executives get the full match benefit of what they could have deferred to the DC plan if not for NQDC plan deferrals.
In addition, according to Burlie, there is often confusion around FICA [Federal Insurance Contributions Act] taxes with nonqualified plans. Plan sponsors should know that they have to take FICA out when nonqualified balances vest. He suggested that plan sponsors engage in a conversation with plan providers about this.
“With more bundling and more advisers handling both DC and NQDC plans, there’s a concern that, if the provider or adviser is used to dealing with DC plans, they may not know the differences, and about FICA taxation,” Roberts said. “Plan sponsors should make sure they are working with NQDC plan experts.”