Finding methods for well-compensated executives to optimize their tax-deferred saving power is high on the priority list of many boards of directors.
Because limitations placed on qualified benefit plans mean proportionally less savings for a companys most highly paid executives, especially regarding 401(k) plans, employers are increasingly looking to non-qualified deferred compensation plans to close the gap, according to Aon Consulting.
Nearly 85% percent of the Fortune 1000 companies have implemented some type of NQDC plan for their executives, Aon says.
The maximum dollar amount that can be deferred annually in a 401(k) plan is $10,500–an amount that will rise to $15,000 if legislation awaiting President Bush is approved. NQDC plans are a way to get past that 401(k) maximum contribution limit. Participation is limited to a select group of highly paid executives; NQDC plans give those executives all the benefits of 401(k) plans without limits on contributions, says Aon.
Non-qualified plans are not meant to be just another pension plan, says Steve Parrish, second vice president, individual markets, Principal Financial Group, Des Moines, Iowa.
“If the company says, Im going to put $10,000 away for you, but you dont have a right to it right now, thats deferred compensation,” says Parrish. “But the government is saying, you cant make this promise, fund it, and then turn around and give the executive access to an actual account; that would be the equivalent of current compensation. But if the company chooses to informally set aside money as a means to fund their promise to the executive, the government says thats not our business.”
Either the executive or the employer decides where the contributions will hypothetically be invested. The contributions are referred to as “hypothetical” only because they are not formally being invested; they are actual investments.
With a NQDC plan, executives decide each year whether to defer a portion of their salary on a pre-tax basis. The pre-tax deferrals, and matching contributions made by the company, are credited with investment earnings on a pre-tax basis, Aon says.
Executives can choose one of three ways to receive payouts: a lump sum at age 65; 20 yearly payments beginning at age 62; or four annual payments beginning six years from the start date (to fund a college education), Aon says.
The fly in the ointment is that plan participants are unsecured creditors of the employer; there is no guarantee that the employer will be able or even want to make the benefit payments as promised. A secure interest can result in the loss of tax deferrals. To counteract these impediments, the “rabbi” trust was developed.
A rabbi trust is irrevocable, meaning the rights to make any changes to it are permanently surrendered by the grantor. The rabbi trust was established to ensure the payment of promised benefits; the benefits are secured for all eventualities–even when there is a change in ownership or control of the employer–except employer bankruptcy, says Clark/Bardes Consulting-Compensation Resource Group, Los Angeles.
“Theres a real desire on the part of these executives to have these plans secured, so companies are taking steps to finance, not fund, these benefits,” says Cameron Sutton, executive vice president with the executive benefits division of Aon Consulting, Southfield, Mich. “Were seeing a real trend toward financing these, and the rabbi trust is by far the most often used.”
A rabbi trust is beneficial to the executive in a psychological sense as well; it provides assurance that the funds set aside will be available to fulfill the employers obligation, says Aon.
Other trends in executive benefits, according to Sutton, include executive life insurance and disability plans. “There will be a lot more executive life and long-term care benefits, simply because there are a lot of baby boomers out there.”
Mutual fund option programs, particularly in not-for-profit organizations, are also fairly new opportunities for executives, says Pat Kopacz, principal and senior consultant with the Executive Benefits National Resource Group of William M. Mercer Inc., New York. “These programs are offered in lieu of or in addition to voluntary deferral plans; however, since the IRS has not issued any guidance, many organizations are taking a wait-and-see approach.”
Reproduced from National Underwriter Life & Health/Financial Services Edition, June 11, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.