Find Opportunity In Making Sure Your Clients Have Enough To Retire
When clients look at their 401(k) and other retirement accounts today, they wonder what happened to the 10% return that was projected in the 1990s. For many, 10% was viewed as a “conservative” growth rate when accounts were growing over 20% year after year.
Reality struck in 2001 and for many it has been a downhill ride. Today, more clients are asking the question, “Will I have enough money to retire?”
That question creates a great opportunity for you to work with individual clients and businesses concerned with helping employees meet their retirement objectives. Now is the time to step back and help clients answer these questions:
1.How much do I need in retirement?
2.How much do I have earmarked for retirement today?
3.If there is a gap, how am I going to fill it?
The retirement gap isnt unique; it is a concern for both low- and high-income earners. Depending on the situation, there are a variety of ways to help the client meet his or her objectives. A key consideration is whether employer contributions or plan sponsorship is an option. When company involvement is not available, vehicles available include:
- Roth IRAs;
- Mutual funds;
- Annuities; and,
- Cash value life insurance
In situations where employer sponsorship and/or contributions are available, the first step is looking at the qualified plan. If qualified plan contributions havent been maximized, increasing contributions should be considered. For many mid- to high-income employees, the qualified plan and Social Security wont be near enough to secure a comfortable retirement. In these situations, nonqualified benefits can be used to fill the void.
Executive bonus. A nonqualified executive bonus plan is a versatile plan design. Depending on employer objectives, the employer can choose to allow all employees to participate or only offer participation to a select group of key employees. The employer will pay out a bonus to the employee, who will be taxed on it. Many employers will offer an additional “tax bonus” to cover this expense. Some employers will choose to offset all tax costs to the employees, but others may only cover a portion of the tax.
Since this plan is so flexible, the employer may select the investment vehicle to be used or allow the employee to choose one. Depending on the situation, mutual funds, annuities and variable life insurance are typically considered.
A variation of the executive bonus plan that can be very attractive to both employers and employees is one that allows an employee to set aside a portion of after-tax income. For example, the employee makes a contribution into an investment he or she owns. The employer then covers all or a portion of the tax on this contribution amount through a bonus to the employee. The employer bonus replicates a pretax arrangement from the employees perspective.
Accumulated values can be used to supplement the employees retirement income. To follow a 401(k) format and provide an incentive, the employer can also match the deferral through an additional tax-deductible match.
Defined Contribution Deferred Compensation Plan. Another popular nonqualified plan design is the defined contribution deferred compensation plan. This employer-sponsored plan allows select key management or highly compensated employees (HCEs), who are limited in their ability to defer dollars to the companys qualified plan, an option of deferring additional income to a nonqualified plan on a pretax basis. The plan can also allow the employer to make discretionary matching and/or profit-sharing contributions to select employees accounts.
Many plans today look and feel very similar to a 401(k) plan because the executive can self-direct his contributions among multiple hypothetical investment options. The employees hypothetical account grows or decreases in value based on the performance of the accounts.
With this plan, participation must be limited to a select group of management or HCEs. This requirement–known as the “top hat” requirement–is necessary to minimize ERISA requirements. To qualify, the plan must also be unfunded, which means benefits are paid solely from the general assets of the employer. Confidence that the employer will be able to meet the obligation is a key factor for the employee. If these requirements are met, the employer only needs to file a letter briefly describing the plan with the Department of Labor within 120 days when the plan is adopted to meet ERISA reporting and disclosure requirements.
In contrast to bonus arrangements, the defined contribution deferred compensation plan provides current tax advantages to the employee. The employee can defer salary on a pretax basis. Therefore, no “tax bonus” is needed from the employer. For the employer, however, this means the tax deduction is delayed. The business will get its tax deduction when the benefit is paid out.
Defined Benefit Deferred Compensation. A defined benefit deferred compensation plan is a fringe benefit provided by an employer for one or more key employees. The employer selects the employees who receive the benefits in addition to their current earnings and other fringe benefits. Additional benefits typically are not in lieu of a raise, bonus or commissions, and the employee is not reducing his or her current compensation. The same top-hat requirements apply to this form of nonqualified deferred compensation plan.
This plan generally provides for a retirement benefit of a certain amount per year for a certain number of years (or for life) based on salary projections. This plan design was the plan of choice in the 1980s, lost favor in the 1990s, but is making a comeback because it offers a fixed benefit. With todays volatile market, a fixed benefit is a real plus to employees focused on meeting their retirement objectives.
In both defined contribution and defined benefit nonqualified deferred compensation plans, the employer makes a contractual promise to pay benefits. Any assets the employer has purchased to informally finance the benefits remain employer assets and are subject to the employers creditors. The employee is in the position of a general creditor of the employer. There are a variety of techniques to minimize the risk, but to avoid taxation prior to receipt of the benefit, the employee must remain a general creditor of the employer.
The retirement gap is a real problem for many of your clients. You can play a key role in helping them identify and fill their retirement gap.
, JD, CLU, is director of advanced markets, Principal Life Insurance Company, Des Moines, Iowa. He may be reached via e-mail at email@example.com.
Reproduced from National Underwriter Edition, May 19, 2003. Copyright 2003 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.