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.
PS: Myth #4 says NQDC plans are primarily used as a tax planning benefit instead of as a retirement plan.
Dorton: The tax benefit is important. NQDC plans allow key employees to manage current income and taxation with a more efficient accumulation of assets over time. But those using the plans cite long-term savings and retirement planning as the key motivators.
In our annual survey, plan sponsors say the top reason for offering an NQDC plan is to help participants save for retirement in excess of qualified plan limits. About 82% of our participants agree that the most important reason for the NQDC plan is retirement readiness.
PS: What would you suggest to employers that are considering or already have NQDC plans as part of their overall benefits program?
Dorton: First and foremost, don’t go it alone. Work with a financial professional to help you establish goals. Your adviser can also help you find an experienced provider, like The Principal®, that has a proven track record with systems and administrative services designed specifically for NQDC plans.
The provider and financial professional can help with the second step, which is to define the purpose for the plan and put it in writing.
Third, make sure the plan design supports the stated purpose of the plan.
Fourth, understand how to drive satisfaction among participants. Our experience has found that participants are most satisfied when employers.
• Offer education and assistance to help participants make decisions and take action;
• Ensure that the number and type of investment choices available in the plan match expectations; and
• Communicate, communicate, communicate. Make sure employees know important dates for making plan decisions and understand how the plan addresses retirement readiness.
Finally, it’s important for participants, sponsors and administrative partners to understand and be aware of Internal Revenue Service (IRS) 409A guidelines. Your financial professional and provider can keep you informed.
PS: Is there a best practice for how often NQDC sponsors should evaluate their plan design?
Dorton: It’s important that NQDC plans evolve with the ongoing needs of the organization and the external business climate. We recommend an annual checkup to ensure internal factors like participation, deferrals, contributions and participant appreciation of the benefit are meeting expectations.
It’s also essential to review your NQDC plan any time there’s an event—from acquisitions or reorganizations to changes in eligibility rules or plan incentives. Shifts in the composition of the participant base, such as a large number of employees retiring, can also warrant an in-depth look.
External regulatory and legislative changes can also impact how the plan should operate. For example, the IRS recently updated its guide for auditing NQDC plans.
Annual check-ups help ensure that the plan design continues to support the organization goals of the plan sponsor while meeting the savings and distribution needs of participants.
About The Principal®: The Principal Financial Group® is a global investment management leader offering businesses, individuals and institutional clients a wide range of financial products and services, including retirement, asset management and insurance solutions through its diverse family of financial services companies.
* The 2014 Principal Nonqualified Deferred Compensation Plan Survey is an online survey of 205 NQDC plan sponsors (conducted between September 22 and October 4, 2014) and 923 plan participants (conducted between September 23 and October 3, 2014).
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