A Powerful Weapon In War For Talent
One of the most important challenges any firm will face is winning the war for talent. Attracting, rewarding and retaining the best and brightest employees–especially senior executives who lead the company toward strategic and financial goals–is critical to ongoing success.
This is certainly true for high-profile Fortune 1000 corporations. But many people forget that its just as important for middle-market and smaller-sized firms.
Both large and small employers use a variety of tactics in the war for talent, including one that has gained tremendous popularity over the past decade–non-qualified deferred compensation plans. This product also offers a tremendous opportunity to financial professionals who understand these plans and how to sell them to middle- and small-market companies.
At many larger companies, the non-qualified deferred compensation plan complements other benefit programs such as a 401(k) plan, a defined benefit program, and stock option plans designed to attract and retain top talent. On the other hand, the nonqualified plan may be the only retirement benefit a small company offers its key executives, or it may be offered alongside a 401(k) plan.
In either case, it is just as effective in recruiting and holding on to key executives, because it is a benefit with high-perceived value. It can also be the single most important retirement-planning tool a small company can offer key employees.
Today, most Americans can no longer assume a financially sound retirement. For example, the savings rate in this country has dropped dramatically over the past decade. Americans saved 9% of their disposable income in 1985. That number was only 2% in 2001. Add to this the very uncertain future of Social Security. In 1990, there were 3.4 workers for every retiree. By the year 2040, there will be just two workers for every retiree. In 15 years, Social Security outflows will exceed contributions, placing a cornerstone of many workers retirement plans in jeopardy.
Even for those diligent about saving for retirement, the limits and restrictions currently in place for qualified plans like 401(k)s raise serious roadblocks to financing a secure retirement. This is especially true for highly compensated employees.
Executives in large and small companies alike are actually at a disadvantage with respect to qualified plans and Social Security. A standard 401(k) plan and Social Security may replace only 20%-25% of an executives earnings, while the same two sources may replace up to 70%-75% of a rank-and-file employees income.
For example, a worker earning $60,000 can contribute up to 20% of his or her income–or $12,000–to a 401(k) plan in 2003. But look at a more highly compensated married couple: The wife earns $150,000 and the husband earns $120,000. While the worker earning $60,000 a year can defer up to 20% of his earnings, the married couple is limited to just 8% and 10% of their earnings, respectively. All things being equal, the higher-compensated employee will end up with a dramatically lower percentage of income replacement at retirement.
A non-qualified plan can be the answer. Unlike qualified plans, the non-qualified deferred compensation plan enables executives voluntarily to defer a greater portion of their compensation until retirement, often up to 100% of salary, bonuses and other compensation–such as restricted stock. And in a professionally implemented plan, employees are not taxed on their deferrals until retirement or at death. But the funds may still earn returns. The result can be a larger retirement benefit than possible with qualified plans.
In addition, executives may be allowed to take whats called “in service” distributions from their non-qualified deferred compensation accounts while they remain active employees. Unlike early 401(k) withdrawals, “in service” distributions are not subject to a 10% tax penalty.
A non-qualified deferred compensation plan also offers the employer more control and flexibility. The plan is not subject to the same minimum coverage and nondiscrimination requirements as qualified plans. So, the employer can choose who will be covered, what benefits will be provided and under what terms. The employer is free to create different non-qualified plans for different individuals. A non-qualified plan is also less expensive to set up because there are no significant filing or reporting requirements.
An employer can elect to fund a non-qualified deferred plan with the executives salary and/or bonuses, with employer contributions, or both. However, the employer loses the ability to deduct as paid compensation any money that is deferred. And this deferred money becomes an additional liability on the balance sheet.
Corporate-owned life insurance (COLI) is a popular solution. COLI is often used as the informal funding instrument to hedge the balance sheet on the liability incurred by deferral plans. Furthermore, the cash value the COLI potentially builds can be available at retirement to supplement other income or, if the insured executive dies before retirement, his or her beneficiary would receive all or a portion of the insurance policys death benefit.
Because of the multitude of complex regulations that pertain to non-qualified deferred compensation plans and because they involve such long-term relationships, plan support and administration is a complicated but very important factor from both the employers and the employees perspectives. This is especially true for middle-market and smaller companies that lack the expertise and resources to do it themselves. There are several options from which to choose.
Employee benefit providers that sell non-qualified deferred compensation plans but dont have the capability to provide full administration and support, might partner with a large, national executive compensation firm. This is a wise choice for large plans, as measured by the number of participants and the amount of the deferrals. Internet-based design and administration platforms are available, either through a life insurance company or as stand-alone products.
Finally, a number of life insurers administer their own non-qualified deferred compensation plans as part of their product package. In all cases, it is important to understand the clients needs and the administrators capabilities so the best match is made.
Ideal firms to access this market are those that already deal with the middle and small corporate markets. This includes 401(k) firms, employee benefit firms, accounting firms and legal firms. The best candidates for a non-qualified deferred compensation plan will be C corporations with sound cash flows and succession plans either in place or in process. In this case, the target of the sale would be the owner of the business in addition to key executives who may be struggling with the reverse discrimination limits.
The recent economic downturn has caused many employers to postpone adopting non-qualified plans for their executives. But as business conditions continue to get stronger and the pressure on employers to attract and retain top executives grows, the demand for this product is likely to explode, especially in the small and middle markets.
is national multi-life sales manager, ING LifeDesign Team, San Francisco, Calif. He can be reached at [email protected].
Reproduced from National Underwriter Edition, June 23, 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.