Nonqualified deferred compensation (NQDC) plans don’t just help organizations attract and retain key employees, they also provide flexibility in pre- and post-retirement income distribution and in tax planning for an organization’s top talent. Gary Dorton, vice president of Nonqualified Employer Solutions at the Principal Financial Group®, recently spoke with Alison Cooke Mintzer, editor-in-chief of PLANSPONSOR, about the role nonqualified deferred compensation benefits can play in providing retirement income.
PS: What role does an employer play in providing benefits and tools to help all employees address the issue of adequate retirement income?
Dorton: Many employees struggle with adequate planning for retirement. They look to their employer as a primary source of information on issues like how much to save and when to retire. So far the focus for most employers has been on helping employees understand the advantages of saving for retirement. However, statistics from our Principal Retirement Readiness Survey1 show that only 15% of sponsors believe their employees are prepared to manage their money in retirement. This growing concern is forcing employers to make sure they have the right tools and education to help all employees prepare, including the top talent that play such a vital role in driving long-term organizational success.
PS: Let’s talk specifically about nonqualified deferred compensation plans: Why haven’t we heard more about these as they relate to retirement income?
Dorton: Most employers understand the role NQDC plans play in achieving an organization’s goal. They help recruit, retain and reward top employees. What they might not understand is how valuable these plans can be for the unique retirement planning needs of these key individuals. In addition to Social Security, qualified defined contribution (DC) and defined benefit (DB) plans provide the main source of retirement income for most employees. But highly compensated individuals are often looking for more workplace savings than their fellow employees. As more key employees max out traditional retirement plans, the need for deferred compensation plans and the flexibility they can provide rises. Employers and the advisors they work with should consider nonqualified solutions that address these concerns and help retain and attract top talent for the organization.
PS: So, why do nonqualified deferred compensation plans matter so much to employers and these key employees?
Dorton: Now more than ever, the primary purpose of NQDC plans is to address the retirement readiness of this group of employees. Results from our annual study of the NQDC market confirmed that for both employers and participants, the No. 1 reason to participate in or offer an NQDC plan is for retirement savings2. We believe that changing demographic and business trends will help accelerate the focus of these plans in the coming years from just additional retirement savings to include retirement income management.
PS: How can the use of these NQDC plans contribute to the retirement income management process?
Dorton: Retirement income management first requires accumulating sufficient savings throughout your career. Then, you must use those savings and other sources to generate income for expenses you will encounter during retirement. The advantage these NQDC participants have is being able to save on a tax-deferred basis beyond qualified plan limits while working. And they benefit from more retirement income flexibility once in retirement. This flexibility occurs because there is an additional source of income to draw from and the option of choosing the timing and form of receiving these benefits from your NQDC plan.
PS: How can employers use NQDC benefit plans to help key employees address income planning in multiple phases—from the working years to early or partial retirement to full retirement?
Dorton: Employers need a nonqualified plan design that meets their needs and works within their benefits structure. In order for key employees to benefit while still working, best practice NQDC plan designs generally include in-service accounts. This enables participants, while still employed, to handle large expenses—i.e. college funding. In-service accounts can also be used to help in preretirement planning or in preparation for a semiretired phase of professional life.
At the time of deferral, a participant has the ability to choose among the payment options offered in the plan and how they will receive distributions after separation from service—which could be retirement, termination or resignation by the employee. This gives the key employee the ability to use NQDC benefits as a “bridge” for early retirement, a method to increase long-term Social Security benefits or to simply supplement retirement income coming from other sources.
Another important aspect for an employer is understanding what other benefits a key employee might have—Social Security, defined benefit or an equity based plan—and how those fit into the overall picture.
PS: What are the things that a participant should evaluate when trying to coordinate NQDC plan benefits with other retirement income sources?
Dorton: Key employees need be conscious of what role a deferred compensation plan must play. Is it bridge funding or needed long-term; should it be used for major events? Once you figure that out, you can put the puzzle pieces together and construct a holistic plan personalized to your lifestyle.
The goal is to integrate the timing of payments from various assets and income sources, including: employer-sponsored retirement benefits; stock options or other equity-based benefits; Social Security benefits; personal retirement savings sources such as individual retirement accounts (IRAs) and Roth IRAs; and personal investments.
Each income source has its own appreciation potential and tax treatment. An individual might fund the first part of retirement with NQDC plan distributions and allow other tax deferred assets to continue to grow until a later age, or even until minimum distributions are required starting at age 70 and a half. And NQDC can be used as a “bridge” to delay and maximize the lifetime benefits available under Social Security. Taxable distributions from NQDC plans can also be coordinated with non-taxable payments—such as selling high-basis assets or using Roth IRA distributions—to effectively manage current taxation.
The role that deferred compensation benefits play in retirement income planning is still evolving, but it is becoming an increasingly important component of the overall benefit package for key employees. It is essential for both employers and their key employees to work with a financial professional to look at ways to maximize retirement income in the most tax-efficient way.
1Principal Retirement Readiness Survey in 2011
22012 Trends in Nonqualified Compensation
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.
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