Market headwinds have led some financial professionals to question the role of nonqualified deferred compensation (NQDC) plans in their business practice. Since 2008, these plans have weathered a variety of issues: Section 409A final regulations, the economic downturn’s wear and tear on employers, investment volatility and negative perceptions of executive compensation.
In the face of this, do NQDC plans have a future? In a word: absolutely. The market is alive and well and appears poised to rebound with growth after a few difficult years.
The NQDC plan’s value
A 2011 survey of NQDC plan sponsors, conducted by the Plan Sponsor Council of America/401(k) and Boston Research Group, cited the following top three areas where employers believe NQDC plans have achieved their business objectives:
• To help eligible employees accumulate retirement assets,
• To have a competitive benefits package,
• To help eligible employees raise their income replacement ratio.
The results show that NQDCs can help employers with the four “R’s” when it comes to key employees: recruit, reward, retain and retire. But how valuable are NQDC benefits as viewed by participants? These plans provide:
• Tax-deferred contributions (federal and state income tax, where applicable),
• Tax-deferred earnings,
• No contribution limitations (up to 100% of earned income),
• Flexible benefit distributions with more withdrawal options than a traditional qualified plan,
• A disciplined approach to building a meaningful retirement benefit.
It’s clear that NQDC plans are helping employers achieve business objectives and providing significant benefits to key employees. Yet, employers still have objections. Advisors can address the negative perceptions in two key areas:
1. Market volatility risk is too great.
This isn’t an issue just for the wealthy or even participants in nonqualified plans. This risk is inherent to investing. So while the past several years have resulted in ups and downs in virtually every investment category, that doesn’t change the fundamental benefits that nonqualified deferred compensation plans provide to employers and participants.
Many of today’s newer NQDC plans come with an administrative services platform that provides information to address market volatility. Features can resemble a 401(k)-type platform with Internet access, multiple fund options from multiple fund families, and online enrollment. If the employer has both a nonqualified and qualified plan with the same provider, access to plan information is now likely available on a single website or participant statement. This allows participants to view their overall retirement savings to see if they are on track.
2. NQDC is executive compensation.
Most plan participants aren’t deferring more than $1 million per year. Most are not super-wealthy professional athletes or even CEOs. For the past several years, the Principal Financial Group has worked with the Boston Research Group to study NQDC plan sponsors and participants. Survey results for 2011 showed participants with a median annual contribution of $20,000 in their plans and a median plan balance of $115,000. This is hardly a reflection of the Wall Street excesses conjured up by executive compensation.
We often think of the definition of highly compensated employees as those exceeding the 414(q) limit of $115,000 for 2012. At a recent meeting in New Jersey, I was reminded of regional differences. While $115,000 is a good income in many parts of the country, in urban areas of the Northeast, that may be considered far from wealthy. Most nonqualified plan participants have successful careers and have worked hard over many years to achieve a level of success. The data suggest most participants are key employees using these plans, in addition to their qualified plans, to build a meaningful retirement benefit.
Employers without a plan
Advisors have a number of opportunities to identify problems and bring solutions to employers when it comes to key employees. For instance, many employers are striving to achieve retirement readiness for these employees as a way to measure success in their retirement benefit strategies.
Often, traditional sources, such as Social Security and qualified retirement plans, fall short of retirement readiness for highly compensated employees (HCEs). NQDC plans can help address this shortfall. When advising a plan sponsor, discuss strategies that include adequate retirement accumulation for key employees as well as all other employees. Start with an analysis of some or all of the HCEs and determine their retirement readiness given the current benefits. You’ll discover, many times, these results are shockingly inadequate. Often, simply adding a current NQDC plan is enough to close this gap.
Another way to approach this with employers is to address how HCEs are limited in their ability to maximize their 401(k) contributions. An advisor can solve this issue for the employer by supplementing the 401(k) with a nonqualified plan. NQDC plans are often used to make the HCEs whole by allowing them to contribute the difference of what they are allowed to contribute to the 401(k) and the 401(g)(1) limit of $17,000.
But don’t stop there. Advisors should recommend employers allow HCEs to contribute higher salary and bonus deferrals into the nonqualified plan. With a new NQDC plan as part of the benefits available to the HCE, their retirement planning opportunity becomes “What would you like to do?” instead of “This is all you are allowed to do.”
Employers with existing plans
Sales opportunities in the NQDC market also exist for employers who have an existing NQDC plan. Concerns over existing employee benefits are top of mind for a variety of reasons. The Department of Labor’s audit of employer-sponsored benefit plans includes deferred compensation plans. And the impact of Reg. 408(b)(2) — which mandates certain fee disclosures for qualified retirement plans — may cause plan sponsors to ask similar questions of their nonqualified plans.
Being proactive in helping plan sponsors conduct a self-audit of their NQDC plans may deepen your value while raising additional opportunities. Here are some things to evaluate:
• Ensure plan documents are not only Section 409A compliant but also continue to meet the business objectives of the employer.
• Identify whether the current plan contains the features seen in newer NQDC plan designs — such as in-service distributions, multiple distribution elections for the same distribution event, and differentiation between participants who leave for another competitor versus those who retire after long service.
• Evaluate the plan’s administrative services. Is it being managed in-house? If so, what are the pros and cons? If the administrative services are outsourced, are there any pain points?
• How broad are the investment offerings available to participants, and how have they been performing?
• What is the financing strategy? Taxable or tax efficient? If it is corporate-owned life insurance, is there enough or too much? What are the costs of the contracts.
A dynamic environment
The marketplace for nonqualified deferred compensation is dynamic. Conditions are changing for advisors, plan sponsors and plan participants. I would contend these changes are creating greater opportunities for advisors. The prospect of tax rate changes for HCEs will likely increase the attraction of tax-deferred savings within these plans. Growing numbers of key employees within the baby boomer generation are getting older and growing concerned about building meaningful retirement assets. Plan sponsors are concerned about providing benefits to address this issue while, at the same time, improving the retention of these key employees.
NQDC plans are increasingly becoming a mainstream part of retirement strategies for many employers — large and small, for-profit and nonprofit. The advisor who understands these opportunities and gets involved in helping clients understand the flexibility and benefits of nonqualified plans can see a significant impact to his or her practice.
Blaine Laverick, CEBS, CRPS, CLU, ChFC, CMS, AIF, is vice president of executive benefit services with the Principal Financial Group. He holds a B.S. in business administration from the University of North Carolina and is a qualifying member of the MDRT. He has twice been recognized as a national top producer with the Principal Life Insurance Company.