Opportunities Abound In Non-Qualified Deferred Comp

By Daniel J. Munroe

In his best selling book, “Who Moved My Cheese,” Dr. Spencer Johnson wrote a metaphorical story about a group of mice and “little people” living in a maze. The characters were constantly searching for cheese, which represented happiness and success. When the cheese began to run out in a section of the maze where the characters all lived, the mice did not fight change. Rather, they went on to explore other parts of the maze in search of the cherished cheese.

The “little people,” frozen in fear, watched the cheese supply dwindle. Instead of recognizing change they resisted, became angry and refused to leave the portion of the maze, which once flourished with cheese.

This story reminds me of many of us in the life insurance industry who, in spite of external factors right before our eyes, remain frozen in the same mindset. Specifically, while estate planning remains important, simply basing ones entire business plan on selling life insurance to pay for estate taxes is akin to the little people waiting for more cheese to magically appear.

Certainly, estate planning remains an important piece of your business, but it should not be the only piece.

Why is the market hot? A recent study on the new “retirees” by noted gerontologist, Dr. Kenneth Dychtwald, revealed some interesting results. Notably, the study found that baby boomers, by and large, were savvy consumers who demanded options, flexibility and control. In addition, Dychtwald provided that between 2000 and 2020, the number of Americans aged 55 to 64 would increase by 73%, and the number of Americans aged 60 to 70 would increase by 54%.

Need there be any more evidence that demonstrates that demographically this is a prime market?

As a society, we are living longer than any previous generation. It follows then, that more money will be required to support our lifestyles in retirement. Indeed, if you have not discussed retirement savings plans with your baby boomer clients who own small businesses, you are missing an opportunity to solve what may be their most pressing financial problem.

The non-qualified deferred compensation market offers the producer an opportunity to distinguish himself from the pack by offering a strategy that provides employers and high-income employees with a wide variety of tax and financial planning opportunities. The small business market for non-qualified deferred plans is significant.

Generally, producers should prospect for businesses with 10 or fewer employees that have an existing qualified plan in place. These businesses should also have owners who desire benefits in excess of the established plan limits to themselves and select key executives.

What is non-qualified deferred compensation? A non-qualified deferred compensation plan is typically a written agreement between an employer and employee to defer certain compensation to be received by the employee. The highly flexible technique provides meaningful benefits to select employees and allows the employer control in plan design to, among other things, determine benefit levels and which employees are covered.

The plan is “non-qualified” because it intentionally fails to qualify for an income tax deduction when the employer enters into the agreement. The plans are also “informally funded.” This means that the employer makes an unsecured promise to pay additional income to the employee at a future date.

Employers frequently use life insurance to provide a future source of funds in a non-qualified deferred compensation plan. The technique is fairly simple. When the plan is being put in place, the employer purchases a permanent life insurance policy on the employee. The policy provides part or all of the employers funds to pay the deferred compensation to the employee, as well as tax deferral on policy earnings.

It is also significant to note that unless life insurance is used to fuel the plan, investment gains on funds set aside will be taxable to the company. The cash value inside a life insurance policy, however, grows on a tax deferred basis (subject to possible corporate alternative minimum taxes).

Despite the dramatic ongoing changes with split dollar, an “endorsement” arrangement should typically be used with a non-qualified deferred compensation plan. Since the employer is already informally funding the plan with cash value life insurance, it may as well use an endorsement plan to provide the executives beneficiary with an income tax-free pre-retirement death benefit.

Finally, it is particularly important that the insurance carrier with whom you choose to work offer products with features designed for this market. In particular, a company implementing a non-qualified deferred compensation arrangement will prefer insurance contracts with high surrender cash values in the early years. In addition, make sure the carrier provides a turnkey marketing kit, offers specimen documents, preferred third-party administration, customized illustration capacity and advanced sales support to assist you in your efforts.

As in any complicated planning technique, the producer should take the time to immerse him or herself with in-depth information and analysis of the concept. The benefit will be well worth the cost.

As the baby boomers begin to hit the golden years, and as employers will be looking for ways in which to attract, retain and reward the dwindling supply of workers, they will be looking to you for solutions. Spending time learning the non-qualified deferred compensation market will not only allow you to provide a valuable service to a lucrative market, but you might also find some great new cheese.

Daniel J. Munroe, JD, CLU, is director of advanced marketing for MONY Partners, Hartford, Conn. He can be reached at dmunroe@mony.com.


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.