Retirement benefit strategies matter as much to organizations as they do to employees. Nonqualified deferred compensation (NQDC) plans can help employers attract and retain top talent while also addressing retirement readiness, yet many times both potential plan sponsors and participants have varying degrees of understanding and information about NQDC plans. PLANSPONSOR spoke with Gary Dorton, vice president, Nonqualified Employer Solutions, at the Principal Financial Group®, about the “urban myths” surrounding NQDC plans.
PS: Why do you think nonqualified deferred compensation plans are viewed with an air of mystery by some employers?
Dorton: NQDC plans are not standardized plans like other employee benefits. They offer design flexibility to meet the organizational needs of each particular employer. Because of this, the plans may look different from employer to employer.
One of the more common goals is to provide effective retirement benefits for a select group of key employees. Until an employer recognizes the need to improve offerings for key employees, the employer may not have been exposed to information about how NQDC plans work.
PS: I’d like your thoughts on some common misconceptions about these plans. Let’s start with Myth #1: NQDC plans are really executive compensation paid to high-income CEOs on Wall Street.
Dorton: While CEOs do participate in NQDC plans, our research shows that the majority of participants are more “Main Street middle management” than “Wall Street executive.”
Our latest annual survey* found that 80% of participants are in senior or middle management positions. Over the past several years, we’ve seen more employers increasing eligibility among middle management ranks. The average participant’s annual deferral is in the $20,000 to $30,000 range.
Generally with NQDC plans, compensation isn’t increased but rather deferred to a later payment date. Plans can allow for employer contributions, employee deferrals or a combination of both. In the majority of the plans we service, participants are making deferrals out of their own compensation.
It’s also important to remember that regardless of who participates, NQDC plans are designed to address organizational goals—primarily to help recruit, retain and retire key employees.
PS: Myth #2 is that only large for-profit companies use NQDC plans, and that these plans haven’t been available to small and midsized businesses. What is your experience?
Dorton: Larger for-profit companies were the first to adopt NQDC plans, but the plans are available now to smaller employers. In fact, over the last 10 to 15 years, we’ve seen an increase in the number of small to medium-sized employers using them.
Smaller employers face the same recruiting and retention challenges as large employers. That is why growing numbers are turning to NQDC as a solution. We’ve made the capabilities, features and best practices of NQDC plans in the larger market accessible to small to medium-sized employers.
NQDC plans are affordable for any size organization when plan provisions are designed properly and if the appropriate plan financing options are considered.
A key is to bundle plan administrative services with the same provider who designed the plan. This helps ensure coordination in how the plan is operating and serviced, to meet the intended organizational and participant needs.
PS: Myth #3 is that employers don’t need to worry about the retirement needs of key employees because they are well compensated and retirement is their own issue to manage.
Dorton: On the contrary, employers are very focused on improving retirement readiness of key employees. Again, going back to our most recent survey, two out of three plan sponsors expressed concern over whether key employees will have enough retirement savings.
Compensation isn’t the only factor to consider in retirement preparation for this group of employees. Key employees often run into a retirement savings barrier. Qualified defined contribution (DC) plan limitations—both annual limits and those due to ADP/ACP testing—reduce the opportunities for pre-tax retirement savings. As a result, retirement replacement ratios in employer-sponsored qualified plans for key employees tend to be lower.
Additional income limits on individual options like individual retirement accounts (IRAs) and Roth IRAs significantly reduce pre-tax savings opportunities for key employees. NQDC plans serve as an option to bridge this retirement savings gap because they allow additional tax-deferred savings.